2013-07970

Federal Register, Volume 78 Issue 70 (Thursday, April 11, 2013)[Federal Register Volume 78, Number 70 (Thursday, April 11, 2013)]

[Rules and Regulations]

[Pages 21749-21785]

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

[FR Doc No: 2013-07970]

[[Page 21749]]

Vol. 78

Thursday,

No. 70

April 11, 2013

Part III

Commodity Futures Trading Commission

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17 CFR Part 50

Clearing Exemption for Swaps Between Certain Affiliated Entities; Final

Rule

Federal Register / Vol. 78 , No. 70 / Thursday, April 11, 2013 /

Rules and Regulations

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 50

RIN 3038-AD47

Clearing Exemption for Swaps Between Certain Affiliated Entities

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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

is adopting regulations to exempt swaps between certain affiliated

entities within a corporate group from the clearing requirement under

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

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

Act). The regulations include specific conditions, as well as reporting

requirements, that affiliated entities must satisfy in order to elect

the inter-affiliate exemption from required clearing.

DATES: This final rule is effective June 10, 2013.

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

202-418-5684, [email protected]; Nadia Zakir, Associate Director,

202-418-5720, [email protected]; Eric Lashner, Special Counsel, 202-418-

5393, [email protected]; Meghan Tente, Law Clerk, 202-418-5785,

[email protected]; Division of Clearing and Risk, Erik Remmler, Associate

Director, 202-418-7630, [email protected]; Camden Nunery, Economist,

202-418-5723, [email protected], Office of the Chief Economist,

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 Notice of Proposed Rulemaking

A. Overview of Comments Received

B. Section 4(c) Authority

C. Definition of Affiliate Status

D. Inter-Affiliate Swap Documentation

E. Centralized Risk Management Program

F. Variation Margin

G. Treatment of Outward-Facing Swaps and Relief

H. Reporting Requirements and Annual Election

I. Implementation

III. Cost-Benefit Considerations

A. Statutory and Regulatory Background

B. Costs and Benefits of Exemption for Eligible Affiliate

Counterparties

C. Costs and Benefits of Exemption's Conditions

D. Costs and Benefits to Market Participants and the Public

E. Costs and Benefits Compared to Alternatives

F. Consideration of CEA Section 15(a) Factors

IV. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

I. Background

On August 21, 2012, the Commission published a notice of proposed

rulemaking proposing to exempt swaps between certain affiliated

entities from the clearing requirement under section 2(h)(1)(A) of the

CEA (NPRM).\1\ As proposed, Sec. 39.6(g) provides that counterparties

to a swap may elect an inter-affiliate exemption from the clearing

requirement if: (1) The financial statements of both counterparties are

reported on a consolidated basis, and either one counterparty directly

or indirectly holds a majority ownership interest in the other, or a

third party directly or indirectly holds a majority ownership interest

in both counterparties; (2) both counterparties comply with the

conditions set forth in the proposed rule; and (3) one of the

counterparties provides certain information on behalf of both

affiliated counterparties to either a registered swap data repository

(SDR) or the Commission if a registered SDR does not accept the

information. The Commission is hereby adopting proposed Sec. 39.6(g),

finalized as Sec. 50.52,\2\ subject to the changes discussed below.

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\1\ Clearing Exemption for Swaps Between Certain Affiliated

Entities, 77 FR 50425 (Aug. 21, 2012).

\2\ For ease of reference, the Commission is re-codifying

proposed Sec. 39.6(g) as Sec. 50.52 so that market participants

are able to locate all rules related to the clearing requirement in

one part of the Code of Federal Regulations.

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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.\3\ Section 2(h)(2)

of the CEA charges the Commission with the responsibility for

determining whether a swap is required to be cleared, through one of

two means: (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.'' On November 29, 2012, the Commission adopted its first

clearing requirement determination, requiring that swaps meeting the

specifications outlined in four classes of interest rate swaps and two

classes of credit default swaps (CDS) are required to be cleared.\4\

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\3\ 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.

\4\ Clearing Requirement Determination Under Section 2(h) of the

CEA, 77 FR 74284 (Dec. 13, 2012) (hereinafter ``Clearing Requirement

Determination'').

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The Clearing Requirement Determination adopting release provided a

specific compliance schedule for market participants to bring their

swaps into compliance with the clearing requirement.\5\ Swap dealers

(SDs), major swap participants (MSPs), and private funds active in the

swaps market were required to comply beginning on March 11, 2013, for

swaps they enter into on or after that date.\6\ Accounts managed by

third-party investment managers, as well as ERISA pension plans, have

until September 9, 2013, to begin clearing swaps entered into on or

after that date. All other financial entities are required to clear

swaps beginning on June 10, 2013, for swaps entered into on or after

that date. With regard to the CDS indices on European corporate names,

iTraxx, the Clearing Requirement Determination provided that, if no DCO

offered iTraxx for client clearing by February 11, 2013, the Commission

would delay compliance for those swaps until 60 days after an eligible

DCO offers iTraxx indices for client clearing. On February 25, 2013,

the Commission received notice from ICE Clear Credit LLC that it had

begun offering customer clearing of the iTraxx CDS indices that are

subject to the clearing requirement under Sec. 50.4(b). In accordance

with the timeframe previously set forth by the Commission,\7\ the

following compliance

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dates shall apply to the clearing of iTraxx indices: Category 1

Entities: Friday, April 26, 2013; Category 2 Entities: Thursday, July

25, 2013; and all other entities: Wednesday, October 23, 2013.\8\

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\5\ See Clearing Requirement Determination at 74319-21.

\6\ The first compliance date for required clearing applies to

Category 1 Entities, as defined in Sec. 50.25(a). SDs and MSPs and

private funds active in the swaps market are defined as Category 1

Entities. Security-based swap dealers and major security-based

participants also are included in the definition. However, as the

Commission has stated, if a security-based swap dealer or a major

security-based swap participant is not yet required to register with

the Securities and Exchange Commission (SEC) at such time as the

Commission issues a clearing determination, then the security-based

swap dealer or a major security-based swap participant would be

treated as a Category 2 Entity, as defined in Sec. 50.25(a). See

Swap Transaction Compliance Implementation Schedule: Clearing and

Trade Execution Requirements under Section 2(h) of the CEA, 76 FR

58186, 58190 n.38 (Sept. 20, 2011).

\7\ Clearing Requirement Determination at 74319-21.

\8\ See Press Release, CFTC's Division of Clearing and Risk

Announces Revised Compliance Schedule for Required Clearing of

iTraxx CDS Indices (Feb. 25, 2013), available at http://www.cftc.gov/PressRoom/PressReleases/pr6521-13.

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II. Comments on the Notice of Proposed Rulemaking

The Commission received 13 comments during the 30-day public

comment period following publication of the NPRM on August 21, 2012,

and one additional comment after the comment period ended. The

Commission considered each of these comments in formulating the final

regulation, Sec. 39.6(g) (finalized as Sec. 50.52).

During the process of proposing and finalizing this rule, the

Chairman and Commissioners, as well as Commission staff, participated

in informational meetings with market participants, trade associations,

public interest groups, and other interested parties. In addition, the

Commission has consulted with other U.S. financial regulators

including: (i) The SEC; (ii) the Board of Governors of the Federal

Reserve System; (iii) the Office of the Comptroller of the Currency;

and (iv) the Federal Deposit Insurance Corporation (FDIC). Staff from

each of these agencies has had the opportunity to provide oral and/or

written comments to this adopting release, and the final regulations

incorporate elements of the comments provided.

The Commission is mindful of the benefits of harmonizing its

regulatory framework with that of its counterparts in foreign

countries. The Commission has therefore monitored global advisory,

legislative, and regulatory proposals, and has consulted with foreign

authorities in developing the final regulations.

A. Overview of Comments Received

Of the 14 comment letters received by the Commission in response to

its NPRM, ten commenters expressed general support for the concept of

an inter-affiliate exemption from the clearing requirement.\9\ These

commenters offered comments addressing the proposed rule generally and

comments addressing specific provisions of the proposed rule. Comments

addressing specific provisions of the proposed rule are discussed in

detail below.

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\9\ Cravath, Swaine & Moore LLP (Cravath), the Coalition for

Derivatives End-Users (CDEU), the Financial Services Roundtable

(FSR), Chris Barnard, the Commercial Energy Working Group (The

Working Group), the Edison Electric Institute (EEI), The Prudential

Insurance Company of America (Prudential), Metropolitan Life

Insurance Company (MetLife), the International Swaps and Derivatives

Association and Securities Industry and Financial Markets

Association, (together, ISDA & SIFMA), and DLA Piper.

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A number of commenters requested a broader exemption with few or no

conditions. Cravath and DLA Piper requested that the Commission exempt

swaps between affiliates from all clearing, margining, and reporting

obligations. The Working Group, Cravath, CDEU, ISDA & SIFMA, DLA Piper,

and EEI \10\ recommended that the Commission eliminate, simplify or

minimize the conditions imposed, or unconditionally exempt inter-

affiliate swaps from clearing. These commenters stated that inter-

affiliate swaps pose little or no risk to the U.S. financial system and

do not increase the interconnectedness between major financial

institutions, particularly if affiliates' financial statements are

consolidated for accounting purposes. The Working Group commented that

entities use inter-affiliate trades not only to net risk related to

market-facing swaps, but also to transfer physical commodity or futures

exposure between affiliates for compliance with international tax law,

customs, or accounting laws. Similarly, MetLife and Prudential

supported the proposed exemption and noted that transactions between

affiliates do not present the same risks as market-facing swaps.

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\10\ EEI commented that ``corporate families typically face

bankruptcy together'' and that it is ``unusual for only one member

of a corporate group to go bankrupt.'' EEI also noted that a

bankruptcy could cause increased risk to clearinghouses that would

face multiple entities going into default at the same time if all

affiliates of one corporate group were required to clear their

inter-affiliate swaps.

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ISDA & SIFMA commented that inter-affiliate swaps provide important

benefits to corporate groups by enabling centralized management of

market, liquidity, capital, and other risks, and allowing affiliated

groups to realize associated hedging efficiencies and netting benefits.

Imposing mandatory clearing on inter-affiliate swaps, according to ISDA

& SIFMA, could compromise the ability of affiliated groups to realize

these benefits.\11\ ISDA & SIFMA also commented that third parties face

no increased risk from inter-affiliate swaps. In their view, the credit

risks faced by a third party entering into an uncleared swap with a

group member are a function of the group member's entire portfolio of

assets and liabilities and other credit factors.

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\11\ ISDA & SIFMA commented that inter-affiliate swaps do not

introduce risk into a corporate group, stating, ``[b]ecause capital,

liquidity and risk allocation decisions, as well as the exercise of

default remedies between group members are under unified management,

group entities do not face default risk of other group entities, so

long as the group as a whole is solvent.''

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Along the same lines, CDEU commented that non-financial entities

typically enter into external swaps with swap dealers and other large

banks that typically evaluate the risks of entering into swaps based on

the overall creditworthiness of their counterparties. These financial

entity counterparties, according to CDEU, have the opportunity to

review financial statements, the creditworthiness of any guarantor, and

a number of other credit-related items. After the credit review,

according to CDEU, the counterparties may request credit risk mitigants

such as corporate parent guarantees, collateral, and credit-based legal

terms.

On the other hand, Americans for Financial Reform (AFR) commented

that a wide-ranging exemption for inter-affiliate swaps could create

systemic risk and threaten the U.S. financial system. AFR cited a

number of reasons for its concern such as: the risk transfer between

separate corporate entities; the possibility for financial contagion to

be transferred from one part of a large financial institution to

different groups within the institution; restrictions on access to

affiliate assets across national boundaries; and reduction in volumes

at DCOs that could hurt liquidity and risk management. AFR further

noted that because the end-user exception is available for non-

financial and small financial entities in connection with swaps that

hedge or mitigate systemic risk, the inter-affiliate exemption is

primarily available for large financial institutions and speculative

trades by large commercial institutions with many affiliates.

Better Markets Inc. (Better Markets) also expressed concern that an

inter-affiliate exemption could be contrary to Congressional intent, as

expressed in the Dodd-Frank Act, if it is not a very narrow and

strictly implemented exemption.

Two individual persons commented against the proposed exemption.

Steve Wentz requested that the Commission not issue any exemptions

because the exemptions ``would just open the door to divert trades

through that open door to avoid protective oversight.'' Aaron D. Small

commented that the ``unregulated derivatives market has been a disaster

for the U.S. and world economy and must be reined in.''

Having considered these comments, and the specific comments

discussed below, the Commission is adopting the

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proposed inter-affiliate exemption rule, subject to several important

modifications. The Commission recognizes the need for an exemption from

clearing for inter-affiliate swaps, but believes it is important to

establish certain conditions for entities electing the exemption. In

reaching this conclusion, the Commission considered the benefits of

clearing as recognized by the fact that Congress included a clearing

requirement in the Dodd-Frank Act, against the benefit to market

participants of being able to continue entering into inter-affiliate

swaps on an uncleared basis. The Commission believes it has reached an

appropriate balance by allowing an exemption from required clearing for

certain inter-affiliate swaps while imposing necessary conditions on

that exemption in order to ensure that all inter-affiliate swaps

exempted from required clearing meet certain risk-mitigating

conditions.

1. Benefits of Clearing and Its Role in the Dodd-Frank Act

As the Commission has previously stated,\12\ in the fall of 2008, a

series of large financial institution failures triggered a financial

and economic crisis that led to unprecedented governmental intervention

to ensure the stability of the U.S. financial system. The financial

crisis made clear that an uncleared, over-the-counter (OTC) derivatives

market can pose significant risks to the U.S. financial system.\13\

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\12\ See Clearing Requirement Determination at 74284-86; Cross-

Border Application of Certain Swaps Provisions of the Commodity

Exchange Act, 77 FR 41214, 41215-17 (July 12, 2012) (hereinafter

``Proposed Cross-Border Interpretive Guidance'').

\13\ See Financial Crisis Inquiry Commission, ``The Financial

Crisis Inquiry Report: Final Report of the National Commission on

the Causes of the Financial and Economic Crisis in the United

States,'' Jan. 2011, at 386, available at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf (``The scale and nature of the [OTC]

derivatives market created significant systemic risk throughout the

financial system and helped fuel the panic in the fall of 2008:

millions of contracts in this opaque and deregulated market created

interconnections among a vast Web of financial institutions through

counterparty credit risk, thus exposing the system to a contagion of

spreading losses and defaults.'').

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One of the most significant examples of this risk was the

accumulation of uncleared CDS entered into by an affiliate in the AIG

corporate group providing default protection on more than $440 billion

in bonds, leaving it with obligations that the AIG corporate family

could not cover as a result of changed market conditions.\14\ As a

result of the CDS exposure of this one affiliate, the U.S. Federal

government bailed out the AIG corporate group with over $180 billion of

taxpayer money in order to prevent AIG's failure and a possible

contagion event in the broader economy.\15\ While the downfall of AIG

was not caused by inter-affiliate swaps, the events surrounding AIG

during the 2008 crisis demonstrate how the risks of uncleared swaps at

one affiliate can have significant ramifications for the entire

affiliated business group.

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\14\ Adam Davidson, ``How AIG fell apart,'' Reuters, Sept. 18,

2008, available at http://www.reuters.com/article/2008/09/18/us-how-aig-fell-apart-idUSMAR85972720080918.

\15\ Hugh Son, ``AIG's Trustees Shun `Shadow Board,' Seek

Directors,'' Bloomberg, May 13, 2009, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aaog3i4yUopo&refer=us.

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Recognizing the peril that the U.S. financial system faced during

the financial crisis, Congress and the President came together to pass

the Dodd-Frank Act in 2010. Title VII of the Dodd-Frank Act establishes

a comprehensive new regulatory framework for swaps, and the requirement

that certain swaps be cleared by DCOs is one of the cornerstones of

that reform. The CEA, as amended by Title VII, now requires a swap to

be cleared through a DCO if the Commission has determined that the

swap, or group, category, type, or class of swaps, is required to be

cleared, unless an exception to the clearing requirement applies. As

noted above, the only exception to the clearing requirement provided by

Congress was the end-user exception in section 2(h)(7) of the CEA.\16\

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\16\ Congress did not provide for an exception or exemption for

inter-affiliate swaps in the Dodd-Frank Act. However, commenters

have pointed to legislative history and statements made by members

of Congress supporting such an exemption at the time the Dodd-Frank

Act was enacted.

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The benefits of clearing derivatives have been recognized

internationally, as well. In September 2009, leaders of the Group of 20

(G-20)--whose membership includes the United States, the European

Union, and 18 other countries--agreed that: (1) OTC derivatives

contracts should be reported to trade repositories; (2) all

standardized OTC derivatives contracts should be cleared through

central counterparties by the end of 2012; and (3) non-centrally

cleared contracts should be subject to higher capital requirements.

The Commission believes that required clearing through a DCO is the

best means of mitigating counterparty credit risk and providing an

organized mechanism for collateralizing the risk exposures posed by

swaps. By clearing a swap, each counterparty no longer needs to rely on

the individual creditworthiness of the other counterparty for payment.

Both original counterparties now look to the DCO that has cleared their

swap to ensure that the payment obligations associated with the swap

are fulfilled. The DCO manages the risk of failure of a counterparty

through appropriate margining, a mutualized approach to default

management among clearinghouse members, and other risk management

mechanisms that have been developed over the more than 100 years that

modern clearinghouses have been in operation. Clearing can avert the

development of systemic risk by reducing the potential knock-on, or

domino, effect resulting from counterparties with large outstanding

exposures defaulting on their swap obligations and causing their

counterparties--counterparties that would otherwise be financially

sound if they had been paid--to default. Failure of those

counterparties could lead to the failure of yet other counterparties,

cascading through the economy and potentially causing systemic harm to

the U.S. financial system. Required clearing reduces this risk by

ensuring that uncollateralized risk does not accumulate in the

financial system.

2. Risks and Benefits Posed by Inter-affiliate Swaps

The Commission is not persuaded by comments suggesting that inter-

affiliate swaps pose no risk to the financial system or that clearing

would not mitigate those risks. Entities that are affiliated with each

other are separate legal entities notwithstanding their affiliation. As

separate legal entities, affiliates generally are not legally

responsible for each other's contractual obligations. This legal

reality becomes readily apparent when one or more affiliates become

insolvent.\17\ Affiliates, as separate legal entities, are managed in

bankruptcy as separate estates and the trustee for each debtor estate

has a duty to the creditors of the affiliate, not the corporate family,

the parent of the affiliates, or the corporate family's creditors.\18\

This potential for separate

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treatment in bankruptcy, calls into question commenters' claims that

third parties can rely on the creditworthiness of the entire corporate

group when entering into swaps with affiliates.

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\17\ Note, for example, that while the Rule 1015 of the Federal

Rules of Bankruptcy Procedure (FRBP) permits a court to consolidate

bankruptcy cases between a debtor and affiliates, FRBP Rule 2009

provides that, among other things, if the court orders a joint

administration of two or more estates under FRBP Rule 1015, the

trustee shall keep separate accounts of the property and

distribution of each estate. See Federal Rules of Bankruptcy

Procedure (2011).

\18\ See In re L & S Indus., Inc., 122 B.R. 987, 993-994 (Bankr.

N.D. Ill. 1991), aff'd 133 B.R. 119, aff'd 989 F.2d 929 (7th Cir.

1993) (``A trustee in bankruptcy represents the interests of the

debtor's estate and its creditors, not interests of the debtor's

principals, other than their interests as creditors of estate.'');

In re New Concept Housing, Inc., 951 F.2d 932, 938 (8th Cir. 1991)

(quoting In re L & S Indus., Inc.). While the concept of

``substantive consolidation'' of affiliates in a business enterprise

when they all enter into bankruptcy is sometimes used by a

bankruptcy court, substantive consolidation is generally considered

an extraordinary remedy to be used in limited circumstances. See

Substantive Consolidation--A Post-Modern Trend, 14 Am. Bankr. Inst.

L. Rev. 527 (Winter 2006).

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On the other hand, inter-affiliate swaps offer certain risk-

mitigating, hedging, and netting benefits as described by several

commenters including ISDA & SIFMA, The Working Group, CDEU, and EEI.

Furthermore, because affiliates in a corporate family generally

internalize the risks of inter-affiliate transactions in the affiliated

group, as described in the NPRM, the corporate family could face

serious reputational harm if affiliates default on their swaps.

Consequently, the entities within an affiliated group are incentivized

to fulfill their inter-affiliate swap obligations to each other, to

support each other to prevent outward-facing failures, and to resolve

any disagreements about the terms of inter-affiliate swaps more quickly

and amicably. As noted by ISDA & SIFMA, when an affiliated business

group is fiscally sound, the capital, liquidity, and risk allocation

decisions and default remedies between group members may be centrally

managed thereby reducing the likelihood of group entities facing

default risk of other group entities, ``so long as the group as a whole

is solvent.''

While in many circumstances, these characteristics of inter-

affiliate swaps may mitigate the risk of an affiliate defaulting on its

obligations--particularly when the group as a whole is financially

healthy--they do not constitute legally enforceable obligations pre-

bankruptcy or in bankruptcy.\19\ Accordingly, despite the existence of

mutual support incentives, a corporate group facing insolvency risk may

ultimately make the decision to allow some affiliates to fail and

default on their swap obligations so that other affiliates can survive

without becoming insolvent.\20\ In cases where an insolvent affiliate

has multiple obligations to third parties (swap-related or otherwise),

those third parties may be subject to a pro rata distribution along

with other creditors if the trust estate of the defaulting affiliate

does not have sufficient liquid assets to cover losses on its uncleared

swaps. It is at such times of financial stress that central clearing

serves as the most effective systemic risk mitigant.

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\19\ See Bankrupt Subsidiaries: The Challenges to the Parent of

Legal Separation, 25 Emory Bankr. Dev. J. 65 (2008); Liability of a

Parent Corporation for the Obligations of an Insolvent Subsidiary

Under American Case Law and Argentine Law, 10 Am. Bankr. Inst. L.

Rev. 217 (Spring 2002).

\20\ See, e.g., the bankruptcy of Residential Capital (ResCap)

and its subsidiaries. ResCap was a mortgage subsidiary of Ally

Financial Inc. ResCap declared bankruptcy independent of Ally

Financial Inc., which is not part of the bankruptcy proceeding and

continues to operate as a legally separate, solvent entity. See In

re Residential Capital, LLC, No. 12-12020 (MG) (Bankr. S.D.N.Y.

2012), available at http://www.kccllc.net/rescap. While the

bankruptcy of ResCap was not the direct result of inter-affiliate

swaps, ResCap's bankruptcy demonstrates that an affiliate can be put

into bankruptcy without forcing the affiliated parent to declare

bankruptcy or to be legally responsible for the affiliate's debts.

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3. The Commission's Consideration of the Risks and Benefits

In providing an inter-affiliate exemption from required clearing,

the Commission has considered the benefits that inter-affiliate swaps

offer corporate groups against the risk of allowing an exemption from

required clearing for swaps entered into by separate, but affiliated,

legal entities. In considering the risks and benefits, the Commission

was guided, in part, by comments pointing to the risk-mitigating

characteristics of inter-affiliate swaps and the sound risk management

practices of corporate groups that rely on inter-affiliate swaps. In

crafting the rule, the Commission sought to codify these

characteristics as eligibility criteria, or conditions, for the

exemption from required clearing. The conditions imposed are designed

to increase the likelihood that affiliates will take into consideration

their mutual interests when entering into, and fulfilling, their inter-

affiliate swap obligations. For example, the inter-affiliate exemption

may be elected only if the affiliates are majority owned and their

financial statements are consolidated, thereby increasing the

likelihood that entities will be mutually obligated to meet the group's

swap obligations. Additionally, the affiliates must be subject to a

centralized risk management program, the swaps and the trading

relationship between affiliates must be documented, and outward-facing

swaps must be cleared or subject to an exemption or exception from

clearing.

Despite the conditions to the exemption adopted in this final rule,

the Commission reminds market participants that the conditions included

in the final rule do not mitigate potential losses between inter-

affiliates to the extent that clearing would, particularly if one or

more affiliated entities become insolvent.

B. Section 4(c) Authority

Section 4(c)(1) of the CEA grants the Commission the authority to

exempt any transaction or class of transactions, including swaps, from

certain provisions of the CEA, including the clearing requirement, in

order to ``promote responsible economic or financial innovation and

fair competition.'' Section 4(c)(2) of the Act further provides that

the Commission may not grant exemptive relief unless it determines

that: (1) The exemption is appropriate for the transaction and

consistent with the public interest; (2) the exemption is consistent

with the purposes of the CEA; (3) the transaction will be entered into

solely between ``appropriate persons''; and (4) the exemption will not

have a material adverse effect on the ability of the Commission or any

contract market to discharge its regulatory or self-regulatory

responsibilities under the CEA.\21\ In enacting section 4(c), Congress

noted that the purpose of the provision is to give the Commission a

means of providing certainty and stability to existing and emerging

markets so that financial innovation and market development can proceed

in an effective and competitive manner.\22\

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\21\ 7 U.S.C. 6(c)(2).

\22\ House Conf. Report No. 102-978, 1992 U.S.C.C.A.N. 3179,

3213.

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In the NPRM, the Commission requested comment as to whether

exempting inter-affiliate swaps from the clearing requirement under

certain terms and conditions would be an appropriate exercise of its

section 4(c) authority.\23\ A number of commenters supported the

Commission's use of its section 4(c) authority to exempt inter-

affiliate swaps from clearing. According to MetLife and Prudential, the

inter-affiliate exemption as proposed promotes responsible economic or

financial innovation and fair competition by allowing corporate groups

to use inter-affiliate swaps to engage in effective and efficient risk

management activities. As an example, MetLife and Prudential explained

that corporate groups can use a single conduit in the market on behalf

of multiple affiliates within the group, which permits the corporate

group to net affiliates' trades. This netting effectively reduces the

overall risk of the corporate group and the number of open positions

with external market participants, which in turn reduces operational,

market, counterparty credit, and settlement risk. MetLife and

Prudential both expressed the view that inter-affiliate swaps do not

pose risks to

[[Page 21754]]

corporate groups and third parties, and both stated that inter-

affiliate swaps may pose less risk to corporate groups given efficient

netting across the corporate group. EEI also supported the Commission's

use of its section 4(c) authority for similar reasons to those stated

by MetLife and Prudential.

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\23\ See NPRM at 50428.

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ISDA & SIFMA stated that the Commission's proposed exemption meets

the requirements of section 4(c) of the CEA by promoting innovation and

competition, and the exemption serves the public interest. ISDA & SIFMA

noted that inter-affiliate swaps are integral to the strategies

consolidated financial institutions rely upon to meet customer needs in

an efficient, competitive, and sound manner. According to ISDA & SIFMA,

inter-affiliate swaps maximize hedging efficiencies and allow customers

to transact with a single client-facing entity in the customer's

jurisdiction, which increases the scope of risk-reducing netting with

individual customers as well as risk-reducing netting of offsetting

positions within the financial group. This allows the institution to

meet customer needs across jurisdictions and provide improved pricing

or other risk management benefits to customers, thereby promoting

financial innovation and competition. ISDA & SIFMA also commented that

inter-affiliate swaps allocate and transfer risks among members of a

corporate group rather than increasing risks.

CDEU also supported the Commission's use of its section 4(c)

authority. CDEU stated that the inter-affiliate exemption would promote

financial innovation, fair competition, and the public interest by

preserving the ability of corporate entities to centrally hedge the

risks of their affiliates. CDEU stated that without such an exemption

firms that currently use a central hedging model will be disadvantaged

as compared to direct competitors that do not use the same, efficient

risk management model. CDEU also noted the additional costs that would

be incurred from subjecting inter-affiliate swaps to clearing.

In the NPRM, the Commission requested comments on whether the

inter-affiliate exemption would be in the public interest. In addition

to responses noted above with regard to the public interest,\24\ the

Commission received two comment letters questioning whether the

proposed exemption serves the public interest.

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\24\ As noted above, CDEU, MetLife, Prudential, and ISDA & SIFMA

stated that an inter-affiliate exemption is consistent with the

public interest.

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According to AFR, there are serious doubts about whether the inter-

affiliate exemption is in the public interest. AFR stated that any

hedging and netting benefits gained from corporate groups engaging in

inter-affiliate swaps must be weighed against the benefits of full

novation to a central counterparty in the form of a clearinghouse,

which is a more comprehensive level of risk management. Given the

experience of the 2008 financial crisis, AFR noted that any risk-

reducing benefit of corporate group risk management practices assumes

that the corporate group actually implements and adheres to sufficient

risk management procedures. AFR is concerned about relying on such an

assumption in light of the fact that there was a large-scale failure of

proper risk management prior to and during the 2008 financial crisis.

Better Markets similarly commented that only a very narrow and

strict inter-affiliate exemption could be in the public interest.

Better Markets suggested ways in which the Commission should strengthen

the proposed exemption to satisfy the public interest standard,

including requiring a 100% majority ownership interest standard,

requiring that both initial and variation margin be exchanged, and

banning rehypothecation of posted collateral.\25\

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\25\ As discussed further below, both AFR and Better Markets

contend that all the proposed conditions must be retained and the

conditions must be strengthened in a number of ways.

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After considering the complete record in this matter, the

Commission has determined that the requirements of section 4(c) of the

Act have been met with respect to the exemptive relief described above.

The Commission believes that the exemption, as modified in this

release, is consistent with the public interest and with the purposes

of the CEA. The Commission's determination is based, in large part, on

the transactions that are covered under the exemption. Namely, as most

commenters noted, inter-affiliate transactions provide an important

risk management role within corporate groups. In addition, and as

discussed in the NPRM, the Commission recognizes that swaps entered

into between corporate affiliates, if properly risk-managed, may be

beneficial to the entity as a whole. Accordingly, in promulgating this

rule, the Commission concludes that an exemption subject to certain

conditions is appropriate for the transactions at issue, promotes

responsible financial innovation and fair competition, and is

consistent with the public interest. As the Commission noted in the

NPRM and as reiterated in AFR's comment, any benefits to the corporate

entity have to be considered in light of the risks that uncleared swaps

pose to corporate groups and market participants generally. For this

reason, the Commission is adopting an inter-affiliate exemption that is

narrowly tailored and subject to a number of important conditions,

including that affiliates seeking eligibility for the exemption

document and manage the risks associated with the swaps.

Further, the Commission finds that the exemption is only available

to ``appropriate persons.'' Section 4(c)(3) of the CEA includes within

the term ``appropriate person'' a number of specified categories of

persons, including ``such other persons that the Commission determines

to be appropriate in light of their financial or other qualifications,

or the applicability of appropriate regulatory protections.'' \26\

Given that only eligible contract participants (ECPs) can enter into

uncleared swaps and that the elements of the ECP definition (as set

forth in section 1a(18)(A) of the CEA and Commission regulation 1.3(m))

generally are more restrictive than the comparable elements of the

enumerated ``appropriate person'' definition, the Commission finds that

ECPs are appropriate persons within the scope of section 4(c)(3)(K) for

purposes of this final release and that in so doing, the class of

persons eligible to rely on the exemption will be limited to

``appropriate persons'' within the scope of section 4(c)(3) of the CEA.

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\26\ 7 U.S.C. 6(c)(3)(K).

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Finally, the Commission finds that this exemption will not have a

material effect on the ability of the Commission to discharge its

regulatory responsibilities. This exemption is limited in scope and, as

described further below, the Commission will have access to information

regarding the inter-affiliate swaps subject to this exemption because

they will be reported to an SDR pursuant to the conditions of the

exemption. In addition to the reporting conditions in the rule, the

Commission retains its special call, anti-fraud, and anti-evasion

authorities, which will enable it to adequately discharge its

regulatory responsibilities under the CEA.

For the reasons described in this release, the Commission believes

it is appropriate and consistent with the public interest to adopt such

an exemption.

[[Page 21755]]

C. Definition of Affiliate Status

As proposed, Sec. 39.6(g)(1) provides that counterparties to a

swap may elect the inter-affiliate exemption to the clearing

requirement if the financial statements of both counterparties are

reported on a consolidated basis, and either one counterparty directly

or indirectly holds a majority ownership interest in the other, or a

third party directly or indirectly holds a majority ownership interest

in both counterparties. The proposed rule further specified that a

counterparty or third party directly or indirectly holds a majority

ownership interest if it directly or indirectly holds a majority of the

equity securities of an entity, or the right to receive upon

dissolution, or the contribution of, a majority of the capital of a

partnership.

1. Majority Ownership Interest

Four commenters supported proposed Sec. 39.6(g)(1), which set

forth the requirements of an affiliate status. CDEU commented that the

majority-ownership test strikes an appropriate balance between ensuring

that the rule is not overly broad and providing companies with the

flexibility to account for differences in corporate structures. EEI

stated that majority ownership is sufficient to mitigate what EEI

believes is ``minimal'' risk posed by uncleared inter-affiliate swaps.

In addition, EEI noted that majority-owned affiliates will have strong

incentives to internalize one another's risks because the failure of

one affiliate impacts all affiliates within the corporate group. The

Working Group generally supported the Commission's definition, but

stated that inter-affiliate swaps should be unconditionally exempt from

mandatory clearing when the affiliates are consolidated for accounting

purposes.\27\ MetLife stated that it would likely limit inter-affiliate

trading to ``commonly-owned'' affiliates, but agreed with the

flexibility of including majority-owned affiliates.\28\

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\27\ The Working Group also stated that it was unable to

determine the scope of the proposed rule until the Commission

provides further guidance on the definition of ``financial entity''

under section 2(h)(7) of the CEA. In particular, The Working Group

asked that the Commission clarify the status of treasury affiliates

acting on behalf of affiliates able to claim an exception or

exemption from required clearing. The Working Group further

requested that the Commission provide guidance regarding what

constitutes being 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, and clarify that trading physical commodities is not

financial in nature. In response to The Working Group and other

comments regarding the applicability of the end-user exception for

certain inter-affiliate swaps, the Commission notes that it will

address the use of treasury affiliates under a separate Commission

action. With regard to the definition of financial entity, the

Commission provided additional guidance in the end-user exception

rulemaking, and declined to interpret statutory provisions within

the jurisdiction of other U.S. authorities. See End-User Exception

to the Clearing Requirement for Swaps, 77 FR 42560, 42567 (July 19,

2012) (explaining that ``business of banking'' is a term of art

found in the National Bank Act and is within the jurisdiction of,

and therefore subject to interpretation by, the Office of the

Comptroller of the Currency and section 4(k) of the Bank Holding

Company Act is within the jurisdiction of, and therefore subject to

interpretation by, the Board of Governors of the Federal Reserve

System). Accordingly, further guidance on this issue is beyond the

scope of this rulemaking, except as provided in note 76 of this

release.

\28\ Prudential stated that its affiliates are all wholly-owned

affiliates and expressed no view on the issue of majority-owned

affiliates.

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Two commenters objected to proposed Sec. 39.6(g)(1) and requested

the Commission require 100% ownership of affiliates. AFR stated that

the systemic impact of swaps is based on ownership, not on corporate

control. AFR also stated that permitting such a low level of joint

ownership would lead to evasion of the clearing requirement through the

creation of joint ventures set up to enable swap trading between banks

without the need to clear the swaps. Similarly, Better Markets agreed

that only 100% owned affiliates should be eligible for the exemption

because allowing the exemption for the majority owner permits that

owner to disregard the views of its minority partners \29\ and creates

an incentive to evade the clearing requirement by structuring

subsidiary partnerships. Finally, Better Markets stated that the

majority-ownership standard would result in corporate groups

transferring price risk and credit risk to different locations,

facilitating interconnectedness and potentially giving rise to systemic

risk during times of market stress.

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\29\ Two other commenters also discussed the issue of minority

investors. ISDA & SIFMA stated that any concerns about the

protection of minority investors in group entities is ``the province

of corporate and securities laws.'' EEI noted that ``to the extent

minority owners have an opinion about electing the exemption, they

may negotiate with majority-owners as they deem commercially

appropriate for the right to participate in inter-affiliate clearing

decisions.''

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Having considered these comments, the Commission is adopting

proposed Sec. 39.6(g)(1) (now Sec. 50.52(a)) with the modifications

discussed below. The Commission believes that the majority-owned

standard is not overly broad and provides entities with flexibility to

account for differences in corporate structure. In particular,

requiring majority ownership serves to ensure that counterparty credit

risk posed by inter-affiliate swaps is internalized by the corporate

group.

In addition, as the NPRM noted, it is important for the inter-

affiliate clearing exemption to be harmonized with foreign

jurisdictions that have or are developing comparable clearing regimes

consistent with the 2009 G-20 Leaders' Statement.\30\ For example, the

European Parliament and Council of the European Union have adopted the

European Market Infrastructure Regulation (EMIR).\31\ Subject to the

relevant provisions, technical standards, and regulations under EMIR,

certain OTC derivatives transactions between parent and subsidiary

entities, could be exempt from its general clearing requirement.

Generally speaking, it appears that the intragroup exemptions under

EMIR will require majority-ownership rights and consolidated accounting

and annual reporting.\32\

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\30\ At the G-20 meeting in Pittsburgh in 2009, as noted above,

the G-20 Leaders declared that, ``[a]ll standardized OTC derivative

contracts should be traded on exchanges or electronic trading

platforms, where appropriate, and cleared through central

counterparties by end-2012 at the latest.'' G-20 Leaders' Final

Statement at Pittsburgh Summit: Framework for Strong, Sustainable

and Balanced Growth (Sept. 29, 2009).

\31\ See Regulation (EU) No 648/2012 of the European Parliament

and of the Council on OTC Derivatives, Central Counterparties and

Trade Repositories, 2012 O.J. (L 201) (hereinafter ``EMIR'')

available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:201:0001:0059:EN:PDF.

\32\ Id. at Articles 3 and 4.

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In response to the concerns of AFR and Better Markets regarding the

need for the Commission to adopt a stricter requirement of 100%

ownership, the Commission recognizes the potential for corporate

entities to structure their affiliates in such a manner as to evade the

clearing requirement. However, the Commission believes it has carefully

crafted a narrow exemption based on the condition that the affiliate is

majority-owned, along with the other conditions imposed under this

exemption. In terms of the interests of minority shareholders, the

Commission believes that the views of all shareholders should be taken

into account when an entity decides whether to clear a swap, but

ultimately, the decision is a matter for corporate and securities laws.

2. Consolidated Financial Statements

In addition to the majority-ownership requirement, proposed Sec.

39.6(g)(1) provided that counterparties to a swap may elect the inter-

affiliate exemption to the clearing requirement if the financial

statements of both counterparties are reported on a consolidated basis.

The Commission received several comments on this provision. The FSR

requested that the

[[Page 21756]]

Commission clarify that alternative accounting standards can be used

for purposes of meeting the requirement that the financial statements

of both affiliates be reported on a consolidated basis. In response to

a question in the NPRM regarding whether the exemption should be

limited to the ownership threshold based on section 1504 of the

Internal Revenue Code, MetLife and Prudential both explained that a

U.S. taxpayer cannot file consolidated U.S. tax returns with its non-

U.S. affiliate. Accordingly, both MetLife and Prudential stated that

they did not support such a limitation on the exemption.

In an effort to clarify the consolidated financial reporting

condition, the Commission is modifying the requirement that financial

statements be reported on a consolidated basis in two ways. First, the

Commission is clarifying which entities are subject to the consolidated

reporting condition. Under revised Sec. 50.52(a)(1)(i), if one of the

two affiliate counterparties claiming the exemption holds a majority

interest in the other affiliate counterparty (the ``majority-interest

holder''), then the financial statements of the majority-interest

holder must be reported on a consolidated basis and such statements

must include the financial results of the majority-owned counterparty.

On the other hand, under revised Sec. 50.52(a)(1)(ii), if a third

party is the majority-interest holder of both affiliate counterparties

claiming the exemption (the ``third-party majority-interest holder''),

then the financial statements of the third-party majority-interest

holder must be reported on a consolidated basis and such statements

must include the financial results of both affiliate counterparties to

the swap. In essence, the rule requires that the financial statements

of the majority-owner (whether a third party or not) are subject to

consolidation under accounting standards and must include either the

other affiliate counterparty's or both majority-owned affiliate

counterparties' financial results. The Commission is using the term

``financial results'' to refer to the financial statements, reports, or

other material of the majority-owned counterparty or counterparties

that must be consolidated with the majority owner's financial

statements.

The second modification to the proposed rule responds to FSR's

request that the Commission clarify that alternative accounting

standards are permitted. Accordingly, the consolidated financial

statements of the majority-interest holder or the third-party majority-

interest holder, as appropriate, may be prepared under either Generally

Accepted Accounting Principles (GAAP) or International Financial

Reporting Standards (IFRS). The modification reflects the fact that

entities claiming the exemption may be subject to different accounting

standards.

The Commission is not modifying the rule to limit the exemption to

an ownership threshold based on section 1504 of the Internal Revenue

Code.

D. Inter-Affiliate Swap Documentation

As proposed, Sec. 39.6(g)(2)(ii) provided that eligible affiliate

counterparties that elect the inter-affiliate exemption must enter into

swaps with a swap trading relationship document that is in writing and

includes all the terms governing the relationship between the

affiliates. These terms include, but are not limited to, payment

obligations, netting of payments, transfer of rights and obligations,

governing law, valuation, and dispute resolution. This requirement will

be satisfied if an eligible affiliate counterparty is an SD or MSP that

complies with the swap trading relationship documentation requirements

of Sec. 23.504. Regulation 23.504 includes all the proposed terms

under proposed Sec. 39.6(g)(2)(ii) plus a number of other specific

requirements. The NPRM stated that the burden on affiliates would not

be onerous because all affiliates should be able to use a master

agreement to document their swaps, however, in the NPRM the Commission

did not require the use of such a master agreement.

The Commission received a number of comments both supporting and

opposing the swap documentation requirement. Better Markets, MetLife,

and Prudential all supported the proposed documentation requirement.

Specifically, MetLife and Prudential did not believe that the

documentation requirement would be any more ``burdensome or costly''

for them because they already document all of their swaps.

Additionally, MetLife and Prudential commented that the proposed

documentation method is ``preferable'' to any other method and

represents industry best practice. Better Markets agreed with the

conditions imposed on the exemption, including the documentation

requirements, and stated that the conditions should not be

weakened.\33\

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\33\ While it did not address the documentation requirements

specifically, AFR stated that the proposed conditions on the

exemption should be fully retained. Similarly, Chris Barnard

generally expressed support for the proposed rules but did not

specifically mention the documentation provisions.

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

Cravath, EEI, CDEU, and DLA Piper opposed the proposed

documentation requirement. Cravath stated that the costs associated

with the imposition of documentation requirements outweigh any benefits

to the financial system, and that the Commission should leave the

determination as to the appropriate level of documentation to boards of

directors and management of companies, to determine based on the

``reasonable exercise of their fiduciary responsibilities.'' DLA Piper

commented that inter-affiliate swaps are typically documented by a

simple intercompany agreement, trade ticket or accounting entry rather

than ISDA Master Agreements, and that the documentation requirements

would be burdensome.

CDEU expressed concern that proposed Sec. 39.6(g)(2)(ii)(B) would

require that full ISDA Master Agreements be used to document inter-

affiliate swaps. CDEU explained that while many market participants use

master agreements, some end users many not have full master agreements

because inter-affiliate swaps are purely internal and do not increase

systemic risk.\34\ CDEU recommended that the proposed rule be revised

to require that the swap documentation ``include all terms necessary

for compliance with its centralized risk management program'' and

eliminate the list of required terms. CDEU also requested that the

Commission clarify that (1) market participants can continue to use

documentation required by their risk management programs, and (2) the

rule does not require market participants to use the ISDA Master

Agreements.

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\34\ CDEU recognized that SDs and MSPs and their counterparties,

including affiliates, will be subject to the requirements of Sec.

23.504, but stated that it is not appropriate to apply the same

requirements to non-registrant affiliates.

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EEI recommended that the Commission eliminate the documentation

requirement because the requirement is duplicative of corporate

accounting records that affiliates maintain as a matter of prudent

business practice. According to EEI, current accounting practices will

address the Commission's tracking and proof-of-claim concerns related

to inter-affiliate swaps. EEI commented that a documentation

requirement imposes ``an additional, costly layer of ministerial

process and documentation that is unnecessary to achieve the

Commission's stated objectives.'' \35\ EEI

[[Page 21757]]

requested that the Commission allow market participants ``to document

their inter-affiliate risk transfers pursuant to standard commercial

accounting and business records practices.''

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\35\ EEI commented on the NPRM's consideration of costs and

benefits and stated that the costs of the proposed documentation

requirement are unjustified. The NPRM included an estimate that

there would be a one-time cost of $15,000 to develop appropriate

documentation for use by an entity's affiliates. EEI objected to

this estimate because, in its view, the legal costs associated with

individually negotiating and amending standard agreements between

individual affiliates would exceed the NPRM's estimates. In

addition, EEI objected to the NPRM's estimate of 22 affiliated

counterparties for each corporate group as ``far too low'' for U.S.

energy companies. However, EEI did not provide specific,

quantitative information in terms of either the legal costs of

complying with the proposed documentation requirement or number of

affiliates for a corporate group subject to this rule.

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ISDA & SIFMA stated that the documentation requirements were overly

prescriptive and would impose unnecessary costs on affiliates.

Specifically, ISDA & SIFMA identified the valuation and dispute

resolution requirements as serving little purpose. ISDA & SIFMA

recommended a more flexible approach that would require adequate

documentation of ``all transaction terms under applicable law.''

The Commission considered all of the comments relating to the

proposed documentation requirement and is retaining the swap

documentation requirement subject to certain modifications recommended

by commenters. As discussed in the NPRM, the Commission is concerned

that without adequate documentation entities will be unable to track

and manage the risks arising from inter-affiliate swaps. Equally

important, affiliates must be able to offer sufficient proof of claim

in the event of insolvency. The Commission is adopting proposed Sec.

39.6(g)(2)(ii)(A) (now Sec. 50.52(b)(2)(i)), which essentially

confirms the applicability of Sec. 23.504 to swaps between affiliates

where one of the affiliates is an SD or MSP. However, with regard to

swaps between affiliates that are not SDs or MSPs, and in response to

commenters' requests for a more flexible standard, the Commission is

adopting ISDA & SIFMA's recommendation that the focus of the

documentation requirement be on documenting all of an inter-affiliate

transaction's terms. Accordingly, the Commission is modifying proposed

Sec. 39.6(g)(2)(ii)(B) (now Sec. 50.52(b)(2)(ii)), to require that

``the terms of the swap are documented in a swap trading relationship

document that shall be in writing and shall include all terms governing

the trading relationship between the eligible affiliate

counterparties.''

Under this modification, the Commission is eliminating the non-

exclusive list of terms, which included payment obligations, netting of

payments, transfer of rights and obligations, governing law, valuation,

and dispute resolution. The change responds to commenters' requests for

a more flexible approach that reflects current market best practices.

While, in most instances, the Commission anticipates that documentation

between affiliates will include all of the previously enumerated terms,

the more general rule formulation signals that market participants

retain the ability to craft appropriate documentation for their

affiliated entities. This modification also serves to address concerns

that the intent of the proposed rule was to require formal master

agreements, such as the ISDA Master Agreement. As explained above, the

proposed rule was not intended to require affiliates to enter into

formal master agreements. Rather, the Commission observed that parties

that already use master agreements to document their inter-affiliate

swaps would likely meet the requirements of the inter-affiliate

exemption without additional costs.\36\ This observation was supported

by commenters such as MetLife and Prudential.

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\36\ See Confirmation, Portfolio Reconciliation, Portfolio

Compression, and Swap Trading Relationship Documentation

Requirements for Swap Dealers and Major Swap Participants, 77 FR

55904, 55906 (Sept. 11, 2012) (recognizing that the ISDA Master

Agreement, and other associated documents in their pre-printed form

as published by ISDA are capable of compliance with the rules, but

noting that such agreements are subject to customization by

counterparties and such customization may or may not comply with

Commission requirements).

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This modification also responds, in part, to CDEU's request that

the documentation ``include all terms necessary for compliance with its

centralized risk management program.'' While the Commission is

modifying the rule to delete the specific references to valuation and

dispute resolution procedures, ensuring that affiliates entering into

swaps have sound procedures in place to value their swaps and resolve

any disputes is critical to risk management. Accordingly, as discussed

further below, the Commission anticipates that affiliates will include

rigorous valuation provisions and procedures for elevating and

resolving disputes in their risk management programs.

In response to comments from Better Markets and AFR that the

proposed regulations should be retained and not weakened, the

Commission does not believe that eliminating the non-exclusive list of

terms and replacing it with a simple requirement that all terms of the

swap transaction and the relationship between the affiliates be

documented will weaken the rule. Rather, eligible affiliates will have

some discretion, but also have the obligation to ensure that their

documentation contains an accurate and thorough written record of their

swaps. The Commission clarifies, however, that book entries would not

suffice for purposes of complying with the swap documentation condition

because such entries do not contain sufficient information to

adequately document the swap or the trading relationship between

affiliates.

EEI requested that, if the Commission retains the documentation

requirement, the Commission clarify that swap confirmations are not

required because executing confirmations would impose substantial

costs. In response to this request, the Commission clarifies that for

swaps between affiliates where one or both of the affiliates is an SD

or MSP, the confirmation rules under Sec. 23.501 are incorporated into

Sec. 23.504.\37\ As a result, those affiliates must confirm all the

terms of their transactions according to the applicable timeframes set

forth under Sec. 23.501.\38\ By contrast, for swaps between affiliates

that are not SDs or MSPs, the provisions of Sec. 23.501 do not apply

and formal confirmation pursuant to Sec. 23.501 is not required.

However, the Commission notes that the terms of the swap will be

documented by the affiliates and confirmation of those terms will be

reported to an SDR under the Commission's reporting rules.\39\

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\37\ See 17 CFR 23.504(b)(2); 77 FR 55907-08.

\38\ See 17 CFR 23.501.

\39\ See, e.g., 17 CFR 45.3(c)(1)(iii) (requiring the reporting

counterparty to report all confirmation data for the swap as soon as

technologically practicable after confirmation, but no later than 30

minutes after confirmation if confirmation occurs electronically or

24 business hours after confirmation if confirmation does not occur

electronically).

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E. Centralized Risk Management Program

Proposed Sec. 39.6(g)(2)(iii) requires the swap to be subject to a

centralized risk management program that is ``reasonably designed to

monitor and manage the risks associated with the swap.'' If at least

one of the eligible affiliate counterparties is an SD or MSP, the

centralized risk management requirement is satisfied by complying with

the requirements of Sec. 23.600.\40\

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\40\ 17 CFR 23.600; Swap Dealer and Major Swap Participant

Recordkeeping, Reporting, and Duties Rules; Futures Commission

Merchant and Introducing Broker Conflict of Interest Rules; and

Chief Compliance Officer Rules for Swap Dealers, Major Swap

Participants, and Futures Commission Merchants, 77 FR 20128 (Apr. 2,

2012).

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[[Page 21758]]

Five commenters generally supported proposed Sec. 39.6(g)(2)(iii).

AFR supported the proposed risk management program requirement and

stated that dispensing with or weakening this condition, or any of the

conditions, would heighten systemic risk and call into question the

Commission's exemptive authority. Better Markets agreed that requiring

a centralized risk management program was wholly appropriate and should

be maintained as a requirement.

Prudential and MetLife confirmed that both companies currently have

centralized risk management programs and consider them to be consistent

with current practice in the industry. Prudential noted that it

structured its risk management system to allow only one affiliate to

enter into swaps with third parties, which permits Prudential to impose

a single credit limit on its market-facing counterparty relationships.

MetLife's enterprise-wide risk management system provides all

affiliates trading derivatives with affiliate-specific sets of

guidelines and limits that are also included in enterprise-wide

guidance and limits.

Finally, CDEU expressed support for the centralized risk management

program requirement, but requested that the Commission clarify that the

level of risk management for inter-affiliate swaps not be interpreted

as requiring the same level of risk management that end-users maintain

for external third-party swaps. CDEU noted that most end users that use

inter-affiliate swaps currently have robust centralized risk management

programs in place to monitor all external swap risks and affiliates are

required to follow group-wide risk polices. CDEU was supportive of the

proposal so long as the requirement is interpreted reasonably and

permits entities to ``implement risk policies and procedures

appropriate to the risks of a corporate group's inter-affiliate

swaps.''

Four commenters objected to the proposed requirement, suggested

alternatives, and/or requested clarification. FSR stated that the

condition should be eliminated because integrated risk management

systems ``are generally not established across international

boundaries'' and are not consistent with general risk practices in

large, multinational organizations. FSR suggested that the requirement

be dropped in favor of each entity making ``its own evaluations of the

risk associated with an inter-affiliate position.''

Cravath stated that in many cases, for companies outside of the

financial sector, the proposed rule will require a substantial change

in the processes and procedures currently maintained by such companies,

and the cost of complying with the risk management program requirements

outweigh any benefits to the financial system. Cravath commented that

rather than subject companies to a risk management rule, ``[c]ompanies

should have the flexibility to engage in prudent risk management for

their corporate group in a manner consistent with the overall level of

risks to their business.''

EEI suggested that the Commission eliminate the centralized risk

management program requirement on the grounds that it would be

duplicative for corporate groups that already have risk management

programs in place. According to EEI, it is standard industry practice

for both private and public companies to have a risk management

program. EEI accordingly does not see a ``need to impose a separate,

discrete regulatory requirement to document with an SDR or the

Commission the existence of a centralized risk management program.'' If

the Commission decides to retain the requirement, EEI requested that

the Commission require a program be ``reasonably designed to monitor

and manage the risks associated with the swap'' and provide the

flexibility to design risk management programs that address the unique

risks of an entity's business.

The Working Group requested that the Commission clarify whether

non-SDs and non-MSPs would be subject to the same enterprise-level risk

management program as required for SDs and MSPs under Sec. 23.600. If

the Commission intended to require the same level of risk management,

The Working Group commented that there are ``a number of commercially

and legally valid reasons'' why a centralized risk management program

in accordance with Sec. 23.600 would be inconsistent with current

industry practice. The Working Group cited cost as a reason companies

do not provide for centralized risk management on different continents,

in addition to antitrust and other regulatory reasons. The Working

Group requested that the Commission clarify that the rule requires only

that both counterparties be subject to a ``robust risk management

program.''

In response to comments, the Commission observes a general

consensus that market participants have risk management policies and

procedures in place, at least with regard to affiliates located in the

same jurisdiction. FSR and The Working Group questioned whether

entities have centralized risk management programs for affiliates in

different jurisdictions and whether such cross-border risk management

systems are prohibitively costly. In response to these comments, the

Commission points to comments stating that inter-affiliate swaps play a

critical role in an entity's overall management of risk and provide

netting benefits among affiliates. Consequently, it stands to reason

that inter-affiliate swaps between affiliates in different

jurisdictions are as much a part of an entity's overall risk management

framework as swaps between affiliates located in the same jurisdiction.

The Commission does not believe that it would be prudent business

practice for affiliates to enter into inter-affiliate swaps without

risk management systems integrated across international boundaries to

the extent that the entity permits affiliates across jurisdictions to

enter into swaps with one another.

In response to comments asking that the Commission clarify the

level of risk management required for non-SDs and non-MSPs, the

Commission confirms that the requirements of proposed Sec.

39.6(g)(2)(iii) (now Sec. 50.52(b)(3)) are intended to be flexible and

do not require the same level of policies and procedures as required

under Sec. 23.600 for SDs and MSPs. Under the rule, a company is free

to structure its centralized risk management program according to its

unique needs, provided that the program reasonably monitors and manages

the risks associated with its uncleared inter-affiliate swaps. In all

likelihood, if a corporate group has a centralized risk management

program in place that reasonably monitors and manages the risk

associated with its inter-affiliate swaps as part of current industry

practice, it is likely that the program would fulfill the requirements

of proposed Sec. 39.6(g)(2)(iii) (now Sec. 50.52(b)(3)).

The Commission did not receive comments regarding the requirement

that SD and MSP affiliates must comply with Sec. 23.600.\41\ The

Commission is adopting that provision of the rule as proposed.

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\41\ 17 CFR 23.600(c)(1)(ii) (``The Risk Management Program

shall take into account risks posed by affiliates and the Risk

Management Program shall be integrated into risk management at the

consolidated entity level.'').

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Given that a number of commenters stated that it is common practice

for market participants, including end users, to have risk management

programs in place, the Commission is not persuaded by Cravath's comment

that the rule will require a substantial change in the processes and

procedures currently maintained by companies to manage risk.

Accordingly, costs will be

[[Page 21759]]

limited where an entity only needs to make modifications to existing

risk management programs. Moreover, a corporate group may not have to

incur any costs if it already has a risk management system that meets

the requirements of the inter-affiliate exemption in place.

F. Variation Margin

Proposed Sec. 39.6(g)(2)(iv) required that variation margin be

collected for swaps between affiliates that are financial entities, in

compliance with the proposed variation margin requirements in proposed

Sec. 39.6(g)(3).\42\ The rule further proposed an exception to the

variation margin requirement for 100% commonly-owned and commonly-

guaranteed affiliates, provided that the common guarantor is under 100%

common ownership.

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\42\ The Commission also requested comments on, among other

things, whether the Commission should promulgate regulations that

set forth minimum standards for initial margin for inter-affiliate

swaps.

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Some commenters expressed support for the proposed variation margin

requirement. Prudential commented that it did not take issue with the

variation margin requirement, but noted that variation margin may not

be appropriate or required in every circumstance.\43\ Prudential also

commented that the Commission should not impose initial margin

requirements for the inter-affiliate exemption.\44\ Chris Barnard

agreed that the Commission should require the exchange of variation

margin for financial entities and noted that the exchange of variation

margin is consistent with the key principles proposed by the Basel

Committee on Banking Supervision (BCBS) and the Board of the

International Organization of Securities Commissions (IOSCO).\45\

Better Markets expressed support for the variation margin requirement

and commented that it should be expanded to non-financial entities.\46\

AFR expressed support for the variation margin proposal. Both Better

Markets and AFR also expressed support for the requirement that

affiliates post initial margin for inter-affiliate swaps subject to the

exemption.\47\

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\43\ Prudential also commented that there is ``no less costly

risk-management tool'' than variation margin.

\44\ MetLife also commented that the Commission should not

impose initial margin requirements for the inter-affiliate

exemption.

\45\ See Margin Requirements for Non-Centrally-Cleared

Derivatives, Consultative Report (July 2012), available at http://www.bis.org/publ/bcbs226.pdf.

\46\ Better Markets also suggested that the Commission ban the

rehypothecation of collateral.

\47\ Better Markets commented that initial margin should be

required because initial margin is the true ``statistical estimate

of the potential consequences of a default'' and that variation

margin is merely the ``daily recalibration'' of the risk estimation

of initial margin.

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Several commenters stated that the proposed variation margin

requirement for swaps between affiliates that are financial entities is

not necessary and should not be a condition of the inter-affiliate

exemption to clearing.\48\ ISDA & SIFMA commented that the benefits of

variation margin for inter-affiliate swaps are ``tenuous'' because the

third party to a swap is exposed to the credit risk of the entire group

not just the specific affiliate with which it enters into a swap. ISDA

& SIFMA maintain that it is not necessary to protect group entities

from the credit risk of other group entities because group management

possesses the tools needed to resolve potential defaults within the

group. According to ISDA & SIFMA, the Commission can fully achieve its

regulatory mandate to protect third-party swap counterparties through

the application of the clearing requirement to those outward-facing

swaps that are subject to the Commission's regulation, as well as

regulation of those group entities whose outward-facing swap activities

are sufficiently large to subject them to SD and MSP registration.\49\

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\48\ Cravath commented that variation margin requirements ``tie

up capital that could otherwise be used for investment purposes to

create jobs and goods and services for the economy.'' MetLife

commented that while it is subject to variation margin under state

insurance law, MetLife believes that the Commission should eliminate

the variation margin requirement for 100%-owned affiliates and

should not require ``inter-affiliate guarantees.'' DLA Piper also

urged the Commission to provide corporate groups with legal

certainty that no margin requirements will be imposed on any inter-

company swaps.

\49\ ISDA & SIFMA claimed that the additional liquidity demands

resulting from variation margin will distort the group's risk

management choices. ISDA & SIFMA further claimed that while they

have previously stated that inter-affiliate margin occurs

``routinely,'' this does not mean that it occurs ``uniformly'' or

that imposing variation margin would not increase cost.

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FSR commented that affiliates should be required to post margin

only in instances where their primary regulator imposes such a

requirement for affiliate transactions.\50\ FSR states that requiring

variation margin for inter-affiliate swaps involving non-bank financial

entities will limit the ability of companies to efficiently allocate

risk among affiliates and manage risk centrally.\51\ FSR further

commented that initial margin should not be required between

affiliates, and requested that the Commission clarify that the

exemption does not require the exchange of initial margin between

affiliates.

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\50\ Citing to sections 23A and 23B of the Federal Reserve Act

and Regulation W as well as public utility, insurance, and

investment company law, FSR commented that a number of regulated

entities may be subject to various restrictions on affiliate

transactions and that for purposes of the inter-affiliate exemption,

margin requirements should only apply ``to the extent other

applicable law . . . imposes such restrictions on affiliate

transactions.'' FSR also points out that subsidiaries of banks are

``generally not treated as `affiliates' '' within the restrictions

of sections 23A and 23B of the Federal Reserve Act.

\51\ FSR further requested that the Commission clarify that to

the extent that financial entities are required, through credit

support arrangements with their affiliates, to have minimum transfer

amounts, thresholds, and other similar arrangements in place, that

such arrangements would be permitted in connection with inter-

affiliate swaps relying on the inter-affiliate exemption.

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CDEU commented that the Commission should not require variation

margin, or initial margin, with respect to inter-affiliate swaps

between end-user affiliates. According to CDEU, while margin

requirements may serve as a risk-management tool for market-facing

swaps, inter-affiliate swaps do not increase counterparty credit risk

or contribute to interconnectedness among market participants. CDEU

stated that a number of specific entities, including banks and

insurance companies, already post variation margin for inter-affiliate

swaps, largely because of prudential requirements, and that applying

variation margin requirement to these entities is unnecessary.\52\ CDEU

requested that if the Commission retains the variation margin

requirement, that it limit the exchange of variation margin to SDs and

MSPs, and that the requirement should not apply to entities that are

considered ``financial entities.''

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\52\ Moreover, CDEU claims that many inter-affiliate swaps

between end-user corporate groups are not subject to variation

margin requirements, and that these entities likely will not have

the liquidity to exchange variation margin, and would likely be

required to borrow the money from the centralized hedging unit with

which it is entering the internal swap. Such an arrangement,

according to CDEU, would transfer the loan back to the centralized

hedging unit and effectively eliminate any perceived benefit from

the exchange of variation margin.

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With respect to the proposed common guarantor exception to the

variation margin requirement, ISDA & SIFMA commented that the

Commission has not provided adequate rationale for requiring a common

guarantor as a condition for exempting group members from the proposed

variation margin requirement, nor has the Commission made it clear

which obligations must be guaranteed. ISDA & SIFMA requested that the

Commission further clarify the guarantee exception in proposed Sec.

39.6(g)(2)(iv), including to clarify that it includes ``direct or

indirect'' ownership, and that swaps between the

[[Page 21760]]

common guarantor and its affiliates are eligible for the exception.\53\

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\53\ ISDA requested that the Commission clarify that the

shareholders of a publicly-owned holding company are the common

owners and that its 100% owned subsidiaries meet the definition of

``100% commonly owned,'' and further stated that the Commission

should address the consequences of a guarantee of a swap being

considered a swap itself.

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CDEU commented that the Commission should not limit the guarantee

exception to 100% commonly-owned affiliates and should allow the

exception for majority-owned affiliates. CDEU requested that the

Commission clarify that only the related market-facing swaps with third

parties are required to be guaranteed by the common owner or parent.

CDEU suggested that the Commission clarify that the parent company has

the option to act as the guarantor of the transactions.

FSR commented that the variation margin requirement should not

apply to 100% commonly-owned affiliates even if they do not have a

common guarantor that is under 100% common ownership. According to FSR,

the 100% common ownership requirement creates sufficient alignment of

interests between swap counterparties and places the risk of the swap

on the ultimate parent entity, and thus, the exchange of variation

margin would do little to mitigate intercompany risk.

MetLife and Prudential commented that inter-affiliate swaps should

not be commonly guaranteed by a 100% wholly-owned affiliate in order to

be exempt from the variation margin requirement. Specifically, MetLife

stated that the Commission should not require guarantees or explicit

credit support as a condition for an exception from the variation

margin requirement and should rely instead on the direct or indirect

common ownership requirement. Both MetLife and Prudential stated that

the corporate group of 100% wholly owned affiliates should be able to

decide whether internal swaps need to be guaranteed by an affiliate.

After considering the comments submitted in response to the

proposed variation margin requirement, the Commission is determining

not to require variation or initial margin as a condition for electing

the inter-affiliate exemption. In so doing, the Commission was guided

by comments expressing concern that a variation margin requirement will

limit the ability of U.S. companies to efficiently allocate risk among

affiliates and manage risk centrally. Notwithstanding the Commission's

determination not to impose variation margin as a condition of the

inter-affiliate exemption, the Commission is encouraged by comments

noting that many companies already exchange variation margin, and

agrees with commenters that collateralizing risk exposure with respect

to any swaps, including inter-affiliate swaps, is critical, and

encourages market participants to do so as a matter of sound business

practice.

G. Treatment of Outward-Facing Swaps and Relief

Proposed Sec. 39.6(g)(2)(v) provided that eligible affiliate

counterparties to a swap may elect the inter-affiliate exemption from

clearing provided that each affiliate counterparty either: (i) Is

located in the United States; (ii) is located in a jurisdiction with a

clearing requirement that is comparable and comprehensive to the

clearing requirement in the United States; (iii) is required to clear

swaps with non-affiliated parties in compliance with U.S. law; or (iv)

does not enter into swaps with non-affiliated parties.\54\

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\54\ In this release, the requirements of proposed Sec.

39.6(g)(2)(v), which are now being adopted in new Sec. 50.52(b)(4),

are referred to as the ``treatment of outward-facing swaps

condition.''

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The Commission received several comments both in support of and in

opposition to various aspects of the conditions related to the

treatment of outward-facing swaps in proposed Sec. 39.6(g)(2)(v). The

Commission has considered each of the comments and has determined to

adopt the treatment of outward-facing swaps conditions of the inter-

affiliate exemption, with certain modifications described below,

because such conditions are necessary to prevent evasion of the

clearing requirement and to help protect the U.S. financial markets.

The remainder of this Section II.G describes the comments received in

response to proposed Sec. 39.6(g)(2)(v) (now Sec. 50.52(b)(4)), along

with the Commission's responses and clarifications with respect to

those comments.

1. Basis for the Cross-border Conditions

While recognizing the benefits of exempting certain inter-affiliate

transactions from the clearing requirement, in the NPRM, the Commission

described two separate grounds for proposing the treatment of outward-

facing swaps condition to the inter-affiliate exemption. First, the

Commission explained that an inter-affiliate exemption from required

clearing could enable entities to evade the clearing requirement

through trades with affiliates that are located in foreign

jurisdictions that do not have a comparable and comprehensive clearing

regime. In addition, the Commission noted in the NPRM that uncleared

inter-affiliate swaps may pose risk to other market participants, and

therefore, the financial system if the affiliate enters into swaps with

third parties that are related on a back-to-back or matched book basis

with inter-affiliate swaps.

In support of the proposed treatment of outward-facing swaps

conditions, AFR stated that inter-affiliate swaps could, without

appropriate restrictions, bring risk back to the U.S. from foreign

affiliates. AFR commented that an inter-affiliate swap might be used to

move parts of the U.S. swaps market outside of U.S. regulatory

oversight by transferring risk to jurisdictions with little or no

regulatory oversight, whereby a non-U.S. affiliate of a U.S. entity

could enter into an outward-facing swap. AFR stated that an inter-

affiliate swap could contribute to financial contagion across different

groups within a complex financial institution, making it more difficult

to ``ring-fence'' risks in one part of an organization. AFR further

commented that laws and regulations of a foreign country might prevent

U.S. counterparties to swaps from having access to the financial

resources of an affiliate in the event of a bankruptcy or

insolvency.\55\ The inability of an affiliate to access resources in

other jurisdictions, according to AFR, may threaten the ability of U.S.

creditors to retrieve assets and may put U.S. taxpayers at risk.\56\

Better Markets also

[[Page 21761]]

supported the proposed treatment of outward-facing swaps condition.\57\

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\55\ AFR suggested that the Commission consult with the U.S.

banking agencies, such as the FDIC, regarding the potential issues

relating to bankruptcy of non-U.S. affiliates. As noted above, the

Commission has consulted with both U.S. and international

authorities in preparing this adopting release. In response to AFR's

comments pertaining to the limitations of foreign bankruptcy laws,

the Commission notes that the specific bankruptcy limitations

attendant to U.S. counterparties with respect to their non-U.S.

affiliates are outside the scope of this rulemaking. The Commission

further notes that the conditions imposed by the rules being adopted

in this release, in large part, are aimed at ensuring that the

benefits of central clearing, particularly with respect to

counterparty and systemic risk mitigation, are maintained with

respect to inter-affiliate swaps involving non-U.S. affiliates.

Specifically, the Commission believes that the conditions imposed by

the rules being adopted in this release will help to mitigate

potential issues that could arise in uncleared inter-affiliate swaps

when financial solvency is not an issue for the corporate

enterprise. Furthermore, these conditions may, to some extent,

diminish the impact of swaps in transmitting losses across

affiliates, and in turn, to third-party creditors, following a

default.

\56\ AFR also noted restrictions under U.S. banking law with

respect to the transfer of risk from non-depository to depository

institutions, and stated that it may be necessary to require ``ring-

fencing'' and separate capitalization of swaps affiliates. The

Commission believes that these issues are outside of the scope of

this rulemaking, and as AFR correctly noted, may be an issue that is

more appropriate for the prudential regulators of such entities to

consider.

\57\ Prudential also commented that in relation to its own

structure, it did not have concerns with the proposed cross-border

conditions applicable to inter-affiliate swaps involving foreign

affiliates.

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By contrast, ISDA & SIFMA, The Working Group, and CDEU all stated

that the treatment of outward-facing swaps condition of the proposed

rule is not necessary or appropriate and that the Commission should

eliminate it altogether. FSR commented that the inter-affiliate

exemption should extend to swaps between non-U.S. affiliates, such that

the swaps should not be subject to mandatory clearing or margin

requirements, even if the affiliated parties are financial entities.

Certain commenters stated that the proposed treatment of outward-

facing swaps condition is not necessary to prevent evasion. ISDA &

SIFMA noted that the Commission's existing anti-evasion authority \58\

can address the anti-evasion objectives of the proposed condition, and

the CDEU made a similar argument with respect to the Commission's new

anti-evasion authority under section 721(c) of the Dodd-Frank Act. ISDA

& SIFMA further noted that the Commission should limit application of

its anti-evasion authority to instances where a foreign affiliate

engages in a pattern of back-to-back swaps with the U.S. affiliate and

where neither the affiliates nor the third-party counterparty are

subject to capital regulation.\59\

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\58\ See e.g., Section 2(i)(2) of the CEA (providing authority

to promulgate rules addressing activities outside of the U.S. to

prevent evasion of the Dodd-Frank Act); section 2(h)(4) of the CEA

(requiring the Commission to issue rules to prevent evasion of the

mandatory clearing requirement); section 721(c) of the Dodd-Frank

Act (requiring the Commission to promulgate a rule defining certain

terms to prevent evasion of the Dodd-Frank Act).

\59\ Entities that are subject to capital regulations include

SDs, MSPs, and banking entities subject to prudential regulation.

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Other commenters opposed the proposed treatment of outward-facing

swaps condition based on their view that inter-affiliate swaps

involving non-U.S. affiliates do not pose a risk to the U.S. financial

markets. CDEU commented that the proposed ``comparable and

comprehensive'' condition is not necessary or appropriate to reduce

risk and prevent evasion because, according to CDEU, transactions

between affiliates do not increase systemic risk, regardless of the

location of the affiliate.\60\ ISDA & SIFMA stated that the concern

that foreign inter-affiliate swaps pose risk to the U.S. financial

system is unfounded because internal swaps have no conclusive effect on

systemic risk.\61\

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\60\ CDEU further stated that inter-affiliate swaps do not

create systemic risk.

\61\ Prudential also stated that it does not believe that there

are any additional risk implications of cross-border inter-affiliate

swaps for the U.S. market, to the extent that the market-facing

entity is located in the U.S.

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The Commission has considered these comments, and for the reasons

described below, has determined to retain the treatment of outward-

facing swaps condition to the inter-affiliate exemption, with certain

modifications and amendments, in order to address comments and provide

greater clarity.

i. Prevention of Evasion

As an initial matter, as discussed above, the Commission believes

that the benefits of inter-affiliate swaps for entities in affiliated

groups warrant the Commission's use of its exemptive authority under

section 4(c) of the Act to exclude certain inter-affiliate swaps from

the clearing requirement. However, the Commission must exercise its

exemptive authority in view of the Commission's charge under the CEA to

prevent evasion of the clearing requirement.\62\ The Commission remains

concerned that absent the treatment of outward-facing swaps condition,

the inter-affiliate exemption from clearing may create a ready means

through which some U.S. entities may be able to evade the clearing

requirement. Accordingly, the Commission believes that the treatment of

outward-facing swaps condition to the inter-affiliate clearing

exemption is necessary to address the potential for evasion.

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\62\ See sections 2(h)(4) and 2(i)(2) of the CEA.

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Section 2(h)(4)(A) of the CEA requires that ``the Commission shall

prescribe rules * * * as determined by the Commission to be necessary

to prevent evasions of the clearing requirement under this Act.'' \63\

As the Commission explained in the NPRM, and as AFR also described in

its comments, a broad inter-affiliate exemption from the clearing

requirement could enable entities to evade the clearing requirement

potentially through third-party trades with their foreign affiliates

that are located in jurisdictions that do not have a clearing regime

that is comparable to, or as comprehensive as, the Commission's

clearing requirement. For example, rather than execute a swap opposite

a U.S. counterparty, which would be subject to the clearing

requirements of section 2(h) of the Act, a U.S. entity could execute an

uncleared swap with its foreign affiliate or subsidiary, which could

then execute a swap with a non-affiliated third-party in a jurisdiction

that is either unregulated or does not have a clearing requirement that

is comparable to or as comprehensive as the U.S. clearing requirement.

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\63\ 7 U.S.C. 2(h)(4).

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The Commission disagrees with commenters that suggest that the

treatment of outward-facing swaps condition is not necessary to deter

evasion because the Commission can rely on its general anti-evasion

authority under the CEA or under section 721(c) of the Dodd-Frank Act

to address the Commission's evasion concerns pertaining to the inter-

affiliate exemption. The Commission notes that section 2(h)(4)(A) of

the CEA specifically imposes an obligation on the part of the

Commission to ``prescribe rules'' and ``issue interpretations of

rules'' that are necessary to prevent evasions of the clearing

requirement.\64\ Furthermore, from an enforcement perspective, a

specific regulation provides more transparency to market participants

with respect to the Commission's enforcement program. While the

Commission has ample general authority to prevent evasion of the CEA

and the swaps-related provisions of the Dodd-Frank Act, the Commission

believes it is appropriate to impose the treatment of outward-facing

swaps condition to the inter-affiliate exemption to prevent evasion of

the clearing requirement.

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\64\ Under the authority of sections 2(h)(4)(A), 2(h)(7)(F), and

8a(5) of the CEA, the Commission recently adopted Sec. 50.10 to

prohibit evasions of the requirements of section 2(h) of the CEA,

including the end-user exception or any other exception or exemption

that the Commission may provide by rule, regulation, or order. See

Clearing Requirement Determination at 74317-19.

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In response to ISDA & SIFMA's claim that anti-evasion authority

should only be applied in limited scenarios where there are back-to-

back trades involving affiliates and non-affiliates who are not subject

to capital requirements, the Commission declines to pre-judge the

potential incentives or ways of evading, or complying with, the

Commission's clearing requirement and the inter-affiliate exemption

from clearing. To the extent that ISDA & SIFMA suggest that the

treatment of outward-facing swaps condition should be limited to

transactions involving back-to-back trades where the affiliates and the

respective third-party are subject to capital requirements, the

Commission is not persuaded that the rule should be so narrowly

tailored to address only the scenario ISDA & SIFMA describe. In

particular, the Commission notes that back-to-back transactions may not

serve as the only potential means by which

[[Page 21762]]

affiliates can evade the U.S. clearing mandate, and for that matter,

transfer risk to one another. Accordingly, the Commission does not

believe that the treatment of outward-facing swaps condition should be

limited to the specific circumstances described by ISDA & SIFMA.

ii. Protection of Financial Markets

In addition to preventing evasion, the Commission believes that the

treatment of outward-facing swaps condition will help to limit the

potential transfer of risks to U.S. companies and financial markets

that may result from third-party swaps between affiliates and non-

affiliated entities domiciled in jurisdictions that do not regulate

swaps or where the regulation is not comparable to, or as comprehensive

as, the CEA and Commission regulations. As described in the preceding

sections of this adopting release, there are numerous benefits

associated with central clearing of swaps. In particular, clearing

mitigates counterparty credit risk, provides an organized mechanism for

collateralizing the risk exposures posed by swaps, and when applied on

a market-wide scale, clearing reduces systemic risk. The counterparty

and systemic risk mitigation benefits of central clearing are also

realized from clearing transactions between affiliates.

The benefits of clearing notwithstanding, the Commission recognized

in the NPRM, commenters' assertions that there is less counterparty

risk associated with inter-affiliate swaps than with swaps between

third parties to the extent that the affiliated counterparties that are

members of the same corporate group internalize each other's

counterparty credit risk.\65\ While the Commission recognizes,

generally, the benefits of inter-affiliate swaps and the incentives for

inter-affiliates to fulfill their inter-affiliate swap obligations to

each other, these swaps are not immune from some of the risks that are

associated with swaps between non-affiliated parties.

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\65\ See NPRM at 50427.

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In particular, the Commission is not persuaded that inter-affiliate

swaps, and swaps between affiliate counterparties outside the U.S. and

non-affiliated counterparties, pose no risks to the U.S financial

markets or that central clearing would not mitigate the risks

associated with such swaps. To the contrary, the counterparty and

systemic risks associated with inter-affiliate swaps are heightened

where, for example, the inter-affiliate transaction involves an

uncleared swap with a foreign affiliate counterparty that is

subsequently hedged with a third-party uncleared swap. Thus, the

Commission disagrees with commenters that suggested that inter-

affiliate swaps involving foreign affiliates do not have the potential

to create systemic risk. As the Commission noted in the NPRM, systemic

risk implications may be present where the foreign affiliate has large

inter-affiliate swap positions and enters into related outward-facing

swaps. If the foreign affiliate defaults on its obligations arising

from the inter-affiliate swaps, it then increases the likelihood that

the foreign affiliate could default on the outward-facing swaps,

potentially jeopardizing the financial integrity of the third-party

counterparty. Furthermore, to the extent that a foreign affiliate

enters into both inter-affiliate swaps and related third-party swaps,

any losses incurred by the foreign affiliate with respect to its inter-

affiliate swaps may flow not only to the unaffiliated third-party

counterparty, but conceivably, to the broader financial system.\66\

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\66\ In the Proposed Cross-Border Interpretive Guidance, the

Commission specifically discussed the flow of risk to the U.S. by

entities that facilitate a U.S. person's ability to execute swaps

outside the Dodd-Frank Act regulatory regime. 77 FR 41228-29, 41234.

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Moreover, the Commission notes AFR's comment that inter-affiliate

swaps can, in some circumstances, contribute to financial contagion

across different groups within a complex financial institution, making

it more difficult to contain risks in one part of an organization. As

evidenced by the events surrounding the 2008 financial crisis, many

large financial institutions are interconnected and highly inter-

dependent, with affiliated legal entities that are inextricably linked

to each other.\67\ The interconnected nature of corporate groups,

therefore, increases the potential that risk in any part of a corporate

group may spread throughout the organization, jeopardizing the

financial integrity of not only the U.S affiliate, but depending on the

scope of a potential default, the broader financial system.

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\67\ For a discussion of specific institutional risks leading up

to the 2008 financial crisis, see Proposed Cross-Border Interpretive

Guidance at 41215-16.

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For the aforementioned reasons, the Commission believes that the

risk of evasion of U.S. laws and the potential systemic risk associated

with uncleared inter-affiliate swaps involving foreign affiliates

necessitates that the inter-affiliate exemption include the treatment

of outward-facing swaps condition.

The treatment of outward-facing swaps condition that is being

adopted as part of the inter-affiliate clearing exemption in this final

release is aimed at addressing the potential risks associated with an

eligible foreign affiliate's swaps with non-affiliated counterparties.

As modified, the final rule requires that, as a condition to the inter-

affiliate exemption, each eligible affiliate counterparty must clear

all swaps that it enters into with an unaffiliated counterparty to the

extent that the swap is included in the Commission's clearing

requirement, i.e., in a class of swaps identified in Sec. 50.4.\68\ In

order to satisfy this requirement, eligible affiliate counterparties

must clear their third-party swaps pursuant to the Commission's

clearing requirement or comply with the requirements for clearing the

swap under a foreign jurisdiction's clearing mandate that is

comparable, and comprehensive but not necessarily identical, to the

clearing requirement of section 2(h) of the Act and part 50 of the

Commission's regulations, as determined by the Commission. In addition,

the Commission is modifying the inter-affiliate exemption to allow for

recognition of clearing exceptions and exemptions under the CEA and an

exception or exemption under a foreign clearing mandate provided that

the foreign jurisdiction's clearing mandate is comparable, and

comprehensive but not necessarily identical, to the clearing

requirement of section 2(h) of the Act and part 50 and the foreign

jurisdiction's exception or exemption is comparable to an exception or

exemption under the CEA or part 50, in each instance as determined by

the Commission.

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\68\ Currently, the scope of the Commission's clearing

requirement is limited to four classes of interest rate swaps and

two classes of CDS.

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For eligible affiliate counterparties that are not located in the

U.S. or in a comparable foreign jurisdiction, as determined by the

Commission, the rule permits such eligible affiliates to clear any

outward-facing swap that is required to be cleared under Sec. 50.4

through a registered DCO or a clearing organization that is subject to

supervision by appropriate government authorities in the home country

of the clearing organization and has been assessed to be in compliance

with the Principles for Financial Market Infrastructures (PFMIs).\69\

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\69\ See Principles for Financial Market Infrastructures, April

2012, available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf.

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The Commission believes that this modified formulation of the

treatment of outward-facing swaps condition being adopted as part of

the final rule will

[[Page 21763]]

more clearly establish the conditions to the exemption and alternative

methods by which eligible affiliates may satisfy the requirements.

Moreover, in finalizing the requirement that eligible affiliate

counterparties clear their swaps with unaffiliated counterparties, the

Commission considered the approach adopted in EMIR. Articles 3, 4, and

13 of EMIR generally exempt from clearing OTC derivatives transactions

between intragroup counterparties, where one counterparty is located in

the European Union and the other counterparty is located outside the

European Union, provided that, among other things, the European

Commission determines that the foreign counterparty is established in a

country with ``equivalent'' requirements to EMIR.\70\ By requiring that

a foreign counterparty to an intragroup transaction be located in a

country with equivalent requirements to EMIR, including clearing, any

third-party swaps entered into by either the European Union

counterparty or the non-European Union counterparty would be subject to

a clearing requirement under EMIR or one that is equivalent to that

required under EMIR, respectively.

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\70\ See EMIR Article 13(1)-(3). The European Union has yet to

make determinations as to whether third countries have equivalent

requirements to EMIR. The European Commission (EC) has instructed

the European Securities and Markets Authority (ESMA) to prepare

possible implementing acts concerning the equivalence between the

legal and supervisory frameworks of certain third countries and

EMIR. Pursuant to the EC's instructions, ESMA must make its

determination regarding the United States' clearing requirement by

March 15, 2013. ``Formal Request to ESMA for Technical Advice on

Possible Implementing Acts Concerning Regulation 648/2012 on OTC

Derivatives, Central Counterparties and Trade Repositories (EMIR)''

available at http://www.esma.europa.eu/system/files/formal_request_for_technical_advice_on_equivalence.pdf.

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In addition to the modifications to the treatment of outward-facing

swaps condition described above, the Commission also is providing a

transition period with alternative compliance frameworks, in response

to concerns raised by commenters pertaining to the timing and

sequencing of the implementation of the inter-affiliate exemption,

which are discussed below.

2. Time-limited Alternative Compliance Frameworks

A number of commenters expressed concern with respect to the

``comparable and comprehensive'' requirement of the proposed rule.

Several commenters expressed concern with respect to the timing and

sequencing of the Commission's comparability determination in relation

to the expected compliance date for the initial clearing requirement

under section 2(h) of the Act.\71\ These commenters noted that the

comparability requirement is dependent upon the adoption of clearing

regimes by other jurisdictions, and that because the U.S. clearing

requirement is likely to take effect in advance of other jurisdictions

adopting or finalizing their clearing regimes, non-U.S. affiliates

effectively will not be able to rely on the inter-affiliate exemption

from clearing when the Commission's initial clearing requirement takes

effect. Significantly, ISDA & SIFMA commented that the cross-border

condition may prove to be unnecessary because it is expected that the

major financial jurisdictions will implement their own clearing

regimes. However, ISDA & SIFMA and CDEU noted that questions of timing

and criteria for comparability render the proposed treatment of

outward-facing swaps condition problematic, and that unless the

condition is satisfactorily resolved, the condition could hamper the

ability of U.S.-based groups to compete in foreign markets. ISDA &

SIFMA further commented that if the Commission retains the cross-border

requirements, the Commission should provide an appropriate transition

period in order to allow foreign jurisdictions to implement their own

G-20 mandates.

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\71\ See Clearing Requirement at 74319-21 (discussing the

compliance dates for the first clearing requirement determination).

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The Working Group commented that because no other jurisdiction has

a comparable clearing requirement,\72\ the proposed rule would impose

an obligation on almost all non-U.S. persons to comply with the U.S.

clearing requirement in the event such entities wanted to engage in a

non-hedge swap that was subject to mandatory clearing with a U.S.

person affiliate. The Working Group claimed that this limitation would

render the exemption unusable and questioned the public policy benefit

of extending the clearing requirement in such instances. The Working

Group further commented that the proposed rule represents a broad

extension of U.S. law by, in effect, imposing the clearing requirement

under section 2(h)(1)(A) on non-U.S. persons that enter into swaps with

U.S. person affiliates in order to satisfy the conditions of the inter-

affiliate exemption. AFR supported the comparability condition and

suggested that the Commission should grant the inter-affiliate

exemption only with respect to foreign affiliate swaps once foreign

jurisdictions finalize and implement their own clearing requirements.

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\72\ This assertion is no longer accurate. As discussed below,

Japan has adopted a clearing mandate for certain interest rate swaps

and CDS.

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The Commission recognizes commenters' concerns pertaining to the

timing and sequencing of the inter-affiliate exemption in light of the

Commission's clearing requirement, and in view of the ongoing progress

of other jurisdictions to adopt and implement their respective clearing

regimes. Accordingly, the Commission has determined to modify the

proposed rule, as described in this release.

As an initial matter, and informed in large part by the reports of

relevant international organizations and ongoing dialogue with

international regulators, the Commission believes that many

jurisdictions have made significant progress in implementing their

clearing regimes. It is the Commission's understanding that the G-20

Leaders reaffirmed their commitment that all standardized OTC

derivatives should be cleared through central counterparties by end-

2012.\73\ Importantly, the majority of G-20 members with major

financial markets have been preparing for mandatory clearing, and

significant steps towards further implementation have been taken by the

United States, Japan, Singapore, and the European Union. In Japan, for

example, the Japanese Financial Services Authority (JFSA) cabinet

office ordinance regarding central counterparties and trade

repositories which, among other things, subjects certain transactions

to mandatory central clearing, became effective on November 1, 2012.

The JFSA initially requires certain financial institutions to clear

yen-denominated interest rate swaps that reference Yen-LIBOR, and CDS

based on the Japanese iTraxx indices at a licensed CCP.

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\73\ ``G20 Leaders Declaration Los Cabos Mexico'' (June 18-19,

2012) at paragraph 39. According to the October 2012 Report of the

Financial Stability Board (FSB), 10 out of the 19 members of the G-

20 group have either proposed or adopted legislation and/or

regulations to implement their clearing framework, as of the date of

that release. FSB, OTC Derivatives Market Reforms: Fourth Progress

Report on Implementation, Oct. 31, 2012 at 74-77, available at

https://www.financialstabilityboard.org/publications/r_121031a.pdf.

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On November 15, 2012, the Singapore Parliament passed the

Securities and Futures (Amendment) Bill 2012 to amend the Singapore

Securities and Futures Act (SFA). This bill puts in place the

regulatory regime for OTC derivatives in Singapore. This legislation

institutes mandatory reporting and clearing requirements for financial

entities and large non-financial entities. The Monetary Authority of

[[Page 21764]]

Singapore is deliberating how to implement these legislative

requirements and is expected to issue further consultation in 2013.

In the European Union, EMIR entered into force on August 16, 2012,

and requires the clearing of all OTC derivatives subject to the

clearing obligation. Clearing determinations are made at the initiative

of the national authorities or the European Securities and Markets

Authority (ESMA). Within six months of ESMA receiving notification by a

national authority that a central counterparty has been authorized to

clear a class of OTC derivatives, ESMA must determine whether that the

class of OTC derivatives should be subject to the clearing obligation.

At its own initiative, ESMA can also identify classes of OTC

derivatives that should be subject to the clearing obligation.

Additional details regarding the specific manner in which clearing

determinations will be made have been set forth in implementing

regulations adopted by the European Commission on December 19,

2012.\74\

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\74\ See http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm.

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As evidenced by the progress of these jurisdictions, and others

that host major financial markets across the world in implementing

their clearing frameworks, the Commission agrees with ISDA & SIFMA that

the comparability requirement of the inter-affiliate exemption is

unlikely to pose a significant impediment to the use of the inter-

affiliate exemption by most foreign affiliates because it is expected

that the major financial jurisdictions will implement their own

mandatory clearing regimes. Notwithstanding the progress of other

jurisdictions to implement their clearing regimes, as discussed above,

the Commission is mindful of commenters' concerns that the compliance

timeframe for the clearing requirement in the U.S. is likely to precede

the adoption and/or implementation of the clearing regimes of most

other jurisdictions.

Accordingly, the Commission believes that it is important to

provide for a transition period for foreign regimes to implement their

clearing mandates to bring swaps into clearing. For certain eligible

affiliate counterparties located in jurisdictions that have adopted

swap clearing regimes and are currently in the process of

implementation, namely Japan, the European Union, and Singapore, the

Commission is modifying the proposed rule to allow for a transition

period of one year from the first compliance date of the U.S. clearing

mandate, until March 11, 2014, for those foreign jurisdictions that are

working to implement their mandatory clearing regimes.\75\ The

Commission believes that a transition period of 12 months after

required clearing began in the U.S. is appropriate given its

understanding of the progress being made on mandatory clearing in the

specified foreign jurisdictions. Regulation 50.52(b)(4)(ii)(A) provides

that during that one-year period, affiliates domiciled in such foreign

jurisdictions can satisfy the requirements of Sec. 50.52(b)(4)(i)

through the following: (i) Each eligible affiliate counterparty, or a

majority-interest holder on behalf of both eligible affiliate

counterparties, pays and collects full variation margin daily on all

its swaps with unaffiliated counterparties; or (ii) each eligible

affiliate counterparty, or a majority-interest holder on behalf of both

eligible affiliate counterparties, pays and collects full variation

margin daily on all its swaps with other eligible affiliate

counterparties.

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\75\ While the time-limited alternative compliance framework of

Sec. 50.52(b)(4)(ii) is limited to jurisdictions that currently

have the legal authority to adopt mandatory clearing regimes, any

jurisdiction that later adopts a mandatory clearing regime will be

eligible for a comparability determination for purposes of this

rule.

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Moreover, the Commission has determined to provide further time-

limited relief for certain eligible affiliated counterparties located

in the European Union, Japan, or Singapore from complying with the

requirements of Sec. 50.52(b)(4)(i) (or (b)(4)(ii)(A)) as a condition

of electing the inter-affiliate exemption. In particular, Sec.

50.52(b)(4)(ii)(B) provides that if one of the eligible affiliate

counterparties is located in the European Union, Japan, or Singapore,

the requirements of paragraph (b)(4)(i) will not apply to such eligible

affiliate counterparty until March 11, 2014, provided that two

conditions are met. The first condition provides that the one

counterparty that directly or indirectly holds a majority ownership

interest in the other counterparty or the third party that directly or

indirectly holds a majority ownership interest in both counterparties

is not a ``financial entity'' as defined in section 2(h)(7)(C)(i) of

the Act.\76\ The second condition requires that neither eligible

affiliate counterparty is affiliated with an entity that is an SD or

MSP, as defined in Sec. 1.3. This condition essentially requires that

the eligible affiliate counterparties are not part of a corporate group

with a member affiliate that is an SD or MSP. Accordingly, eligible

affiliate counterparties that are located in European Union, Japan, or

Singapore and meet these two conditions, are exempt from the

requirements of Sec. 50.52(b)(4)(i) until March 11, 2014. The

Commission believes that providing the time-limited exemption in Sec.

50.52(b)(4)(ii)(B) to the specific entities described above is

consistent with comments requesting that the exchange of variation

margin requirement, to the extent retained, be limited to SDs and MSPs.

Specifically, ISDA & SIFMA noted in their comments that the scope of

the Commission's regulatory concern should be limited to SDs and MSPs,

and that the regulatory regime applicable to SDs already contained

applicable safeguards, including variation margin requirements.

Similarly, CDEU commented that any variation margin requirements be

limited to SDs and MSPs.

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\76\ For purposes of meeting the requirements of Sec.

50.52(b)(4)(ii)(B)(1) until March 11, 2014, the holding company

(i.e., the ultimate parent of the corporate group) may not be

considered to be a ``financial entity,'' as defined in section

2(h)(7)(C)(i) of the CEA, under certain circumstances. The holding

company must be able to identify all affiliates that meet the

requirements of Sec. 50.52(a). Of those identified affiliates, a

predominant number must qualify for the end-user exception under

Sec. 50.50. If a predominant number of the affiliates meeting the

requirements of Sec. 50.52(a) qualify for the end-user exception

under Sec. 50.50, then the holding company may treat the activities

of all of its affiliates meeting the requirements of Sec. 50.52(a)

as if the holding company was engaged directly in such activities

and consider such affiliates' activities on a cumulative basis with

the holding company's other activities when assessing whether the

holding company is ``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'' under section 2(h)(7)(C)(i)(VIII) of the CEA. In effect,

the holding company may ``look through'' its investment in

affiliates to all of the activities of the affiliates meeting the

requirements of Sec. 50.52(a). Accordingly, the activities of

affiliates meeting the requirements of Sec. 50.52(a) that are not

in the business of banking or financial in nature, as defined in

section 4(k) of the Bank Holding Company Act of 1956, would be

attributed to the holding company. Conversely, if the affiliates

meeting the requirements of Sec. 50.52(a) are engaged in activities

that are in the business of banking or of a financial nature, then

those activities would be attributed to the holding company for

purposes of determining whether the holding company is a financial

entity for purposes of meeting the requirements of Sec.

50.52(b)(4)(ii)(B)(1).

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For eligible affiliate counterparties that are located in

jurisdictions other than the European Union, Japan or Singapore, the

Commission also is providing another time-limited alternative

compliance framework for meeting the requirements of Sec.

50.52(b)(4)(i). Specifically, Sec. 50.52(b)(4)(iii) provides that if

an eligible affiliate counterparty located in the United States enters

into swaps (that are included in a class of swaps identified in Sec.

50.4), with eligible

[[Page 21765]]

affiliate counterparties located in jurisdictions other than the United

States, the European Union, Japan, and Singapore, and the aggregate

notional value of such swaps, which are included in a class of swaps

identified in Sec. 50.4 does not exceed five percent of the aggregate

notional value of all swaps, which are included in a class of swaps

identified in Sec. 50.4, in each instance the notional value as

measured in U.S. dollar equivalents and calculated for each calendar

quarter, held by the eligible affiliate counterparty located in the

United States, then such swaps shall be deemed to satisfy the

requirements of paragraph (b)(4)(i) until March 11, 2014, provided

that: (A) Each eligible affiliate counterparty, or a third party that

directly or indirectly holds a majority interest in both eligible

affiliate counterparties, pays and collects full variation margin daily

on all swaps entered into between the eligible affiliate counterparties

located in jurisdictions other than the United States, the European

Union, Japan, and Singapore and an unaffiliated counterparty; or (B)

each eligible affiliate counterparty, or a third party that directly or

indirectly holds a majority interest in both eligible affiliate

counterparties, pays and collects full variation margin daily on all of

the eligible affiliate counterparties' swaps with the other eligible

affiliate counterparties.

The options provided under the two alternative compliance

frameworks described above are intended to mitigate the risk associated

with uncleared third-party swaps. The payment and collection of

variation margin is a vital component of the clearing process. As the

Commission noted in the NPRM, variation margin is an essential risk-

management tool that serves both as a check on risk-taking that might

exceed a party's financial capacity and as a limitation on losses when

there is a failure.\77\ In addition to the risk-management benefits of

variation margin, certain commenters expressed support for the

inclusion of variation margin as a condition of the inter-affiliate

exemption, and thus, the inclusion of variation margin within the

alternative compliance frameworks is consistent with those comments.

The Commission further clarifies that eligible affiliate counterparties

that are eligible to comply with the alternative compliance frameworks

in Sec. 50.52(b)(4)(ii) or Sec. 50.52(b)(4)(iii) and choose to pay

and collect variation margin daily on either all of their inter-

affiliate swaps or all of their third party swaps, will have

flexibility in tailoring their daily variation margin arrangements,

including with respect to establishing appropriate prices for purposes

of marking to market and threshold levels at which margin will be

settled.

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\77\ As described in the NPRM, variation margin entails marking

open positions to their current market value each day and

transferring funds between the parties to reflect any change in

value since the previous time the positions were marked. This

process prevents uncollateralized exposures from accumulating over

time and thereby reduces the size of any loss resulting from a

default should one occur. NPRM at 50429.

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Notwithstanding the alternative compliance frameworks, the

Commission encourages all eligible affiliate counterparties to clear

their outward-facing swaps on a voluntary basis in order to best

mitigate the risks associated with those swaps. The Commission notes

that in lieu of complying with the alternative compliance frameworks

through March 11, 2014, eligible affiliate counterparties also may

satisfy the outward-facing swap condition by complying with Sec.

50.52(b)(4)(ii)(E) by clearing their third-party swaps through a

registered DCO or a clearing organization that is subject to

supervision by the appropriate government authorities in the home

country of the clearing organization and has been assessed to be in

compliance with the PFMIs.

The Commission believes that the alternative compliance framework

adopted in this release addresses commenters' concerns pertaining to

the timing and sequencing of the inter-affiliate exemption and the

effective date of the Commission's initial clearing determination, and

incorporates ISDA & SIFMA's recommendation to provide an appropriate

transition period for foreign jurisdictions to implement their clearing

regimes.

In response to The Working Group, the Commission notes that the

treatment of outward-facing swaps condition is needed to protect U.S.

financial markets and to prevent evasion of the clearing requirement.

The modified condition requires that eligible affiliate counterparties,

whether domiciled in the U.S. or in a foreign jurisdiction, that elect

the inter-affiliate exemption must clear their outward-facing swaps, if

such swaps fall within a class identified in Sec. 50.4, or satisfy one

the provisions in the alternative compliance frameworks, as applicable,

until March 11, 2014. The alternative compliance frameworks are a

direct response to concerns raised by The Working Group, and other

commenters, regarding providing other jurisdictions with sufficient

time to implement their clearing regimes. The alternative compliance

framework provides eligible affiliates that elect the inter-affiliate

exemption with other options, in addition to clearing, for managing the

risks associated with their outward-facing swaps. In response to

concerns that foreign-domiciled eligible affiliates would not be able

to enter into uncleared non-hedge swaps with third parties that are

foreign-domiciled end users, the Commission notes that it would take

into consideration any comparable exceptions or exemptions granted

under a comparable foreign jurisdiction's clearing regime.

In response to The Working Group's statement that the treatment of

outward-facing swap condition expands the cross-border application of

the clearing requirement to cover swaps between U.S. persons and non-

U.S. persons, the Commission observes that U.S. persons are subject to

the CEA's clearing requirement and part 50 of the Commission's

regulations. Furthermore, the Commission notes that the final rule

would permit eligible affiliate counterparties that are not located in

the U.S. or in a comparable and comprehensive jurisdiction, to elect

the inter-affiliate exemption provided that they clear any outward-

facing swaps that are required to be cleared under Sec. 50.4, through

a registered DCO or a clearing organization that is subject to

supervision by appropriate government authorities in the home country

of the clearing organization and has been assessed to be in compliance

with the PFMIs.\78\

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\78\ The Commission believes that the use of an international

standard that is substantially similar, though not identical, to the

requirements under part 39 imposed upon DCOs registered with the

Commission is appropriate for purposes of the condition. The PFMIs

were developed with broad participation and comment from entities

from multiple nations and have been approved by both IOSCO's

Technical Committee and the CPSS. The Commission further notes that

eligible affiliate counterparties that are not located in the U.S.

or in a comparable and comprehensive jurisdiction must comply with

the requirements of Sec. 50.52(b)(4)(i)(E). However, if such

entities prefer to clear their swaps pursuant to the clearing

requirement regime in the U.S. or in a jurisdiction that the

Commission has determined to have a comparable clearing requirement,

they also may comply with one of the conditions in Sec.

50.52(b)(4)(i)(A) or (b)(4)(i)(B).

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Although the Commission believes that the alternative frameworks

described above are necessary in the circumstances described, these

alternatives are not equivalent to clearing and would not mitigate

potential losses between swap counterparties in the same manner that

clearing would. Thus, notwithstanding the alternative compliance

frameworks, the Commission believes that the requirement that eligible

affiliates clear

[[Page 21766]]

swaps entered into with non-affiliated counterparties is the most

appropriate method in which to prevent evasion of the clearing

requirement and to help protect U.S. financial markets, and encourages

market participants to do so. As noted above, incorporated within the

requirement that eligible affiliate counterparties clear their outward-

facing swaps is the option to comply with the requirements of a foreign

jurisdiction's clearing mandate for the outward-facing swaps, including

any comparable exception or exemption granted under the foreign

clearing mandate, provided that such foreign jurisdiction's clearing

mandate is determined by the Commission to be comparable, and

comprehensive but not necessarily identical, to the clearing

requirement established under the CEA, and the exception or exemption

is determined by the Commission to be comparable to an exception or

exemption provided under the CEA or part 50.

In the next section of the release, the Commission describes the

specific comments raised with respect to the proposed ``comparable and

comprehensive'' standard and provides a discussion of the its

consideration of these comments, as well as an explanation of the

Commission's anticipated process for reviewing and issuing

comparability determinations in the context of the inter-affiliate

exemption from clearing.

3. Application of the Comparable and Comprehensive Standard to

Mandatory Clearing

Commenters raised questions as to the criteria the Commission would

consider in rendering a comparability determination. ISDA & SIFMA

requested that the Commission clarify that ``comparability'' does not

mean that the host country must have the ``same'' requirement. CDEU

questioned what specific criteria the Commission would consider in

making a comparability finding. CDEU recommended that the Commission

limit the applicability of the comparability requirement to SDs and

MSPs, and claimed that extending the condition to end-users would

disproportionately impact end-users that have global operations,

particularly in emerging markets.\79\ CDEU further suggested that the

Commission extend the inter-affiliate exemption to non-U.S. affiliates

that enter into 20 or less third-party swaps per month. The Working

Group noted that many commercial energy firms have operations in

foreign jurisdictions that have less commercially robust financial

markets than those in the U.S., and that the treatment of outward-

facing swaps condition may place significant limitations on the ability

of commercial enterprises to hedge risk associated with such

operations, thereby resulting in higher cost of doing business in the

foreign country or decreasing the business activity of the U.S. company

in the foreign jurisdiction. The Working Group further commented that

the proposed rule extends the reach of U.S. law on non-U.S. persons

``far beyond'' the immediate clearing requirement.\80\

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\79\ CDEU claimed that end users would be adversely impacted by

the increased costs for risk-mitigating transactions between

affiliates, and noted that the Dodd-Frank Act did not contemplate

regulation of end-user transactions in the same manner as SD and MSP

transactions.

\80\ According to The Working Group, the proposed rule, for

instance, would require certain non-U.S. persons to enter into an

agreement with a futures commission merchant (FCM), and to enter

into a commercial relationship in the U.S. including posting capital

in U.S. markets that would subject such entities to U.S. bankruptcy

law.

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AFR suggested that the final rule should specifically state that

the ``comparable and comprehensive'' requirement must apply to each

``specific type of swap'' being considered for the exemption. AFR

further stated that the Commission should provide a detailed

comparability procedure, such as the procedure described in the

proposed cross-border guidance. MetLife also suggested that rather than

broadly prohibiting non-U.S. affiliates (that are not located in a

comparable jurisdiction) from entering into any third-party swaps as a

condition of the inter-affiliate exemption, the Commission should

narrow the prohibition in the proposed rule to prohibit non-U.S.

affiliates (that are not located in a comparable jurisdiction) from

entering into ``similar swaps of the same product type'' with

unaffiliated third parties.

As described above, a number of commenters requested further

clarification on how the Commission will apply the ``comparable and

comprehensive'' standard in the context of the mandatory clearing. The

comparability requirement originally was discussed in the Commission's

Proposed Cross-Border Interpretive Guidance. Drawing on its experience

in exempting foreign brokers from certain registrations requirements

under its rule 30.10 ``comparability'' determinations, the Commission

proposed the ``comparable and comprehensive'' concept in the Proposed

Cross-Border Interpretive Guidance \81\ in order to permit certain

classes of non-U.S. registrants to substitute compliance with the

requirements of its home jurisdiction's law and regulations, in lieu of

compliance with the CEA and the Commission's regulations, if the

Commission finds that the relevant jurisdiction's laws and regulations

are comparable to the relevant requirements of the CEA and Commission

regulations.\82\

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\81\ Proposed Cross-Border Interpretive Guidance at 41232-35.

\82\ The Proposed Cross-Border Interpretive Guidance identified

transaction-level requirements to include mandatory clearing and

swap processing, margining, segregation, trade execution, swap

trading documentation, portfolio reconciliation and compression,

real time public reporting, trade confirmation, and daily trading

records requirements. The Proposed Cross-Border Interpretive

Guidance proposed to allow substituted compliance with respect to

transaction level requirements for swaps between a non-U.S. SD or

non-U.S. MSP with a non-U.S. person that is guaranteed by a U.S.

person, as well as swaps with non-U.S. affiliate conduits. See

Proposed Cross-Border Interpretive Guidance at 41230.

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In the Proposed Cross-Border Interpretive Guidance, the Commission,

in describing its intended approach to making comparability

determinations, noted that similar to its policy with respect to rule

30.10, the Commission would retain broad discretion to determine that

the objectives of any program elements are met, notwithstanding the

fact that the foreign requirements may not be identical to that of the

Commission.

i. Comparability of Foreign Clearing Mandate

In response to comments seeking additional clarity around the

Commission's comparability determination process, the Commission

clarifies that it will review the comparability and comprehensiveness

of a foreign jurisdiction's clearing mandate under Sec.

50.52(b)(4)(i)(B) by reviewing: (i) The foreign jurisdiction's laws and

regulations with respect to its mandatory clearing regime (i.e.,

jurisdiction-specific review), and (ii) the foreign jurisdiction's

clearing determinations with respect to each class of swaps for which

the Commission has issued a clearing determination under Sec. 50.4 of

the Commission's regulations (i.e., product-specific review).

As noted above, and in response to ISDA & SIFMA, the Commission

reiterates that for purposes of the treatment of outward-facing swaps

condition of the inter-affiliate exemption, comparability findings with

respect to a foreign jurisdiction's clearing regime will not require an

identical regime to the clearing framework established under the Act

and Commission regulations. Rather, the Commission anticipates that it

will

[[Page 21767]]

make jurisdiction-specific comparability determinations by comparing

the regulatory requirements of a foreign jurisdiction's clearing regime

with the requirements and objectives of the Dodd-Frank Act. Notably,

the Commission anticipates that the product-specific comparability

determination will necessarily be made on the basis of whether the

applicable swap is included in a class of swaps covered under Sec.

50.4, and if so, whether such swap or class of swaps is covered under

the foreign jurisdiction's clearing mandate.

ii. Comparability of Exemption or Exception Under Foreign Clearing

Regime

With respect to determining whether an exemption or exception under

a comparable foreign clearing mandate is comparable to an exception or

exemption under the CEA or part 50, as provided under Sec.

50.52(b)(4)(i)(D), the Commission anticipates that it would review for

comparability purposes the foreign jurisdiction's laws and regulations

with respect to its mandatory clearing regime, as well as the relevant

exception or exemption. In doing so, the Commission would exercise

broad discretion to determine whether the requirements and objectives

of such exemption or exception are consistent with those under the

Dodd-Frank Act and that such objectives are being met, notwithstanding

the fact that the exemption or exception from clearing under the

comparable foreign clearing regime may not be identical to those

established under the Act or the Commission's regulations. Accordingly,

the Commission anticipates that comparability determinations with

respect to a foreign jurisdiction's exemption or exception from

mandatory clearing could be made at either the entity level, or the

transaction type, as appropriate.

iii. Responses to Additional Comments

In response to comments seeking clarification on what will trigger

a Commission comparability determination, the Commission anticipates

that it will render jurisdiction-specific and product-specific

comparability determinations upon the adoption of clearing regimes by

foreign jurisdictions for classes of swaps covered under Sec. 50.4,

upon the request of a counterparty that is located in a foreign

jurisdiction, or upon receipt of a request from another appropriate

party.

The Commission further anticipates that once a comparability

determination is made with respect to the foreign jurisdiction's

clearing regime, and with regard to a particular class of swaps covered

under Sec. 50.4, eligible affiliates domiciled in such jurisdiction

may rely on such determinations for swaps included within the

applicable class, without further Commission action. To the extent that

the Commission proposes a change to its regulations governing the

clearing requirement generally or with respect to any particular

product class, the Commission will reevaluate whether the proposed

regulatory change would affect the basis upon which the Commission made

the comparability determination. To the extent that there are

discrepancies in the requirements between the foreign jurisdiction and

the Commission's proposed regulatory change, the Commission anticipates

that it would issue additional guidance or notifications to market

participants to determine how affected entities can address any

discrepancy in requirements.

The Commission declines to limit the condition that eligible

affiliates clear their outward-facing swaps to SDs and MSPs, as

suggested by CDEU. As explained throughout this release, the Commission

believes that the requirements of Sec. 50.52(b)(4) are necessary to

prevent evasion of the clearing requirement and to protect U.S.

financial markets. Moreover, the requirements of section 2(h)(1)(A)

apply to all market participants not able to elect an exception under

section 2(h)(7) of the CEA, not just to SDs and MSPs. The Commission

believes that the modified rule and time-limited alternative compliance

frameworks adopted in the final rule will provide end users, amongst

others, with substantial flexibility to comply with the conditions of

the exemption. Furthermore, the Commission notes that end users also

may elect the end-user exception from clearing for hedging transactions

that comply with the requirements of the CEA and Sec. 50.50.

For the reasons described in this release, the Commission is

adopting in Sec. 50.52(b) the conditions to the inter-affiliate

exemption, initially proposed as Sec. 39.6(g)(2)(v), pertaining to

swaps entered into with unaffiliated counterparties, with the

modifications described above.

H. Reporting Requirement and Annual Election

In the NPRM, the Commission explained that general reporting

requirements under sections 2(a)(13) and 4r of the CEA and part 45

apply to uncleared inter-affiliate swaps.\83\ In addition, the proposed

regulations require the reporting counterparty to provide, or cause to

be provided, to a registered SDR, or if no registered SDR is available,

to the Commission, certain additional information. Proposed Sec.

39.6(g)(4)(i) requires the reporting counterparty to confirm that both

counterparties to the inter-affiliate swap are electing not to clear

the swap and that both counterparties meet the requirements in proposed

Sec. 39.6(g)(1)-(2). Proposed Sec. 39.6(g)(4)(ii) requires the

reporting counterparty to submit information regarding how the

financial obligations of both counterparties are generally satisfied

with respect to uncleared swaps. Proposed Sec. 39.6(g)(4)(iii)

implements section 2(j) of the CEA for purposes of the inter-affiliate

exemption. Section 2(j) of the CEA applies to an issuer of securities

registered under section 12 of the Securities Exchange Act of 1934

(Exchange Act) \84\ or an entity required to file reports under

Exchange Act section 15(g) (``electing SEC Filers'') that elects an

exemption from the CEA's clearing requirement under section 2(h)(1)(A)

of the CEA. Section 2(j) requires that an appropriate committee of the

electing SEC Filer's board or governing body review and approve its

decision to enter into swaps subject to an exemption clearing. Proposed

Sec. 39.6(g)(4)(iii)(A) requires an electing SEC Filer to notify the

Commission of its SEC Filer status by submitting its SEC Central Index

Key number. In addition, proposed Sec. 39.6(g)(4)(iii)(B) requires the

counterparty to report whether an appropriate committee of its board of

directors (or equivalent governing body) has reviewed and approved the

decision to enter into the inter-affiliate swaps that are exempt from

clearing.\85\

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\83\ See NPRM at 50432.

\84\ 15 U.S.C. 78l.

\85\ The proposed requirements under regulations implementing

section 2(j) mirror the requirements that the Commission finalized

in its end-user exception rulemaking, End-User Exception to the

Clearing Requirement for Swaps, 77 FR 42560.

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Lastly, proposed Sec. 39.16(g)(5) permits a counterparty to

provide information related to how it generally meets its financial

obligations and information related to its status as an electing SEC

Filer on an annual basis in anticipation of electing the inter-

affiliate clearing exemption for one or more swaps. This election is

effective for inter-affiliate swaps entered into within 365 days

following the date of such reporting. During the 365-day period, the

affiliate counterparty would be required to amend the information as

necessary to

[[Page 21768]]

reflect any material changes to the reported information. Under the

proposal, confirmation that both counterparties are electing not to

clear the swap and that they both satisfy the other requirements of the

exemption would not be subject to an annual filing, but must be done on

a swap-by-swap basis.

The Commission received several comments in response to the

reporting obligations of affiliates. Prudential and MetLife both

commented that the Commission should clarify that only one counterparty

is required to report the swap to an SDR. In addition, both Prudential

and MetLife stated that annual reporting is more efficient than swap-

by-swap reporting.

EEI stated that the Commission should eliminate the transaction-by-

transaction reporting requirement under proposed Sec. 39.6(g)(4)(i)

for the election of the exemption and confirmation that the conditions

have the exemption have been met. Instead, EEI recommended that one of

the affiliates be permitted to file an annual notice on behalf of both

affiliates to exempt all of their swaps from clearing for an entire

year. EEI contended that it will increase costs if both affiliates have

to communicate that they elect not to clear the swap and meet the

conditions of the exemption for each swap. EEI also stated that the

Commission should state that part 45 does not apply to inter-affiliate

swaps because the Commission will be able to obtain information

regarding an inter-affiliate transaction based on reporting of a

corresponding market-facing swap.\86\

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\86\ EEI cited to a statement in the NPRM's consideration of

costs and benefits as support for an argument that the Commission

did not intend for part 45 reporting to apply to inter-affiliate

swaps. See NPRM at 50433. The statement in the cost-benefit

consideration of the NPRM merely drew a comparison between the

reporting requirements under the proposed exemption and the general

reporting requirements under parts 45 and 46, and those reporting

requirements applicable to SDs and MSPs under part 23. The statement

should not be read as calling into question the applicability of

part 45 to inter-affiliate swaps.

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CDEU also objected to reporting any information to an SDR on a

trade-by-trade basis for inter-affiliate swaps as such reporting would

be costly and onerous for parties. Instead, CDEU recommended that all

reporting be done on an annual basis through a board resolution.\87\

CDEU also requested that part 45 data be reported on a quarterly basis

for all inter-affiliate swaps between financial and non-financial end

users, and that inter-affiliate swaps not be subject to historical swap

reporting under part 46. Similarly, Cravath asked that the Commission

``provide meaningful relief from the reporting requirements of Part 45

and Part 46.''

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\87\ Cravath stated that the Commission has determined that part

43 reporting does not apply to inter-affiliate swaps.

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DLA Piper commented that the regulatory reporting requirements are

unnecessary for inter-affiliate swaps and should be eliminated.\88\ DLA

Piper claimed that the reporting of both the outward-facing swap and

the inter-affiliate swap would increase systemic risk by distorting the

risk to the financial system. DLA Piper also commented that the

imposition of recordkeeping obligations with respect to inter-affiliate

swaps would result in significant additional burdens on corporate

groups. DLA Piper stated that inter-affiliate swaps should be expressly

exempt from the part 45 and part 46 reporting requirements.

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\88\ According to its comment letter, DLA Piper's comments are

limited to corporate end-users who enter into intercompany hedging

transactions.

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Under sections 2(a)(13) and 4r of the CEA, all swaps must be

reported to an SDR (or the Commission if there is no available SDR) and

are subject to comprehensive recordkeeping obligations.\89\ Reporting

and recordkeeping obligations apply to both historical swaps \90\ and

those swaps executed after the applicable compliance date listed in

part 45 of the Commission's regulations.\91\ As indicated in the

preamble to the final end-user exception \92\ and the NPRM,\93\ parts

45 and 46 of the Commission's regulations apply to inter-affiliate

swaps.\94\ Whether an inter-affiliate swap is subject to the part 43

real-time reporting rules will depend on whether the transaction fits

within the definition of a ``publically reportable swap transaction.''

\95\

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\89\ See 17 CFR part 45; 17 CFR 45.2 (recordkeeping

obligations); Swap Data Recordkeeping and Reporting Requirements, 77

FR 2136 (Jan. 13, 2012); 17 CFR part 46; Swap Data Recordkeeping and

Reporting: Pre-Enactment and Transition Swaps, 77 FR 35200 (June 12,

2012).

\90\ As described in the part 46 rules, historical swaps include

pre-enactment swaps, that is, swaps still in existence after the

date of enactment of the Dodd-Frank Act, and transition swaps, that

is, swaps entered into on or after the date of enactment but before

the compliance date specified in part 45 and other no-action or

regulatory guidance issued by the Commission or one of the

Commission's divisions or offices.

\91\ These reporting obligations may be subject to no-action or

other regulatory guidance issued by the Commission or any of the

Commission's divisions or offices. See www.cftc.gov for a complete

list of the staff no-action letters, Frequently Asked Questions, and

other regulatory guidance.

\92\ See End-User Exception to the Clearing Requirement for

Swaps, 77 FR 42567 (``Congress did not exempt such inter-affiliate

swaps from the reporting requirements'' and ``inter-affiliate swaps

must be reported'').

\93\ NPRM at 50432 (noting that section 4r applies to uncleared

swaps and that counterparties must comply with proposed rule

39.6(g)(4) ``[i]n addition to any general reporting requirements

applicable under other applicable rules'').

\94\ In addition, under part 45 non-SDs and MSPs must keep

``full, complete, and systematic records, together with all

pertinent data and memoranda, with respect to each swap in which

they are a counterparty.'' 17 CFR 45.2(b). These recordkeeping

obligations applied to inter-affiliate swaps as early as October 14,

2010. See Interim Final Rule for Reporting Pre-Enactment Swap

Transactions, 75 FR 63090 (Oct. 14, 2010). Thus, as of the date of

this release, swap counterparties already have an obligation to

maintain swap records that has existed for more than two years.

\95\ See 17 CFR 43.2 (defining ``publicly reportable swap

transaction'' as an executed swap that is an arm's length

transaction between two parties that results in a change in the

market risk position between the two parties and citing ``internal

swaps between one-hundred percent owned subsidiaries of the same

parent entity'' as an example of a swap that does not meet the

definition); see also Real-Time Public Reporting of Swap Transaction

Data, 77 FR 1182, 1187 (Jan. 9, 2012) (discussing the real-time

public reporting of inter-affiliate swaps).

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In response to commenters' requests, the Commission is clarifying

that the reporting obligations under Sec. 39.6(g)(2)(i) (now Sec.

50.52(c)) can be fulfilled by one of the affiliate counterparties on

behalf of both counterparties. The selection of which affiliate will be

considered to be the reporting counterparty should be determined in

accordance with the provisions of Sec. 45.8 and, for part 43, the

reporting party under Sec. 43.3(a)(3).

As noted in the NPRM, the Commission believes that affiliates

within a corporate group may make independent determinations on whether

to submit an inter-affiliate swap for clearing. Given the possibility

that each affiliate may reach different conclusions regarding clearing

the swap, Sec. 39.6(g)(2)(i) would require that both counterparties

elect the proposed inter-affiliate clearing exemption. The Commission

is therefore adopting the electing requirement as proposed.

With regard to comments recommending that all reporting be done on

an annual basis rather than a swap-by-swap basis, the Commission

declines to modify the rule. The Commission believes it is appropriate

to provide for annual reporting of certain information, including how

affiliates generally meet their financial obligations and information

related to its status as an electing SEC Filer.\96\ However, it would

not be appropriate to allow one annual report to cover both

[[Page 21769]]

affiliate counterparties' election of the exemption from clearing and

the confirmation that both affiliates meet the conditions of the

exemption because each affiliate is under an ongoing obligation to

demonstrate its eligibility to claim the exemption and because

effective regulatory monitoring requires an indication of the election

on a swap-by-swap basis.\97\ Accordingly, the election of the exemption

and the confirmation that the exemption's conditions are met must be

made for each swap. The Commission does not believe that this reporting

requirement will impose a significant burden on affiliate

counterparties because, as discussed above, other detailed information

for every swap must be reported under sections 2(a)(13) and 4r of the

CEA and Commission regulations. This approach comports with the

approach adopted for market participants claiming the end-user

exception under section 2(h)(7) of the CEA.\98\

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\96\ The Commission is modifying the proposed reporting

requirements relating to section 2(j) of the CEA to make them

consistent with the approach adopted in the end-user exception to

required clearing. As finalized, under Sec. 50.52(c)(3)(ii), the

committee of the board of directors (or equivalent body) of the

eligible affiliate counterparty must have ``reviewed and approved

the decision to enter into swaps that are exempt from the

requirements of sections 2(h)(1) and 2(h)(8) of the Act.''

\97\ If reports to the SDR were made on an annual basis, but

included swap-by-swap information, regulators would not be able to

monitor the transmission of risk through the market in a timely

fashion. Regulators would have a one-year lag before such data could

be used effectively for such purposes. If reports to the SDR were

made on an annual basis and did not include swap-by-swap

information, the regulators would be permanently hindered in their

ability to monitor the swap markets. As noted above, inter-affiliate

swaps and outward-facing swaps both transfer risk, but they do so in

different ways and in differing degrees. Regulators must be able to

distinguish between inter-affiliate swaps and outward-facing swaps

in order to monitor markets effectively. If electing entities

provided an annual statement that they are electing the exemption,

and do not identify the individual swaps for which the exemption has

been elected, the data would not allow regulators to distinguish

between the two groups.

\98\ See End-User Exception to the Clearing Requirement for

Swaps, 77 FR 42565-66.

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The Commission does not agree with EEI's comment that the

Commission will be able to obtain information on inter-affiliate swaps

from the information reported on market-facing swaps, and disagrees

with DLA Piper's comment that reporting and recordkeeping obligations

are unnecessary or would increase systemic risk. The reporting and

recordkeeping requirements promote accountability and transparency, and

will aid the Commission in monitoring compliance with the inter-

affiliate exemption. Moreover, the Commission does not believe that the

information relating to inter-affiliate swaps will necessarily be

identical to market-facing swaps. Also, the Commission does not believe

that all inter-affiliate swaps will match up to market-facing swaps

because, as The Working Group commented, entities use inter-affiliate

trades to transfer physical commodity or futures exposure between

affiliates for compliance with international tax law, customs, or

accounting laws.

I. Implementation

The clearing requirement under section 2(h)(1)(A) of the CEA and

part 50 of the Commission's regulations shall not apply to a swap

executed between affiliated counterparties that have the status of

eligible affiliate counterparties, as defined in Sec. 50.52(a), and

elect not to clear such swap until the effective date of this

rulemaking. The effective date of this rulemaking shall be 60 days

after publication in the Federal Register.

III. Cost-Benefit Considerations

A. Statutory and Regulatory Background

Section 15(a) of the CEA \99\ 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.

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\99\ 7 U.S.C. 19(a).

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Prior to the passage of the Dodd-Frank Act, swaps were not required

to be cleared. In the wake of the financial crisis of 2008, Congress

adopted the Dodd-Frank Act, which, among other things, amends the CEA

to impose a clearing requirement for swaps based on determinations by

the Commission regarding which swaps are required to be cleared through

a DCO.\100\ This clearing requirement is designed to reduce

counterparty risk associated with swaps and, in turn, mitigate the

potential systemic impact of such risk and reduce the risk that swaps

could cause or exacerbate instability in the financial system.\101\ In

amending the CEA, however, the Dodd-Frank Act preserved the

Commission's authority to ``promote responsible economic or financial

innovation and fair competition'' by exempting any transaction or class

of transactions, including swaps, from select provisions of the

CEA.\102\ For reasons explained above,\103\ the Commission proposes to

exercise its authority under section 4(c)(1) of the CEA to exempt

inter-affiliate swaps--that is, swaps between majority-owned affiliates

with financial statements that are reported on a consolidated basis

under GAAP or IFRS--from the clearing requirement under section

2(h)(1)(A) of the CEA, subject to certain conditions.

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\100\ See section 2(h)(1) of the CEA, 7 U.S.C. 2(h)(1).

\101\ 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.

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.

\102\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1). Section

4(c)(1) is discussed in greater detail above in Section II.A.

\103\ See Section II.A above.

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In the discussion that follows, the Commission considers the costs

and benefits of the inter-affiliate exemption to the public and market

participants generally. The Commission also separately considers the

costs and benefits of the conditions placed on affiliates that would

elect the exemption: (1) Majority ownership and financial statements

that are reported on a consolidated basis under GAAP or IFRS as

conditions for status as an eligible affiliate counterparty; (2) swap

trading relationship documentation, which would require affiliates to

document in writing all terms governing the trading relationship; (3)

centralized risk management requirement, which would require affiliates

to subject the swap to centralized risk management; and (4) reporting

requirements, which would require counterparties to advise an SDR, or

the Commission if no SDR is available, that both counterparties elect

the inter-affiliate clearing exemption and to identify the types of

collateral used to meet financial obligations. In addition to the

foregoing reporting requirements, counterparties that are issuers of

securities registered under section 12 of the Securities Exchange Act

of 1934 or those that are required to file reports under section 15(d)

of that Act, would be required to identify the SEC central index key

number and confirm that an appropriate committee of board of directors

has approved of the affiliates' decision not to clear a swap. The rule

also would permit affiliates to report certain information on an annual

basis, rather

[[Page 21770]]

than swap-by-swap. Finally, the Commission considers the costs and

benefits of the condition regarding the treatment of outward-facing

swaps.

In the NPRM, where reasonably feasible, the Commission sought to

estimate quantifiable dollar costs. In some instances, however, the

Commission explained that certain costs were not susceptible to

meaningful quantification, and in those instances, the Commission

discussed proposed costs and benefits in qualitative terms. As stated

above, the Commission received a total of 14 comment letters following

the publication of the NPRM, many of which strongly supported the

proposed regulations. Some commenters generally addressed the cost-and-

benefit aspect of the current rule; none of them, however, provided any

quantitative data in response to the Commission's requests for

comment.\104\

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\104\ As discussed further below, EEI commented on the NPRM's

consideration of costs and benefits and stated that the costs of the

proposed documentation requirement are unjustified. The NPRM

included an estimate that there would be a one-time cost of $15,000

to develop appropriate documentation for use by an entity's

affiliates. EEI objected to this estimate because, in its view, the

legal costs associated with individually negotiating and amending

standard agreements between individual affiliates would exceed the

NPRM's estimates. In addition, EEI objected to the NPRM's estimate

of 22 affiliated counterparties for each corporate group as ``far

too low'' for U.S. energy companies. However, EEI did not provide

specific, quantitative information in terms of either the legal

costs of complying with the proposed documentation requirement or

number of affiliates for a corporate group subject to this rule.

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In the sections that follow the Commission considers: (1) Costs and

benefits of the exemption for eligible affiliate counterparties; (2)

costs and benefits of the exemption for market participants and the

public; (3) alternatives contemplated by the Commission and the costs

and benefits relative to the approach adopted herein; (4) the impact of

exemption in light of the 15(a) factors. The Commission also discusses

the corresponding comments accordingly.

B. Costs and Benefits of Exemption for Eligible Affiliate

Counterparties

Without the final rule exempting swaps between certain affiliated

counterparties, those entities would have to clear their inter-

affiliate swaps pursuant to section 2(h)(1)(A) of the CEA (unless one

of the affiliates is able to claim an exception under section 2(h)(7)

of the CEA and/or Sec. 50.50).\105\ This rule allows eligible

affiliates to exempt inter-affiliate swaps from clearing, which creates

both costs and benefits for those entities. Regarding costs, by

allowing affiliates not to clear certain swaps that would otherwise be

subject to required clearing, the rule may allow those affiliates to be

exposed to greater measures of counterparty credit risk with respect to

one another. On the other hand, the primary benefit of providing this

exemption for inter-affiliate swaps between eligible affiliate

counterparties is that each affiliate will not have to incur the costs

of required clearing. These costs include clearing fees, as well as

costs associated with margin and capital requirements. The rule also

facilitates affiliates' use of swaps to hedge various types of risk

more efficiently.

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\105\ Under the Sec. 50.50 exception, end users and small

financial institutions that are hedging or mitigating commercial

risk may elect not to clear their swaps, subject to certain

conditions. Because of this exception, as explained in the NPRM, the

Commission anticipates that the inter-affiliate exemption will be

elected only when the two counterparties are financial entities that

do not qualify for the end-user exception. See NPRM at 50426.

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1. Benefits of Clearing Inter-Affiliate Swaps

The benefits of required clearing have been well-documented by the

Commission.\106\ As described in the preceding sections of this

adopting release, there are numerous benefits associated with central

clearing of swaps. In particular, clearing mitigates counterparty

credit risk, provides an organized mechanism for collateralizing the

risk exposures posed by swaps, and when applied to channels where

systemic risk could be transmitted, clearing reduces systemic risk.

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\106\ See e.g., Clearing Requirement Determination at 74329.

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The counterparty and systemic risk mitigation benefits of central

clearing also are realized from clearing transactions between

affiliates. Central clearing would ensure that inter-affiliate swaps

are fully documented and abide by valuation procedures set by the DCO,

which would help to ensure that affiliates have current and accurate

information regarding the value of their positions and would help

prevent the possibility of valuation disputes.\107\ In addition, when a

bilateral swap is cleared, the clearinghouse becomes the counterparty

to each of the original counterparties to the swap. This reduces and

standardizes the counterparty risk borne by each of the original

parties to the swap.\108\ Moreover, clearing mitigates the risk of

financial contagion because the clearinghouse serves as a sort of

``buffer'' that protects each of the original counterparties from the

credit risk of the other. This would also be true for inter-affiliate

swaps. Novating the swap to a clearinghouse so that each affiliate

faces the clearinghouse would ensure that each affiliate is facing

minimal counterparty credit risk and would minimize the possibility of

inter-affiliate swaps becoming a mechanism through which financial

instability could pass from one affiliate to another.

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\107\ ISDA & SIFMA stated that valuation and dispute resolution

procedures would appear to serve little purpose among majority-owned

affiliates. This comment is discussed above in Section II.D, as well

as in Section III.C.2. below.

\108\ A clearinghouse is one of the most credit-worthy

counterparties available in the market because of the panoply of

risk management tools it has at its disposal. These tools include

the contractual right to: (1) Collect initial and variation margin

associated with outstanding swap positions; (2) mark positions to

market regularly (usually one or more times per day) and issue

margin calls whenever the margin in a customer's account has dropped

below predetermined levels set by the DCO; (3) adjust the amount of

margin that is required to be held against swap positions in light

of changing market circumstances, such as increased volatility in

the underlying; and (4) close out the swap positions of a customer

that does not meet margin calls within a specified period of time.

Moreover, in the event that a clearing member defaults on their

obligations to the DCO, the latter has a number of remedies to

manage associated risks, including transferring the swap positions

of the defaulted member, and covering any losses that may have

accrued with the defaulting member's margin and other collateral on

deposit. In order to transfer the swap positions of a defaulting

member and manage the risk of those positions while doing so, the

DCO has the ability to: (1) Hedge the portfolio of positions of the

defaulting member to limit future losses; (2) partition the

portfolio into smaller pieces; (3) auction off the pieces of the

portfolio, together with their corresponding hedges, to other

members of the DCO; and (4) allocate any remaining positions to

members of the DCO. In order to cover the losses associated with

such a default, the DCO would typically draw from (in order): (1)

The initial margin posted by the defaulting member; (2) the guaranty

fund contribution of the defaulting member; (3) the DCO's own

capital contribution; (4) the guaranty fund contribution of non-

defaulting members; and (5) an assessment on the non-defaulting

members. These mutualized risk mitigation capabilities are largely

unique to clearinghouses, and help to ensure that they remain

solvent and creditworthy swap counterparties even when dealing with

defaults by their members or other challenging market circumstances.

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This rule reduces these benefits by allowing affiliates to exempt

swaps from required clearing. In the absence of clearing, affiliated

entities will not be required to collect initial or variation margin,

or to implement other measures that clearinghouses typically use to

mitigate their own counterparty credit risk. As a consequence, the

affiliates may accumulate large outstanding positions with one another

as the value of their swap positions change value between payment

dates. If an affiliate with large, out-of-the-money, inter-affiliate

swap positions defaulted, it could cause financial instability in its

affiliates, leading to a cascading series of defaults among them. As

discussed below, the Commission expects that internalization of costs

and risks among

[[Page 21771]]

affiliated entities, as well as the conditions for electing the

exemption will mitigate this cost, but will not eliminate it entirely.

2. Reduced Clearing Costs

As stated above, by exempting qualified affiliates from clearing

inter-affiliate swaps that would otherwise be subject to the clearing

requirement, the rule ensures that each affiliate will not incur the

costs of required clearing for those swaps. These costs include

clearing fees as well as costs associated with margin and capital

requirements. Regarding clearing fees, assuming that the affiliated

counterparties cannot clear on their own behalves or through an

affiliated clearing member of a DCO, the affiliated counterparties

would have to arrange to clear their swaps through a futures commission

merchant (FCM) that is a member of a DCO. Regardless of whether the

affiliated counterparties clear on their own behalf or contract with an

FCM, they will incur fees from the DCO.

For customer clearing, DCOs typically charge FCMs an initial

transaction fee for each customer swap that is cleared, as well as an

annual maintenance fee for each of the customers' open positions. For

example, not including customer-specific and volume discounts, the

transaction fees for interest rate swaps at CME range from $1 to $24

per million notional amount and the maintenance fees are $2 per year

per million notional amount for open positions.\109\ LCH transaction

fees for interest rate swaps range from $1 to $20 per million notional

amount, and the maintenance fee ranges from $5 to $20 per swap per

month, depending on the number of outstanding swap positions that an

entity has with the DCO.\110\ It is within the FCM's discretion to

determine whether or how to pass these fees on to their customers.\111\

Accordingly, allowing affiliates to elect not to clear swaps that meet

the requirements of the final rule will result in the affiliates not

having to pay clearing-related fees, either directly or indirectly,

with respect to those swaps.

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\109\ See CME pricing charts at: http://www.cmegroup.com/trading/cds/files/CDS-Fees.pdf; http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Customer-Fee.pdf; and http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Self-Clearing-Fee.pdf.

\110\ See LCH pricing for clearing services related to OTC

interest rate swaps at: http://www.lchclearnet.com/swaps/swapclear_for_clearing_members/fees.asp.

\111\ See discussion of clearing fees in the Clearing

Requirement Determination, 77 FR 74324-25.

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Second, permitting an exemption from clearing for swaps between

affiliates, the final rule will reduce the amount of initial margin

that such entities are required to post or pay for those swaps. In the

clearing requirement determination, the Commission estimated that if

every interest rate swap and CDS that is not currently cleared were

moved into clearing, the additional initial margin that would need to

be posted is approximately $19.2 billion for interest rate swaps and

$53 billion for CDS.\112\ While the estimates provided by the

Commission in its clearing requirement determination adopting release

did not include data related to inter-affiliate swaps,\113\ the

estimates do support a conclusion that the exemption will reduce the

amount of margin that affiliates would be obligated to allocate to

initial margin in order to clear inter-affiliate swaps that are subject

to the clearing requirement. As a consequence, the exemption is likely

to increase the amount of capital that affiliates may distribute to

their owners or put to other uses.

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\112\ See Clearing Requirement Determination at 74326

(explaining how this estimate was reached and noting that the

estimate may either over-estimate or under-estimate the amount of

additional initial margin that would need to be posted).

\113\ For example, swap data collected by the Bank of

International Settlements (BIS) does not contain information

regarding transactions between affiliates (i.e., branches and

subsidiaries) of the same institution. See, e.g., Statistical

release: OTC derivatives statistics at end-June 2012, Monetary and

Economic Department, Bank of International Settlements (Nov. 2012),

available at http://www.bis.org/publ/otc_hy1211.pdf. The Commission

relied on BIS data in calculating its additional initial margin

requirements for required clearing of certain interest rate swaps

and credit default swaps.

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Third, by exempting inter-affiliate swaps from required clearing,

inter-affiliate swaps would not be subject to variation margin

requirements under a DCO's rules. Exempting inter-affiliate swaps from

required clearing's variation margin requirements may help affiliates

and corporate entities as a whole manage their liquidity needs because

the entities would not have to routinely collateralize losses at the

DCO. It is also likely to reduce the operational costs that the

affiliates would otherwise bear in order to manage margin calls and

associated variation margin payments.

3. Risk Management Benefits of Inter-Affiliate Swaps

A number of commenters stated that executing swaps with the market

through one affiliate enables entities to more efficiently and

effectively manage corporate risk.\114\ In this arrangement, the one

affiliate engages in inter-affiliate swaps with other affiliated

entities in order to hedge the risks of those affiliates. The one,

central affiliate then engages in market-facing swaps to offset the

risk that it has taken on. Executing swaps through one affiliate may

enable corporate entities to concentrate their swap and hedging

expertise and activity within a single affiliate, which reduces

personnel costs. It also allows the corporation to net various

positions before facing the market, thus reducing the number of market

facing swaps, and the attendant fees.

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\114\ See, e.g., letters from The Working Group, EEI, and ISDA &

SIFMA.

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Moreover, these affiliate structures may not only reduce costs, but

certain types of risk for the corporation as well. By concentrating

personnel with swap and hedging expertise in one affiliate, and running

inter-affiliate and market facing swap activities through a single

entity, corporations may reduce the risk of operational errors. Such

errors can create considerable risk when engaging in large hedging

transactions. Moreover, the corporation's operational risk may be

further mitigated by reducing the total number of market facing swaps

into which the affiliated entities enter.\115\

Additionally, as stated above and as noted in the NPRM, affiliates

that are commonly owned internalize a portion of one another's

risk.\116\ To the extent that affiliated entities internalize one

another's risk, those entities have an economic incentive to perform on

their obligations with respect to one another, thus reducing the

counterparty risk that they bear as a consequence of their swaps with

one another. However, the qualification ``to the extent that affiliated

entities internalize one other's risk'' is significant. Two important

factors limit the degree to which affiliates internalize one another's

risk. First, if either of the affiliated entities has a portion of

ownership that is not held in common, then a corresponding portion of

the risks transferred to that entity will not be borne by the common

owners, and thus will not be internalized. In other words, a smaller

common ownership stake will cause less counterparty risk to be

internalized, and will lessen the incentive affiliates will have to

perform on their obligations toward one another. Second, as described

above, there are circumstances in bankruptcy where affiliates do not

internalize each other's risks, which may also reduce, or

[[Page 21772]]

eliminate, the affiliates' incentives to perform with respect to their

obligations they have toward one another.\117\

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\115\ Commenters also asserted that inter-affiliate swaps are

used in order to assist in tax management and compliance with

international laws, stating that the exemption would help to

preserve those benefits. Commenters did not provide sufficient

information regarding their operations, tax management strategies,

and international compliance requirements for the Commission to

evaluate these stated benefits.

\116\ See NPRM at 50426 and Section II.A.

\117\ See Section II.A.

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Reduced internalization of risk among affiliates may create

incentives for certain affiliates to use inter-affiliate swaps to shift

risk to other affiliates in ways that are not necessarily in the best

interests of minority stakeholders or counterparties to certain

affiliates. In order to address this concern, the Commission has

conditioned election of the exemption on several requirements that are

intended to mitigate the costs created by reduced internalization of

risk among affiliates, as well as the foregone benefits of required

clearing.

C. Costs and Benefits of Exemption's Conditions

The inter-affiliate exemption from required clearing sets forth

five conditions that must be satisfied in order to elect the exemption:

(1) Both affiliates must be majority-owned and their financial

statements must be reported on a consolidated basis; (2) the swap must

be documented in a written swap trading relationship document; (3) the

swap must be subject to a centralized risk management program; (4)

certain information regarding the swap must be reported to an SDR; and

(5) both affiliates must meet certain conditions with regard to their

outward-facing swaps. The Commission believes that entities will have

to incur costs to satisfy these conditions. Those costs may offset some

of the benefits that would otherwise result from the exemption.

However, the exemption is permissive, and therefore the Commission also

believes that an affiliate will elect the exemption only if these costs

are less than the costs that an affiliate will incur should it decide

not to elect the exemption. Moreover, as described below, the

conditions provide certain benefits to the affiliates' counterparties

and to the public that the Commission believes are essential in order

to mitigate counterparty credit risk in situations where affiliates do

not completely internalize each other's risks. Lastly, the Commission

believes that in some cases entities are already meeting some or all of

the requirements for electing the exemption, in which cases the

affiliates would bear less new costs, or no new costs at all, due to

the conditions.\118\

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\118\ See, e.g., letters from MetLife and Prudential (explaining

that it is current business practice to document inter-affiliate

swaps); letter from EEI (explaining that inter-affiliate swaps are

subject to risk management).

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1. Eligible Affiliate Counterparty Status

In order to qualify as an eligible affiliate counterparty under the

terms of the exemption, two factors must be met. First, one affiliate

must directly or indirectly hold a majority ownership interest in the

other, or a third party must hold a majority ownership interest in

both. Second, the financial statements of both affiliates are reported

on a consolidated basis under Generally Accepted Accounting Principles

(GAAP) or International Financial Reporting Standards (IFRS).

The Commission anticipates that in a relatively small number of

cases entities may alter their ownership structures in order to qualify

for the inter-affiliate exemption's majority-ownership condition. In

these cases, entities may bear certain legal costs, and in some cases,

costs associated with negotiations with other owners in the entity.

These costs could vary significantly, depending on the complexity of

the entity's existing ownership structure, including the number of

owners and the alignment or misalignment of their interests. The

Commission does not have adequate information to determine which

entities or how many entities may consider altering their ownership

structure in order to become eligible for the inter-affiliate

exemption, but notes again that entities would only do this if they

anticipate that the benefits of the exemption are greater than the

costs of meeting the qualifying criteria.

Four commenters supported proposed majority-ownership requirement.

CDEU commented that the majority-ownership test strikes an appropriate

balance between ensuring that the rule is not overly broad and

providing companies with the flexibility to account for differences in

corporate structures. EEI noted that majority-owned affiliates will

have strong incentives to internalize one another's risks because the

failure of one affiliate impacts all affiliates within the corporate

group. The Working Group generally supported the Commission's

definition, but stated that inter-affiliate swaps should be

unconditionally exempt from mandatory clearing when the affiliates are

consolidated for accounting purposes. MetLife stated that it would

likely limit inter-affiliate trading to ``commonly-owned'' affiliates,

but agreed with the flexibility of including majority-owned affiliates.

Two commenters objected to the proposal and requested the

Commission require 100% ownership of affiliates. AFR stated that

permitting such a low level of joint ownership would lead to evasion of

the clearing requirement through the creation of joint ventures set up

to enable swap trading between banks without the need to clear the

swaps. Similarly, Better Markets agreed that only 100% owned affiliates

should be eligible for the exemption because allowing the exemption for

the majority owner permits that owner to disregard the views of its

minority partners and creates an incentive to evade the clearing

requirement by structuring subsidiary partnerships. Finally, Better

Markets stated that the majority-ownership standard will result in

corporate groups transferring price risk and credit risk to different

locations facilitating interconnectedness and potentially giving rise

to systemic risk during times of market stress.

As discussed above, the degree to which one affiliate's risks are

internalized by another affiliate depends significantly on the

percentage of common ownership between them. For example, two

affiliates that are 100% commonly owned are likely to internalize much

of one another's risk. This creates a strong incentive for affiliates

to perform on their obligations to one another. Therefore, if the

Commission were to increase the common ownership requirement above a

majority stake, it would likely result in affiliate counterparties

internalizing more of one another's risk with respect to inter-

affiliate swaps in order to qualify for the exemption. This, in turn,

would provide additional incentives for affiliates to perform on their

inter-affiliate swap obligations. However, if the Commission were to

increase the common ownership percentage requirement, it also would

reduce the number of affiliates that could qualify for, and benefit

from, the exemption.

On the other hand, if the Commission lowered the percentage of

common ownership that is required to be eligible for the exemption

(i.e., made it 50% or less), it would increase the number of affiliates

that are eligible for the exception. This lower standard would allow

affiliates that internalize less of each other's risks and therefore

have weaker incentives to perform on their obligations to one another

to qualify for the exemption. Moreover, the absence of a majority

common ownership requirement could create opportunities for otherwise

unrelated entities to form joint ventures and transact swaps with one

another in order to claim the inter-affiliate exemption from clearing,

which would undermine the effectiveness of the clearing requirement.

The Commission considered each of these factors and concluded that

the majority stake requirement is sufficient to internalize costs and

incentivize affiliates to perform on their obligations

[[Page 21773]]

to one another. The Commission also believes that the potential for

evasion is mitigated through the conditions to the final rule, which

have been carefully crafted in order to narrow the exemption. For

example, two unrelated entities cannot each hold a majority stake in

the same affiliate. Consequently, such unrelated entities cannot use an

inter-affiliate swap as an indirect means of trading without being

subject to the clearing requirement under section 2(h) of the CEA and

part 50 of the Commission's regulations.

As an additional consideration, as noted above, the majority

requirement also harmonizes with Commission's understanding of the EMIR

requirements. Harmonizing with EMIR is likely to reduce compliance

monitoring costs for entities electing the affiliated entity exemption.

In terms of potential costs in the form of disregarding the interests

of minority shareholders, the Commission recognizes that a 100%

ownership requirement would eliminate the risk of minority

shareholders' interests not being aligned with decisions to elect the

exemption. However, the Commission is also cognizant that such a

requirement would reduce the number of affiliates that are able to

claim the exemption. The Commission believes that the majority-

ownership requirement appropriately considers the risk of the former

and the benefits of the latter.

With regard to the consolidation of financial statements, FSR

requested that the Commission clarify that alternative accounting

standards can be used for purposes of meeting the requirement that the

financial statements of both affiliates be reported on a consolidated

basis. The Commission considered this comment and is adopting the

alternative suggested by FSR. As modified the rule requires that the

financial statements of both counterparties be reported on a

consolidated basis under GAAP or IFRS. This change recognizes the fact

that some entities claiming the exemption may report their financial

statements under different accounting standards, and makes it possible

for those entities to elect the exemption as long as they would be

required to report their financial statements on a consolidated basis

under GAAP or IFRS. This likely increases the number of entities that

may elect the exemption relative to the form of the rule proposed in

the NPRM while maintaining the protections that were intended with the

requirement for consolidated financial statements. The Commission also

modified the rule to clarify which entities are subject to the

consolidated financial statement requirement.

2. Inter-Affiliate Swap Documentation

As proposed, the inter-affiliate exemption required that eligible

affiliate counterparties that elect the inter-affiliate exemption must

enter into swaps with a swap trading relationship document that is in

writing and includes all the terms governing the relationship between

the affiliates. These terms included, but were not limited to, payment

obligations, netting of payments, transfer of rights and obligations,

governing law, valuation, and dispute resolution. This requirement

would be satisfied if an eligible affiliate counterparty is an SD or

MSP that complies with the swap trading relationship documentation

requirements of Sec. 23.504.\119\

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\119\ For a discussion of the costs and benefits incurred by

swap dealers and major swap participants that must satisfy

requirements under Sec. 23.504, see Confirmation, Portfolio

Reconciliation, Portfolio Compression, and Swap Trading Relationship

Documentation Requirements for Swap Dealers and Major Swap

Participants, 77 FR 55904, 55906 (Sept. 11, 2012) (final rule) and

Swap Trading Relationship Documentation Requirements for Swap

Dealers and Major Swap Participants, 76 FR 6715, 6724-25 (Feb. 8,

2011) (proposed rule).

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The Commission received a number of comments both supporting and

opposing the swap documentation requirement. Better Markets, MetLife,

and Prudential all supported the proposed documentation requirement.

Specifically, MetLife and Prudential did not believe that the

documentation requirement would be any more ``burdensome or costly''

for them because they already document all of their swaps.

Cravath, EEI, CDEU, and DLA Piper opposed the proposed

documentation requirement. Cravath stated that the costs associated

with the imposition of documentation requirements outweigh any benefits

to the financial system, and that the Commission should leave the

determination as to the appropriate level of documentation to boards of

directors and management of companies, to determine based on the

``reasonable exercise of their fiduciary responsibilities.'' DLA Piper

commented that the documentation requirements are burdensome and

questioned the benefits of imposing documentation requirements on

transactions between two parties.

CDEU expressed concern that proposed documentation condition would

require that full ISDA Master Agreements be used to document inter-

affiliate swaps. CDEU explained that while many market participants use

master agreements, some end users many not have full master agreements

because inter-affiliate swaps are purely internal and do not increase

systemic risk. CDEU recommended that the proposed rule be revised to

require that the swap documentation ``include all terms necessary for

compliance with its centralized risk management program'' and eliminate

the list of required terms. CDEU also requested that the Commission

clarify that (1) market participants can continue to use documentation

required by their risk management programs and (2) the rule does not

require market participants use ISDA Master Agreements.

EEI recommended that the Commission eliminate the documentation

requirement because the requirement is duplicative of corporate

accounting records that affiliates currently maintain. EEI commented

that a documentation requirement imposes ``an additional, costly layer

of ministerial process and documentation that is unnecessary to achieve

the Commission's stated objectives.'' EEI commented on the NPRM's

consideration of costs and benefits and stated that the costs of the

proposed documentation requirement are unjustified. The NPRM included

an estimate that there would be a one-time cost of $15,000 to develop

appropriate documentation for use by an entity's affiliates. EEI

objected to this estimate because, in its view, the legal costs

associated with individually negotiating and amending standard

agreements between individual affiliates would exceed the NPRM's

estimates. In addition, EEI objected to the NPRM's estimate of 22

affiliated counterparties for each corporate group as ``far too low''

for U.S. energy companies.\120\ However, EEI did not provide specific,

quantitative information in terms of either the legal costs of

complying with the proposed documentation requirement or number of

affiliates for a corporate group subject to this rule. Accordingly, the

Commission is unable to verify whether the legal costs or average

number of affiliates estimates are too low.

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\120\ This estimate appeared in the NPRM section regarding the

Paperwork Reduction Act not in the consideration of costs and

benefits section.

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ISDA & SIFMA stated that the documentation requirements were overly

prescriptive and would impose unnecessary costs on affiliates. ISDA &

SIFMA recommended a more flexible approach that would require adequate

documentation of ``all transaction terms under applicable law.''

In response to commenters' requests for a more flexible standard,

the Commission modified the proposal for swaps between affiliates that

are not

[[Page 21774]]

SDs or MSPs. The Commission adopted ISDA & SIFMA's recommendation that

the focus of the documentation requirement be on documenting all of an

inter-affiliate transaction's terms.\121\

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\121\ The Commission is modifying the documentation condition to

require that ``the terms of the swap are documented in a swap

trading relationship document that shall be in writing and shall

include all terms governing the trading relationship between the

affiliates.''

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Under this modification, the Commission is eliminating the non-

exclusive list of terms, which included payment obligations, netting of

payments, transfer of rights and obligations, governing law, valuation,

and dispute resolution. The change responds to commenters' requests for

a more flexible approach that reflects current market best practices,

and signals that market participants retain the ability to craft

appropriate documentation for their affiliated entities so long as such

documentation includes the terms of the swap and ``all terms governing

the trading relationship between the eligible affiliate

counterparties.'' \122\ This modification also serves to address

concerns that the intent of the proposed rule was to require formal

master agreements, such as the ISDA Master Agreement.\123\ The proposed

rule was not intended to require affiliates to enter into formal master

agreements. Rather, the Commission observed that parties that already

use master agreements (of any sort) to document their inter-affiliate

swaps would likely meet the requirements of the proposed rule without

additional costs. This observation was supported by commenters such as

MetLife and Prudential. The Commission believes that these

modifications to the proposal and clarifications respond to commenters'

concerns and will serve to reduce documentation costs for those

electing the inter-affiliate exemption.\124\

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\122\ See Sec. 50.52(b)(2)(ii).

\123\ In the NPRM, the Commission estimated that affiliates

could pay a law firm for up to 30 hours of work at $495 per hour to

modify an ISDA Master Agreement, resulting in a one-time cost of

$15,000, and there may be additional costs related to revising

documentation to address a particular swap. All salaries in these

calculations are taken from the 2011 SIFMA Report on Management and

Professional Earnings in the Securities Industry. Annual wages were

converted to hourly wages assuming 1,800 work hours per year and

then multiplying by 5.35 to account for bonuses, firm size, employee

benefits and overhead. The Commission also estimated that affiliates

would incur costs of less than $1,000 per year related to signing

swap documents and retaining copies.

\124\ In response to comments from Better Markets and AFR that

the proposed regulations should be retained and not weakened, the

Commission does not believe that eliminating the non-exclusive list

of terms and replacing it with a simple requirement that all terms

of the swap transaction and the relationship between the affiliates

be documented will weaken the rule. Rather, while affiliates will

have discretion to select the appropriate terms to document their

swap, they will still have an obligation to ensure that their

documentation contains an accurate and thorough written record of

their swaps. In most instances, this will necessarily include all of

the previously enumerated terms.

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Entities that have already established systems for documenting the

terms of their inter-affiliate swaps and all the terms of the trading

relationship between eligible affiliates will not bear any costs as a

consequence of this requirement.\125\ However, as noted in the NPRM,

the Commission understands that some affiliates may enter into inter-

affiliate swaps with little documentation regarding the terms of the

swaps.\126\ Such entities may not have systems to document the terms of

their inter-affiliate swaps or all the terms of the trading

relationship between eligible affiliates. They will bear some initial

costs and ongoing costs in order to comply with this requirement. In

the NPRM, the Commission estimated that the initial costs of up to

$15,000 to create such the necessary documentation, and less than

$1,000 per year on an ongoing basis to sign and retain appropriate

documentation.\127\

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\125\ See comments letters from MetLife and Prudential.

\126\ See NPRM at 50428-50429.

\127\ See id. at 50434.

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In response to EEI's comment regarding duplicative requirements, to

the extent that the documentation requirement is duplicative of an

affiliate's existing recordkeeping practices, it will not introduce new

costs. However, the Commission notes that if existing records do not

contain the terms of each inter-affiliate swap or all the terms of the

trading relationship between affiliates, affiliates will be required to

implement new documentation that creates incremental costs, as noted

above.

Regarding benefits, documentation of inter-affiliate swaps is

essential to effective risk management. In the absence of such

documentation, affiliates cannot track or value their swaps

effectively. Documentation also helps ensure that affiliates have proof

of claim in the event of bankruptcy. As explained earlier, insufficient

proof of claim could create challenges and uncertainty at bankruptcy

that could adversely affect affiliates and third party creditors. The

documentation requirement, to the extent that it requires entities to

document all the terms that are necessary in order to value inter-

affiliate swaps and to provide legal certainty in the event of

bankruptcy, will promote effective risk management and resolution of

claims in the event of insolvency.\128\

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\128\ As discussed in Section II.D above, the Commission expects

that, in most instances, documentation between affiliates will

include all of the previously enumerated terms, several of which are

essential to effective valuation of swaps and resolution in

bankruptcy. However, the Commission notes that a more flexible

approach makes it possible that some entities could document the

terms of their inter-affiliate swaps and all the terms of their

trading relationship without covering all of the terms that are

necessary for effective valuation or resolution in bankruptcy. If

this occurs, it would reduce the risk management and bankruptcy

benefits created by the documentation requirement.

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3. Centralized Risk Management

Another condition of the inter-affiliate exemption requires that

the swap be subject to a centralized risk management program that is

``reasonably designed to monitor and manage the risks associated with

the swap.'' If at least one of the eligible affiliate counterparties is

an SD or MSP, the centralized risk management requirement is satisfied

by complying with the requirements of Sec. 23.600.\129\

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\129\ For a discussion of the costs and benefits incurred by

swap dealers and major swap participants that must satisfy

requirements under Sec. 23.600, see Swap Dealer and Major Swap

Participant Recordkeeping, Reporting, and Duties Rules; Futures

Commission Merchant and Introducing Broker Conflicts of Interest

Rules; and Chief Compliance Officer Rules for Swap Dealers, Major

Swap Participants, and Futures Commission Merchants, 77 FR 20173-75.

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Four commenters objected to the proposed requirement, suggested

alternatives, and/or requested clarification. FSR stated that the

condition should be eliminated because integrated risk management

systems ``are generally not established across international

boundaries'' and are not consistent with general risk practices in

large, multinational organizations. FSR suggested that the requirement

be dropped in favor of each entity making ``its own evaluations of the

risk associated with an inter-affiliate position.''

Cravath stated that in many cases, for companies outside of the

financial sector, the proposed rule will require a substantial change

in the processes and procedures currently maintained by such companies,

and the cost of complying with the risk management program requirements

outweigh any benefits to the financial system. Cravath commented that

rather than subject companies to a risk management rule, ``[c]ompanies

should have the flexibility to engage in prudent risk management for

their corporate group in a manner consistent with the overall level of

risks to their business.''

EEI suggested that the Commission eliminate the centralized risk

[[Page 21775]]

management program requirement on the grounds that it would be

duplicative for corporate groups that already have risk management

programs in place. According to EEI, it is standard industry practice

for both private and public companies to have a risk management

program. EEI accordingly does not see a ``need to impose a separate,

discrete regulatory requirement to document with an SDR or the

Commission the existence of a centralized risk management program.'' If

the Commission decides to retain the requirement, EEI requested that

the Commission require a program be ``reasonably designed to monitor

and manage the risks associated with the swap'' and provide the

flexibility to design risk management programs that address the unique

risks of an entity's business.

The Working Group requested that the Commission clarify whether

non-SDs and non-MSPs would be subject to the same enterprise-level risk

management program as required for SDs and MSPs under Sec. 23.600. The

Working Group proposed that the Commission require ``a robust risk

management program'' rather than ``a centralized risk management

program.''

In response to comments asking that the Commission clarify the

level of risk management required for non-SDs and non-MSPs, the

Commission confirms that the risk management condition is intended to

be flexible and does not require the same level of policies and

procedures as required under Sec. 23.600 for SDs and MSPs. Under the

rule, a company would be free to structure its centralized risk

management program according to its unique needs, provided that the

program reasonably monitors and manages the risks associated with its

uncleared inter-affiliate swaps. In all likelihood, if a corporate

group has a centralized risk management program in place that

reasonably monitors and manages the risk associated with its inter-

affiliate swaps as part of current industry practice, it is likely that

the program would fulfill the requirements of exemption and therefore

the exemption would not create new costs in such cases.

Given that a number of commenters stated that it is common practice

for market participants, including end users, to have risk management

programs in place,\130\ expects that the majority of companies with

eligible affiliates will not have to create centralized risk management

programs from scratch in order to meet the eligibility requirements for

the exemption. Those with existing systems may need to make some

changes in order to centralize them, but the Commission has provided

significant flexibility to companies in determining the specific

contours of the centralized risk management system. Given this

flexibility, and the fact that it is common practice for market

participants to have risk management programs in place, the Commission

is not persuaded by Cravath's comment that the rule will require a

substantial change in the processes and procedures currently maintained

by companies to manage risk. Accordingly, costs will be limited where

an entity only needs to make modifications to existing risk management

programs. Moreover, a corporate group may not have to incur any costs

if it already has in place a risk management system that meets the

requirements of the inter-affiliate exemption.

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\130\ See, e.g., letters from Prudential, MetLife, and CDEU.

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The Commission also declined to modify the requirement to state ``a

robust risk management program'' rather than ``a centralized risk

management program.'' While change proposed by the Working Group may

prevent certain entities from having to reorganize their risk

management program in order to meet the requirements of the inter-

affiliate exemption, it could also significantly reduce the ability of

the risk management program to mitigate counterparty risk among

affiliates. In the absence of variation margin, or clearing to mitigate

counterparty credit risk among affiliates, risk management committees

must have a clear line of sight into the financial health and

obligations of each affiliate involved in inter-affiliate swaps.

In the NPRM, the Commission explained that some affiliates may have

to create a risk management system to meet the risk management

condition.\131\ The Commission itemized a number of specific costs,

including the purchase of equipment and software to adequately evaluate

and measure inter-affiliate swap risk.\132\ In addition, in the NPRM,

the Commission estimated that centralized risk management could require

up to ten full-time staff at an average salary of $150,000 per

year.\133\ The Commission received no comments in response to its risk

management condition cost estimates.

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\131\ As pointed out above, industry commenters underscored the

fact that many corporate groups that currently use inter-affiliate

swaps have centralized-risk-management procedures in place.

\132\ See NPRM at 50434 (estimating such costs to be as high as

$150,000 for purchasing a computer network at approximately $20,000;

purchasing personal computers and monitors for 15 staff members at

approximately $30,000; purchasing software at approximately $20,000;

purchasing other office equipment, such as printers, at

approximately $5,000; and installation and unexpected costs that

could increase up-front costs).

\133\ This average annual salary is based on 15 senior credit

risk analysts only. The Commission appreciates that an affiliate

would likely choose to employ different positions as well, such as

risk management specialists at $130,000 per year, and computer

supervisors at $140,000. But for the purposes of this estimate, the

Commission has assumed salaries at the high end for risk management

professionals. The Commission also estimated a data subscription for

price and other market data may have to be purchased at cost of up

to $100,000 per year.

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There are benefits that derive from the centralized-risk management

condition. The Commission expects that centralized risk management

programs will establish appropriate measurements and procedures to

monitor the amount of risk that each individual affiliate bears, and to

monitor the condition of each entity's affiliate counterparties.

Because a centralized risk management program is more likely to have a

clear line of sight into the financial condition of all affiliated

entities, it is better positioned to manage each affiliate's exposure

to the counterparty risk of other affiliates than a risk management

program situated inside any single affiliate. As a consequence,

centralized risk management programs may reduce the likelihood that

individual affiliates could become insolvent because of their exposure

to other affiliates, which not only benefits the affiliates, but their

third party counterparties as well.

4. Reporting to an SDR

Another condition of electing the inter-affiliate exemption is that

certain information about the swap and the election of the exemption be

reported to an SDR. The reporting condition requires affiliates to

report specific information to an SDR, or to the Commission if no SDR

is available. Such information includes a notice that both affiliates

are electing the exemption and that they both meet the other conditions

of exemption, as well as information regarding how the financial

obligations of both affiliates are generally satisfied with respect to

uncleared swaps. The final rule also requires reporting certain

information if the affiliate is an SEC filer.

The Commission received several comments in response to the

reporting obligations of affiliates. Prudential and MetLife both

commented that the Commission should clarify that only one counterparty

is required to report the swap to an SDR. EEI stated that the

Commission should eliminate the transaction-by-transaction reporting

[[Page 21776]]

requirement for the election of the exemption and confirmation that the

conditions have the exemption have been met. Instead, EEI recommended

that one of the affiliates be permitted to file an annual notice on

behalf of both affiliates to exempt all of their swaps from clearing

for an entire year. EEI contended that it will increase costs if both

affiliates have to communicate that they elect not to clear the swap

and meet the conditions of the exemption for each swap.\134\ CDEU also

objected to reporting any information to an SDR on a trade-by-trade

basis for inter-affiliate swaps as such reporting would be costly and

onerous for parties. Instead, CDEU recommended that all reporting be

done on an annual basis through a board resolution.

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\134\ EEI also commented that the Commission should state that

part 45 does not apply to inter-affiliate swaps because the

Commission will be able to obtain information regarding an inter-

affiliate transaction based on reporting of a corresponding market-

facing swap. EEI cited to a statement in the NPRM's consideration of

costs and benefits as support for an argument that the Commission

did not intend for part 45 reporting to apply to inter-affiliate

swaps. See NPRM at 50433. As explained above, the statement in the

cost-benefit consideration of the NPRM merely drew a comparison

between the reporting requirements under the proposed exemption and

the general reporting requirements under parts 45 and 46, and those

reporting requirements applicable to SDs and MSPs under part 23. The

statement should not be read as calling into question the

applicability of part 45 to inter-affiliate swaps.

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In response to commenters' requests, the Commission clarified that

the reporting condition can be fulfilled by one of the affiliate

counterparties on behalf of both counterparties. As noted in the NPRM,

the Commission believes that affiliates within a corporate group may

make independent determinations on whether to submit an inter-affiliate

swap for clearing. Given the possibility that each affiliate may reach

different conclusions regarding clearing the swap, the final rule

requires that both counterparties elect the proposed inter-affiliate

clearing exemption.

DLA Piper commented that corporate groups do not maintain back-

office systems necessary to keep the level of detail required under

parts 45 and 46 with respect to their inter-company swaps. DLA Piper

further commented that many corporate groups will need to develop

costly systems and procedures, which will increase their hedging costs,

in order to comply with the reporting rules. The Commission observes

that the costs of parts 45 and 46 reporting have been addressed in

prior rulemakings and are beyond the scope of this rule.

With regard to comments recommending that all reporting be done on

an annual basis rather than a swap-by-swap basis, the Commission

declines to modify the rule. The Commission believes it is appropriate

to provide for annual reporting of certain information, including how

affiliates generally meet their financial obligations and information

related to its status as an electing SEC Filer. However, it would not

be sufficient to allow one annual report to cover both affiliate

counterparties' election of the exemption from clearing and the

confirmation that both affiliates meet the conditions of the exemption.

Eligible affiliates may choose to elect or not elect the exemption

on a swap-by-swap basis. As noted above, whether a swap is cleared or

not has a significant impact on its ability to transfer credit risk

from one entity to another. Regulators must know which swaps are

cleared and which swaps are not cleared in order to monitor potential

accumulations and transfers of risk within the financial system. In

addition, they must know which exemption is being used to exempt

certain swaps in order to monitor the use of each exemption and its

possible effect on systemic risk. Consequently, the election of the

exemption and the confirmation that the exemption's conditions are met

must be made for each swap.

The Commission does not believe that this reporting requirement

will impose a significant burden on affiliate counterparties because,

as discussed above, other detailed information for every swap must be

reported under sections 2(a)(13) and 4r of the CEA and Commission

regulations. This approach comports with the approach adopted for

market participants claiming the end-user exception under section

2(h)(7) of the CEA.\135\

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\135\ See End-User Exception to the Clearing Requirement for

Swaps, 77 FR 42565-66.

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In the NPRM, the Commission estimated specific costs for the

reporting condition, including entering a notice of election into the

reporting system.\136\ Cost estimates in the NPRM also included costs

of identifying how the affiliates expect to meet the financial

obligations associated with their uncleared swap and providing

information if either electing affiliate is an SEC Filer.\137\ The

Commission also estimated costs for entities to modify their reporting

systems to accommodate the additional data fields required by this

rule.\138\ The Commission also estimated costs for non-reporting

affiliates.\139\ Finally, in the NPRM, the Commission explained that

SDRs would bear costs associated with the reporting conditions insofar

as SDRs would be required to add or edit reporting data fields to

accommodate information reported by affiliates electing the inter-

affiliate clearing exemption.\140\ The Commission received no comments

in response to its cost estimates for the reporting condition.

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\136\ The NPRM at 50435, included an estimate that each

counterparty may spend 15 seconds to two minutes per swap entering a

notice of election of the exemption into the reporting system. The

hourly wage for a compliance attorney is $390, resulting in a per

transaction cost of $1.63-$13.00.

\137\ See NPRM at 50435. Affiliates may decide to report

financial obligation information and SEC Filer information on either

a swap-by-swap or annual basis, and the costs would vary depending

on the reporting frequency. Regarding the financial obligation

information, the Commission estimated in the NPRM that it may take

the reporting counterparty up to 10 minutes to collect and submit

the information for the first transaction, and one to five minutes

to collect and submit the information for subsequent transactions

with that same counterparty. The hourly wage for a compliance

attorney is $390 resulting in a cost of $65.00 for reporting the

first inter-affiliate swap, and a cost range of $6.50-$32.50 for

reporting subsequent inter-affiliate swaps.

\138\ See id. (estimating that such modifications would create a

one-time programming expense of approximately one to ten burden

hours per affiliate, which means a one-time, per entity cost ranging

from $341 and $3,410).

\139\ See id. (noting that costs would likely vary substantially

depending on how frequently the affiliate enters into swaps, whether

the affiliate undertakes an annual filing, and the due diligence

that the reporting counterparty chooses to conduct, but estimating

that a non-reporting affiliate would incur annually between five

minutes and ten hours of compliance attorney time to communicate

information to the reporting counterparty, translating to an

aggregate annual cost for communicating information to the reporting

counterparty of between $33 to $3,900). See also, id. (noting that

an annual filing option may be less costly than swap-by-swap

reporting and estimating that such an option would take an average

of 30 to 90 minutes, translating to an aggregate annual cost for

submitting the annual report of between $195 to $585).

\140\ See generally, Swap Data Recordkeeping and Reporting

Requirements, 77 FR 2176-2193 (for costs and benefits incurred by

SDRs). To the extent that no SDR is available to accept this data,

the costs would fall to the Commission.

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The benefits of the reporting condition include enhancing the level

of transparency associated with inter-affiliate swaps activity, thereby

affording the Commission new insights into the practices of affiliates

that engage in inter-affiliate swaps, and helping the Commission and

other appropriate regulators identify emerging or potential risks. As

noted above, regulators must know whether swaps are cleared or

uncleared in order to use swap data to monitor emerging risks. In

short, the overall benefit of reporting would be a greater body of

information for the Commission to analyze with the goal of identifying

and reducing systemic risk.\141\

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\141\ The Commission received no comments in response to its

cost estimates for the reporting condition.

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[[Page 21777]]

5. Treatment of Outward-Facing Swaps

The final condition imposed on the inter-affiliate exemption from

required clearing relates to the treatment of outward-facing swaps

entered into by the two eligible affiliate counterparties to the inter-

affiliate swap. As proposed, the condition required that each affiliate

counterparty either: (i) Is located in the United States; (ii) is

located in a jurisdiction with a clearing requirement that is

comparable and comprehensive to the clearing requirement in the United

States; (iii) is required to clear swaps with non-affiliated parties in

compliance with U.S. law; or (iv) does not enter into swaps with non-

affiliated parties.

The Commission received a number of comments in support of and

opposed to this proposed condition, but did not receive any comments

quantifying the costs or benefits of the proposed condition. AFR

supported the proposal and stated that inter-affiliate swaps could,

without appropriate restrictions, bring risk back to the U.S. from

foreign affiliates. AFR commented that an inter-affiliate swap might be

used to move parts of the U.S. swaps market outside of U.S. regulatory

oversight by transferring risk to jurisdictions with little or no

regulatory oversight, whereby a non-U.S. affiliate of a U.S. entity

could enter into an outward-facing swap. AFR stated that an inter-

affiliate swap could contribute to financial contagion across different

groups within a complex financial institution, making it more difficult

to ``ring-fence'' risks in one part of an organization. AFR further

commented that laws and regulations of a foreign country might prevent

U.S. counterparties to swaps from having access to the financial

resources of an affiliate in the event of a bankruptcy or insolvency.

Better Markets also supported the proposed treatment of outward-facing

swaps condition.

In opposition to the proposed condition, CDEU commented that the

proposed ``comparable and comprehensive'' condition is not necessary or

appropriate to reduce risk and prevent evasion because, according to

CDEU, transactions between affiliates do not increase systemic risk,

regardless of the location of the affiliate. ISDA & SIFMA stated that

the concern that foreign inter-affiliate swaps pose risk to the U.S.

financial system is unfounded because internal swaps have no conclusive

effect on systemic risk.\142\

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\142\ Other commenters, including The Working Group and FSR also

opposed the condition regarding treatment of outward-facing swaps.

See Section II.G above.

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The Commission considered each of these comments and decided to

adopt the treatment of outward-facing swaps condition, with certain

important modifications, because the Commission believes that the risk

of evasion of the U.S. clearing requirement and the potential systemic

risk associated with uncleared inter-affiliate swaps involving foreign

affiliates and non-affiliated counterparties necessitates that the

inter-affiliate exemption include such a condition. As modified, the

final rule requires that each eligible affiliate counterparty must

clear all swaps that it enters into with third parties to the extent

that the swap is subject to the Commission's clearing requirement. In

order to satisfy this requirement, eligible affiliates may clear their

third-party swaps pursuant to the Commission's clearing requirement or

comply with the requirements for clearing the swap under a foreign

jurisdiction's clearing mandate that is comparable to, and as

comprehensive as, the clearing requirement of section 2(h) of the Act

and part 50 of the Commission's regulations, as determined by the

Commission. In addition, the Commission modified the condition to allow

for recognition of clearing exemptions and exceptions under the CEA and

an exception or exemption under a comparable foreign jurisdiction's

clearing mandate that is comparable to an exception or exemption under

section 2(h)(7) of the CEA or part 50. For entities that are not in a

jurisdiction with a clearing requirement that is comparable to, and as

comprehensive as, the clearing mandate in 2(h) of the Act, they may

comply by clearing swaps with unaffiliated counterparties through a

registered DCO or clearing organization that is subject to supervision

by appropriate government authorities in the home country of the

clearing organization and has been assessed to be in compliance with

the PFMIs.

The Commission believes that this modification will provide greater

clarity and transparency by more clearly establishing the conditions to

the exemption and alternative methods by which eligible affiliates may

satisfy the requirements. In addition, the Commission considered the

approach adopted in EMIR.\143\ To the extent there is consistency with

the international authorities, including the European Union, the

likelihood of regulatory arbitrage is reduced. Regulatory arbitrage can

impose high costs in terms of market efficiency.

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\143\ See Section II.G above.

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As AFR noted, without appropriate restrictions, inter-affiliate

swaps could transfer risk back to the United States from foreign

affiliates. The final rule takes steps to mitigate this risk insofar as

the intent of the condition on outward-facing swaps is to narrow the

exemption such that the risk of a cascading series of defaults among

unrelated entities is reduced.

For companies whose inter-affiliate swap activities are conducted

exclusively through entities in the United States and jurisdictions

with clearing mandates that are comparable to, and as comprehensive as,

the clearing requirement of section 2(h) of the CEA, all outward-facing

swaps that fall under a Sec. 50.4 class will be subject to required

clearing,\144\ which will serve as a buffer to the spread of credit

risk from one corporation to another through those swaps, thus reducing

the risk of financial contagion. Affiliates that meet the conditions of

the inter-affiliate exemption will be able to transfer risk from one

affiliate to the other without clearing those swaps, but third parties

that enter into swaps that are required to be cleared with either of

those affiliates will continue to be protected by clearing requirement.

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\144\ In these jurisdictions, outward-facing swaps that are not

subject to required clearing may be subject to margin requirements,

which can serve to mitigate counterparty credit risk.

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For companies whose inter-affiliate swap activities extend to

countries without clearing mandates that are comparable to, and as

comprehensive as, the clearing requirement of section 2(h) of the CEA,

the requirements of the rule mitigate counterparty risk associated with

swaps that are required to be cleared under Sec. 50.4 by requiring

those swaps to be cleared at a DCO or a clearing organization that is

subject to supervision by appropriate government authorities and that

is in compliance with the PFMIs. In this manner, swaps that the

Commission has determined must be cleared cannot be used as a means of

transferring financial risk among unaffiliated entities where one of

the counterparties is also claiming an exemption from required clearing

under this inter-affiliate exemption. However, the Commission observes

that outward-facing swaps that are not required to be cleared under

Sec. 50.4 and that are entered into between unrelated entities in a

jurisdiction without comparable margin requirements, may be a means

through which financial risk could be passed between unaffiliated

entities without the protection of required clearing, creating the

possibility of

[[Page 21778]]

financial contagion.\145\ It is possible that such contagion could then

be transferred back to the United States or other jurisdictions through

inter-affiliate swaps, creating potential costs for the public.\146\

The Commission notes, however, that this is only a concern to the

extent that affiliates in such jurisdictions enter into outward-facing

swaps that are not required to be cleared under Sec. 50.4 in order to

meet their needs.

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\145\ This risk may be mitigated if such swaps were subject to

bilateral margining.

\146\ Not only is there the possibility of risk transfer but

also a potential inability for regulators to monitor the risks that

are capable of being transferred.

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The Commission does not agree with CDEU's assertion that

transactions between affiliates do not increase systemic risk,

regardless of the location of the affiliate, or with ISDA & SIFMA's

comment that the concern that foreign inter-affiliate swaps pose risk

to the U.S. financial system is unfounded. As noted above, in the

absence of any restrictions on outward-facing swaps, inter-affiliate

swaps could be used to transfer risk to jurisdictions without clearing

requirements or margin requirements for uncleared swaps. Risk could

then be transferred between unrelated entities without the protection

of clearing or margin requirements to mitigate the risk of financial

contagion spreading from one to the other.

In addition to the modifications to the treatment of outward-facing

swaps condition described above, the Commission also accepted

commenter's suggestions and is providing a transition period with two

alternative compliance frameworks for eligible affiliates domiciled in

certain foreign jurisdictions that have the legal authority to

implement mandatory clearing regimes. As noted above, ISDA & SIFMA and

CDEU stated that questions of timing and criteria for comparability

render the proposed treatment of outward-facing swaps condition

problematic, and that unless the condition is satisfactorily resolved,

the condition could hamper the ability of U.S.-based groups to compete

in foreign markets. ISDA & SIFMA further commented that if the

Commission retains the cross-border requirements, the Commission should

provide an appropriate transition period in order to allow foreign

jurisdictions to implement their own G-20 mandates. The Commission is

adopting two alternative compliance frameworks in response to concerns

raised by commenters pertaining to the timing and sequencing of the

implementation of the inter-affiliate exemption.

The Commission is adopting a time-limited alternative compliance

framework, available until March 11, 2014, for certain eligible

affiliates transacting swaps with affiliated counterparties located in

the European Union, Japan, or Singapore. The alternative compliance

framework will allow affiliated counterparties, or a third party that

directly or indirectly holds a majority interest in both eligible

affiliate counterparties, to pay and collect full variation margin

daily on all swaps entered into between affiliates or between an

affiliate and its unaffiliated counterparties, rather than submitting

such swaps for clearing. In addition, the Commission has determined to

provide time-limited relief for certain eligible affiliated

counterparties located in the European Union, Japan, or Singapore from

complying with the requirements of Sec. 50.52(b)(4)(i) as a condition

of electing the inter-affiliate exemption. In particular, Sec.

50.52(b)(4)(ii)(B) provides that if one of the eligible affiliate

counterparties is located in the European Union, Japan, or Singapore,

the requirements of paragraph (b)(4)(i) will not apply to such eligible

affiliate counterparty until March 11, 2014, provided that: (1) The one

counterparty that directly or indirectly holds a majority ownership

interest in the other counterparty or the third party that directly or

indirectly holds a majority ownership interest in both counterparties

is not a ``financial entity'' as defined in section 2(h)(7)(C)(i) of

the Act, and (2) neither eligible affiliate counterparty is affiliated

with an entity that is a swap dealer or major swap participant, as

defined in Sec. 1.3.

Another time-limited alternative compliance framework also will be

available for eligible affiliates transacting swaps with affiliated

counterparties located outside the European Union, Japan, and

Singapore, as long as the aggregate notional value of such swaps, which

are included in a class of swaps identified in Sec. 50.4, does not

exceed five percent of the aggregate notional value of all swaps, which

are included in a class of swaps identified in Sec. 50.4, in each

instance the notional value as measured in U.S. dollar equivalents and

calculated for each calendar quarter, entered into by the eligible

affiliate counterparty located in the United States.

These alternative compliance frameworks will mitigate the

competitive effects that ISDA & SIFMA and CDEU noted by allowing

certain entities to collect variation margin rather than clearing such

swaps until March 11, 2014. The Commission expects that collecting full

variation margin is likely to be less costly than clearing because the

latter includes initial margin in addition to variation margin, as well

as clearing fees. To the extent that the alternative compliance

approach is less costly, it will reduce the competitive effects that

foreign affiliates experience during the period of time when comparable

clearing requirements do not yet exist for competitors operating in

foreign jurisdictions.

The time-limited alternative compliance frameworks may,

nevertheless, have some temporary competitive effects in the market.

Companies with foreign affiliates that are required to pay and collect

variation margin daily on all swaps entered into between affiliates or

between an affiliate and its unaffiliated counterparties will bear some

costs that competing firms based entirely in foreign jurisdictions may

not bear because comparable clearing mandates have not yet been

implemented. In the European Union, Japan, and Singapore, these effects

are likely to largely disappear once comparable regimes are established

and companies with entities in those jurisdictions are required to

clear. In jurisdictions where comparable regimes are never implemented,

the competitive effects will be longer-standing.

The Commission, however, believes that such costs are warranted in

light of the benefits provided by mitigating the likelihood of

transferring risk back to the United States through inter-affiliate

swaps that are not cleared or margined. Requiring the payment and

collection of full variation margin will address the possibility of

foreign affiliates developing significant counterparty credit risk

exposures and then passing that risk back to affiliates in the United

States through non-cleared swaps. Variation margin is one of the tools

used by clearinghouses to mitigate counterparty credit risk. As an

independent risk management tool, it reduces counterparty credit risk

by requiring counterparties to make daily payments reflecting gains or

losses based on each swap's value. However, it is not a complete

replacement for the panoply of risk management tools that are used by

clearinghouses to manage counterparty credit risk. As a consequence,

this time-limited alternative compliance framework will mitigate

counterparty credit risk, but not to the extent that clearing would.

The Commission, however, believes that this measure will enable

affiliates in the European Union, Japan, or Singapore to take advantage

of the exemption while comparable clearing regimes are being

established in those jurisdictions, while

[[Page 21779]]

simultaneously mitigating the risk of financial risk being transferred

back to the United States through uncleared inter-affiliate swaps. In

this way it provides benefits to companies with affiliates in these

jurisdictions, and also to the American public.

Moreover, the Commission believes that providing additional time-

limited relief for certain affiliates located in the European Union,

Japan, or Singapore from the requirements of Sec. 50.52(b)(4)(i) to

clear their outward-facing swaps until March 11, 2014 under Sec.

50.52(b)(4)(ii)(B) also will mitigate the competitive effects noted

commenters by allowing such entities to continue to enter into inter-

affiliate swaps without requiring those swaps to be submitted to

clearing or variation margin, and is likely to be less costly than

requiring such entities to either clear or exchange variation margin on

their inter-affiliate or outward-facing swaps.

Lastly, the Commission received several comments regarding the

criteria for issuing comparability determinations, and expressing

concern that unless such issues are satisfactorily resolved, the

condition could hamper the ability of U.S.-based groups to compete in

foreign markets. In response, the Commission has provided in this final

release a significant amount of additional information regarding how

and when those determinations will be made.

In the NPRM, the Commission stated that the condition for the

treatment of outward-facing swaps would not impose additional

costs.\147\ Commenters stated that the proposed condition would

increase the costs of inter-affiliate swaps.\148\ In terms of the

revised rule, there may be some additional costs for entities that must

clear their outward-facing swaps. Such costs, as discussed above, would

include the cost of initial and variation margin, contributions to a

guaranty fund, and clearing fees. However, in light of the comments

discussed above, the Commission observes that, as modified, and with

the transition period provided for under the rule, costs have been

mitigated to the extent possible while preserving the goal of

preventing evasion.

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\147\ See NPRM at 50435.

\148\ See e.g., letter from CDEU.

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In terms of benefits, the Commission stated in the NPRM that the

corporate group and U.S. financial markets may bear additional risk if

the foreign affiliate is free to enter into an uncleared swap with a

third-party that would be subject to clearing were it entered into in

the United States. The Commission believes that the requirements for

outward-facing swaps will prevent foreign affiliates from taking on

significant risk through outward-facing swaps that fall under a Sec.

50.4 class, which reduces the risk that could then be transferred back

to the United States through exempt inter-affiliate swaps.

D. Costs and Benefits to Market Participants and the Public

Many commenters asserted that inter-affiliate swaps do not create

any additional risk for third parties facing those affiliates.\149\ In

addition, some commenters state that third parties may benefit from an

inter-affiliate exemption because it will allow corporate entities to

hedge their swaps more efficiently.\150\

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\149\ See, e.g., letters from EEI, The Working Group, and DLA

Piper.

\150\ See, e.g., letters from EEI, The Working Group, and ISDA &

SIFMA.

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The Commission recognizes that these claims may be true to the

extent that each affiliate, or a common parent, completely internalizes

the risks facing the other affiliate. Majority ownership facilitates

such internalization of costs among affiliated entities, and the threat

of reputational risk is another factor that may cause related entities

to act in the best interests of affiliate counterparties. However, as

discussed above, two other factors reduce the degree to which

affiliated entities may internalize each other's costs. Ownership

stakes that are less than 100% reduce the percentage of costs that one

affiliate internalizes from another, and bankruptcy laws providing

protection for the assets of one affiliate from the creditors of

another affiliate may create incentives to permit one affiliate to

fail. These factors reduce the internalization of costs among

affiliates.

As a consequence, the counterparty risk that creditors to a given

entity face may be increased by the inter-affiliate swaps into which

that the entity enters. This risk may not be ``new'' in the sense that

it is risk that was previously borne by another affiliate. But from the

perspective of counterparties to the entity that now bears the risk, it

is new. It increases the credit risk that the entity they face bears.

The Commission, however, has established conditions on the inter-

affiliate exemption that are intended to mitigate any increase in

counterparty risk that third parties might bear as the result of the

exemption. As described above, the documentation and centralized risk

management requirements help to ensure that each group of affiliates

engaging in inter-affiliate swaps has a centralized risk management

program with adequate information to value and risk manage swap

positions effectively. Moreover, the reporting requirements will help

to ensure that regulators have information that is necessary to

understand the use of inter-affiliate swaps under this exemption.

In terms of costs, some commenters assert that this exception

creates risk of contagion and systemic risk that could threaten the

U.S. financial system.\151\ As explained above, this concern is

substantiated to the extent that the inter-affiliate exemption prevents

affiliates from protecting themselves from counterparty risk they bear

with respect to one another, and to the extent that it prevents third

parties from protecting themselves from affiliates' counterparty risk.

The Commission believes that internalization of risk among affiliated

entities mitigates this concern, and that the application of required

clearing to swaps between affiliates and third parties further reduces

the probability of risk cascading through the financial system via

inter-affiliate swaps.

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\151\ See letters from AFR and Better Markets.

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AFR stated that the exemption may deprive DCOs of swaps volume and

liquidity that is necessary for risk management. In effect, the

exemption will reduce the number of swaps being cleared. All other

things being equal, this may cause DCOs to increase the margin

requirements for those swaps to compensate for having less volume,

which may increase the cost of using cleared swaps. AFR also stated

that the inter-affiliate exception will enable banks to set up joint

ventures to trade swaps without clearing them. The Commission believes

that its conditions with regard to treatment of outward-facing swaps

address AFR's concerns about evasion of the clearing requirement.

E. Costs and Benefits Compared to Alternatives

The Commission considered several alternatives to the final

rulemaking, including: (1) Alternative definitions of eligible

affiliate counterparty; (2) more prescriptive documentation

requirements; (3) alternative risk management requirements; (4)

different requirements for treatment of outward-facing swaps; and (5)

requiring variation margin for swaps between affiliated financial

entities. The first four alternatives are discussed at length above.

The fifth alternative, the imposition of variation margin on swaps

between affiliates that are financial entities, was considered by the

Commission and ultimately rejected based on comments.

[[Page 21780]]

As proposed, the inter-affiliate exemption would have required

affiliated financial entities to pay and collect variation margin

associated with their swaps unless the affiliates were 100% commonly

owned and commonly guaranteed by a 100% commonly owned guarantor. In

the final rule, the Commission has eliminated the variation margin

requirement. This change is likely to create significant savings for

eligible affiliates. Reduced margin requirements will reduce the

capital costs that entities bear when transacting inter-affiliate

swaps, and may reduce the capital requirements for financial entities

under prudential regulation. In addition, it may help entities avoid

liquidity crunches when their positions move significantly out of the

money in a short period of time.

However, eliminating the variation margin requirement also

significantly reduces the protective value of the eligibility

requirements that the Commission established in order to reduce the

likelihood of cascading defaults among affiliated entities, and the

associated risk to third parties transacting with those entities.

Without the variation margin requirements, affiliated entities may

develop large outstanding exposures toward one another, and to the

degree that affiliated entities do not internalize one another's costs,

an affiliate that is out of the money will have incentives not to

perform on its obligations. In addition if the obligations of one

entity are sufficiently large, its default may jeopardize the health of

other affiliated entities, which would also increase counterparty risk

for third parties that have uncleared outstanding positions with those

entities.

F. Consideration of CEA Section 15(a) Factors

1. Protection of Market Participants and the Public

In deciding to finalize the inter-affiliate clearing exemption, the

Commission assessed how to protect affiliated entities, third parties

in the swaps market, and the public. The Commission has sought to

ensure that in the absence of a clearing requirement the risks

presented by uncleared inter-affiliate swaps would be mitigated so that

significant losses to one affiliate counterparty or a default of one of

the affiliate counterparties is less likely to create significant

repercussions for third-parties or the American public. Toward that

end, the Commission has required that affiliates to execute swap

trading relationship documentation, maintain a centralized-risk

management process, and report specific information to an SDR, and meet

certain requirements related to outward-facing swaps in order to be

eligible for the exception. As explained in this cost-benefit section,

these conditions serve multiple objectives that ultimately protect

market participants and the public.

For instance, the documentation requirement will reduce

uncertainties where affiliates incur significant swaps-related losses

or where there is a defaulting affiliate. Because the documentation

would be in writing, the Commission expects that there will be less

contractual ambiguity should disagreements between affiliates arise.

The condition that an inter-affiliate swap be subject to a centralized

risk management program reasonably designed to monitor and manage risk

will also help mitigate the risks associated with inter-affiliate

swaps. As noted throughout this final rulemaking, inter-affiliate swap

risk could adversely impact third parties that enter into uncleared

swaps or other contracts with affiliates engaging in inter-affiliate

swaps.

The reporting condition would help the Commission and the

affiliate's leadership monitor compliance with the inter-affiliate

clearing exemption. For example, an affiliate that also is an SEC Filer

must receive a governing board's approval for electing the proposed

exemption. It cannot act independently. In the Commission's opinion,

the reporting conditions promote accountability and transparency,

offering another public safeguard by keeping the Commission and each

entity's board of directors informed.

On the other hand, the rule also creates certain costs that will be

borne by eligible entities, the counterparties to those entities, and

the public. Regarding costs for eligible entities, the qualification

requirements will create some new costs for those that do not already

have recordkeeping and risk management systems that are in compliance

with the rule. However, as noted above, the Commission believes that

some entities may already have systems in place that meet most or all

of the requirements. Moreover, entities will elect the exemption only

if they project the benefit of doing so is greater than the costs

associated with the qualifying requirements. Therefore, these costs may

decrease the value of the exemption, but they will not create new costs

for entities that choose not to elect the exemption.

2. Efficiency, Competitiveness, and Financial Integrity of Futures

Markets

Exempting swaps between majority-owned affiliates within a

corporate group from the clearing requirement will promote allocational

efficiency by reducing overall clearing costs for eligible affiliate

counterparties. The Commission also anticipates that the exemption will

increase allocational efficiency and the financial integrity of markets

because it will make it less costly for corporate groups to centralize

their hedging and market facing swap activities within a single

affiliate. As explained above, commenters stated that clearing swaps

through single affiliates enables affiliates and corporate groups to

more efficiently and effectively manage corporate risk.

Certain provisions of the proposed rule, such as the requirements

that inter-affiliate swaps be subject to centralized risk management

and that certain information be reported, also would discourage abuse

of the exemption. Together, these conditions promote the financial

integrity of swap markets and financial markets as a whole.

3. Price Discovery

Under Commission regulation 43.2, a ``publicly reportable swap

transaction,'' means, among other things, ``any executed swap that is

an arm's length transaction between two parties that results in a

corresponding change in the market risk position between the two

parties.'' \152\ The Commission does not consider non-arms-length swaps

as contributing to price discovery in the markets.\153\ Given that

inter-affiliate swaps as defined in this rulemaking are generally not

arm's length transactions, the Commission does not anticipate the

inter-affiliate clearing exemption to have any significant effect on

price discovery.\154\

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\152\ 17 CFR 43.2. See also Real-Time Public Reporting of Swap

Transaction Data, 77 FR 1182 (Jan. 9, 2012).

\153\ Transactions that fall outside the definition of

``publicly reportable swap transaction''--that is, transactions that

are not arms-length--``do not serve the price discovery objective of

CEA section 2(a)(13)(B).'' Real-Time Public Reporting of Swap

Transaction Data, 77 FR 1195. See also id. at 1187 (discussing

``Swaps Between Affiliates and Portfolio Compression Exercises'').

\154\ The definition of ``publicly reportable swap transaction''

identifies two examples of transactions that fall outside the

definition, including ``internal swaps between one-hundred percent

owned subsidiaries of the same parent entity.'' 17 CFR 43.2 (adopted

by Real-Time Public Reporting of Swap Transaction Data, 77 FR 1244).

The Commission notes that the list of examples is not exhaustive.

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4. Sound Risk Management Practices

As a general rule, the Commission believes that clearing swaps is a

sound

[[Page 21781]]

risk management practice. Exempting certain inter-affiliate swaps from

the clearing requirement creates additional counterparty exposure for

affiliates that do not completely internalize each other's risk, and

for third parties that enter into uncleared swaps or other transactions

with those affiliated entities. This increased counterparty risk among

affiliates may increase the likelihood that a default within one

affiliate could cause significant losses in other affiliated entities.

If the default causes other affiliated entities to default, then third

parties that have entered into uncleared swaps or other agreements with

those entities also could be affected. But, in finalizing the inter-

affiliate clearing exemption, the Commission has assessed the risks of

inter-affiliate swaps, and believes that the partial internalization of

costs among affiliated entities, combined with the documentation, risk

management, reporting, and treatment of outward-facing swaps

requirements for electing the exception, will mitigate some of the

risks associated with uncleared inter-affiliate swaps. However, they

are not a complete substitute for the protections that would be

provided by required clearing, or by a requirement to use some of the

same risk management tools that a clearinghouse would use to mitigate

counterparty credit risk (i.e., initial and variation margin).

Also, as noted above, without clearing to mitigate transmission of

risk among affiliates, the risk that any one affiliate takes on, and

any contagion that may be caused by that risk, may be transferred more

easily to other affiliates. This makes the risk mitigation requirements

for outward-facing swaps more important. The Commission's requirements

for outward-facing swaps mitigate the risk that swaps that the

Commission has determined are required to be cleared could transfer

risk that would then be spread among the affiliates, but does not

eliminate the possibility that swaps that are not required to be

cleared and are transacted in a regime without mandatory clearing (or

bilateral margin requirements) for uncleared swaps could result in

financial risk that impacts its affiliates and counterparties of those

affiliates.\155\

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\155\ The Commission notes that even in the absence of required

clearing or margin requirements for swaps between certain affiliated

entities, such entities may choose to use initial and variation

margin to manage risks that could otherwise be transferred from one

affiliate to another. Similarly, third parties that have entered

into swaps with affiliates may also include variation margin

requirements in their swap agreements.

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The Commission also believes that SEC Filer reporting is a prudent

practice. As detailed in this preamble and the rule text, SEC Filers

are affiliates that meet certain SEC-related qualifications, and their

governing boards or equivalent bodies are directly responsible to

shareholders for the financial condition and performance of the

affiliate. The boards also have access to information that would give

them a comprehensive picture of the company's financial condition and

risk management strategies. Therefore, any oversight they provide to

the affiliate's risk management strategies would likely encourage sound

risk management practices. In addition, the condition that affiliates

electing the inter-affiliate clearing exemption must report their

boards' knowledge of the election is a sound risk management practice.

5. Other Public Interest Considerations

Aside from those discussed in Section II.A above, the Commission

has identified no other public interest considerations.

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.\156\

As stated in the NPRM, the clearing requirement determinations and

rules proposed by the Commission will affect only ECPs because all

persons that are not ECPs are required to execute their swaps on a

designated contract market (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.\157\ Accordingly, the Chairman,

on behalf of the Commission, certified pursuant to 5 U.S.C. 605(b) that

the proposed rules would not have a significant economic impact on a

substantial number of small entities. The Commission then invited

public comment on this determination. The Commission received no

comments.

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\156\ See 5 U.S.C. 601 et seq.

\157\ To the extent that this rulemaking affects DCMs, DCOs, or

FCMs, the Commission has previously determined that DCMs, DCOs, and

FCMs are not small entities for purposes of the RFA. See,

respectively and as indicated, 47 FR 18618, 18619 (Apr. 30, 1982)

(DCMs and FCMs); and 66 FR 45604, 45609 (Aug. 29, 2001) (DCOs).

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The Commission has previously determined that ECPs are not small

entities for purposes of the RFA.\158\ However, in its proposed

rulemaking to establish a schedule to phase in compliance with certain

provisions of the Dodd-Frank Act, including the clearing requirement

under section 2(h)(1)(A) of the CEA, the Commission received a joint

comment (Electric Associations Letter) from the Edison Electric

Institute (EEI), the National Rural Electric Cooperative Association

(NRECA) and the Electric Power Supply Association (EPSA) asserting that

certain members of NRECA may both be ECPs under the CEA and small

businesses under the RFA.\159\ 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.'' \160\

Although the Electric Associations Letter does not provide details on

whether or how the NRECA members that have been determined to be small

entities use the interest rate swaps and CDS that are the subject of

this rulemaking, the Electric Associations Letter does state that the

EEI, NRECA, and EPSA members ``engage in swaps to hedge commercial

risk.'' \161\ 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 this rulemaking.

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\158\ See 66 FR 20740, 20743 (Apr. 25, 2001).

\159\ See joint letter from EEI, NRECA, and ESPA, dated Nov. 4,

2011, (Electric Associations Letter), commenting on Swap Transaction

Compliance and Implementation Schedule: Clearing and Trade Execution

Requirements under Section 2(h) of the CEA, 76 FR 58186 (Sept. 20,

2011).

\160\ Small Business Administration, Table of Small Business

Size Standards, Nov. 5, 2010.

\161\ See Electric Associations Letter, at 2. The letter also

suggests that EEI, NRECA, and EPSA members are not financial

entities. See id., at note 5, and at 5 (the associations' members

``are not financial companies'').

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Thus, because nearly all of the ECPs that may be subject to the

proposed 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 CFTC, hereby certifies pursuant to 5 U.S.C. 605(b) that

the rules herein will not have a significant economic impact on a

substantial number of small entities.

[[Page 21782]]

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (PRA) \162\ imposes certain

requirements on Federal agencies in connection with their conducting or

sponsoring any collection of information as defined by the PRA. An

agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information unless it has been approved by

the Office of Management and Budget (OMB) and displays a currently

valid control number.\163\

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\162\ 44 U.S.C. 3501 et seq.

\163\ Id.

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Certain provisions of this final rulemaking impose new information

collection requirements within the meaning of the PRA, for which the

Commission must obtain a valid control number. Accordingly, the

Commission requested, and OMB has assigned control number 3038-0104 for

the new collection of information. The Commission also has submitted

this final rule release, the proposed rulemaking, and all required

supporting documentation to OMB for review in accordance with 44 U.S.C.

3507(d) and 5 CFR 1320.11. The title for this new collection of

information is ``Rule 50.52 (proposed as rule 39.6(g)) Affiliate

Transaction Uncleared Swap Notification.'' Responses to this collection

of information will be mandatory.

The Commission will protect proprietary information in accordance

with the Freedom of Information Act and 17 CFR part 145, entitled

``Commission Records and Information.'' In addition, section 8(a)(1) of

the CEA strictly prohibits the Commission, unless specifically

authorized by the Act, from making public ``data and information that

would separately disclose the business transactions or market positions

of any person and trade secrets or names of customers.'' \164\ The

Commission also is required to protect certain information contained in

a government system of records according to the Privacy Act of 1974, 5

U.S.C. 552a.

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\164\ 7 U.S.C. 12(a)(1).

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1. Information Provided by Reporting Entities

The regulations being adopted in this final rule release impose

certain reporting requirements on eligible affiliates that enter into

inter-affiliate swaps and elect the inter-affiliate exemption from

clearing such swaps. As described in the NPRM and in this final

release, the reporting requirements are designed to address Commission

concerns regarding inter-affiliate swap risk and to provide the

Commission with information necessary to regulate the swaps market. In

particular, regulation 50.52(c) (proposed as Sec. 39.6(g)(4)) will

require an electing counterparty to provide, or cause to be provided,

certain information to a registered SDR or, if no registered SDR is

available to receive the information, to the Commission, in the form

and manner specified by the Commission. As further described in this

final rule release, Sec. 50.52(c)(1) requires reporting counterparties

to notify the Commission each time they elect the inter-affiliate

clearing exemption for each swap, by reporting certain information to a

registered SDR, or to the Commission, if no registered SDR is available

to receive the information. Reporting counterparties also must report

the information required by Sec. 50.52(c)(2) and (3), and have the

option to report such information each time that the eligible

counterparties elect the inter-affiliate exemption for each swap, or on

an annual basis in anticipation of electing the exemption.

To determine the total time burden and cost associated with the

proposed rule for PRA purposes, the Commission estimated the number of

affiliates that likely would seek to claim the exemption and the

average number of inter-affiliate swaps for which the affiliates would

elect to use the proposed exemption. The Commission also estimated the

time burden required for entities to comply with the reporting

requirements.

In estimating the number of affiliates and the average number of

inter-affiliate swaps that likely would claim the inter-affiliate

exemption, the Commission used data from the U.S. Bureau of Economic

Analysis (BEA) to estimate that there are approximately 22 subsidiaries

per U.S. multinational parent company (MNC), resulting in a total of

53,195 affiliates that might elect the inter-affiliate exemption.\165\

As more fully described in the NPRM, the Commission surveyed five

corporations to obtain information that allowed it to estimate that

affiliates enter into an average of 2,230 inter-affiliate swaps

annually.\166\

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\165\ NPRM at 50439-40.

\166\ Id.

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In estimating the time burden associated with complying with the

reporting requirements of the rules, the Commission stated in the NPRM

that it expected each reporting counterparty would likely spend between

15 seconds to two minutes per transaction entering information required

by Sec. 50.52(c)(1) (proposed Sec. 39.6(g)(4)(i)) into the reporting

system.\167\ The Commission further estimated that it would take the

reporting counterparty up to 10 minutes to collect and submit the

information required under Sec. 50.52(c)(2)-(3) (proposed Sec.

39.6(g)(4)(ii)-(iii)), for the first transaction and one to five

minutes to collect and submit the information for subsequent

transactions with that same counterparty. The Commission estimated that

together these requirements would cost a reporting counterparty between

$1.63 and $13.00 to comply with Sec. 50.52(c)(1) (proposed Sec.

39.6(g)(4)(i)), $65.00 to comply with Sec. 50.52(c)(2)-(3) (proposed

Sec. 39.6(g)(4)(ii)-(iii)) for the first inter-affiliate swap, and

between $6.50 and $32.50 to comply with Sec. 50.52(c)(2)-(3) (proposed

Sec. 39.6(g)(4)(ii)-(iii)) for subsequent inter-affiliate swaps with

the same counterparty.\168\

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\167\ The NPRM noted that to comply with proposed Sec.

39.6(g)(4)(i) (now Sec. 50.52(c)(1)), each reporting counterparty

would be required to check a box indicating that both counterparties

to the swap are electing not to clear the swap.

\168\ NPRM at 50440.

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With respect to the annual reporting option described in Sec.

50.52(d), the Commission stated in the NPRM that it anticipated that at

least 90% of MNCs would choose to file an annual report in lieu of

reporting each swap separately. The Commission estimated in the NPRM

that it would take an average of 30 to 90 minutes to complete and

submit the filing, resulting in an annual aggregate cost for submitting

the annual report of approximately $195 to $585.\169\

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\169\ NPRM at 50441.

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In addition to the specific reporting obligations described in the

rules, the NPRM also noted that reporting counterparties may need to

update established reporting systems to comply with the reporting

requirement, and non-reporting affiliate counterparties may need to

transmit information to reporting counterparties after entering into a

swap subject to the rules. In the NPRM, the Commission stated that it

anticipated that reporting counterparties may have to modify their

established reporting systems in order to accommodate the additional

data fields required by Sec. 50.52(c) (proposed Sec. 39.6(g)(4)), and

estimated that the modifications would create a one-time cost of

between $341 and $3,410 per entity.\170\ The Commission further stated

in the NPRM that it anticipated that an affiliate who is not the

reporting counterparty may need to communicate information to the

reporting counterparty after executing an inter-affiliate swap, and

estimated the cost of, among other things, providing

[[Page 21783]]

information to facilitate any due diligence that the reporting

counterparty may conduct, to be between $33 and $3,900.\171\

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\170\ Id.

\171\ Id.

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Using these figures, the Commission estimated that the inter-

affiliate exemption could result in an average total annual burden of

1,758,369 hours and average total annual costs of $685,309,281, or

approximately 1.8 minutes and $10.48 per inter-affiliate swap.

2. Information Collection Comments

The Commission invited public comment on the proposed PRA analysis

and estimates and on any aspect of the reporting burdens resulting from

proposed Sec. 39.6(g) (now Sec. 50.52(c)). One commenter submitted

comments in relation to the Commission's estimate of the number of

eligible affiliates seeking to claim the exemption. No commenters

submitted comments to OMB, and OMB itself did not submit any comments

to the Commission pertaining to the proposed rule.\172\

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

\172\ See 5 CFR 1320.11(f).

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In the context of its comments pertaining to the costs and benefits

of the reporting requirements of the proposed rule, EEI claimed that

the Commission's estimation of 22 eligible affiliates per MNC was ``far

too low'' for many U.S. energy companies. Although EEI commented that

the Commission's estimate of the number of affiliates per MNC was too

low in the context of U.S. energy companies, EEI did not provide an

alternative estimate or point to any other sources of information that

might provide an alternative source for estimating the average number

of subsidiaries per MNC.

The Commission has considered EEI's comment and declines to revise

its estimate of the number of affiliates of an MNC.\173\ As described

in the NPRM, the Commission estimated that a total of 53,195 affiliates

might elect the inter-affiliate clearing exemption. The Commission's

estimation of the number of affiliates of an MNC was based on the most

recent data collected by the BEA, which indicated that there are 2,347

MNCs in the U.S. and 25,424 foreign subsidiaries that are majority

owned by such MNCs.\174\ To account for the number of majority-owned

U.S. subsidiaries of MNCs, the Commission doubled the BEA's foreign

subsidiaries, and determined that there are an estimated 50,848 U.S.

and foreign subsidiaries, or approximately 22 subsidiaries per MNC.

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\173\ The Commission further notes that EEI's comments were made

exclusively with respect to U.S. energy companies and not the

broader spectrum of potential MNCs that are included within the

estimation.

\174\ See Table I.A 2., ``Selected Data for Foreign Affiliates

and U.S. Parents in All Industries,'' located at http://www.bea.gov/international/pdf/usdia_2009p/Group%20I%20tables.pdf. The BEA

defines a U.S. Parent of a MNC as a person that is a resident in the

United States and owns or controls 10 percent or more of the voting

securities, or the equivalent, of a foreign business enterprise. A

Guide to BEA Statistics on U.S. Multinational Companies, available

at http://www.bea.gov/scb/pdf/internat/usinvest/1995/0395iid.pdf.

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The Commission further notes that the estimate of the number of

affiliates per MNC proposed in the NPRM and adopted in this release for

purposes of the PRA, is an averaged approximation based on publically

available information collected by the BEA, and acknowledges that the

number of affiliates of an MNC may be higher or lower than 22. However,

there is no basis for concluding that the use of a different source for

estimating the average number of affiliates per MNC would result in a

higher number estimate, nor did the Commission receive comments to that

effect. Accordingly, the Commission believes that its estimation is

reasonable in light of the information that is publicly available at

this time, and that its original proposed estimates remain appropriate

for purposes of the PRA.

List of Subjects in 17 CFR Part 50

Business and industry, Clearing, Swaps.

For the reasons stated in the preamble, amend 17 CFR part 50 as

follows:

PART 50--CLEARING REQUIREMENT AND RELATED RULES

0

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

Authority: 7 U.S.C. 2(h) and 7a-1 as amended by Pub. L. 111-203,

124 Stat. 1376.

0

2. The heading for part 50 is revised to read as set forth above.

0

3. Add Sec. 50.52 to subpart C to read as follows:

Sec. 50.52 Exemption for swaps between affiliates.

(a) Eligible affiliate counterparty status. Subject to the

conditions in paragraph (b) of this section:

(1) Counterparties to a swap may elect not to clear a swap subject

to the clearing requirement of section 2(h)(1)(A) of the Act and this

part if:

(i) One counterparty, directly or indirectly, holds a majority

ownership interest in the other counterparty, and the counterparty that

holds the majority interest in the other counterparty reports its

financial statements on a consolidated basis under Generally Accepted

Accounting Principles or International Financial Reporting Standards,

and such consolidated financial statements include the financial

results of the majority-owned counterparty; or

(ii) A third party, directly or indirectly, holds a majority

ownership interest in both counterparties, and the third party reports

its financial statements on a consolidated basis under Generally

Accepted Accounting Principles or International Financial Reporting

Standards, and such consolidated financial statements include the

financial results of both of the swap counterparties.

(2) For purposes of this section:

(i) A counterparty or third party directly or indirectly holds a

majority ownership interest if it directly or indirectly holds a

majority of the equity securities of an entity, or the right to receive

upon dissolution, or the contribution of, a majority of the capital of

a partnership; and

(ii) The term ``eligible affiliate counterparty'' means an entity

that meets the requirements of this paragraph.

(b) Additional conditions. Eligible affiliate counterparties to a

swap may elect the exemption described in paragraph (a) of this section

if:

(1) Both counterparties elect not to clear the swap;

(2)(i) A swap dealer or major swap participant that is an eligible

affiliate counterparty to the swap satisfies the requirements of Sec.

23.504 of this chapter; or

(ii) If neither eligible affiliate counterparty is a swap dealer or

major swap participant, the terms of the swap are documented in a swap

trading relationship document that shall be in writing and shall

include all terms governing the trading relationship between the

eligible affiliate counterparties;

(3) The swap is subject to a centralized risk management program

that is reasonably designed to monitor and manage the risks associated

with the swap. If at least one of the eligible affiliate counterparties

is a swap dealer or major swap participant, this centralized risk

management requirement shall be satisfied by complying with the

requirements of Sec. 23.600 of this chapter; and

(4)(i) Each eligible affiliate counterparty that enters into a

swap, which is included in a class of swaps identified in Sec. 50.4,

with an unaffiliated counterparty shall:

[[Page 21784]]

(A) Comply with the requirements for clearing the swap in section

2(h) of the Act and this part;

(B) Comply with the requirements for clearing the swap under a

foreign jurisdiction's clearing mandate that is comparable, and

comprehensive but not necessarily identical, to the clearing

requirement of section 2(h) of the Act and this part, as determined by

the Commission;

(C) Comply with an exception or exemption under section 2(h)(7) of

the Act or this part;

(D) Comply with an exception or exemption under a foreign

jurisdiction's clearing mandate, provided that:

(1) The foreign jurisdiction's clearing mandate is comparable, and

comprehensive but not necessarily identical, to the clearing

requirement of section 2(h) of the Act and this part, as determined by

the Commission; and

(2) The foreign jurisdiction's exception or exemption is comparable

to an exception or exemption under section 2(h)(7) of the Act or this

part, as determined by the Commission; or

(E) Clear such swap through a registered derivatives clearing

organization or a clearing organization that is subject to supervision

by appropriate government authorities in the home country of the

clearing organization and has been assessed to be in compliance with

the Principles for Financial Market Infrastructures.

(ii)(A) Except as provided in paragraph (b)(4)(ii)(B) of this

section, if one of the eligible affiliate counterparties is located in

the European Union, Japan, or Singapore, the following may satisfy the

requirements of paragraph (b)(4)(i) of this section until March 11,

2014:

(1) Each eligible affiliate counterparty, or a third party that

directly or indirectly holds a majority interest in both eligible

affiliate counterparties, pays and collects full variation margin daily

on all swaps entered into between the eligible affiliate counterparty

located in the European Union, Japan, or Singapore and an unaffiliated

counterparty; or

(2) Each eligible affiliate counterparty, or a third party that

directly or indirectly holds a majority interest in both eligible

affiliate counterparties, pays and collects full variation margin daily

on all of the eligible affiliate counterparties' swaps with other

eligible affiliate counterparties.

(B) If one of the eligible affiliate counterparties is located in

the European Union, Japan, or Singapore, the requirements of paragraph

(b)(4)(i) of this section shall not apply to the eligible affiliate

counterparty located in the European Union, Japan, or Singapore until

March 11, 2014, provided that:

(1) The one counterparty that directly or indirectly holds a

majority ownership interest in the other counterparty or the third

party that directly or indirectly holds a majority ownership interest

in both counterparties is not a ``financial entity'' as defined in

section 2(h)(7)(C)(i) of the Act; and

(2) Neither eligible affiliate counterparty is affiliated with an

entity that is a swap dealer or major swap participant, as defined in

Sec. 1.3.

(iii) If an eligible affiliate counterparty located in the United

States enters into swaps, which are included in a class of swaps

identified in Sec. 50.4, with eligible affiliate counterparties

located in jurisdictions other than the United States, the European

Union, Japan, and Singapore, and the aggregate notional value of such

swaps, which are included in a class of swaps identified in Sec. 50.4,

does not exceed five percent of the aggregate notional value of all

swaps, which are included in a class of swaps identified in Sec. 50.4,

in each instance the notional value as measured in U.S. dollar

equivalents and calculated for each calendar quarter, entered into by

the eligible affiliate counterparty located in the United States, then

such swaps shall be deemed to satisfy the requirements of paragraph

(b)(4)(i) of this section until March 11, 2014, provided that:

(A) Each eligible affiliate counterparty, or a third party that

directly or indirectly holds a majority interest in both eligible

affiliate counterparties, pays and collects full variation margin daily

on all swaps entered into between the eligible affiliate counterparties

located in jurisdictions other than the United States, the European

Union, Japan, and Singapore and an unaffiliated counterparty; or

(B) Each eligible affiliate counterparty, or a third party that

directly or indirectly holds a majority interest in both eligible

affiliate counterparties, pays and collects full variation margin daily

on all of the eligible affiliate counterparties' swaps with other

eligible affiliate counterparties.

(c) Reporting requirements. When the exemption described in

paragraph (a) of this section is elected, the reporting counterparty,

as determined in accordance with Sec. 45.8 of this chapter, shall

provide or cause to be provided the following information to a

registered swap data repository or, if no registered swap data

repository is available to receive the information from the reporting

counterparty, to the Commission, in the form and manner specified by

the Commission:

(1) Confirmation that both eligible affiliate counterparties to the

swap are electing not to clear the swap and that each of the electing

eligible affiliate counterparties satisfies the requirements in

paragraph (b) of this section applicable to it;

(2) For each electing eligible affiliate counterparty, how the

counterparty generally meets its financial obligations associated with

entering into non-cleared swaps by identifying one or more of the

following categories, as applicable:

(i) A written credit support agreement;

(ii) Pledged or segregated assets (including posting or receiving

margin pursuant to a credit support agreement or otherwise);

(iii) A written guarantee from another party;

(iv) The electing counterparty's available financial resources; or

(v) Means other than those described in paragraphs (c)(2)(i), (ii),

(iii) or (iv) of this section; and

(3) If an electing eligible affiliate counterparty is an entity

that is an issuer of securities registered under section 12 of, or is

required to file reports under section 15(d) of, the Securities

Exchange Act of 1934:

(i) The relevant SEC Central Index Key number for that

counterparty; and

(ii) Acknowledgment that an appropriate committee of the board of

directors (or equivalent body) of the eligible affiliate counterparty

has reviewed and approved the decision to enter into swaps that are

exempt from the requirements of section 2(h)(1) and 2(h)(8) of the Act.

(d) Annual reporting. An eligible affiliate counterparty that

qualifies for the exemption described in paragraph (a) of this section

may report the information listed in paragraphs (c)(2) and (3) of this

section annually in anticipation of electing the exemption for one or

more swaps. Any such reporting by a reporting counterparty under this

paragraph will be effective for purposes of paragraphs (c)(2) and (3)

of this section for 365 days following the date of such reporting.

During the 365-day period, the reporting counterparty shall amend the

report as necessary to reflect any material changes to the information

reported. Each reporting counterparty shall have a reasonable basis to

believe that the eligible affiliate counterparties meet the

requirements for the exemption under this section.

[[Page 21785]]

Issued in Washington, DC, on April 1, 2013, by the Commission.

Melissa D. Jurgens,

Secretary of the Commission.

Note: The following appendices will not appear in the Code of

Federal Regulations.

Appendices to Clearing Exemption for Swaps Between Certain Affiliated

Entities--Commission Voting Summary and Statements of Commissioners

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Chilton,

O'Malia, and Wetjen voted in the affirmative; Commissioner Sommers

voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support the final rule to exempt swaps between certain

affiliated entities within a corporate group from the clearing

requirement in the Dodd-Frank Wall Street Reform and Consumer

Protection Act.

Since the late 19th century, clearinghouses have lowered risk

for the public and fostered competition in the futures market.

Clearing also has democratized the market by fostering access for

farmers, ranchers, merchants and other participants.

The Commission approved the first clearing requirement for swaps

last November, following through on the U.S. commitment at the 2009

G-20 meeting that standardized swaps be cleared by the end of 2012.

Following Congress' direction, end-users are not required to bring

swaps into central clearing.

A key milestone was reached on March 11 with the requirement

that swap dealers and the largest hedge funds begin clearing the

vast majority of interest rate and credit default index swaps.

Compliance will continue to be phased in throughout this year. Other

financial entities begin clearing June 10. Accounts managed by third

party investment managers and ERISA pension plans have until

September 9.

The final rule allows for an exemption from clearing for swaps

between affiliates under the following limitations:

First, the exemption covers swaps between majority-

owned affiliates whose financial statements are reported on a

consolidated basis.

Second, the rule requires documentation of such

exempted swaps, centralized risk management, and reporting

requirements for such swaps.

Third, the exemption requires that each swap entered

into by the affiliated counterparties with unaffiliated

counterparties must be cleared. This approach largely aligns with

the Europeans' approach to an exemption for inter-affiliate

clearing.

In order to promote international harmonization regarding

mandatory clearing, the final rulemaking provides for two time-

limited alternative compliance frameworks for swaps entered into

with unaffiliated counterparties in jurisdictions outside of the

United States.

With regard to affiliated counterparties located in the European

Union, Japan and Singapore--jurisdictions that have adopted swap

clearing regimes and are currently in the process of

implementation--the Commission is phasing compliance with the

requirement to clear swaps with unaffiliated counterparties until

March 11, 2014. During the phase-in period affiliated counterparties

located in these jurisdictions will be able to pay and collect

variation margin in lieu of clearing. Affiliated counterparties that

are located in these jurisdictions (that are not affiliated with

swap dealers or major swap participants) will not have to pay or

collect such variation margin during the phase-in period, provided

they are not directly or indirectly majority-owned by a financial

entity.

With regard to affiliated counterparties located in other

foreign jurisdictions, the Commission is phasing compliance with the

requirement to clear swaps with unaffiliated counterparties until

March 11, 2014. Until that date, an affiliated counterparty located

outside the United States, the European Union, Japan and Singapore

does not have to clear its swaps with unaffiliated counterparties so

long as the aggregate notional value of such swaps does not exceed

five percent of the notional value of all swaps entered into by the

affiliated counterparty located in the United States.

This phasing in of the inter-affiliate exemption provides a

transition period for foreign jurisdictions to implement comparable

and comprehensive clearing regimes.

[FR Doc. 2013-07970 Filed 4-10-13; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: April 11, 2013