Federal Register, Volume 77 Issue 162 (Tuesday, August 21, 2012)[Federal Register Volume 77, Number 162 (Tuesday, August 21, 2012)]
[Proposed Rules]
[Pages 50425-50443]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-20508]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 39
RIN 3038-AD47
Clearing Exemption for Swaps Between Certain Affiliated Entities
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or
``Commission'') is proposing a rule to exempt swaps between certain
affiliated entities within a corporate group from the clearing
requirement (the ``inter-affiliate clearing exemption'' or the
``proposed exemption'') under Section 2(h)(1)(A) of the Commodity
Exchange Act (``CEA''). The Commission also is proposing rules that
detail specific conditions counterparties must satisfy to elect the
proposed inter-affiliate clearing exemption, as well as reporting
requirements for affiliated entities that avail themselves of the
proposed exemption. The Commission has finalized a rule that addresses
swaps that are subject to the end-user exception. Counterparties to
inter-affiliate swaps that qualify for the end-user exception would be
able to elect to not clear swaps pursuant to the end-user exception or
the proposed rule. The proposed rule does not address swaps that an
affiliate enters into with a third party that are related to inter-
affiliate swaps that are subject to the end-user exception. The
Commission intends separately to propose a rule addressing swaps
between an affiliate and a third party where the swaps are used to
hedge or mitigate commercial risk arising from inter-affiliate swaps
for which the end-user exception has been elected.
DATES: Comments must be received on or before September 20, 2012.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD47,
by any of the following methods:
The agency's Web site, at: http://comments.cftc.gov.
Follow the instructions for submitting comments through the Web site.
Mail: David A. Stawick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Please submit your comments using only one method.
All comments must be submitted in English, or if not, accompanied
by an English translation. ``Inter-affiliate Clearing Exemption'' must
be in the subject field of responses submitted via email, and clearly
indicated on written submissions. Comments will be posted as received
to http://www.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that is exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the established procedures in
CFTC regulation 145.9.\1\
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\1\ 17 CFR 145.9. Commission regulations may be accessed through
the Commission's Web site, http://www.cftc.gov.
_____________________________________-
Throughout this proposed rulemaking, the Commission requests
comment in response to specific questions. For convenience, the
Commission has numbered each of these comment requests. The Commission
asks that, in submitting responses to these requests, commenters
identify the specific number of each request to which their comments
are responsive.
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse, or remove any or all of a
submission from www.cftc.gov that it may deem to be inappropriate for
publication, such as obscene language. All submissions that have been
redacted or removed that contain comments on the merits of the
rulemaking will be retained in the public comment file and will be
considered as required under the Administrative Procedure Act and other
applicable laws, and may be accessible under the Freedom of Information
Act.
FOR FURTHER INFORMATION CONTACT: Gloria Clement, Assistant General
Counsel, (202) 418-5122, [email protected], Office of General Counsel;
Jonathan Lave, Associate Director, Exchange & Data Repository, (202)
418-5983, [email protected], and Alexis Hall-Bugg, Attorney-Advisor, (202)
418-6711, [email protected], Division of Market Oversight; Warren
Gorlick, Supervisory Attorney-Advisor, (202) 418-5195,
[email protected], and Anuradha Banerjee, Attorney-Advisor, (202) 418-
5661, [email protected], Office of International Affairs; Theodore
Kneller, Attorney-Advisor, (202) 418-5727, [email protected], Division
of Enforcement; Elizabeth Miller, Attorney-Advisor, (202) 418-5985,
[email protected], Division of Swap Dealer and Intermediary Oversight;
Esen Onur, Research Economist, (202) 418-6146, [email protected], Office
of the Chief Economist; and Jolanta Sterbenz, Counsel, (202) 418-6639,
[email protected], Office of General Counsel, Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street, NW.,
Washington, DC 20581.
I. Background
A. Clearing Requirement for Swaps
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act (``Dodd-Frank Act'' or ``DFA'').\2\
Title VII of the Dodd-Frank Act amended the CEA,\3\ and established a
new regulatory framework for swaps. The legislation was enacted to
reduce systemic risk, increase transparency, and promote market
integrity within the financial system by, among other things: (1)
Imposing clearing and trade execution requirements on standardized
derivative products; (2) creating rigorous recordkeeping and data
reporting regimes with respect to swaps, including real-time public
reporting; and (3) enhancing the Commission's rulemaking and
enforcement authorities over all registered entities, intermediaries,
and swap counterparties subject to the Commission's oversight.
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (July 21, 2010).
\3\ 7 U.S.C. 1 et seq. (2006).
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Section 723 of the Dodd-Frank Act added section 2(h) to the CEA,
which establishes a clearing requirement for swaps.\4\ The new section
makes it unlawful for any person to engage in a swap, if the Commission
determines such swap is required to be cleared, unless the person
submits the swap for clearing to a registered derivatives clearing
organization (``DCO'') (or a DCO that is exempt from registration).\5\
The
[[Page 50426]]
CEA, however, permits exceptions and exemptions to the clearing
requirement.
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\4\ CEA section 2(h)(1)(A), 7 U.S.C. 2(h)(1)(A).
\5\ See CEA section 2(h)(1)(A), 7 U.S.C. 2(h)(1)(A). The CEA's
clearing requirement states that, ``[i]t shall be unlawful for any
person to engage in a swap unless that person submits such swap for
clearing to a derivatives clearing organization that is registered
under this Act or a derivatives clearing organization that is exempt
from registration under this Act if the swap is required to be
cleared.''
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A person may elect not to clear certain swaps if such person
qualifies for an exception under CEA section 2(h)(7) and the Commission
regulations issued in connection therewith (the ``end-user
exception'').\6\ To summarize the principal components of the end-user
exception, for a swap to qualify, a counterparty to the swap electing
the exception must (i) not be a ``financial entity,'' as defined in CEA
section 2(h)(7)(C)(i) or qualify for an exemption from that defined
term under section 2(h)(7)(D),\7\ or through a Commission-issued
exemption under CEA sections 2(h)(7)(C)(ii) \8\ or 4(c) \9\ and (ii) be
using the swap to hedge or mitigate commercial risk. The Commission has
determined to exempt certain small banks, savings associations, farm
credit institutions, and credit unions under section 2(h)(7)(C)(ii) of
the CEA from the definition of ``financial entity.''\10\
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\6\ CEA section 2(h)(7)(A), 7 U.S.C. 2(h)(7)(A). CEA section
2(h)(7)(A) provides an elective exception to the clearing
requirement to any counterparty to a swap that is not a financial
entity, is using the swap to hedge or mitigate commercial risk, and
notifies the Commission how it generally meets the financial
conditions associated with entering into non-cleared swaps. The
Commission issued the end-user exception in a rulemaking entitled,
``End-User Exception to the Clearing Requirement for Swaps,'' 77 FR
42560, July 19, 2012 (final).
\7\ CEA section 2(h)(7)(D), 7 U.S.C. 2(h)(7)(D).
\8\ CEA section 2(h)(7)(C)(ii), 7 U.S.C. 2(h)(7)(C)(ii) (``The
Commission shall consider whether to exempt small banks, savings
associations, farm credit system institutions, and credit unions * *
* '').
\9\ CEA section 4(c), 7 U.S.C. 6(c).
\10\ ``End-User Exception to the Clearing Requirement for
Swaps,'' 77 FR 42560, July 19, 2012 (see Sec. 39.6(d)).
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Importantly, a counterparty to an inter-affiliate swap that
qualifies for both the end-user exception and the inter-affiliate
exemption may elect not to clear the inter-affiliate swap under either
the end-user exception or the inter-affiliate exemption. As such, the
Commission believes that the rule proposed in this rulemaking may not
be necessary for the vast majority of inter-affiliate swaps involving a
non-financial entity or a small financial institution because the end-
user exception can be elected for those swaps. Accordingly, it is
likely the proposed rule will be used for inter-affiliate swaps between
two financial entities that do not qualify for the end-user exception
or for swaps involving a non-financial entity that do not qualify for
the end-user exception because the swaps do not hedge or mitigate
commercial risk.
Finally, CEA section 4(c)(1), described in more detail below,
grants the Commission general exemptive powers.\11\ Pursuant to that
authority, the Commission has proposed a rule that would allow
cooperatives meeting certain conditions to elect not to submit for
clearing certain swaps subject to a clearing requirement.\12\
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\11\ Section 4(c)(1) of the CEA empowers the Commission to
exempt any transaction or class of transactions, including swaps,
from certain CEA provisions, such as the clearing requirement.
\12\ ``Clearing Exemption for Certain Swaps Entered into by
Cooperatives,'' 77 FR 41940, July 17, 2012.
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B. Swaps Between Affiliated Entities
Except as provided with respect to certain financing affiliates as
noted above, CEA section 2(h) does not provide any specific exception
to swaps entered into by affiliates that are subject to a clearing
requirement (``inter-affiliate swaps'').\13\ Inter-affiliate swaps that
are hedged by back-to-back or matching book swaps entered into with
third parties may pose risks to the financial system if the inter-
affiliate swaps are not properly risk managed thereby raising the
likelihood of default on the outward facing swaps. Furthermore, there
could be systemic risk implications if an affiliate used by the
corporate group to trade outward facing swaps (commonly referred as
centralized treasury or conduit affiliates) has large positions and
defaulted on obligations arising from inter-affiliate swaps if such
swaps are hedged with third-party swaps.\14\ Such a default could harm
third-party swap counterparties, and potentially, financial markets as
a whole, if the treasury/conduit affiliate was unable to satisfy third-
party obligations as a consequence of the default.
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\13\ For the purposes of this proposed rulemaking, ``inter-
affiliate swaps'' refers to swaps between ``affiliates,'' as that
term is defined in proposed Sec. 39.6(g)(1): ``[c]ounterparties to
a swap * * * may elect not to clear a swap with an affiliate if one
party directly or indirectly holds a majority ownership interest in
the other, or if a third party directly or indirectly holds a
majority interest in both, based on holding 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.'' See infra pt. II.B.1 for further discussion.
\14\ There does not appear to be a common definition of a
``treasury affiliate'' or a ``conduit affiliate.'' For purposes of
this proposed rulemaking, a treasury/conduit affiliate (or
structure) is an affiliate that enters into inter-affiliate swaps
and enters into swaps with third parties that are related to such
inter-affiliate swaps on a back-to-back or aggregate basis.
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A number of commenters in a variety of Commission rulemakings have
recommended that the Commission adopt an exemption to the clearing
requirement for inter-affiliate swaps.\15\ Some commenters claimed that
inter-affiliate swaps offer significant benefits with substantially
less risk than swaps between unaffiliated entities. They contended that
inter-affiliate swaps enable a corporate group to aggregate its risks
on a global basis in one entity through risk transfers between
affiliates. Commenters also described varying structures through which
corporate groups entered into inter-affiliate swaps and manage risks.
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\15\ The Commission notes that comment letters to other proposed
rulemakings under Title VII of the Dodd-Frank Act are not part of
the administrative record for this rulemaking unless specifically
cited herein.
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Prudential Financial, Inc. (``PFI''), stated that it employs a
``conduit'' structure where separate legal entities are commonly owned
by PFI.\16\ Under this structure, PFI uses one affiliate to directly
face the market as a ``conduit'' to hedge the net commercial and
financial risk of the various operating affiliates within PFI. PFI
contended that the use of a conduit diminishes the demands on PFI's
financial liquidity, operational assets, and management resources,
because ``affiliates within PFI avoid having to establish independent
relationships and unique infrastructure to face the market.'' Moreover,
PFI explained that its conduit facilitates the netting of its
affiliates' trades (e.g., where one affiliate hedges floating rates
while another hedges fixed rates). PFI stated that this conduit
structure effectively reduces the overall risk of PFI and its
affiliates, and it allows PFI to manage fewer outstanding positions
with external market participants.\17\
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\16\ Prudential Financial, Inc. comment letter to the proposed
rulemaking, ``Further Definition of `Swap Dealer,' `Security-Based
Swap Dealer,' `Major Swap Participant,' `Major Security-Based Swap
Participant' and `Eligible Contract Participant,' '' 75 FR 80147,
Dec. 21, 2010.
\17\ J.P. Morgan commented that the most efficient way to manage
risk is often at one entity and on a portfolio level. This way all
the risk for the corporate group resides in one entity. J.P. Morgan
maintained that this reduces market risk at each legal entity and
can reduce risk on a group level because offsetting positions held
by different members of the group can be aggregated to mitigate the
overall risk of the portfolio. J.P. Morgan asserted that portfolio
risk management enables regulators to more easily assess the net
risk position on a group level rather than piecing together data
from separate affiliates to reconstruct the actual risk profile of
the group. J.P. Morgan comment letter to the proposed rulemaking,
``Process for Review of Swaps for Mandatory Clearing,'' 75 FR 67277,
Nov. 2, 2010.
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In a letter to Congress, the Coalition for Derivatives End-Users
(``CDEU'') asserted that inter-affiliate swaps do not create external
counterparty exposure and, therefore, pose none of the systemic or
other risks that the clearing requirement is designed to protect
against.\18\ Thus, in CDEU's view, the
[[Page 50427]]
imposition of required clearing on inter-affiliate swaps would not
reduce systemic risk. CDEU also commented that a conduit or treasury
structure is beneficial because it centralizes trade expertise and
execution in a single or limited number of entities. Finally, CDEU
claimed that a treasury or conduit structure benefits affiliates
because they can enjoy their parents' corporate credit ratings and
associated pricing benefits.
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\18\ Coalition for Derivatives End-Users comment letter for H.R.
2682, H.R. 2779, and H.R. 2586 (Mar. 23, 2012).
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These comments suggest that swaps entered into between corporate
affiliates, if properly risk-managed, may be beneficial to the
operation of the corporate group as a whole. They indicate that inter-
affiliate swaps may improve a corporate group's risk management
internally and allow the corporate group to use the most efficient
means to effectuate swaps with third parties. While the Commission
recognizes these potential benefits of inter-affiliate swaps, the
Commission is also taking into account the systemic risk repercussions
of inter-affiliate swaps as it considers and proposes an exemption to
the CEA's clearing requirement applicable to those inter-affiliate
swaps.
II. Inter-Affiliate Clearing Exemption Under CEA Section 4(c)(1)
A. The Commission's Section 4(c)(1) Authority
Section 4(c)(1) of the CEA empowers the Commission to ``promote
responsible economic or financial innovation and fair competition'' by
exempting any transaction or class of transactions, including swaps,
from any of the provisions of the CEA (subject to exceptions not
relevant here).\19\ In enacting CEA section 4(c)(1), Congress noted
that the goal 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.'' \20\ Observant of that objective,
the Commission has determined preliminarily that it would be
appropriate to exempt inter-affiliate swaps from the clearing
requirement in CEA section 2(h) under certain terms and conditions. The
proposed exemption, however, would not extend to swaps that affiliates
entered into with third parties.
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\19\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1), provides, in
pertinent part, that:
In order to promote responsible economic or financial innovation
and fair competition, the Commission by rule, regulation, or order,
after notice and opportunity for hearing, may (on its own initiative
or on application of any person * * * ) exempt any agreement,
contract, or transaction (or class thereof) that is otherwise
subject to subsection (a) of this section * * * either
unconditionally or on stated terms or conditions or for stated
periods and either retroactively or prospectively, or both, from any
of the requirements of subsection (a) of this section, or from any
other provision of this Act.
By issuing a proposed exemptive rule, the Commission also is
exercising its general rulemaking authority under CEA section 8a(5),
7 U.S.C. 12a(5).
\20\ House Conf. Report No. 102-978, 1992 U.S.C.C.A.N. 3179,
3213 (``4(c) Conf. Report'').
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The primary benefit of clearing is the reduction of counterparty
risk. The Commission notes commenters' assertions that there is less
counterparty risk associated with inter-affiliate swaps than swaps with
third parties to the extent that affiliated counterparties internalize
each other's counterparty risk because they are members of the same
corporate group. This internalization can be demonstrated by the
example of a swap entered into between affiliates A and B that are
majority owned by the same person.\21\ If affiliate A fails to perform,
then affiliate B would be harmed. However, affiliate A also may be
harmed if (1) B's harm adversely impacts the profits of A and B's
corporate group \22\ or (2) A's failure to perform drives the group
into bankruptcy, because, for instance, B has entered into a swap with
a third party and B is unable to perform as a consequence of A's
failure to perform. The potential harm to A for failing to perform is
greater than the harm A would experience if B was not a majority-owned
affiliate. Accordingly, A internalizes B's counterparty risk and A has
a greater economic incentive to perform than if B were a third party.
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\21\ The meaning of ``majority-owned'' is set forth and
discussed in part B1.
\22\ A's corporate group is the group that contains the person
with a majority ownership interest of A. Similarly, B's corporate
group is the group that contains the person with a majority
ownership interest of B.
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The Commission does not believe there is significantly reduced
counterparty risk with respect to swaps between affiliates that are not
majority-owned by the same person because there is less economic
feedback. If A is a majority-owned affiliate and B is a minority-owned
affiliate, then any harm that B experiences as a consequence of A's
failure to perform is likely to have a less adverse impact on the
profits of A's corporate group than if B was a majority-owned
affiliate. In addition, the Commission believes that B's failure to
perform would be significantly less likely to drive A's corporate group
into bankruptcy than if B were majority-owned.
On the basis of reduced counterparty risk, the Commission has
determined preliminarily that inter-affiliate swap risk may not need to
be mitigated through clearing, but can be reduced through other means.
The Commission also believes at the proposal stage that exempting
inter-affiliate swaps would enable corporations to structure their
groups so that corporate risk is concentrated in one entity--whether it
be at a treasury- or conduit-type affiliate, or at the parent
company.\23\ The Commission recognizes there may be advantages for the
corporate group and regulators if risk is appropriately managed and
controlled on a consolidated basis and at a single affiliate. Based
upon the comments received, the Commission understands that some
corporate groups use this type of structure.
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\23\ Treasury/conduit affiliates, for example, often enter into
swaps with third parties that hedge aggregate inter-affiliate swap
risk. The aggregation is based on risk correlations. If those
correlations break down, then the treasury/conduit affiliate may no
longer be able to satisfy its third-party swap obligations.
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The Commission, nevertheless, believes that uncleared inter-
affiliate swaps could pose risk to corporate groups and market
participants, generally. Uncleared inter-affiliate swaps also may pose
risk to other market participants, and therefore the financial system,
if the treasury/conduit affiliate enters into swaps with third parties
that are related on a back-to-back or matched book basis with inter-
affiliate swaps. To continue the above example, if A's failure to
perform (for whatever reason) makes it impossible for B to meet its
third-party swap obligations, then those third parties would be harmed
and risk could spread into the marketplace. However, A's risk of
nonperformance is less than it would be if B were a third party to the
extent A internalizes B's counterparty risk.
To address these concerns, the Commission is proposing rules that
would exempt inter-affiliate swaps from clearing if certain conditions
are satisfied. First, the proposed exemption would be limited to swaps
between majority-owned affiliates whose financial statements are
reported on a consolidated basis. Second, the proposed rules would
require the following: Centralized risk management, documentation of
the swap agreement, variation margin payments (for financial entities),
and satisfaction of reporting requirements. In addition, the exemption
would be limited to swaps between U.S. affiliates, and swaps between a
U.S. affiliate and a foreign affiliate located in a jurisdiction with a
comparable and comprehensive clearing regime or the non-United States
counterparty is otherwise required to clear the swaps it enters into
with third
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parties in compliance with United States law or does not enter into
swaps with third parties. Additionally, the Commission notes that the
proposed exemption does not limit the applicability of any CEA
provision or Commission regulation to any person or transaction except
as provided in the proposed rulemaking. These conditions will be
discussed in further detail below.
Request for Comments
Q1. The Commission requests comment on whether it should exercise
its authority under CEA section 4(c).
Q2. Do inter-affiliate swaps pose risk to the corporate group? If
so, what risk is posed? In particular, do inter-affiliate swaps pose
less risk to a corporate group than swaps with third parties? If so,
why is that the case?
Q3. Do inter-affiliate swaps pose risk to the third parties that
have entered into swaps that are related to the inter-affiliate swaps?
If so, what risk is posed?
Q4. Would the proposed exemption promote responsible economic or
financial innovation and fair competition?
Q5. Would the proposed exemption promote the public interest?
Q6. Inter-affiliate swaps that do not meet the conditions to the
proposed exemption would be subject to the clearing requirement under
CEA section 2(h)(1)(A) and, potentially, the trade execution
requirement under CEA section 2(h)(8) as well. What would be the costs
and benefits of imposing the trade execution requirement on these
inter-affiliate swaps? Should the Commission exempt some or all inter-
affiliate swaps from the trade execution requirement regardless of
whether the conditions to the proposed inter-affiliate clearing
exemption are met?
B. Proposed Regulations
1. Proposed Sec. 39.6(g)(1): Definition of Affiliate Relationship
Under proposed Sec. 39.6(g)(1), the inter-affiliate clearing
exemption would only be available for swaps between majority-owned
affiliates. As explained above, the Commission believes there is
reduced counterparty risk with respect to such swaps. Under the
proposed rule, affiliates would be majority-owned if one affiliate
directly or indirectly holds a majority ownership interest in the other
affiliate, or if a third party directly or indirectly holds a majority
ownership interest in both affiliates and the financial statements of
both affiliates are reported on a consolidated basis. A majority-
ownership interest would be based on holding 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.\24\
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\24\ The affiliate status required by proposed Sec. 39.6(g)(1)
to elect the proposed exemption is based on and functionally
equivalent to the definition of majority-owned affiliates in
recently adopted CFTC regulation 1.3(ggg)(6)(i).
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The Commission is not proposing to extend the exemption to
affiliates that are related on a minority-owned basis. As explained
above, the Commission does not believe there is significantly reduced
counterparty risk with respect to swaps between such affiliates. The
Commission also believes it is important for the proposed 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.\25\ For example, the
European Parliament and Council of the European Union have adopted the
European Market Infrastructure Regulation (``EMIR'').\26\ Subject to
the relevant provisions, technical standards, and regulations under
EMIR, certain derivatives transactions between parent and subsidiary
entities, could be exempt from its general clearing requirement.
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\25\ In 2009, the G20 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.'' G20
Leaders' Final Statement at Pittsburgh Summit: Framework for Strong,
Sustainable and Balanced Growth (Sept. 29, 2009).
\26\ 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) available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:201:0001:0059:EN:PDF.
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Request for Comments
Q7. The Commission requests comments on all aspects of the
Commission's proposed requirement that the inter-affiliate clearing
exemption be available to majority-owned affiliates.
Q8a. Should the Commission consider requiring a percentage of
ownership greater than majority ownership to qualify for the inter-
affiliate clearing exemption?
Q8b. If so, what percentage should be used and what are the
benefits and burdens of such ownership requirements?
Q8b. Should the Commission require a 100% ownership threshold for
the inter-affiliate clearing exemption? Would a 100% ownership
threshold reduce counterparty risk and protect minority owners better
than the proposed threshold. Are there other means to lessen risk to
minority owners, such as consent?
Q9. Should the Commission consider an 80% ownership threshold based
on section 1504 of the Internal Revenue Code, which establishes an 80%
voting and value test for an affiliate group.\27\ In light of the
potential benefits from centralized risk management in an affiliated
group, would an 80% threshold sufficiently reduce overall risk to
financial system
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\27\ The Internal Revenue Service allows a business conglomerate
to file consolidated tax returns if the parent company and its
subsidiaries meet a relationship test that is outlined in 26 U.S.C.
1504(a)(2):
(a) Affiliated group defined for purposes of this subtitle--
(1) In general. The term ``affiliated group'' means--
(A) 1 or more chains of corporations connected through stock
ownership with a common parent corporation which is a corporation,
but only if--
(B) (i) the common parent owns directly stock meeting the
requirements of paragraph (2) in at least 1 of the other
corporations, and
(ii) stock meeting the requirements of paragraph (2) in each of
the includible corporations (except the common parent) is owned
directly by 1 or more of the other includible corporations.
(2) 80-percent voting and value test The ownership of stock of
any corporation meets the requirements of this paragraph if it--
(A) possesses at least 80 percent of the total voting power of
the stock of such corporation, and
(B) has a value equal to at least 80 percent of the total value
of the stock of such corporation.
(3) Stock not to include certain preferred stock
For purposes of this subsection, the term ``stock'' does not
include any stock which--(A) is not entitled to vote,
(B) is limited and preferred as to dividends and does not
participate in corporate growth to any significant extent,
(C) has redemption and liquidation rights which do not exceed
the issue price of such stock (except for a reasonable redemption or
liquidation premium), and
(D) is not convertible into another class of stock.
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2. Proposed Sec. 39.6(g)(2)(i): Both Counterparties Must Elect the
Inter-Affiliate Clearing Exemption
The Commission believes that affiliates within a corporate group
may make independent determinations on whether to submit an inter-
affiliate swap for clearing. Ostensibly, each affiliate may reach
different conclusions regarding the appropriateness of clearing. Given
this possibility, proposed Sec. 39.6(g)(2)(i) would require that both
counterparties elect the proposed inter-affiliate clearing exemption
(each, an ``electing counterparty'').
Request for Comments
Q10. Would this requirement create any operational issues?
3. Proposed Sec. 39.6(g)(2)(ii): Swap Documentation
The Commission understands that affiliates may enter into swaps
with
[[Page 50429]]
each other with little documentation about the terms and conditions of
the swaps. The Commission is concerned that without proper
documentation affiliates would be unable to effectively track and
manage risks arising from inter-affiliate swaps or offer sufficient
proof of claim in the event of bankruptcy. This could create challenges
and uncertainty that could adversely affect affiliates, third party
creditors, and potentially the financial system. The Commission also is
concerned about transparency should there be a need for an audit or
enforcement proceeding.
Proposed Sec. 39.6(g)(2)(iii) would address these concerns by
requiring affiliates to enter into swaps with a swap trading
relationship document.\28\ The proposed rule would require the document
to be in writing and to include all terms governing the trading
relationship between the affiliates, including, without limitation,
terms addressing payment obligations, netting of payments, events of
default or other termination events, calculation and netting of
obligations upon termination, transfer of rights and obligations,
governing law, valuation, and dispute resolution procedures.\29\ The
Commission believes this requirement would not be onerous because
affiliates should be able to use a master agreement to document most of
the terms of their inter-affiliate swaps.
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\28\ For swap dealers and major swap participants, these issues
are addressed in the swap trading relationship documentation rules
proposed by the Commission in Sec. 23.504. See ``Swap Trading
Relationship Documentation Requirements for Swap Dealers and Major
Swap Participants,'' 76 FR 6715, Feb. 8, 2011. The proposed rule
requires that if one or more of the parties to the swap for which
the inter-affiliate exemption is elected is a swap dealer or major
swap participant, then that party shall comply with Sec. 23.504 for
that swap. Swap dealers and major swap participants that comply with
that provision would also satisfy the proposed requirements.
\29\ The requirements of the swap trading relationship document
are informed by proposed CFTC regulation 23.504(b)(1). See ``Swap
Trading Relationship Documentation Requirements for Swap Dealers and
Major Swap Participants,'' 76 FR 6715, Feb. 8, 2011.
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Request for Comments
Q11. The Commission requests comment as to the burden or cost of
the proposed rule requiring documentation of inter-affiliate swaps.
Q12. The Commission also requests comment as to whether its risk
tracking and management and proof-of-claim concerns could be addressed
by other means of documentation.
Q13. The Commission requests comment as to whether the Commission
should create a specific document template. Should the industry do so?
4. Proposed Sec. 39.6(g)(2)(iii): Centralized Risk Management
Proposed Sec. 39.6(g)(2)(iii) would require inter-affiliate swaps
to be subject to a centralized risk management program reasonably
designed to monitor and manage the risks associated with the inter-
affiliate swaps. As noted in Part I.B. above, inter-affiliate swaps may
pose risk to third parties if risks are not properly managed.
Accordingly, to encourage prudent risk management, the proposed inter-
affiliate clearing exemption would be conditioned on a corporate
group's evaluation, measurement and control of such risks. The
Commission anticipates that the program would be implemented and run by
the parent company or the treasury/conduit affiliate, but the rule
provides flexibility to determine how best to satisfy this
requirement.\30\
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\30\ The Commission has adopted risk management rules for swap
dealers and major swap participants in 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 20128, 20173-75, April 3, 2012 (final rule). The
rule requires that if one or more of the parties to the swap for
which the inter-affiliate exemption is elected is a swap dealer or
major swap participant, then that party shall comply with Sec.
23.600 for that swap. Swap dealers and major swap participants that
comply with that provision will also satisfy the proposed
requirements.
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The Commission understands that some groups that use inter-
affiliate swaps, particularly large financial entities, already have a
centralized risk management program.\31\ Indeed, several commenters--
e.g., SIFMA and ISDA--supported centralized risk management and claimed
that centralized risk management for inter-affiliate swaps ``would be
compromised'' by a clearing requirement.\32\ CDEU also commented that
inter-affiliate swaps are beneficial because they allow swaps with
third parties to be traded at a treasury-type structure which contains
risk management expertise.\33\ Based on comments received, the
Commission believes that the proposed rule is in line with industry
practice. Proposed Sec. 39.6(g)(2)(iii) also is in harmony with
similar requirements under EMIR, which would require under certain
circumstances for both counterparties to intra-group transactions to be
``subject to an appropriate centrali[z]ed risk evaluation, measurement
and control procedures. * * *'' \34\
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\31\ See, e.g., Letter from SIFMA and ISDA submitted to the
Commission on their own initiative (May 14, 2012).
\32\ Id.
\33\ See 3/23/23 Letter from CDEU.
\34\ See EMIR Article 3, paragraphs 1 and 2. EMIR identifies
factors necessary to establish a transaction as an intra-group
transaction.
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Request for Comments
Q14. The Commission requests comments that explain how current
centralized risk management programs operate.
Q15. The Commission requests comment on whether it should
promulgate additional regulations that set forth minimum standards for
a centralized risk management program. If so, what should those
standards be? Is there a consistent industry practice which could be
observed?
Q16. Is the proposed rule in line with industry practice?
5. Proposed Sec. 39.6(g)(2)(iv): Variation Margin
Proposed Sec. 39.6(g)(2)(iv) would require that variation margin
be collected for swaps between affiliates that are financial entities,
as defined in CEA section 2(h)(7)(C), in compliance with the proposed
variation margin requirements set forth in proposed Sec.
39.6(g)(3).\35\ Variation margin is an essential risk-management tool.
A well-designed variation margin system protects both parties to a
trade. It 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. 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.\36\ This process prevents uncollateralized
exposures from accumulating over time and thereby reduces the size of
any loss resulting from a default should one occur. Required margining
also might cause parties to more carefully consider the risks involved
with swaps and manage those risks more closely over time. The
Commission believes, at this stage, that inter-affiliate swap risk may
be mitigated through variation margin and notes that requiring
variation margin for inter-affiliate swaps is being discussed by
international regulators working on harmonizing regulations governing
swap clearing.
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\35\ Discussed in pt. II.B.8., below.
\36\ Variation margin is distinguished from initial margin,
which is intended to serve as a performance bond against potential
future losses. If a party defaults, the other party may use initial
margin to cover most or all of any loss that may result between the
time the default occurs and when the non-defaulting party replaces
the open position.
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The Commission understands that a number of financial entities
currently
[[Page 50430]]
post variation margin for their inter-affiliate swaps. According to
SIFMA and ISDA, ``[t]he posting of variation margin limiting the impact
of market movements upon the respective positions of the affiliated
parties now occurs routinely in financial groups and its imposition on
affiliates who transact directly with affiliated swap dealers (SDs) or
major swap participants (MSPs) should not be unduly disruptive.'' \37\
The Commission has proposed rules requiring certain financial entities
to pay and collect variation and initial margin for uncleared swaps
entered into with other financial entities.\38\
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\37\ See, e.g., 5/14/12 Letter from SIFMA and ISDA.
\38\ The Commission does not propose that variation margin
posted in respect of inter-affiliate swaps be required to be held in
a segregated account or be otherwise unavailable for use and
rehypothecation by the counterparty holding such variation margin.
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The proposed requirement would not apply to 100% commonly-owned and
commonly-guaranteed affiliates, provided that the common guarantor is
also under 100% common ownership. As discussed above, the risk of an
inter-affiliate swap may be mitigated through the posting of variation
margin. The Commission believes that when the economic interests of two
affiliates are both (i) fully aligned and (ii) a common guarantor bears
the ultimate risk associated swaps entered into with a third party,
non-affiliated counterparty, the posting of variation margin does not
substantially mitigate the risk of an inter-affiliate swap. This
exception is intended to apply to swaps between two wholly-owned
subsidiaries of a common parent or in instances where one affiliate is
wholly owned by the other.
The first of the conditions required to claim the exception to the
requirement under proposed regulation 39.6(g)(2)(iv) to post variation
margin relates to complete common ownership. When two affiliates are
owned by the same owner or one is wholly owned by the other, the
underlying owners are the same and the economic interests of the two
affiliates are aligned.\39\ In such circumstances, the two affiliates
are subject to the control of a common owner or common set of
owners.\40\
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\39\ In contrast, if two affiliates do not have the same owners,
the potential exists that the two affiliates may have differing
economic interests. See also Copperweld v. Independence Tube--467
U.S. 752 (1984) at 771 (``The coordinated activity of a parent and
its wholly owned subsidiary must be viewed as that of a single
enterprise for purposes of Sec. 1 of the Sherman Act. A parent and
its wholly owned subsidiary have a complete unity of interest. Their
objectives are common, not disparate, and their general corporate
objectives are guided or determined not by two separate corporate
consciousnesses, but one.'').
\40\ Under such circumstances, the two affiliates are subject to
common control, in actuality or potentially--i.e., the common owner
could assert full control when one or both affiliates cease to act
in the common owner's best interest.
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A person would not be able to claim 100 percent ownership for the
purposes of this provision based on a contingent right or obligation,
by contract or otherwise, to take ownership of the equity interest in
the affiliate by purchase or otherwise.\41\ Conversely, structures in
which a person owns 100 percent of the equity but has an obligation or
right, by contract or otherwise, to give up, by sale or otherwise, all
or a portion of that equity interest would not meet the 100 percent
ownership test. Such contingent or residual rights evidence a less than
complete responsibility for the affiliate, including its swap
obligations, that the 100 percent ownership and guaranty provision is
intended to require. Under such circumstances, the interests of the
owner and the affiliate are not fully aligned. The second condition
requires the existence of a common guarantor. When two affiliates share
a common guarantor that is under the same common ownership, the
Commission believes that the risk created by a swap with a non-
affiliated third party is ultimately borne by the enterprise (which is
defined by an alignment of economic interests). To provide an example,
assume that A and B are guaranteed wholly-owned subsidiaries of X. B
enters into a swap with non-affiliated third party T. B then enters
into a back-to-back swap (mirroring the risk created in the swap with
T) with A (i.e., an inter-affiliate swap). In this scenario, the risk
associated with the swap with T is effectively borne by X and therefore
ultimately borne by the enterprise. In such circumstances therefore the
inter-affiliate swap does not create new risks for the enterprise,
rather, it allocates the risk from one wholly-owned subsidiary to
another. The posting of variation margin here would not substantially
mitigate the risk of the inter-affiliate swap because the inter-
affiliate swap itself does not create new risks for the enterprise.
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\41\ For example, if a financial entity established a trust,
partnership, corporation or other type of entity, and sells the
equity interests therein to investors, but retains the right to
call, repurchase, or otherwise take control of the equity interest,
or has a contingent obligation to call, repurchase or otherwise take
control of the equity interest, such right or obligation would not
be sufficient to constitute ownership of the affiliate for purposes
of this provision.
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Request for Comments
Q17a. The Commission requests comment as to whether it should
promulgate regulations that set forth minimum standards for variation
margin. If so, what should those standards be?
Q17b. The Commission requests comment as to whether it should
promulgate regulations that set forth minimum standards for initial
margin. If so, what should those standards be?
Q17c. The Commission requests comment as to whether it should
promulgate regulations that set forth minimum standards for both
initial and variation margin for inter-affiliate swaps. If so, what
should those standards be?
Q17d. The Commission's proposed rule ``Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants''--17 CFR
Part 23--would require initial and variation margin for certain swaps
that are not cleared by a registered designated clearing organization.
Should inter-affiliate swaps that are not subject to the clearing
requirement of CEA section 2(h)(1)(A) be subject to the margin
requirements as set out in proposed Part 23 or otherwise?
Q18. The Commission requests comment on the costs and benefits of
requiring variation margin for inter-affiliate swaps, both in general
and specifically, regarding corporate groups that do not currently
transfer variation margin in respect of inter-affiliate swaps.
Q19. The Commission requests comment on whether 100% commonly-owned
affiliates sharing a common guarantor--that is, a guarantor that is
also 100% commonly owned--should be exempt from the requirement to
transfer variation margin. Please explain the impact on the corporate
group, if any, if the described affiliates are required to transfer
variation margin.
Q20a. Should any other categories of entities or corporate groups,
such as non-swap dealers and non-major swap participants, be exempt
from the variation margin requirement for their inter-affiliate swaps?
If so, which categories and why?
Q20b. Should the Commission limit the variation margin requirements
to those inter-affiliate swaps for which at least one counterparty is a
swap dealer, major swap participant, or financial entity, as defined in
paragraph (g)(6) of the proposed rule text, that is subject to
prudential regulation?
Q21. The Commission requests comment as to whether it should
eliminate the proposed exemption's variation margin condition for swaps
between 100% owned affiliates.
Q22. The Commission requests comment as to whether it should
eliminate the proposed exemption's
[[Page 50431]]
variation margin condition for swaps between 80% owned affiliates.
Q23. The Commission requests comment on whether all types of
financial entities identified in CEA section 2(h)(7)(C) should be
subject to the variation margin requirement. Should entities that are
part of a commercial corporate group and are financial entities solely
because of CEA section 2(h)(7)(C)(i)(VIII) be excluded from such
requirement? Why?
6. Proposed Sec. 39.6(g)(2)(v): Both Affiliates Must Be Located in the
United States or in a Country With a Comparable and Comprehensive
Clearing Regime or the Non-United States Counterparty Is Otherwise
Required To Clear Swaps With Third Parties in Compliance With United
States Law or Does Not Enter Into Swaps With Third Parties
The Commission is proposing to limit the inter-affiliate clearing
exemption to inter-affiliate swaps between two U.S.-based affiliates or
swaps where one affiliate is located abroad in a jurisdiction with a
comparable and comprehensive clearing regime or the non-United States
counterparty is otherwise required to clear swaps with third parties in
compliance with United States law or does not enter into swaps with
third parties. The limitation in Sec. 39.6(g)(2)(v) is designed to
address the Commission's concerns about risk and to deter evasion as
directed by CEA section 2(h)(4)(A).
Under section 2(h)(4)(A), the Commission must prescribe rules
necessary to prevent evasion of the clearing requirement.\42\ The
Commission is concerned that an inter-affiliate clearing exemption
could enable entities to evade the clearing requirement through trades,
for example, with affiliates that are located in foreign jurisdictions
that do not have a comparable and comprehensive clearing regime.
Informed in part by certain relevant intra-group transactions
provisions under EMIR,\43\ proposed Sec. 39.6(g)(2)(v) would require
that both affiliates be U.S. persons or one of the affiliates is a U.S.
person and the other affiliate is domiciled in a non-U.S. jurisdiction
with a comparable and comprehensive regulatory regime for swap clearing
or the non-United States counterparty is otherwise required to clear
swaps with third parties in compliance with United States Law or does
not enter into swaps with third parties.\44\
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\42\ See CEA section 2(h)(4)(A), 7 U.S.C. 2(h)(4)(A).
Additionally, CEA section 6(e)(4)-(5) states that any DCO, SD, or
MSP may be subject to double civil monetary penalties should they
evade the clearing requirement, among other things. The relevant CEA
sections state, ``that knowingly or recklessly evades or
participates in or facilitates an evasion of the requirements of
section 2(h) shall be liable for a civil monetary penalty twice the
amount otherwise available for a violation of section 2(h).'' See
CEA section 6(e)(4)-(5), 7 U.S.C. 9a(4)-(5).
\43\ See, generally, EMIR Articles 3, 4, 11, 13.
\44\ For example, a counterparty located in a country that does
not have a comparable clearing regime may be required to clear swaps
with third parties in compliance with United States law if it meets
the definition of a ``conduit'' as described in the Commission's
proposed interpretive guidance and policy statement entitled,
``Cross-Border Application of Certain Swaps Provisions of the
Commodity Exchange Act,'' 77 FR 41214, July 12, 2012.
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The Commission recognizes that there may be a legitimate reason for
an inter-affiliate swap where one affiliate is located in a country
that does not have a comparable clearing regime. However, the
Commission believes that financial markets may be at risk if the
foreign affiliate enters into a related third-party swap that would be
subject to clearing were it entered into in the United States, but is
not cleared. On balance, the Commission believes that the risk of
evasion and the systemic risk associated with uncleared swaps
necessitates that the exemption be limited to swaps between affiliates
located in the United States or in foreign countries with comparable
clearing regimes or the non-United States counterparty is otherwise
required to clear swaps with third parties in compliance with United
States law or does not enter into swaps with third parties.
Request for Comments
Q24a. The Commission requests comment on proposed Sec.
39.6(g)(2)(v). Is the proposed condition that both affiliates must be
located in the United States or in a country with a comparable and
comprehensive clearing jurisdiction or the non-United States
counterparty is otherwise required to clear swaps with third parties or
does not enter into swaps with third parties a necessary and
appropriate means of reducing risk and evasion concerns related to
inter-affiliate swaps? If not, how should these concerns be addressed?
Q24b. Should the Commission limit the inter-affiliate clearing
exemption to foreign affiliates that only enter into inter-affiliate
swaps if such foreign affiliates are not located in a jurisdiction with
a comparable and comprehensive clearing requirement or are otherwise
required to clear swaps with third parties in compliance with United
States?
Q24c. Should the Commission limit the inter-affiliate clearing
exemption to foreign affiliates that enter into swaps with third
parties on an occasional basis if such foreign affiliates are not
located in a jurisdiction with a comparable and comprehensive clearing
requirement or are otherwise required to clear swaps with third parties
in compliance with United States. What would constitute an occasional
basis? For example, would once a year be an appropriate time frame?
Q25. The Commission requests comment on (1) the prevalence of
cross-border inter-affiliate swaps and the mechanics of moving swap-
related risks between U.S. and non-U.S. affiliates for risk management
and other purposes (including an identification of such purposes); (2)
the risk implications of cross-border inter-affiliate swaps for the
U.S. markets; and (3) specific means to address the risk issues
potentially presented by cross-border inter-affiliate swaps.
Q26. The Commission recently adopted anti-evasion provisions
relating to cross-border swap activities in its new rule 1.6.\45\ To
what extent are the risk issues potentially presented by cross-border
inter-affiliate swaps addressed by the anti-evasion provisions in rule
1.6?
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\45\ Rule 1.6 was included in the Commission's ``Product
Definitions'' rulemaking, which was adopted jointly with the SEC.
See ``Further Definition of `Swap,' `Security-Based Swap,' and
`Security-Based Swap Agreement;' Mixed Swaps; Security-Based Swap
Agreement Recordkeeping,'' 77 FR 39626 (July 23, 2012).
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Q27. The Commission also is considering an alternative condition to
address evasion. That condition would require non-U.S. affiliates to
clear all swap transactions with non-U.S. persons, provided that such
transactions are related to inter-affiliate swaps which would be
subject to a clearing requirement if entered into by two U.S.
persons.\46\ Should the Commission adopt such a condition? Would such a
condition help enable the Commission to ensure that the proposed inter-
affiliate clearing exemption is not abused or used to evade the
clearing requirement? Are there any other means to prevent evasion of
the clearing requirement or abuse of the proposed inter-affiliate
clearing exemption that the Commission should adopt?
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\46\ The Commission has proposed separately interpretative
guidance on certain entity-level and transaction-level requirements
imposed by Title VII of Dodd-Frank for cross-border swaps. See
Proposed Interpretive Guidance and Policy Statement entitled,
``Cross-Border Application of Certain Swaps Provisions of the
Commodity Exchange Act,'' 77 FR 41214 (July 12, 2012).
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7. Proposed Sec. 39.6(g)(2)(vi): Notification to the Commission
As explained in more detail below, the Commission has preliminarily
determined that it must receive certain
[[Page 50432]]
information to effectively regulate inter-affiliate swaps. Proposed
Sec. 39.6(g)(2)(vi) would require one of the counterparties to an
inter-affiliate swap to comply with the reporting requirements set
forth in Sec. 39.6(g)(4.).
8. Proposed Sec. 39.6(g)(3): Variation Margin Requirements
Proposed Sec. 39.6(g)(3) would set forth the requirements for
transferring variation margin. Proposed Sec. 39.6(g)(3)(i) would
require that if both counterparties to the swap are financial entities,
each counterparty shall pay and collect variation margin for each
inter-affiliate swap for which the proposed exemption is elected.
Proposed Sec. 39.6(g)(3)(ii) would require that the swap trading
relationship document set forth and describe the methodology to be used
to calculate variation margin with sufficient specificity to allow the
counterparties, the Commission, and any appropriate prudential
regulator to calculate the margin requirement independently. The
Commission believes that the proposed rule would help ensure that
affiliates have a written methodology. The proposed rule also would
allow affiliates to manage their risks more effectively throughout the
life of the swap and to avoid disputes regarding issues such as
valuation.\47\
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\47\ For further discussion on the concept of variation margin
for uncleared swaps, see proposed rulemaking, ``Margin Requirements
for Uncleared Swaps for Swap Dealers and Major Swap Participants,''
76 FR 27621, Feb. 12, 2011.
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9. Proposed Sec. 39.6(g)(4): Reporting Requirements
Pursuant to CEA section 4r,\48\ uncleared swaps must be reported to
a Swap Data Repository (``SDR''), or to the Commission if no repository
will accept such information, by one of the counterparties (the
``reporting counterparty'').\49\ In addition to any general reporting
requirements applicable under other applicable rules to a particular
type of entity that is an affiliate or to the inter-affiliate swap,
proposed Sec. 39.6(g)(4) would implement reporting requirements
specifically for uncleared inter-affiliate swaps.\50\ Proposed Sec.
39.6(g)(4)(i) would require the reporting counterparty to affirm 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). Besides alerting the Commission of the
election, the information would help ensure that each counterparty is
aware of, and satisfies the definitions and conditions set forth in
proposed Sec. 39.6(g)(1)-(2).
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\48\ CEA section 4r; 7 U.S.C. 6r.
\49\ See CEA sections 2(a)(13) (reporting of swaps to SDRs) and
4r (reporting alternatives for uncleared swaps); 7 U.S.C. 2(a)(13)
and 7 U.S.C. 6r.
\50\ See ``Swap Data Recordkeeping and Reporting Requirements,''
77 FR 2136, Jan. 13, 2012 (``Swap Data Recordkeeping and
Reporting''). Regulation 45.11 contemplates that this information
may be delivered to the Commission directly in limited circumstances
when a SDR is not available. 77 FR at 2168. When permitted, such
delivery would also meet the proposed inter-affiliate clearing
exemption reporting requirement.
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Proposed Sec. 39.6(g)(4)(ii)-(iii) would require the reporting
counterparty to provide certain information, unless such information
had been provided in a current annual filing pursuant to proposed Sec.
39.6(g)(5). Proposed Sec. 39.6(g)(4)(ii) would require the reporting
counterparty to submit information regarding how the financial
obligations of both counterparties are generally satisfied with respect
to uncleared swaps. The information is valuable because it would
provide the Commission a more complete view of the risk characteristics
of uncleared swaps. The information also would enhance the Commission's
efforts to identify and reduce potential systemic risk.
Proposed Sec. 39.6(g)(4)(iii) would implement CEA section 2(j) for
purposes of the inter-affiliate exemption.\51\ That CEA section places
a prerequisite on issuers of securities registered under section 12 of
the Securities Exchange Act of 1934 (``Exchange Act'') \52\ or required
to file reports under Exchange Act section 15(g) \53\ (``electing SEC
Filer'') that elect exemptions from the CEA's clearing requirement
under section 2(h)(1)(A). 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 the clearing
exemption.
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\51\ 7 U.S.C. 2(j), in pertinent part:
Exemptions from the requirements of subsection (h)(1) to clear a
swap and subsection (h)(8) to execute a swap through a board of
trade or swap execution facility shall be available to a
counterparty that is an issuer of securities that are registered
under section 12 of the Securities Exchange Act of 1934 (15 U.S.C.
78l) or that is required to file reports pursuant to section 15(d)
of the Securities Exchange Act of 1934 (15 U.S.C. 78o) only if an
appropriate committee of the issuer's board or governing body has
reviewed and approved its decision to enter into swaps that are
subject to such exemptions.
\52\ 15 U.S.C. 78l.
\53\ 15 U.S.C. 78o.
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Proposed Sec. 39.6(g)(4)(iii)(A) would require an electing SEC
Filer to notify the Commission of its SEC Filer status by submitting
its SEC Central Index Key number. This information would enable the
Commission to cross-reference materials filed with the relevant SDR
with information in periodic reports and other materials filed by the
electing SEC Filer with the U.S. Securities and Exchange Commission
(``SEC''). In addition, proposed Sec. 39.6(g)(4)(iii)(B) would require
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.\54\ If both affiliates/counterparties are
electing SEC Filers, both counterparties would have to report the
additional information in proposed Sec. 39.6(g)(4)(iii).
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\54\ For example, a board resolution or an amendment to a board
committee's charter could expressly authorize such committee to
review and approve decisions of the electing person not to clear the
swap being reported. In turn, such board committee could adopt
policies and procedures to review and approve decisions not to clear
swaps, on a periodic basis or subject to other conditions determined
to be satisfactory to the board committee.
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Finally, proposed Sec. 39.16(g)(5) would permit counterparties to
provide the information listed in proposed (g)(4)(ii)-(iii) on an
annual basis in anticipation of electing the inter-affiliate clearing
exemption for one or more swaps. Any such reporting under this
paragraph would be effective for inter-affiliate swaps entered into
within 365 days following the date of such reporting. During the 365-
day period, the affiliate would be required to amend the information as
necessary to reflect any material changes to the reported information.
In addition, the Commission anticipates that for most corporate groups,
affiliates would submit identical annual reports.
Request for Comments
Q28. The Commission requests comment on whether affiliates would
submit identical annual reports for most corporate groups.
Q29a. The Commission requests comment as to whether reporting
counterparties that would not report to an SDR should be subject to
swap-by-swap reporting requirements? Should the Commission allow such
entities to report all information on an annual basis? Please provide
any information as to the number of reporting counterparties that would
be affected by such a rule change.
Q29b. The Commission requests comment as to whether different sized
entities should be subject to the proposed reporting requirements or
the reporting requirements for affiliates that elect the end-user
exception, as applicable. If different sized entities should not be
subject to such reporting requirements, please explain why.
Alternatively, should the Commission
[[Page 50433]]
allow phased compliance for different sized entities?
III. Consideration of Costs and Benefits
A. Introduction
Section 15(a) of the CEA \55\ 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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\55\ 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.\56\ 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 such swaps could cause or exacerbate
instability in the financial system.\57\ 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.\58\ For reasons explained above,\59\
the Commission proposes to exercise its authority under CEA section
4(c)(1) to exempt inter-affiliate swaps--that is, swaps between
majority-owned affiliates--from the Section 2(h)(1)(A) clearing
requirement.
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\56\ See Section 2(h)(1) of the CEA, 7 U.S.C. 2(h)(1).
\57\ 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.
\58\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1). CEA section
4(c)(1) is discussed in greater detail above in part II.A.
\59\ See pt.II.A.
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In the discussion that follows, the Commission considers the costs
and benefits of the proposed 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 proposed exemption: (1) Swap trading relationship
documentation, which would require affiliates to document in writing
all terms governing the trading relationship; (2) centralized risk
management and variation-margin requirements, which would require
affiliates to subject the swap to centralized risk management and to
post variation margin; and (3) 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
than swap-by-swap.
Finally, the inter-affiliate clearing exemption would require one
of the following four conditions be satisfied for each affiliate: The
affiliate is located in the United States; the affiliate is located in
a jurisdiction with a comparable and comprehensive clearing
requirement; the affiliate is required to clear all swaps it enters
into with non-affiliated counterparties; or the affiliate does not
enter into swaps with non-affiliated counterparties.
B. Proposed Baseline
The Commission's proposed baseline for consideration of the costs
and benefits of this proposed exemption are the costs and benefits that
the public and market participants (including potentially eligible
affiliates) would experience in the absence of this regulatory action.
In other words, the proposed baseline is an alternative situation in
which the Commission takes no action, meaning that potentially eligible
affiliates would be required to comply with the clearing requirement.
More specifically, under the CEA, as amended by the Dodd-Frank Act, and
Commission regulations (finalized or future) inter-affiliate swaps will
be subject to a clearing requirement and, depending on whether the
affiliate is an SD, MSP, or eligible contract participant, a variety of
record-keeping and reporting requirements. In such a scenario, the
public and market participants, including corporate affiliates
transacting swaps with each other, would experience the costs and
benefits related to clearing and complying with Commission regulations
under parts 23, 45, and 46.\60\ The proposed exemption would alter
these costs and benefits. For example, among other things, the public
and market participants would not experience the full benefits related
to clearing or satisfying all the requirements under parts 23, 45, and
46. At the same time, affiliates electing the exemption would likely
incur lower costs for two reasons. First, the cost of variation margin
is significantly less than the cost of clearing.\61\ Second, the costs
of satisfying the reporting requirements under the proposed exemption
would be less than the costs associated with satisfying all of the
requirements under parts 23, 45, and 46.
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\60\ See, e.g., costs and benefits discussion in the following
rulemakings: ``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 20128, 20194, Apr. 3, 2012; ``Business
Conduct Standards for Swap Dealers and Major Swap Participants with
Counterparties,'' 77 FR 9803, 9804, Feb. 17, 2012; ``Swap Data
Record Keeping and Reporting Requirements,'' 77 FR 2136, 2171, Jan.
13, 2012; ``Opting Out of Segregation,'' 66 FR 20740, 20743, Apr.
25, 2001; ``Swap Data Recordingkeeping and Reporting Requirements:
Pre-Enactment and Transition Swaps,'' 77 FR 35200, Jun. 12, 2012.
\61\ The cost of clearing includes posting initial and variation
margin.
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The Commission also considers the regulatory landscape as it
existed before the Dodd-Frank Act's enactment. Entities that transacted
inter-affiliate swaps within a corporate group were neither subject to
a clearing requirement nor compelled to comply with regulatory
requirements, including requirements to record and report inter-
affiliate swaps. Thus, measured against a pre-Dodd-Frank Act reference
point, affiliates that avail themselves of the proposed exemption would
experience incremental costs and benefits occasioned by compliance with
the conditions for exercising the proposed exemption.
[[Page 50434]]
In the discussion that follows, where reasonably feasible, the
Commission endeavors to estimate quantifiable dollar costs. The
benefits of the proposed exemption, as well as certain costs, however,
are not presently susceptible to meaningful quantification. Where it is
unable to quantify, the Commission discusses proposed costs and
benefits in qualitative terms.
C. Costs
1. To Market Participants and the Public
As discussed above, inter-affiliate swaps--though possessing a
lesser degree of counterparty risk than swaps transacted between non-
affiliated counterparties--are not risk-free. As evidenced in the 2008
financial crisis, counterparty swap risk, transmitted systemically, can
exact a heavy cost on market participants as well as the public. Thus,
unconditionally exempting inter-affiliate swaps from the clearing
requirement would come with a cost of increased risk that clearing is
intended to contain. This includes the risk that the failure of one
party to perform under the terms of a swap transaction would cause the
counterparty to be unable to perform under the terms of swaps it had
entered into with other counterparties, thereby causing a cascading
series of non-performance throughout the financial system. Clearing
both reduces this risk of non-performance and promotes confidence
throughout the financial system that the failure of one firm will not
lead to a systemic crisis, thereby lessening the chance of such a
crisis or the need for the federal government to intervene to prevent
any such failures. Accordingly, the Commission does not propose an
unconditional, blanket exemption. Rather, the Commission proposes an
exemption with conditions carefully tailored to offset the narrower,
counterparty-risk profile that inter-affiliate swaps present relative
to all swaps generally. Based on the expectation that for the subset of
inter-affiliate swaps covered by this proposed exemption these
conditions are capable of closely approximating the risk protections
that clearing provides to swaps more generally, the Commission foresees
no significant additional risk cost from the proposed exemption.
2. To Potentially Eligible Entities
The proposed rule is exemptive and would provide potentially
eligible affiliates with relief from the clearing requirement and
attendant Commission regulations. As with any exemptive rule or order,
the proposed rule is permissive, meaning that potentially eligible
affiliates are not required to elect it. Accordingly, the Commission
assumes that an entity would rely on the proposed exemption only if the
anticipated benefits warrant the costs. Here, the proposed inter-
affiliate clearing exemption identifies three categories of conditions
that an eligible affiliate must satisfy to elect the proposed
exemption: documentation, risk management, and reporting. The
Commission believes that a person would have to incur costs to satisfy
these conditions. The Commission also believes that an affiliate would
elect the exemption only if these costs are less than the costs that an
affiliate would incur should it decide not to elect the exemption.
Regarding the documentation condition, the Commission believes that
affiliates electing the exemption (other than SDs/MSPs satisfying the
swap documentation condition and risk-management conditions by
satisfying the requirements of regulations 23.504 and 23.600,
respectively) would likely incur costs to develop a standardized
document to comply with the proposed Sec. 39.6(g)(2)(ii) requirement
that all terms governing the trading relationship be in writing.\62\
The Commission estimates 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. Unless otherwise stated, the
remaining wage calculations used in this proposed rule also are derived
from this source and modified in the same manner. The Commission,
however, is unable to estimate such costs with greater specificity
because it is unable to estimate the frequency of, and costs associated
with modifying a swap agreement.
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\62\ 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 ``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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Affiliates also would incur costs related to signing swap documents
and retaining copies. The Commission believes that affiliates would
incur less than $1,000 per year for such activities. The Commission
notes, however, that these estimates may overstate the actual costs
because it expects that affiliates within a corporate group would be
able to share legal-drafting and record-retention costs, as well as
labor costs.
The second category of conditions concerns risk management.
Affiliates electing the proposed exemption would have to subject inter-
affiliate swaps to centralized risk management, which would include
variation margin.\63\ To meet the centralized-risk-management condition
under Sec. 39.16(g)(2)(iii), some affiliates may have to create a risk
management system.\64\ To do so, affiliates would have to purchase
equipment and software to adequately evaluate and measure inter-
affiliate swap risk. The Commission believes that such costs could be
possibly as high as $150,000. For example, these costs might include
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. The total
would amount to $75,000. There also might be installation and
unexpected costs that could increase up-front costs to approximately
$150,000. In addition to these start-up costs, there could be ongoing
costs. The Commission estimates that centralized risk management could
require up to ten full-time staff at an average salary of $150,000 per
year.\65\ Finally, 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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\63\ 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 20128,
20173-75, April 3, 2012 (final rule).
\64\ 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.
\65\ 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.
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Proposed Sec. 39.6(g)(2)(iv) would require counterparties to post
variation margin in compliance with proposed Sec. 39.6(g)(3)'s
documentation and other
[[Page 50435]]
requirements. The Commission believes that companies may have to hire
attorneys and financial analysts to develop and document the variation
margin methodology to comply with this rule, resulting in a one-time
cost of $29,000 per entity electing the proposed exemption. This
estimate assumes up to 100 hours of financial analyst time at an
average cost of $208 per hour, and up to 20 hours of compliance
attorney time at an average cost of $390 per hour.
The Commission also believes that affiliates would incur certain
costs to comply with the proposed Sec. 39.16(g)(2)(iv) condition to
post variation margin. The Commission anticipates that affiliates would
have to hire up to three people at an average salary of $150,000 per
year to estimate the price of inter-affiliate swaps and to manage
variation margin payments between affiliates. In addition, the
Commission expects that companies would have to purchase equipment and
software to estimate the price of inter-affiliate swaps and to
subscribe to a data service. However, the Commission anticipates that
such costs also would be incurred to satisfy the centralized risk
management condition in proposed Sec. 39.6(g)(2)(iii). Finally,
affiliates would have to incur the opportunity costs associated with
posting collateral to cover variation margin.\66\
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\66\ The opportunity cost of posting collateral is the highest
return an affiliate would have earned by investing that collateral
instead of using it to cover variation margin under similar
conditions.
---------------------------------------------------------------------------
The third category of conditions involves reporting requirements.
Proposed Sec. 39.6(g)(4) would require affiliates to report specific
information to an SDR or to the Commission if no SDR would accept such
information. Proposed Sec. 39.16(g)(4)(i) would require notice
reporting on a swap-by-swap basis that two affiliates are electing the
exemption and that they both meet the requirements in proposed Sec.
39.6(g)(1)-(2). The Commission believes 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.
Affiliates would incur costs to satisfy the conditions that the
reporting party (1) identify how the affiliates expect to meet the
financial obligations associated with their uncleared swap as required
under proposed Sec. 39.6(g)(4)(ii), and (2) provide the information
required under proposed Sec. 39.6(g)(4)(iii) if either electing
affiliate is an SEC Filer. Affiliates may decide to report this
information on either a swap-by-swap or annual basis, and the costs
would vary depending on the reporting frequency. Regarding the
financial information in proposed Sec. 39.6(g)(4)(ii)-(iii), the
Commission believes 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 complying with proposed Sec. 39.6(g)(4)(ii)-(iii) for
the first inter-affiliate swap, and a cost range of $6.50-$32.50 for
complying with proposed Sec. 39.6(g)(4)(ii)-(iii) for subsequent
inter-affiliate swaps.
The Commission anticipates that companies electing not to clear
would have established reporting systems to comply with other
Commission rules regarding swap reporting. However, all reporting
counterparties likely would need to modify their reporting systems to
accommodate the additional data fields required by this rule. The
Commission estimates that those modifications would create a one-time
programming expense of approximately one to ten burden hours per
affiliate. The Commission estimates that the hourly wage for a senior
programmer is $341, which means that the one-time, per entity cost for
modifying reporting systems would likely be between $341 and $3,410.
An affiliate that does not function as the reporting counterparty
may need to communicate information to the reporting counterparty after
the swap is entered. That information could include, among other
things, whether the affiliate has filed an annual report pursuant to
proposed Sec. 39.6(g)(5) and information to facilitate any due
diligence that the reporting counterparty may conduct. These 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. The Commission estimates 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.
The hourly wage for a compliance attorney is $390, translating to an
aggregate annual cost for communicating information to the reporting
counterparty of between $33 to $3,900.
The Commission expects a proportion of affiliates would choose to
file an annual report pursuant to proposed Sec. 39.6(g)(5). The annual
filing option may be less costly than swap-by-swap reporting. The
Commission estimates that it would take an average of 30 to 90 minutes
to complete and submit this filing. The average hourly wage for a
compliance attorney is $390, translating to an aggregate annual cost
for submitting the annual report of between $195 to $585.
The Commission anticipates that SDRs and the Commission also would
bear costs associated with the proposed reporting conditions. SDRs
would be required to add or edit reporting data fields to accommodate
information reported by affiliates electing the inter-affiliate
clearing exemption.\67\ Similarly, the Commission would need to create
a reporting system for affiliates electing the exemption should there
be no available SDR.
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\67\ See generally, ``Swap Data Recordkeeping and Reporting
Requirements,'' 77 FR 2137 at 2176-2193, Jan. 13, 2012 (for costs
and benefits incurred by SDRs).
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Finally, the rule would impose a limitation on those affiliates
electing the inter-affiliate clearing exemption. Namely, the inter-
affiliate clearing exemption would require one of the following four
conditions be satisfied for each affiliate: the affiliate is located in
the United States; the affiliate is located in a jurisdiction with a
comparable and comprehensive clearing requirement; the affiliate is
required to clear all swaps it enters into with non-affiliated
counterparties; or the affiliate does not enter into swaps with non-
affiliated counterparties. This limitation would impose no additional
cost over not providing the exemption. However, as compared to the
state of regulation that existed pre-Dodd-Frank Act, this condition
would impose the costs of clearing for those inter-affiliate swaps that
occur in countries without a clearing regime comparable to the United
States.
D. Benefits
The CEA does not require the Commission to issue an exemption to
the clearing requirement for inter-affiliate swaps. Section 4(c)(1) of
the CEA, however, provides the Commission with authority to exempt
certain entities and types of transactions from CEA obligations. The
statutory section requires that the Commission consider two objectives
when it decides to issue an exemption: (1) The promotion of responsible
economic or financial innovation, and (2) the promotion of fair
competition.
The Commission believes there are benefits to exempting swaps
between certain affiliated entities. For example,
[[Page 50436]]
as explained above,\68\ a number of commenters stated that clearing
swaps through treasury or conduit affiliates enables entities to more
efficiently and effectively manage corporate risk.
---------------------------------------------------------------------------
\68\ See pt. I.B. for in-depth discussion of relevant comments
regarding inter-affiliate swaps and the advantages of such treasury
or conduit structures.
---------------------------------------------------------------------------
The Commission also is considering the previously-discussed
comments that an exemption is appropriate because inter-affiliate swaps
pose reduced counterparty risk relative to swaps with third
parties.\69\ The Commission remarks that this proposition is more
likely to hold true provided that the terms and conditions of the swaps
are the same. The Commission believes that inter-affiliate swap risk
may be appropriately managed, in lieu of clearing, through the proposed
conditions that affiliates would be required to satisfy to elect the
proposed exemption. It has considered the benefits of each of these
conditions. The Commission believes that the first category--
documentation of the swap trading relationship between affiliates--
would benefit affiliates and the overall financial system.
Specifically, the Commission believes that requiring documentation of
inter-affiliate swaps in a swap confirmation would help 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. Also, though not a documentation condition, the
proposed exemption would require that the affiliates would be able to
elect this exemption for their inter-affiliate swaps if one of the
following four conditions is satisfied for each affiliate: The
affiliate is located in the United States; the affiliate is located in
a jurisdiction with a comparable and comprehensive clearing
requirement; the affiliate is required to clear all swaps it enters
into with non-affiliate counterparties; or the affiliate does not enter
into swaps with non-affiliate counterparties. This limitation should
help mitigate systemic risk attributable to affiliates who, subsequent
to conducting inter-affiliate swaps, transact uncleared, market-facing
(i.e., not inter-affiliate) swaps in a jurisdiction without a clearing
regime comparable to the United States.
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\69\ See pt. II.A.
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The Commission recognizes that there may be a legitimate reason for
inter-affiliate swaps where one affiliate is located in a country that
does not have a comparable clearing regime or the non-United States
counterparty is otherwise required to clear swaps with third parties.
However, the Commission believes that the corporate group and financial
markets may be at risk if the foreign affiliate is free to enter into a
related, uncleared swap with a third party that would be subject to
clearing were it entered into in the United States. On balance, the
Commission believes that the risk associated with uncleared swaps
necessitates that the proposed exemption be limited to swaps between
affiliates located in the United States or in foreign countries with
comparable clearing regimes or the non-United States counterparty is
otherwise required to clear swaps with third parties or the affiliates
do not enter into swaps with third parties.
Centralized-risk management and variation margin are also
beneficial conditions. The requirement that an inter-affiliate swap be
subject to centralized-risk management is beneficial because it is
intimately connected to the variation-margin condition. Centralized-
risk management establishes appropriate measurements and procedures so
that affiliates can mitigate the amount being concentrated in a single
treasury or conduit-type affiliate. Moreover, the Commission believes
that proper risk management benefits the public by reducing risk and
the losses related to defaults.
The requirement that affiliates post variation margin should
protect both parties to a trade by ensuring that each party to the swap
has the financial wherewithal to meet the obligations of the swap.
Variation margin also would serve as a resource that could reduce
losses to a counterparty when there is a default. Overall, the
variation-margin condition would benefit each affiliate and the
financial system, at large, by increasing the security of affiliate
positions.
The final category of conditions, reporting certain information
about inter-affiliate swaps, should enhance the level of transparency
associated with inter-affiliate swaps activity, afford the Commission
new insights into the practices of affiliates that engage in inter-
affiliate swaps, and help the Commission and other appropriate
regulators identify emerging or potential 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.
E. Costs and Benefits as Compared to Alternatives
The Commission considered several alternatives to the proposed
rulemaking. For instance, the Commission could have: (1) Chosen not to
propose an inter-affiliate clearing exemption; (2) proposed an
alternative definition of affiliate; or (3) decided not to place
certain conditions on those electing the inter-affiliate clearing
exemption. The Commission, however, has proposed what it considers a
measured approach--in terms of the implicated costs and benefits of the
exemption--given its current understanding of inter-affiliate swaps.
First, the Commission considered not exempting inter-affiliate
swaps from the clearing requirement. Without an exemption, inter-
affiliate swaps subject to a clearing requirement would have to be
cleared. This alternative was not favored by the Commission because the
Commission believes that there are considerable benefits of exempting
inter-affiliate swaps from clearing to the market, as discussed in
detail above. In addition, while the Commission does not believe inter-
affiliate swaps are riskless, the Commission is considering comments
that inter-affiliate swaps pose less risk than swaps with third parties
because of reduced counterparty risk and therefore risk-reducing
conditions may be a satisfactory alternative to clearing for these
swaps. Commenters in other rulemakings as discussed above recognized
implicitly risk concerns by sharing that some corporate groups manage
inter-affiliate risk via centralized risk management programs that
include variation-margin calculations. Consequently, it would not be
prudent to exempt inter-affiliate swaps categorically from the CEA's
clearing requirement without conditions that address inter-affiliate
swap risk.
Second, the Commission also considered ownership requirements of
greater than, and lesser than majority ownership.\70\ Increasing the
ownership requirement would reduce the number of affiliates that could
benefit from the exemption.\71\ At the same time, a higher ownership
threshold for affiliates could help protect minority owners and reduce
counterparty risk and risk to third parties who have entered into swaps
that are related to inter-affiliate swaps.
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\70\ See pt. II.B.1 for further discussion and other requests
for comment on this issue.
\71\ In the Paperwork Reduction Act, the Commission points out
that it does not possess sufficient information to estimate the
number of affiliates, even majority-owned, that might avail
themselves of the proposed inter-affiliate clearing exemption.
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Nevertheless, the Commission believes that any benefit from an
ownership requirement of greater than majority ownership, in the form
of reduced counterparty risk, would not be
[[Page 50437]]
substantial due to the risk mitigation conditions such as centralized
risk management programs that are being proposed with majority
ownership. The Commission welcomes comments as to the costs and
benefits of an increased ownership requirement.
Similarly, the Commission considered an ownership requirement of
less than majority ownership. While a reduction in the ownership
requirement would allow more affiliates to benefit from the exemption,
it would also considerably increase the counterparty risk in the
market. The Commission welcomes comments as to the costs and benefits
of a decreased ownership requirement.
Finally, the Commission considered not requiring each condition--
i.e., swap trading relationship documentation; centralized risk
management that includes variation margin; or reporting. In other
words, the Commission could have proposed an inter-affiliate clearing
exemption with fewer or no conditions. Because there is no indication
at this stage that inter-affiliate swaps are riskless, the Commission
proposed conditions. The Commission's views on the costs and benefits
of each condition are discussed above. The Commission invites comments
as to the costs and benefit of each condition.
F. Consideration of CEA Section 15(a) Factors
1. Protection of Market Participants and the Public
In deciding to propose the inter-affiliate clearing exemption, the
Commission assessed how to protect affiliated entities, third parties
in the swaps market, and the public. The Commission sought to ensure
that in the absence of a clearing requirement the risks presented by
uncleared inter-affiliate swaps would be minimized should there be
significant losses to one affiliate counterparty or a default of one of
the affiliate counterparties. Toward that end, the Commission proposed
that affiliates eligible to elect the proposed exemption must execute
swap trading relationship documentation; post variation margin as part
of a centralized-risk management process; and report specific
information to an SDR, or to the Commission if no SDR would accept the
information. 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 would 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 would be less
contractual ambiguity should disagreements between affiliates arise.
The proposed condition that an inter-affiliate swap be subject to a
centralized risk management program reasonably designed to monitor and
manage risk would help mitigate the risks associated with inter-
affiliate swaps. As noted throughout this proposed rulemaking, inter-
affiliate swap risk could adversely impact third parties who enter into
swaps that are related to an inter-affiliate swap. In addition, if
inter-affiliate swap risk is not carefully monitored, there could be
greater probability that an adverse financial event could lead to
bankruptcy, which could harm market participants and the public
overall. Similarly, the proposed condition that affiliated
counterparties post variation margin should help to prevent unrealized
losses from accumulating over time and thereby reduce both the chance
of default and the size of any default should one occur. In turn, this
should lessen the likelihood and extent of harm to third parties that
enter into swaps that are related to inter-affiliate swaps.
The proposed reporting obligations would help the Commission
monitor compliance with the proposed 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 informed.
2. Efficiency, Competitiveness, and Financial Integrity of Futures
Markets
Exempting swaps between majority-owned affiliates within a
corporate group from the clearing requirement would promote efficiency
by reducing overall clearing costs for eligible counterparties. The
Commission is also considering comments that the proposed exemption
would increase the efficiency and financial integrity of markets
because it would enable corporate groups to clear swaps through their
treasury or conduit affiliates. As explained above,\72\ commenters in
other rulemakings have stated that clearing swaps through treasury or
conduit affiliates enables affiliates and corporate groups to more
efficiently and effectively manage corporate risk.
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\72\ See pt. I.B. for in-depth discussion of relevant comments
regarding inter-affiliate swaps and the advantages of such treasury
or conduit structures.
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Certain provisions of the proposed rule, such as the requirements
that inter-affiliate swaps be subject to centralized risk management,
that affiliates post variation margin, and that certain information be
reported, also would discourage abuse of the exemption. Together, these
conditions would 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.'' \73\ The Commission does not consider non-arms-length swaps
as contributing to price discovery in the markets.\74\ Given that
inter-affiliate swaps as defined in this proposed rulemaking are
generally not arm's length transactions, the Commission does not
anticipate the proposed inter-affiliate clearing exemption would have
any effect on price discovery.\75\
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\73\ 17 CFR 43.2. See also ``Real-Time Public Reporting of Swap
Transaction Data,'' 77 FR 1182, Jan. 9, 2012 (Real-Time Reporting).
\74\ Transactions that fall outside the definition of ``publicly
reportable swap transaction''--that is, they are not arms-length--
``do not serve the price discovery objective of CEA section
2(a)(13)(B).'' Real-Time Reporting, 77 FR at 1195. See also Id. at
1187 (discussion entitled ``Swaps Between Affiliates and Portfolio
Compression Exercises'').
\75\ The definition of ``publicly reportable swap transaction''
identifies two examples of transactions that fall outside
definition, including ``internal swaps between one-hundred percent
owned subsidiaries of the same parent entity.'' 17 CFR 43.2 (adopted
by Real-Time Reporting, 77 FR at 1244). The Commission remarks 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 risk management practice. But, in proposing the inter-affiliate
clearing exemption, the Commission has assessed the risks of inter-
affiliate swaps, and proposes that it can impose alternative, sound
risk-management practices for these particular swaps in the form of
conditions. In other words, a prudent use of the Commission's exemptive
authority would include proposing an exemption that requires affiliates
to manage risks appropriately.\76\ In this case, the specific
[[Page 50438]]
risk-management conditions include: documentation of swap terms;
establishment of centralized risk management, and the posting of
variation margin. The Commission also believes that SEC Filer reporting
is a prudent practice. As detailed in this preamble and the proposed
rule text,\77\ 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.
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\76\ Furthermore, CEA section 8a(5) states that ``in the
judgment of the Commission,'' it is authorized to make and
promulgate rules ``necessary to effectuate any'' CEA provisions or
to accomplish any CEA purpose. 7 U.S.C. 12a(5).
\77\ See pt. II.B.9 and proposed Sec. 39.6(g)(4)(iii).
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5. Other Public Interest Considerations
The Commission believes that the proposed exemptive rulemaking
would reduce the costs of transacting swaps between majority-owned
affiliates. At the same time, the proposed rulemaking would foster the
financial integrity of swap markets by mandating that certain
conditions be satisfied by affiliates electing the inter-affiliate
clearing exemption. The Commission believes that the financial savings
by affiliates, and, ultimately, corporate groups would serve public-
interest considerations. For example, affiliates and corporate groups
could use the cost-savings to provide new services or products for the
public. They could also pass-on some or all of the cost-savings through
prices they charge the public for their services and products.
G. Request for Public Comment on Costs and Benefits
Q30. The Commission invites public comment on its cost-benefit
considerations, including the consideration of reasonable alternatives.
Q31. If the Commission were to propose a clearing exemption limited
to 100% owned affiliates, what costs and benefits would affect market
participants and the public?
Q32. If the Commission were to propose a clearing exemption with an
ownership requirement of greater or less than majority ownership what
costs and benefits would affect market participants and the public?
Q33. If the Commission were to issue a proposed clearing exemption
limited to those affiliates that file consolidated tax returns, what
costs and benefits would affect market participants and the public?
Q34. Do inter-affiliate swaps affect price discovery? To what
extent would the inter-affiliate clearing exemption affect price
discovery?
Q35. Besides variation margin, is there a less costly risk-
management tool that would serve the same risk-management objectives as
variation margin?
Q36. Besides affiliates, SDRs, and the Commission, are there any
other entities that might bear a direct cost as a result of the
proposed inter-affiliate clearing exemption? If so, who and to what
extent?
Q37. Commenters are invited to submit any data or other information
that they may have quantifying or qualifying the costs and benefits of
the proposal with their comment letters.
Q38. Commenters are invited to submit any data or other information
that they may have quantifying or qualifying start-up and on-going
costs and benefits associated with establishing a centralized risk
management program.
IV. Administrative Compliance
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the proposed rules will have a significant economic
impact on a substantial number of small entities and, if so, provide a
regulatory flexibility analysis respecting the impact.
Consistent with other Commission rulemakings, the proposed rules
will not have a significant economic impact on a substantial number of
small entities. The proposed rules would affect the electing and
reporting parties, which could be SDs, MSPs, and Eligible Contract
Participants (``ECPs''). The Commission has certified previously that
neither category involves small entities for purposes of the RFA in
other Commission rulemakings, including those implementing requirements
of the Dodd-Frank Act.\78\ The Commission is making a similar
determination for purposes of this proposal. Accordingly, the Chairman,
on behalf of the Commission, hereby certifies, pursuant to 5 U.S.C.
605(b), that the proposed rules will not have a significant economic
impact on a substantial number of small entities with respect to SDs,
MSPs, and ECPs.
---------------------------------------------------------------------------
\78\ For SDs and MSPs, see, e.g., ``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 20128,
20194, Apr. 3, 2012 (SDs and MSPs); ``Business Conduct Standards for
Swap Dealers and Major Swap Participants with Counterparties,'' 77
FR 9803, 9804, Feb. 17, 2012 (SDs and MSPs); ``Policy Statement and
Establishment of Definitions of `Small Entities' for Purposes of the
Regulatory Flexibility Act,'' 47 FR 18618, Apr. 30, 1982 (MSPs). For
ECPs, see, e.g., ``Commodity Options,'' 77 FR 25320, 25334, Apr. 27,
2012; ``Swap Data Record Keeping and Reporting Requirements,'' 77 FR
2136, 2171, Jan. 13, 2012; ``Opting Out of Segregation,'' 66 FR
20740, 20743, Apr. 25, 2001.
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The proposed rules also would affect SDRs, which the Commission has
similarly determined not to be small entities for purposes of the
RFA.\79\ The Commission is making the same determination with respect
to the proposed rules. Accordingly, the Chairman, on behalf of the
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the
proposed regulation would not have a significant economic impact on a
substantial number of small entities with respect to SDRs.
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\79\ See Swap Data Repositories, 75 FR 80898, 80926, Dec. 23,
2010; Registration of Swap Dealers and Major Swap Participants, 75
FR 71379, 71385, Nov. 23, 2010.
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Request for Comments
Q39. The Commission invites comments on the impact of this proposed
regulation on small entities.
B. Paperwork Reduction Act
1. Overview
The Paperwork Reduction Act (``PRA'') \80\ 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 displays a currently
valid control number issued by the Office of Management and Budget
(``OMB''). Certain provisions of proposed Sec. 39.6(g) would result in
new collection of information requirements within the meaning of the
PRA. These new reporting requirements are not currently covered by any
existing OMB control number and OMB has not yet assigned a control
number for this new collection. The Commission therefore is submitting
this proposal to the OMB for review in accordance with 44 U.S.C.
3507(g) and 5 CFR 1320.11.
---------------------------------------------------------------------------
\80\ 44 U.S.C. 3501 et seq.
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[[Page 50439]]
The title for this collection of information is ``Rule 39.6(g)
Affiliate Transaction Uncleared Swap Notification.'' If adopted,
responses to this collection of information would be mandatory. The
Commission will protect proprietary information according to the
Freedom of Information Act and 17 CFR part 145, ``Commission Records
and Information.'' In addition, section 8(a)(1) of the CEA strictly
prohibits the Commission, unless specifically authorized by the CEA,
from making public ``data and information that would separately
disclose the business transactions or market positions of any person
and trade secrets or names of customers.'' The Commission is also
required to protect certain information contained in a government
system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.
2. Information Provided by Reporting Entities
Proposed Sec. 39.6(g) would set forth certain reporting conditions
that must be satisfied for affiliates to elect the inter-affiliate
clearing exemption. As described above, these conditions are designed
to address Commission concerns regarding inter-affiliate swap risk and
to provide the Commission with information necessary to regulate swaps
markets. In particular, the reporting conditions in proposed Sec.
39.6(g)(4) and the optional annual report set forth in proposed Sec.
39.6(g)(5) would establish new collection of information requirements
within the meaning of the PRA. Additionally, affiliates may be required
to update their reporting systems for purposes of complying with the
proposed reporting requirement, and non-reporting affiliates electing
the proposed exemption may incur costs in transmitting information to
their reporting counterparties.
The Commission has estimated the time burden required for entities
to comply with the proposed requirements.\81\ The Commission has
estimated quantifiable costs, including one-time and annual costs per
affiliate and costs that are incurred on a swap-by-swap basis. The
dollar estimates are offered as ranges with upper and lower bounds,
which is necessary to accommodate uncertainty regarding the estimates.
The Commission notes that the most likely outcome with respect to each
estimate is the average cost. With that in mind, the Commission has
included tables that provide the average burden hour and average cost
for each of the PRA requirements in the proposed exemption.
---------------------------------------------------------------------------
\81\ See 5 CFR 1320.3(b) for the definition of the term
``burden.''
---------------------------------------------------------------------------
The total cost of the inter-affiliate clearing exemption would
depend on the number of affiliates electing the proposed exemption, as
well as the number of inter-affiliate swaps for which affiliates would
elect to use the proposed exemption. To identify the number of
affiliates that could elect the proposed exemption, the Commission is
relying upon the most recent data collected by the U.S. Bureau of
Economic Analysis (``BEA'').\82\ The BEA has determined that there are
2,347 U.S. multinational parent companies (``MNCs''),\83\ and 25,424
foreign subsidiaries that are majority-owned by such MNCs.\84\ Because
the BEA does not provide the number of majority-owned U.S.
subsidiaries, the Commission has decided to double BEA's foreign-
subsidiary total to identify the number of potential U.S. subsidiaries
that might elect the proposed inter-affiliate clearing exemption. The
result is that there are an estimated 50,848 U.S. and foreign
subsidiaries [25,424 x 2], or approximately 22 subsidiaries per MNC
[50,848 / 2,347], that is, 11 U.S. subsidiaries and 11 foreign
subsidiaries. This total number of U.S. and foreign subsidiaries
combined with the total U.S. parent companies equals 53,195 [2,347 +
50,848] affiliates that might elect the inter-affiliate clearing
exemption.
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\82\ The BEA's Web site is located at http://www.bea.gov/. BEA's
most recent data on the number of U.S. parent companies of
multinational corporations and their affiliates is listed in the
``U.S. Direct Investment Abroad: Preliminary Results from the 2009
Benchmark Survey,'' located at http://www.bea.gov/international/usdia2009p.htm.
\83\ 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 an 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, located at http://www.bea.gov/scb/pdf/internat/usinvest/1995/0395iid.pdf.
\84\ See Table II.A 1., ``Selected Data for Foreign Affiliates
in All Countries in Which Investment Was Reported,'' located at
http://www.bea.gov/international/pdf/usdia_2009p/Group%20II%20tables.pdf. The BEA limited foreign affiliates to those
with total assets, sales, or net income of more than $25 million.
---------------------------------------------------------------------------
To obtain information on the average number of inter-affiliate
swaps, the Commission surveyed five corporations.\85\ Two corporations
were large financial companies and the other three were manufacturing
companies. Recognizing that most MNCs are manufacturers as opposed to
financial companies, the Commission decided to take a weighted average
of the sample and assumed that 95% of MNCs are manufacturers and 5% are
financial companies. Based on this weighted average, the Commission
estimates that affiliates enter into 2,230 inter-affiliate swaps
annually on average.\86\
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\85\ The Commission is unable to provide additional information
regarding the survey because information was submitted on a
confidential basis.
\86\ Due to the small sample size and data inconsistencies, this
estimate may not provide a complete representation of the affiliate
corporate structure or inter-affiliate swaps. For instance,
responses were not consistent in format (quarterly figures versus
six-month or annual figures) and also provided data for different
time periods in 2010 or 2011. To generate its estimates, the
Commission had to extrapolate this data by assuming that the amount
of inter-affiliate swaps transacted during one quarter would be the
same for the remaining three quarters of the year, or that inter-
affiliate swap data from 2010 and 2011 are comparable and can be
combined for averaging purposes. The Commission also notes that
responses regarding the number of inter-affiliate swap transactions
varied widely and a much larger sample size would be required to
generate a more accurate estimate. The Commission requests comment
on the typical annual inter-affiliate swap activity within corporate
groups and the total number of affiliates that would potentially
elect the proposed inter-affiliate clearing exemption.
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Using the figures above, namely 2,347 MNCs with 22 subsidiaries
each and each affiliate transacting an average of 2,230 swaps, the
Commission has estimated that there are approximately 64,768,399 inter-
affiliate swaps entered into annually. To make this calculation, the
Commission assumed that all U.S. inter-affiliate swaps and most foreign
inter-affiliate swaps are with a single U.S. treasury/conduit
affiliate. The Commission also assumed that 75% of treasury/conduit
affiliates would be subsidiaries and would therefore be subject to this
rulemaking. The remaining 25% of treasury/conduit affiliates would be
the parent MNC and would not be the subject of this rulemaking because
in general such swaps would qualify for the end-user exception.\87\
Finally, the Commission assumed that 50% of the inter-affiliate swaps
entered into by foreign affiliates would be entered into with a U.S.
treasury/conduit affiliate while the remaining swaps would be entered
into with foreign affiliates and would not be
[[Page 50440]]
subject to this rulemaking. Table A summarizes the Commission's
estimates of the number of MNCs, subsidiaries, affiliates, and annual
inter-affiliate swaps.
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\87\ As noted above, the Commission assumes that 95% of MNCs are
commercial entities and 5% are financial companies. Based on these
numbers, the Commission believes that most of the swaps between
affiliates are likely to qualify for the end-user exception because
in most cases one of the affiliates will be a manufacturer and the
inter-affiliate swap will hedge or mitigate the commercial risk of
that affiliate. The Commission, however, does not have information
as to how many inter-affiliate swaps would qualify for the end-user
exception. Accordingly, the Commission has taken a conservative
approach and assumed that none of the inter-affiliate swaps would
qualify for the end-user exception.
Table A--MNC, Affiliate, and Inter-Affiliate Swap Estimates
------------------------------------------------------------------------
------------------------------------------------------------------------
Number of MNCs....................................... 2,347
Number of Subsidiaries per MNC....................... 22 \88\
Total Number of Subsidiaries......................... 50,848
Total Number of Affiliates Potentially Electing the 53,195
Proposed Exemption.................................. [50,848 + 2,347]
Estimated Number of MNCs Subject to Proposed 1,760
Reporting Requirements.............................. [2,347 x 75%]
Estimated Number of Reporting MNCs that Would File 1,584
Annual Reports \89\................................. [1,760 x 90%]
Average Annual Number of Inter-Affiliate Swaps per 2,230
Affiliate...........................................
Total Annual Number of Inter-Affiliate Swaps \90\.... 64,768,399
------------------------------------------------------------------------
Request for Comments
Q40. As discussed above, the Commission does not have information
as to how many inter-affiliate swaps would qualify for the end-user
exception. The Commission invites comments on whether most inter-
affiliate swaps would qualify for the end-user exception because one of
the affiliates is a commercial entity and the swap hedges or mitigates
the commercial risk of that affiliate. The Commission also requests any
information that would help to quantify the number of inter-affiliate
swaps or the share of inter-affiliate swaps that would qualify for the
end-user exception.
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\88\ Eleven of the 22 affiliates are assumed to be U.S.
affiliates.
\89\ The Commission assumed that at least 90% of MNCs would
elect to file annual reports, see further discussion below.
\90\ The Total Annual Number of Inter-Affiliate Swaps is the
total number of inter-affiliate swaps that MNCs, U.S. subsidiaries,
and foreign subsidiaries entered into that would be subject to this
rule. The total number of inter-affiliate swaps that MNC's entered
into that would be subject to this rule is the number of MNCs
(2,347) times the number of swaps per MNC (2,230) times 75%, or 0.75
x 2,347 x 2,230. The total number of inter-affiliate swaps that U.S.
subsidiaries entered into that would be subject to this rule is 10 x
(0.75 x 2,230 x 2,347). There are 11 U.S. subsidiaries per MNC and
each subsidiary enters into as many as swaps as each MNC, on
average. However, 1 of the U.S. subsidiaries is the treasury/conduit
affiliate and it enters into swaps with every other affiliate,
including foreign affiliates. To avoid double counting, that
subsidiary is removed from the equation and the number of U.S.
subsidiaries is 10. Finally, the total number of inter-affiliate
swaps that foreign subsidiaries entered into that would be subject
to this rule is 0.5 x (11 x 0.75 x 2,230 x 2,347). Each foreign
subsidiary enters into as many swaps as each U.S. subsidiary, but
only 50% of foreign subsidiary swaps would be subject to this rule.
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a. Proposed Sec. 39.6(g)(4) Reporting Requirements
Proposed Sec. 39.6(g)(4) would require electing entities that are
reporting counterparties to notify the Commission each time the inter-
affiliate clearing exemption is elected by delivering specified
information to a registered SDR or, if no registered SDR is available,
the Commission. Except as noted below, the notification would occur
only once at the beginning of the swap life cycle.
The reporting counterparty would have to report the information
required in proposed Sec. 39.6(g)(4)(i) for each swap. It would also
have to report the information required in proposed Sec. Sec.
39.6(g)(4)(ii)-(iii) for each swap if no annual report had been filed.
To comply with proposed Sec. 39.6(g)(4)(i), each reporting
counterparty would be required to check one box indicating that both
counterparties to the swap are electing not to clear the swap. The
Commission expects that each reporting counterparty would likely spend
15 seconds to two minutes per transaction entering this information
into the reporting system. Regarding the proposed Sec. Sec.
39.6(g)(4)(ii)-(iii) information, the Commission expects that it would
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 Commission expects a compliance attorney
may be responsible for the collection at $390 per hour, resulting in
the following per transaction costs to reporting counterparties: A
range of $1.63-$13.00 for proposed Sec. 39.6(g)(4)(i); a cost of
$65.00 for complying with proposed Sec. Sec. 39.6(g)(4)(ii)-(iii) for
the first inter-affiliate swap; and range of $6.50-$32.50 for complying
with proposed Sec. Sec. 39.6(g)(4)(ii)-(iii) for subsequent inter-
affiliate swaps with the same counterparty. Table B summarizes the
estimated average burden hours and costs per reporting entity under
proposed Sec. 39.6(g)(4), as follows:
Table B--Burden and Cost Estimates of Proposed Sec. 39.6(g)(4)
----------------------------------------------------------------------------------------------------------------
Average burden Average cost
Proposed regulation/requirement hours per per Total average annual Total average
description transaction transaction burden hours annual cost
----------------------------------------------------------------------------------------------------------------
Sec. 39.6(g)(4)(i)............ 0.019 hours (1.14 $7.41 1,230,600 $479,933,837
minutes). [64,768,399 x .019] [64,768,399 x
$7.41] \91\
Sec. Sec. 39.6(g)(4)(ii)- First Transaction: 65.00 648 [(50,848 x 75% x $247,884 [(50,848 x
(iii) (costs incurred if no 0.17 hours (10 10% x 0.17] 75%) x 10% x $65]
annual report filed under Sec. minutes). \93\
39.6(g)(5) \92\).
Subsequent 19.50 323,651 [(64,768,399 $126,224,013
Transactions: 0.05 - 50,848 x 75%) x [(64,768,399 -
hours (3 minutes). 10% x .05] 50,848 x 75%) x
10% x $19.50]\94\
----------------------------------------------------------------------------------------------------------------
[[Page 50441]]
b. Other Costs
i. Updating Reporting Procedures
The Commission believes that companies subject to this rule would
have established reporting systems to comply with other Commission
rules regarding swap reporting. However, reporting counterparties may
need to modify their reporting systems in order to accommodate the
additional data fields required by this rule. The Commission estimates
that those modifications would create a one-time expense of
approximately one to ten burden hours per reporting counterparty. The
Commission estimates that the hourly wage for a senior programmer is
$341, which means that the one-time, per entity cost for modifying
reporting systems to comply with proposed Sec. 39.6(g)(4) would likely
be between $341 and $3,410.
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\91\ To derive the annual burden hours and cost for this row,
the Commission calculated the following: the average burden hours or
cost per transaction times total number of inter-affiliate swaps
annually.
\92\ The Commission assumes that at least 90% of corporations
would elect to file an annual report to supply the information
required by proposed Sec. 39.6(g)(4)(ii)-(iii) rather than report
the information on a swap-by-swap basis; 10% of affiliates would
report the required information on a swap-by-swap basis.
\93\ To derive the annual burden hours and cost for this row,
the Commission calculated the following: (A) The total number of
subsidiaries (see Table A) times 75% to determine the number of
affiliates involved in a first transaction subject to reporting; (B)
then multiplied that number--38,136--with 10% to determine the
number of affiliates that would report swap-by-swap, i.e., 3,813.6,
and (C) then multiplied that number by 0.16667, to obtain the
average burden hours to report, or $65, to obtain the average cost
to report.
\94\ To derive the annual burden hours and cost for this row,
the Commission calculated following: (A) The total number of
subsequent transactions, which is the total number of transactions
(64,768,399) minus the total number of first time transactions (0.75
x 50,848); (B) then multiplied that number--64,730,263--by 10% to
determine the number of affiliates that would report swap-by-swap,
i.e., 6,473,26.3, and (C) then multiplied that number by 0.05, to
obtain the average burden hours to report, or $19.50, to obtain the
average cost to report.
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ii. Burden on Non-Reporting Affiliates
An affiliate who does not function as the reporting counterparty
may need to communicate information to the reporting counterparty after
the swap is entered. That information could include, among other
things, information to facilitate any due diligence that the reporting
counterparty may conduct. These costs would likely vary substantially
depending on how frequently the affiliate enters into swaps and the due
diligence that the reporting counterparty chooses to conduct. The
Commission estimates that a non-reporting affiliate would incur a
burden of between five minutes and ten hours annually. The hourly wage
for a compliance attorney is $390, which means that the aggregate
annual cost for an electing counterparty communicating information to
the reporting counterparty would likely be between $33 and $3,900.
iii. Annual Reporting Under Proposed Sec. 39.6(g)(5)
The Commission expects at least 90% of MNCs would choose to file an
annual report pursuant to proposed Sec. 39.6(g)(5). This assumption is
based on feedback in comment letters submitted in response to other
proposed rulemakings, in which commenters proposed an annual reporting
requirement in lieu of swap-by-swap reporting. Additionally, the
Commission believes that there is an economic incentive for corporate
groups to file an annual report because filing annually is less costly
and operationally simpler than swap-by-swap reporting. The Commission
estimates that it would take an average of 30 minutes to 90 minutes to
complete and submit this filing, resulting in 0.5 to 1.5 burden hours
per MNC that elects to file the annual report. The average hourly wage
for a compliance attorney is $390, which means that the aggregate
annual cost for submitting the annual report would likely be
approximately $195 to $585. Table C summarizes the estimated average
burden hours and costs for modifying the reporting system, for non-
reporting affiliates to communicate information to the reporting
counterparty after the swap is entered into, and for providing the
annual report under proposed Sec. 39.6(g)(5), as follows:
Table C--Other Burdens and Costs to Reporting and Non-Reporting Affiliates
----------------------------------------------------------------------------------------------------------------
Average burden
Proposed regulation/requirement hours per Average cost Total average Total average
description affiliate per affiliate annual burden hours annual cost
----------------------------------------------------------------------------------------------------------------
Modifying Reporting System (One- 5.5 hours.......... $1,875.50 9,680 [5.5 x 1,760] $3,300,880
time cost).\95\ [$1,875.50 x
1,760] \96\
Burden on Non-Reporting 5.04 hours......... 1,966.25 192,205 [5.04 x $74,984,910
Affiliates. 38,136] [$1,966.25 x
38,136] \97\
Sec. 39.6(g)(5) Annual Report. 1 hour............. 390.00 1,584 [(1,760 x 90%) $617,760 [$390 x
x 1] \98\ 1,760 * 90%]
----------------------------------------------------------------------------------------------------------------
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\95\ The Commission assumes that there is only one reporting
counterparty at each MNC.
\96\ 1,760 represents the 75% of 2,347 MNCs that the Commission
estimates would be reporting parties.
\97\ 38,136 represents 75% of 50,848, the total number of
affiliates potentially electing the proposed exemption.
\98\ This calculation represents the total burden hours for the
estimated 90% of MNCs--1,584.2--that would file annual reports.
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c. Total Burden Hours
The Commission estimates that the proposed exemption could result
in an average total annual burden of 1,758,369 hours and average total
annual costs of $685,309,281.\99\ The burden and cost estimates are
approximately 1.8 minutes and $10.48 per inter-affiliate swap. Table D
provides the total burden hours and costs of the proposed exemption and
breaks down the totals into burden hours and costs per MNC, per
affiliate, and per inter-affiliate swap.
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\99\ These numbers are obtained by adding all of the burden
hours or costs in Tables B and C.
Table D--Average Annual Burden and Cost Estimates of the Proposed
Exemption
------------------------------------------------------------------------
Cost of
Burden proposed
hours exemption
------------------------------------------------------------------------
Total......................................... 1,758,369 685,309,281
Total Average Annual per MNC \100\............ 999 389,380
[[Page 50442]]
Total Average Annual per Affiliate \101\...... 46 17,970
Total Average per Inter-Affiliate Swap \102\.. * 0.03 \103\ 10.58
------------------------------------------------------------------------
* (1.8 minutes).
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\100\ Total Hours or Costs divided by 1,760 MNCs, which is equal
to 75% x 2,347.
\101\ Total Hours or Costs divided by 38,136 affiliates, which
is equal to 75% x 50,848.
\102\ Total Hours or Costs per Affiliate divided by 64,768,399
inter-affiliate swaps.
\103\ The ``Total Average per Inter-Affiliate Swap'' of $10.58
is less than the average transaction costs listed in Table B (i.e.,
$65 and $19.50) for two reasons. First, $10.58 is the average cost
for over 64 million inter-affiliate swaps. Second, the ``average
total transaction costs'' in Table B apply only to the assumed ten
percent (10%) of reporting counterparties that might choose to
report swap-by-swap under Sec. Sec. 39.6(g)(4)(ii)-(iii).
---------------------------------------------------------------------------
3. Information Collection Comments
The Commission invites public comment on any aspect of the
reporting burdens discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B),
the Commission solicits comments in order to: (i) Evaluate whether the
proposed collection of information is necessary for the proper
performance of the functions of the Commission, including whether the
information will have practical utility; (ii) evaluate the accuracy of
the Commission's estimate of the burden of the proposed collection of
information; (iii) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected; and
(iv) minimize the burden of the collection of information on those who
are to respond, including through the use of automated collection
techniques or other forms of information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs (``OIRA'') in OMB, by fax at (202) 395-6566, or by
email at [email protected]. Please provide the Commission
with a copy of submitted comments so that they can be considered in
connection with a final rule. Refer to the Addresses section of this
release for comment submission instructions to the Commission. A copy
of the supporting statements for the collections of information
discussed above may be obtained by visiting www.RegInfo.gov. OMB is
required to make a decision concerning the collection of information
between 30 and 60 days after publication of this release in the Federal
Register. Consequently, a comment to OMB is most assured of being fully
effective if received by OMB (and the Commission) within 30 days after
publication.
V. Text of Proposed Rules
List of Subjects in 17 CFR Part 39
Business and industry, Clearing, Cooperatives, Reporting
requirements, Swaps.
For the reasons stated in the preamble, the Commission proposes to
amend 17 CFR part 39 as follows:
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
1. The authority citation for part 39 is revised to read as
follows:
Authority: 7 U.S.C. 2, 6, 12a, and 24a, 7a-1 as amended by Pub.
L. 111-203, 124 Stat. 1376 (2010).
2. In Sec. 39.6, add paragraph (g) to read as follows:
Sec. 39.6 Exceptions to the clearing requirement.
* * * * *
(g) Exemption for swaps between affiliates.
(1) Affiliate Status. 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 if one counterparty directly or indirectly holds a majority
ownership interest in the other, or if a third party directly or
indirectly holds a majority ownership interest in both counterparties,
and the financial statements of both counterparties are reported on a
consolidated basis (``eligible affiliate counterparties''). 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.
(2) Conditions. Eligible affiliate counterparties to a swap may
elect the exemption described in paragraph (g)(1) of this section if:
(i) Both counterparties elect not to clear the swap;
(ii)(A) A swap dealer or major swap participant that is an eligible
affiliate counterparty to the swap satisfies the requirements of Sec.
23.504; or (B) the swap is, if neither eligible affiliate counterparty
is a swap dealer or major swap participant, documented in a swap
trading relationship document that shall be in writing and shall
include all terms governing the trading relationship between the
affiliates, including, without limitation, payment obligations, netting
of payments, events of default or other termination events, calculation
and netting of obligations upon termination, transfer of rights and
obligations, governing law, valuation, and dispute resolution
procedures;
(iii) 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;
(iv) With the exception of 100% commonly-owned and commonly-
guaranteed affiliates where the common guarantor is also 100% commonly-
owned, for a swap for which both counterparties are financial entities,
as defined in paragraph (g)(6), both parties shall pay and collect
variation margin and comply with paragraph (g)(3) of this section;
(v) Each counterparty either:
(A) Is located in the United States;
(B) Is located in a jurisdiction that has a clearing requirement
that is comparable and comprehensive to the clearing requirement in the
United States;
(C) Is required to clear swaps with non-affiliated parties in
compliance with United States law; or
(D) Does not enter into swaps with non-affiliated parties; and
(vi) The reporting counterparty for the swap, as determined in
accordance with Sec. 45.8 of this chapter, complies with paragraph
(g)(4) of this section with respect to each of the counterparties.
(3) Variation Margin. When both counterparties are financial
entities each counterparty shall pay and collect any variation margin
as calculated pursuant to paragraph (g)(3)(i) for each uncleared swap
for which the exemption described in paragraph (1) is elected.
(i) The swap trading relationship documentation required in
paragraph (g)(2)(ii) of this section must set forth the methodology to
be used to calculate variation margin and describe it with sufficient
specificity to allow the counterparties, the Commission, and any
appropriate prudential regulator to calculate the margin requirement
independently.
(ii) Variation margin calculations and payments shall start on the
business day after the swap is executed and continue
[[Page 50443]]
each business day until the swap is terminated.
(iii) Each counterparty shall pay the entire variation margin
amount as calculated pursuant to paragraph (g)(3)(i) when due.
(iv) The swap trading relationship documentation required in
paragraph (g)(2)(ii) of this section shall specify for each
counterparty where margin assets will be held and under what terms.
(4) Reporting Requirements. When the exemption described in
paragraph (g)(1) of this section is elected, the reporting counterparty
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:
(i) Confirmation that both counterparties to the swap are electing
not to clear the swap and that each of the counterparties satisfies the
requirements in paragraphs (g)(1) and (2) of this section applicable to
it;
(ii) For each 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:
(A) A written credit support agreement;
(B) Pledged or segregated assets (including posting or receiving
margin pursuant to a credit support agreement or otherwise);
(C) A written guarantee from another party;
(D) The counterparty's available financial resources; or
(E) Means other than those described in subparagraphs (A), (B), (C)
or (D); and
(iii) If a 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:
(A) The relevant SEC Central Index Key number for that
counterparty; and
(B) Acknowledgment that an appropriate committee of the board of
directors (or equivalent body) of the counterparty has reviewed and
approved the decision not to clear the swap.
(5) Annual Reporting. An affiliate that qualifies for the exemption
described in paragraph (g)(1) of this section may report the
information listed in paragraphs (g)(4)(ii) and (iii) of this section
annually in anticipation of electing the exemption for one or more
swaps. Any such reporting under this paragraph will be effective for
purposes of paragraphs (g)(4)(ii) and (iii) of this section for 365
days following the date of such reporting. During the 365-day period,
the affiliate 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 Sec. 39.6(g).
(6) Financial Entity. For purposes of this Sec. 39.6(g), the term
``financial entity'' shall have the meaning given such term in section
2(h)(7)(C) of the Act.
Issued in Washington, DC, on August 15, 2012, by the Commission.
Sauntia Warfield,
Assistant Secretary of the Commission.
Appendices to Clearing Exemption for Swaps Between Certain Affiliated
Entities--Commission Voting Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Chilton and
Wetjen voted in the affirmative; Commissioner Sommers and O'Malia
voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rules to exempt swaps between certain
affiliated entities within a corporate group, known as inter-
affiliates, from the clearing requirement in the Dodd-Frank Wall
Street Reform and Consumer Protection Act.
One of the primary benefits of swaps market reform is that
standard swaps between financial firms will move into central
clearing, which will significantly lower the risks of the highly
interconnected financial system.
Transactions between affiliates, however, pose less risk to the
financial system because the risks are internalized within the
financial institution.
The proposed rule would allow for an exemption from clearing for
swaps between affiliates under the following limitations.
First, the proposed exemption would be limited to swaps between
majority-owned affiliates whose financial statements are reported on
a consolidated basis.
Second, the proposed rules would require centralized risk
management, documentation of the swap agreement, payment of
variation margin and completion of reporting requirements.
Third, the exemption would be limited to swaps between U.S.
affiliates and swaps between a U.S. affiliate and a foreign
affiliate located in a jurisdiction with a comparable and
comprehensive clearing regime.
This approach largely aligns with the Europeans' approach to an
exemption for inter-affiliate clearing.
I look forward to the public's comments on this proposal.
Appendix 2--Joint Statement of Commissioners Jill Sommers and Scott
O'Malia
We respectfully dissent from the notice of proposed rulemaking
to exempt swaps between certain affiliated entities from the
clearing requirement. While we wholly support a clearing exemption
for swaps between affiliated entities within a corporate group, we
cannot support the proposal before the Commission today because in
certain instances it imposes an unnecessary requirement for
variation margin on corporate entities that engage in inter-
affiliate trades.
Inter-affiliate swaps enable a corporate group to aggregate risk
on a global basis in one entity through risk transfers between
affiliates. Once aggregated, commercial risk of various affiliates
is netted, thereby reducing overall commercial and financial risk.
This practice allows for more comprehensive risk management within a
single corporate structure.
Another benefit to this practice is that it allows one affiliate
to face the market and hedge the risk of various operating
affiliates within the group. Notably, inter-affiliate swaps between
majority owned affiliates do not create external counterparty
exposure and therefore do not pose the systemic risks that the
clearing requirement is designed to protect against. The practice
actually reduces risk and simply allows for more efficient business
management of the entire group.
We believe it is entirely appropriate that the Commission exempt
inter-affiliate swaps from the clearing mandate. Unfortunately, this
proposal inserts a requirement that most financial entities engaging
in inter-affiliate swaps post variation margin to one another. It is
not clear that this requirement will do anything other than create
administrative burdens and operational risk while unnecessarily
tying up capital that could otherwise be used for investment.
The variation margin requirement is also largely inconsistent
with the requirements included in the European Market Infrastructure
Regulation. As we have both made clear during the implementation
process, we believe coordination with our global counterparts is
critical to the success of this new framework.
Finally, the legislative history on this issue is clear. During
the passage of the Dodd-Frank Act many Members' statements directly
addressed the concerns regarding inter-affiliate swaps.
Additionally, Members of the U.S. House of Representatives passed,
by an overwhelming bi-partisan majority, an inter-affiliate swap
exemption that does not include a variation margin requirement.
We believe this proposal may have the unintended consequence of
imposing substantial costs on the economy and consumers. With this
in mind, we welcome comments from the public as to the costs and
benefits of the variation margin requirement and hope that we
incorporate those views in adopting the final rule.
[FR Doc. 2012-20508 Filed 8-20-12; 8:45 am]
BILLING CODE P
Last Updated: August 21, 2012