2019-06109
Federal Register, Volume 84 Issue 62 (Monday, April 1, 2019)
[Federal Register Volume 84, Number 62 (Monday, April 1, 2019)]
[Rules and Regulations]
[Pages 12450-12475]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-06109]
[[Page 12449]]
Vol. 84
Monday,
No. 62
April 1, 2019
Part IV
Commodity Futures Trading Commission
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17 CFR Part 1
De Minimis Exception to the Swap Dealer Definition--Swaps Entered Into
by Insured Depository Institutions in Connection With Loans to
Customers; Final Rule
Federal Register / Vol. 84 , No. 62 / Monday, April 1, 2019 / Rules
and Regulations
[[Page 12450]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AE68
De Minimis Exception to the Swap Dealer Definition--Swaps Entered
Into by Insured Depository Institutions in Connection With Loans to
Customers
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is amending the de minimis exception within the ``swap
dealer'' definition in the Commission's regulations by establishing as
a factor in the de minimis threshold determination whether a given swap
has specified characteristics of swaps entered into by insured
depository institutions in connection with loans to customers.
DATES: This rule is effective April 1, 2019.
FOR FURTHER INFORMATION CONTACT: Matthew Kulkin, Director, 202-418-
5213, [email protected], Rajal Patel, Associate Director, 202-418-5261,
[email protected], or Jeffrey Hasterok, Data and Risk Analyst, 646-746-
9736, [email protected], Division of Swap Dealer and Intermediary
Oversight; Bruce Tuckman, Chief Economist, 202-418-5624,
[email protected] or Scott Mixon, Associate Director, 202-418-5771,
[email protected], Office of the Chief Economist; or Mark Fajfar,
Assistant General Counsel, 202-418-6636, [email protected], Office of
General Counsel, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Statutory and Regulatory Background
1. Statutory Authority
2. Regulatory History
3. Policy Considerations
B. Proposal
II. Final Rule--Swaps Entered Into by Insured Depository
Institutions in Connection With Loans to Customers
A. Proposal
1. Background
2. Proposed IDI De Minimis Provision
B. Final Rule, Summary of Comments, and Commission Response
1. Generally
2. Timing of Execution of Swap
3. Relationship of Swap to Loan
4. Duration of Swap
5. Level of Funding of Loan
6. Other Comments
7. Commission Authority To Amend the De Minimis Exception
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
1. General Costs and Benefits
2. Section 15(a)
D. Antitrust Considerations
I. Background
A. Statutory and Regulatory Background
1. Statutory Authority
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act'') \1\ established a statutory
framework to reduce risk, increase transparency, and promote market
integrity within the financial system by regulating the swap market.
Among other things, the Dodd-Frank Act amended the Commodity Exchange
Act (``CEA'') \2\ to provide for the registration and regulation of
swap dealers (``SDs'').\3\ The Dodd-Frank Act directed the CFTC and the
U.S. Securities and Exchange Commission (``SEC'' and together with the
CFTC, ``Commissions'') to jointly further define, among other things,
the term ``swap dealer,'' \4\ and to exempt from designation as an SD a
person that engages in a de minimis quantity of swap dealing.\5\
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\1\ Public Law 111-203, 124 Stat. 1376 (2010), available at
https://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf.
\2\ The CEA is found at 7 U.S.C. 1, et seq.
\3\ See generally 7 U.S.C. 6s.
\4\ Dodd-Frank Act section 712(d)(1). See the definitions of
``swap dealer'' in CEA section 1a(49) and Sec. 1.3 of the
Commission's regulations. 7 U.S.C. 1a(49); 17 CFR 1.3.
\5\ See Dodd-Frank Act section 721.
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CEA section 1a(49) defines the term ``swap dealer'' to include any
person who: (1) Holds itself out as a dealer in swaps; (2) makes a
market in swaps; (3) regularly enters into swaps with counterparties as
an ordinary course of business for its own account; or (4) engages in
any activity causing the person to be commonly known in the trade as a
dealer or market maker in swaps (collectively referred to as ``swap
dealing,'' ``swap dealing activity,'' or ``dealing activity'').\6\ The
statute also requires the Commission to promulgate regulations to
establish factors with respect to the making of a determination to
exempt from designation as an SD an entity engaged in a de minimis
quantity of swap dealing.\7\ CEA section 1a(49) further provides that
in no event shall an insured depository institution (``IDI'') be
considered to be an SD to the extent it offers to enter into a swap
with a customer in connection with originating a loan with that
customer.\8\
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\6\ 7 U.S.C. 1a(49)(A). In general, a person that satisfies any
one of these prongs is deemed to be engaged in swap dealing
activity. See also the definitions of ``swap'' in CEA section 1a(47)
and Sec. 1.3 of the Commission's regulations. 7 U.S.C. 1a(47); 17
CFR 1.3.
\7\ 7 U.S.C. 1a(49)(D).
\8\ 7 U.S.C. 1a(49)(A).
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2. Regulatory History
Pursuant to the statutory requirements, in December 2010, the
Commissions issued a proposing release (``SD Definition Proposing
Release'') \9\ further defining, among other things, the term ``swap
dealer.'' Subsequently, in May 2012, the Commissions issued an adopting
release (``SD Definition Adopting Release'') \10\ further defining,
among other things, the term ``swap dealer'' in Sec. 1.3 of the CFTC's
regulations (``SD Definition'') and providing for a de minimis
exception in paragraph (4) therein (``De Minimis Exception'').\11\
Pursuant to an amendment proposed in June 2018,\12\ and adopted by the
Commission in November 2018,\13\ the De Minimis Exception now states
that a person shall not be deemed to be an SD unless its swaps
connected with swap dealing activities exceed an aggregate gross
notional amount (``AGNA'') threshold of $8 billion (measured over the
prior 12-month period).\14\
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\9\ Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' 75 FR 80174
(proposed Dec. 21, 2010).
\10\ Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596 (May 23, 2012).
\11\ See 17 CFR 1.3, Swap dealer. As discussed in more detail in
section II, the Commission notes that a joint rulemaking with the
SEC is not required to amend the De Minimis Exception, pursuant to
paragraph (4)(v) of the De Minimis Exception. See 17 CFR 1.3, Swap
dealer, paragraph (4)(v); 77 FR at 30634 n.464.
\12\ See De Minimis Exception to the Swap Dealer Definition, 83
FR 27444 (proposed June 12, 2018).
\13\ See De Minimis Exception to the Swap Dealer Definition, 83
FR 56666 (Nov. 13, 2018).
\14\ See 17 CFR 1.3, Swap dealer, paragraph (4)(i)(A).
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3. Policy Considerations
(i) Swap Dealer Registration Policy Considerations
The policy goals underlying SD registration and regulation
generally include reducing systemic risk, increasing counterparty
protections, and increasing market efficiency, orderliness, and
transparency.
Reducing systemic risk: The Dodd-Frank Act was enacted in the wake
of the financial crisis of 2008, in significant part, to reduce
systemic risk, including the risk to the broader U.S.
[[Page 12451]]
financial system created by interconnections in the swap market.\15\
Pursuant to the Dodd-Frank Act, the Commission has adopted regulations
designed to mitigate the potential systemic risk inherent in the
previously unregulated swap market.\16\
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\15\ Dodd-Frank Act, Preamble (indicating that the purpose of
the Dodd-Frank Act was to promote the financial stability of the
United States by improving accountability and transparency in the
financial system, to end ``too big to fail,'' to protect the
American taxpayer by ending bailouts, to protect consumers from
abusive financial services practices, and for other purposes). See
also 83 FR at 56667; 83 FR at 27446.
\16\ For example, registered SDs have specific requirements for
risk management programs and margin. See, e.g., 17 CFR 23.600; 17
CFR 23.150-23.161.
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Increasing counterparty protections: Providing regulatory
protections for swap counterparties who may be less experienced or
knowledgeable about the swap products offered by SDs (particularly end-
users who use swaps for hedging or investment purposes) is a
fundamental policy goal advanced by the regulation of SDs.\17\ The
Commissions recognized that a narrower or smaller de minimis exception
would increase the number of counterparties that could potentially
benefit from those regulatory protections.\18\
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\17\ For example, registered SDs are subject to external
business conduct standard regulations designed to provide
counterparty protections. See, e.g., 17 CFR 23.400-23.451.
\18\ SD Definition Adopting Release, 77 FR at 30628 (``On the
one hand, a de minimis exception, by its nature, will eliminate key
counterparty protections provided by Title VII for particular users
of swaps and security-based swaps.''). See also 83 FR at 56667; 83
FR at 27446.
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Increasing market efficiency, orderliness, and transparency:
Increasing swap market efficiency, orderliness, and transparency is
another goal of SD regulation.\19\ Regulations requiring SDs, for
example, to keep detailed daily trading records, report trade
information, and engage in portfolio reconciliation and compression
exercises help achieve these market benefits.\20\
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\19\ 77 FR at 30629 (The statutory requirements that apply to
swap dealers include requirements aimed at helping to promote
effective operation and transparency of the swap markets.''). See
id. at 30703 (Those who engage in swaps with entities that elude
swap dealer or major swap participant status and the attendant
regulations could be exposed to increased counterparty risk;
customer protection and market orderliness benefits that the
regulations are intended to provide could be muted or sacrificed,
resulting in increased costs through reduced market integrity and
efficiency.). See also 83 FR at 56667-68; 83 FR at 27446.
\20\ See, e.g., 17 CFR 23.200-23.205; 17 CFR parts 43 and 45; 17
CFR 23.502-23.503.
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(ii) De Minimis Exception Policy Considerations
Consistent with Congressional intent, an appropriately calibrated
de minimis exception has the potential to advance other interests.\21\
These interests include increasing efficiency, allowing limited swap
dealing in connection with other client services, encouraging new
participants to enter the market, and focusing regulatory
resources.\22\ The policy objectives underlying the de minimis
exception are designed to encourage participation and competition by
allowing persons to engage in a de minimis amount of dealing without
incurring the costs of registration and regulation.\23\
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\21\ See 77 FR at 30628. See also 83 FR 56668; 83 FR at 27446.
\22\ See 77 FR at 30628-30, 30707-08. See also 83 FR at 56668;
83 FR at 27446-47.
\23\ In considering the appropriate de minimis threshold,
excluding entities whose dealing activity is sufficiently modest in
light of the total size, concentration and other attributes of the
applicable markets can be useful in avoiding the imposition of
regulatory burdens on those entities for which dealer regulation
would not be expected to contribute significantly to advancing the
customer protection, market efficiency and transparency objectives
of dealer regulation. 77 FR at 30629-30. See also 83 FR at 56668; 83
FR at 27446-47.
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Increasing efficiency: A de minimis exception based on an objective
test with a limited degree of complexity enables entities to engage in
a lower level of swap dealing with limited concerns about whether their
activities would require registration.\24\ The de minimis exception
thereby fosters efficient application of the SD Definition.
Additionally, the Commission is of the view that the potential for
regular or periodic changes to the de minimis threshold may reduce its
efficacy by making it challenging for persons to calibrate their swap
dealing activity as appropriate for their business models. Further, the
Commission is mindful that objective, predictable standards in the de
minimis exception increase efficiency by establishing a simple test for
whether a person's swaps connected with swap dealing activity must be
included in the de minimis calculation. On the other hand, more
complexity in the de minimis calculation potentially results in less
efficiency.\25\
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\24\ 77 FR at 30628-29 (The de minimis exception may further the
interest of regulatory efficiency when the amount of a person's
dealing activity is, in the context of the relevant market, limited
to an amount that does not warrant registration. In addition, the
exception can provide an objective test.). See also 83 FR at 56668;
83 FR at 27446-47.
\25\ 77 FR at 30707-08 (On the other hand, requiring market
participants to consider more variables in evaluating application of
the de minimis exception would likely increase their costs to make
this determination.). See also 83 FR at 56668; 83 FR at 27446-47.
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Allowing limited ancillary dealing: A de minimis exception allows
persons to accommodate existing clients that have a need for swaps (on
a limited basis) along with other services.\26\ This enables end-users
to continue transacting within existing business relationships, for
example to hedge interest rate or currency risk.
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\26\ 77 FR at 30629, 30707-08. See also 83 FR at 56668; 83 FR at
27447.
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Encouraging new participants: A de minimis exception also promotes
competition by allowing a person to engage in some swap dealing
activities without immediately incurring the regulatory costs
associated with SD registration and regulation.\27\ Without a de
minimis exception, SD regulation could become a barrier to entry that
may stifle competition. An appropriately calibrated de minimis
exception could lower the barrier to entry of becoming an SD by
allowing smaller participants to gradually expand their business until
the scope and scale of their activity warrants regulation (and the
costs involved with compliance).
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\27\ 77 FR at 30629. See also 83 FR at 56668; 83 FR at 27447.
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Focusing regulatory resources: Finally, the de minimis exception
also increases regulatory efficiency by enabling the Commission to
focus its limited resources on entities whose swap dealing activity is
sufficient in size and scope to warrant oversight.\28\
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\28\ 77 FR at 30628-29. See also 83 FR at 56668; 83 FR at 27447.
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As noted in the SD Definition Adopting Release, implementing the de
minimis exception requires a careful balancing that considers the
regulatory interests that could be undermined by an unduly broad
exception as well as those regulatory interests that may be promoted by
an appropriately limited exception.\29\ A narrower de minimis exception
would likely mean that a greater number of entities would be required
to register as SDs and become subject to the regulatory framework
applicable to registered SDs. However, a de minimis exception that is
too narrow could, for example, discourage persons from engaging in
limited swap dealing activity to avoid the burdens associated with SD
regulation.
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\29\ 77 FR at 30628. See SD Definition Proposing Release, 75 FR
at 80179 (The de minimis exception should apply only when an
entity's dealing activity is so minimal that applying dealer
regulations to the entity would not be warranted.). See also 83 FR
at 56668; 83 FR at 27447.
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B. Proposal
On June 12, 2018, the Commission published for public comment a
Notice of Proposed Rulemaking (``NPRM'') to amend the De Minimis
Exception by: (1)
[[Page 12452]]
Setting the AGNA threshold for the De Minimis Exception at $8 billion
in swap dealing activity entered into by a person over the preceding 12
months; (2) adding new factors to the De Minimis Exception that would
lead to excepting from the AGNA calculation: (a) Certain swaps entered
into with a customer by an IDI in connection with originating a loan to
that customer, (b) certain swaps entered into to hedge financial or
physical positions, and (c) certain swaps resulting from multilateral
portfolio compression exercises; and (3) providing that the Commission
may determine the methodology to be used to calculate the notional
amount for any group, category, type, or class of swaps, and delegating
to the Director of the Division of Swap Dealer and Intermediary
Oversight (``DSIO'') the authority to make such determinations
(collectively, the ``Proposal'').\30\
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\30\ 83 FR 27444.
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In addition, the Commission sought comment on the following
additional potential changes to the De Minimis Exception: (1) Adding as
a factor a minimum dealing counterparty count threshold and/or a
minimum dealing transaction count threshold; (2) adding as a factor
whether a swap is exchange-traded and/or cleared; and (3) adding as a
factor whether a swap is categorized as a non-deliverable forward
transaction.
The Commission received 43 letters and Commission staff
participated in four ex parte meetings \31\ concerning the NPRM.\32\
Twelve of the letters addressed the IDI-related proposed amendment.\33\
As discussed above, the Commission adopted an $8 billion de minimis
threshold in November 2018. This release does not include discussion
regarding other aspects of the NPRM as they were addressed in the
adopting release for the $8 billion threshold.\34\
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\31\ Comments were submitted by the following entities: 360
Trading Networks Inc. (``360 Trading''); American Bankers
Association (``ABA'') (ABA also attached a report prepared by NERA
Economic Consulting); American Gas Association (``AGA''); Americans
for Financial Reform (``AFR''); Associated Foreign Exchange, Inc.
and GPS Capital Markets, Inc. (``AFEX/GPS''); Association of Global
Custodians (``AGC''); Better Markets, Inc. (``Better Markets'');
Bond Dealers of America (``BDA''); Capital One Financial Corporation
(``Capital One''); Cboe SEF, LLC (``Cboe SEF''); Citizens Financial
Group, Inc. (``Citizens''); CME Group Inc. and Intercontinental
Exchange, Inc. (``CME/ICE''); Coalition for Derivatives End-Users
(``CDEU''); Coalition of Physical Energy Companies (``COPE'');
Commercial Energy Working Group (``CEWG''); Commodity Markets
Council (``CMC'') (CMC also expressed support for the CEWG comment
letter); Covington & Burling LLP (``Covington''); Daiwa Securities
Co. Ltd. (``Daiwa''); Edison Electric Institute and Electric Power
Supply Association (``EEI/EPSA''); Foreign Exchange Professionals
Association (``FXPA''); Frost Bank; Futures Industry Association and
FIA Principal Traders Group (``FIA''); Institute for Agriculture and
Trade Policy (``IATP''); Institute of International Bankers
(``IIB''); International Energy Credit Association (``IECA'') (IECA
also expressed support for the EEI/EPSA comment letter);
International Swaps and Derivatives Association and Securities
Industry and Financial Markets Association (``ISDA/SIFMA'');
Japanese Bankers Association (``JBA''); M&T Bank (``M&T''); Managed
Funds Association (``MFA''); National Council of Farmer Cooperatives
(``NCFC''); National Rural Electric Cooperative Association and
American Public Power Association (``NRECA/APPA''); Natural Gas
Supply Association (``NGSA''); NEX Group plc (``NEX''); Northern
Trust; Optiver US LLC (``Optiver'') (Optiver also expressed support
for the FIA comment letter); Regions Financial Corp. (``Regions'');
State Street; SVB Financial Group (``SVB''); Thomson Reuters (SEF)
LLC (``TR SEF''); six U.S. Senators (``Senators''); Virtu Financial
Inc. (``Virtu''); Western Union Business Solutions (USA), LLC and
Custom House USA, LLC (``Western Union''); and XTX Markets Limited
(``XTX''). Additionally, there were three meetings with Delta
Strategy Group, DRW, Jump Trading, and Optiver, and one meeting with
Better Markets. The comment letters and notice of the ex parte
meetings are available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=2885.
\32\ Additionally, in March 2017, Chairman Giancarlo initiated
an agency-wide internal review of CFTC regulations and practices to
identify those areas that could be simplified to make them less
burdensome and costly (``Project KISS''). See Remarks of then-Acting
Chairman J. Christopher Giancarlo before the 42nd Annual
International Futures Industry Conference in Boca Raton, FL (Mar.
15, 2017), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-20. The Commission subsequently
published in the Federal Register a Request for Information
soliciting suggestions from the public regarding how the
Commission's existing rules, regulations, or practices could be
applied in a simpler, less burdensome, and less costly manner. A
number of responses submitted pursuant to the Project KISS Request
for Information supported modifications to the De Minimis Exception.
Project KISS, 82 FR 21494 (May 9, 2017), amended by 82 FR 23765 (May
24, 2017). The suggestion letters filed by the public are available
at https://comments.cftc.gov/KISS/KissInitiative.aspx.
\33\ See ABA, Better Markets, BDA, Capital One, CDEU, Citizens,
Frost Bank, IIB, ISDA/SIFMA, JBA, M&T, and Regions comment letters.
\34\ See 83 FR 56666.
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II. Final Rule--Swaps Entered Into by Insured Depository Institutions
in Connection With Loans to Customers
Given the more complete information now available regarding certain
portions of the swap market, the data analytical capabilities developed
since the SD regulations were adopted, five years of implementation
experience, and comments received in response to the NPRM, the
amendment being adopted in this release: (1) Supports a clearer and
more streamlined application of the De Minimis Exception; (2) provides
greater clarity regarding which swaps need to be counted towards the
AGNA threshold; and (3) accounts for practical considerations relevant
to swaps in different circumstances.
In this adopting release, the Commission is amending the De Minimis
Exception by establishing as a factor in the AGNA threshold
determination whether a given swap has specified characteristics of
swaps entered into by IDIs in connection with originating loans to
customers.\35\ The CFTC may in the future separately propose or adopt
rules addressing any aspect of the NPRM that is not finalized in this
release, or that has not already been finalized.\36\
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\35\ This exception would be independent of the existing
exclusion in paragraph (5) of the SD Definition for swaps entered
into by IDIs.
\36\ See ICI v. CFTC, 720 F.3d 370, 379 (D.C. Cir. 2013) (``[A]s
the Supreme Court has emphasized, `[n]othing prohibits federal
agencies from moving in an incremental manner.' '') (quoting FCC v.
Fox Television Stations, Inc., 556 U.S. 502, 522 (2009)).
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The changes to the De Minimis Exception are being adopted pursuant
to the Commission's authority under CEA section 1a(49)(D), which
requires the Commission to exempt from designation as an SD an entity
that engages in a de minimis quantity of swap dealing in connection
with transactions with or on behalf of its customers, and to promulgate
regulations to establish factors with respect to the making of this
determination to exempt.\37\ The Commissions issued the SD Definition
Adopting Release pursuant to section 712(d)(1) of the Dodd-Frank Act,
which requires the CFTC and SEC to jointly adopt rules regarding the
definition of, among other things, the term ``swap dealer.'' The CFTC
continues to coordinate with the SEC on SD and security-based swap
dealer regulations. However, as discussed in the NPRM and the SD
Definition Adopting Release, a joint rulemaking is not required with
respect to the De Minimis Exception.\38\ The Commission notes that it
has consulted with the SEC and prudential regulators regarding the
changes to the De Minimis Exception adopted herein.\39\
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\37\ 7 U.S.C. 1a(49)(D). See also 17 CFR 1.3, Swap dealer,
paragraph (4)(v).
\38\ 83 FR at 27448; 77 FR at 30634 n.464 (stating that we do
not interpret the joint rulemaking provisions of section 712(d) of
the Dodd-Frank Act to require joint rulemaking here, because such an
interpretation would read the term ``Commission'' out of CEA section
1a(49)(D) (and Exchange Act section 3(a)(71)(D)), which themselves
were added by the Dodd-Frank Act.'').
\39\ As required by section 712(a)(1) of the Dodd-Frank Act.
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[[Page 12453]]
A. Proposal
The Commission proposed adding an IDI loan-related factor in the De
Minimis Exception (the ``IDI De Minimis Provision'') to address
concerns that there are circumstances where swaps not covered by the
IDI loan-related swap exclusion in paragraph (5) of the SD Definition
(the ``IDI Swap Dealing Exclusion'') should be excluded from the de
minimis calculation. Specifically, the Commission proposed to add
specific factors that an IDI can consider when assessing whether swaps
entered into with customers in connection with originating loans to
those customers must be counted towards the IDI's de minimis
calculation.\40\ The IDI could exclude qualifying swaps from the de
minimis calculation pursuant to the IDI De Minimis Provision regardless
of whether the swaps would qualify for the IDI Swap Dealing Exclusion.
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\40\ A joint rulemaking is not required with respect to changes
to the de minimis exception-related factors. See supra note 38; 77
FR at 30634 n.464. As noted above, pursuant to section 712(a)(1) of
the Dodd-Frank Act, the Commission consulted with the SEC and
prudential regulators regarding the changes to the De Minimis
Exception discussed in this adopting release.
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1. Background
The Commissions jointly adopted the IDI Swap Dealing Exclusion \41\
as paragraph (5) of the SD Definition. It allows an IDI to exclude--
when determining whether it is an SD--certain swaps it enters into with
a customer in connection with originating a loan to that customer.\42\
For a swap to be considered to have been entered into in connection
with originating a loan, the IDI Swap Dealing Exclusion requires that:
(1) The IDI enter into the swap no earlier than 90 days before and no
later than 180 days after execution of the loan agreement (or transfer
of principal); \43\ (2) the rate, asset, liability, or other notional
item underlying the swap be tied to the financial terms of the loan or
be required as a condition of the loan to hedge risks arising from
potential changes in the price of a commodity; \44\ (3) the duration of
the swap not extend beyond termination of the loan; \45\ (4) the IDI be
the source of at least 10 percent of the principal amount of the loan,
or the source of a principal amount greater than the notional amount of
swaps entered into by the IDI with the customer in connection with the
loan; \46\ (5) the AGNA of swaps entered into in connection with the
loan not exceed the principal amount outstanding; \47\ (6) the swap be
reported as required by other CEA provisions if it is not accepted for
clearing; \48\ (7) the transaction not be a sham, whether or not the
transaction is intended to qualify for the IDI Swap Dealing Exclusion;
\49\ and (8) the loan not be a synthetic loan, including, without
limitation, a loan credit default swap or a loan total return swap.\50\
A swap that meets the above requirements would not be considered when
assessing whether a person is an SD.
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\41\ The IDI Swap Dealing Exclusion was adopted pursuant to
statutory language stating that in no event shall an IDI be
considered to be an SD to the extent it offers to enter into a swap
with a customer in connection with originating a loan with that
customer. 7 U.S.C. 1a(49)(A).
\42\ 17 CFR 1.3, Swap dealer, paragraph (5).
\43\ 17 CFR 1.3, Swap dealer, paragraph (5)(i)(A).
\44\ 17 CFR 1.3, Swap dealer, paragraph (5)(i)(B).
\45\ 17 CFR 1.3, Swap dealer, paragraph (5)(i)(C).
\46\ 17 CFR 1.3, Swap dealer, paragraph (5)(i)(D).
\47\ 17 CFR 1.3, Swap dealer, paragraph (5)(i)(E).
\48\ 17 CFR 1.3, Swap dealer, paragraph (5)(i)(F).
\49\ 17 CFR 1.3, Swap dealer, paragraph (5)(iii)(A).
\50\ 17 CFR 1.3, Swap dealer, paragraph (5)(iii)(B).
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The Commission understands that certain IDIs are restricting loan-
related swaps because of the potential that such swaps would not be
covered by the IDI Swap Dealing Exclusion and therefore would have to
be counted towards an IDI's de minimis threshold, requiring the IDI to
register as an SD and incur registration-related costs.\51\ The
restrictions on loan-related swaps by IDIs may result in reduced
availability of swaps for the loan customers of these IDIs, potentially
hampering the ability of end-user borrowers to enter into hedges in
connection with their loans.
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\51\ See, e.g., ABA, Capital One, Citizens, and Regions comment
letters.
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2. Proposed IDI De Minimis Provision
Any swap that meets the requirements of the IDI Swap Dealing
Exclusion would also meet the requirements of the IDI De Minimis
Provision. Beyond this, the IDI De Minimis Provision furthers the
purposes of the de minimis exception by setting out additional factors
for determining which swaps need to be counted towards an IDI's de
minimis calculation. The Commission expects that including the IDI De
Minimis Provision in the De Minimis Exception would facilitate the
provision of swaps by IDIs that are not registered as SDs to their loan
customers because the IDIs would be able to provide these risk-
mitigating swaps in connection with originating loans without counting
the swaps towards the AGNA threshold.
The Commission proposed that the IDI De Minimis Provision include
the following requirements: \52\
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\52\ See 83 FR at 27458-62, 27478-79.
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The swap is entered into with the customer no earlier than
90 days before execution of the applicable loan agreement, or no
earlier than 90 days before transfer of principal to the customer by
the IDI pursuant to the loan, unless an executed commitment or forward
agreement for the applicable loan exists, in which event the 90 day
restriction does not apply.
The rate, asset, liability or other term underlying such
swap is, or is related to, a financial term of such loan, which
includes, without limitation, the loan's duration, rate of interest,
the currency or currencies in which it is made and its principal
amount; or the swap is required as a condition of the loan, either
under the IDI's loan underwriting criteria or as is commercially
appropriate, in order to hedge risks incidental to the borrower's
business (other than for risks associated with an excluded commodity)
that may affect the borrower's ability to repay the loan.
The duration of the swap does not extend beyond
termination of the loan.
The IDI is committed to be, under the terms of the
agreements related to the loan, the source of at least five percent of
the maximum principal amount under the loan; or if the IDI is committed
to be, under the terms of the agreements related to the loan, the
source of less than five percent of the maximum principal amount under
the loan, then the aggregate notional amount of all swaps entered by
the IDI with the customer in connection with the financial terms of the
loan cannot exceed the principal amount of the IDI's loan.
The swap is considered to have been entered into in
connection with originating a loan with a customer if the IDI directly
transfers the loan amount to the customer; is a part of a syndicate of
lenders that is the source of the loan amount that is transferred to
the customer; purchases or receives a participation in the loan; or
under the terms of the agreements related to the loan, is, or is
intended to be, the source of funds for the loan.
The loan to which the swap relates shall not include: any
transaction that is a sham, whether or not intended to qualify for the
exception from the de minimis threshold in this definition; or any
synthetic loan.
B. Final Rule, Summary of Comments, and Commission Response
Upon consideration of the comments described below, the Commission
is adopting the IDI De Minimis Provision in paragraph (4)(i)(C) of the
De Minimis Exception as proposed, with a few modifications as discussed
in detail below.
[[Page 12454]]
The Commission believes that the IDI De Minimis Provision advances
the policy objectives of the de minimis exception by allowing some IDIs
that are not registered SDs to provide swaps to customers in connection
with originating loans. The IDI De Minimis Provision should facilitate
an appropriate level of swap dealing in connection with other client
services and may encourage more IDIs to participate in the swap
market--two policy objectives of the de minimis exception. Greater
availability of loan origination-related swaps may also improve the
ability of customers to hedge their loan-related exposure. The
Commission also believes that the proposed IDI De Minimis Provision may
allow for more focused, efficient application of the SD Definition to
the activities of those IDIs that offer swaps in connection with loans.
The Commission also considered how the IDI De Minimis Provision
would affect the policy objectives of the SD registration requirement.
The de minimis exception should allow amounts of swap dealing activity
that are sufficiently small that they do not warrant registration to
address concerns implicated by SD regulations.\53\ As discussed in the
Proposal,\54\ Commission staff reviewed the AGNA of swaps activity
entered into by entities that were identified as IDIs \55\ with at
least 10 counterparties in interest rate swaps (``IRS''), credit
default swaps (``CDS), foreign exchange (``FX'') swaps,\56\ and equity
swaps. In particular, the AGNA of swaps activity of IDIs within various
AGNA ranges from $1 billion to $50 billion was analyzed. The range of
$1 billion to $50 billion was analyzed because larger IDIs appear to
have a significant amount of non-IDI loan origination-related swaps
activity, and therefore, the Commission believes that the addition of
the IDI De Minimis Provision would be beneficial primarily to small and
mid-sized IDIs with lower AGNA of activity. As seen in Table 1, during
the review period, the AGNA of swaps activity that these unregistered
IDIs entered into with other non-registered entities was low relative
to the total swap market analyzed.
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\53\ SD Definition Adopting Release, 77 FR at 30626-28. See also
SD Definition Proposing Release, 75 FR at 80179.
\54\ See 83 FR at 27459-60.
\55\ Based on information on the Federal Deposit Insurance
Corporation website, available at https://www5.fdic.gov/idasp/advSearch_warp_download_all.asp.
\56\ The term ``FX swaps'' is used in this release to only
describe those FX transactions that are counted towards a person's
de minimis calculation. The term ``FX swaps'' does not refer to
swaps and forwards that are not counted towards the de minimis
threshold pursuant to the exemption granted by the Secretary of the
Treasury. See Determination of Foreign Exchange Swaps and Foreign
Exchange Forwards Under the Commodity Exchange Act, 77 FR 69694,
69704-05 (Nov. 20, 2012); Further Definition of ``Swap,''
``Security-Based Swap,'' and ``Security-Based Swap Agreement'';
Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 FR
48208, 48253 (Aug. 13, 2012).
\57\ 83 FR at 27459.
Table 1--IDI Activity (Ranges between $1 Bn and $ 50 Bn) \57\ IRS, CDS, FX Swaps, and Equity Swaps
[Minimum 10 counterparties]
----------------------------------------------------------------------------------------------------------------
Number of IDIs AGNA of swaps activity \1\
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Total with no
Range of AGNA of swaps activity Total with at Total with no registered SDs
($Bn) Registered as Not registered least one registered SDs (percent of
SDs as SDs registered SD ($Bn) overall
($Bn) market)
----------------------------------------------------------------------------------------------------------------
1-3............................. 0 13 13.5 8.9 0.004
3-8............................. 0 10 37.5 16.5 0.007
8-20............................ 0 4 42.6 6.5 0.003
20-50........................... 2 3 160.7 14.2 0.006
----------------------------------------------------------------------------------------------------------------
\1\ The AGNA totals are not mutually exclusive across rows, and therefore cannot be added together without
double counting. For example, some IDIs in the $1 billion to $3 billion range transact with IDIs in the $3
billion to $8 billion range. Transactions that involve entities from multiple rows are reported in both rows.
For example, there were four IDIs that had between $8 billion and
$20 billion each in AGNA of swaps activity--none of which are
registered SDs.\58\ In aggregate, these IDIs entered into approximately
$49.1 billion in AGNA of swaps activity. However, only $6.5 billion of
that activity was between two entities not registered as SDs,
representing only 0.003 percent of the total AGNA of swaps activity
during the review period. Depending on the range of AGNA of swaps
activity examined, the level of activity occurring between two entities
not registered as SDs (at least one of which is an IDI) ranged from
only approximately $6.5 billion to $16.5 billion, or 0.003 percent and
0.007 percent of the total AGNA of swaps activity. Though these
entities are active in the swap market, the Commission is of the view
that their activity poses relatively low systemic risk because of their
limited AGNA of swaps activity as compared to the overall size of the
swap market. Additionally, the Commission notes that because only IDIs
entering into swaps with customers in connection with loan origination
may exclude such swaps from de minimis calculations, the IDIs will be
subject to prudential supervision of their lending and swap dealing
activities, thereby maintaining regulatory oversight of the risks of
such swaps. Further, subject to certain exceptions, whether or not a
swap involves a registered SD, the swap and the swap's counterparties
are still subject to the Commission's regulations, including provisions
regarding mandatory clearing, trade execution, and swap data reporting,
which advance the policy considerations underlying SD regulations.
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\58\ See Table 1.
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The Commission believes that end-users would primarily benefit from
the IDI De Minimis Provision by entering into IRS, FX swaps, and NFC
swaps with IDIs to hedge loan-related risks. SDR data indicates that
IDIs that have between $1 billion and $50 billion in AGNA of swaps
activity primarily enter into IRS, FX swaps, and NFC swaps, as measured
by AGNA and transaction count.\59\ Further, market participants have
also indicated that IDIs primarily provide swaps to customers to hedge
interest rate, FX, and commodity price
[[Page 12455]]
risk.\60\ Because IDI swaps are entered into in connection with loans,
the Commission believes the most common IDI swaps will be entered into
by loan customers to reduce interest rate risk associated with loan
obligations. Similarly, the Commission also believes that some IDI
swaps will be used by loan customers to reduce currency or commodity
price risk associated with loans and the borrower's repayment ability.
This usage of IDI swaps is likely to continue after adoption of the IDI
De Minimis Provision because: (1) On a notional and trade count basis,
IRS and FX swaps are the largest components of the market, and loans
are expected to generally continue to have an interest rate or FX
component that can be hedged; and (2) IDIs may more effectively be able
to provide loan customers the option to enter into NFC swaps to hedge
loan-related risk.\61\ The Commission believes that increased IDI swap
dealing not only benefits borrowers for the reasons stated above, but
also provides benefits to IDIs who also seek to provide swaps in
connection with originating loans. Generally, IDIs improve loan
customers' ability to repay loans by better allowing the customers to
hedge loan-related risks using IRS, FX swaps, or NFC swaps.
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\59\ This is based on an analysis of SDR data from January 1,
2017, through December 31, 2017. The data was sourced from data
reported to the four registered SDRs: BSDR LLC, Chicago Mercantile
Exchange Inc., DTCC Data Repository, and ICE Trade Vault. See 83 FR
at 27449.
\60\ See, e.g., ABA and Capital One comment letters. ABA
generally referenced a January 19, 2016 comment letter that it
submitted in response to the Swap Dealer De Minimis Exception
Preliminary Report (Nov. 18, 2015), in which it stated that IRS and
NFC swaps are examples of how banks use swaps to serve customers.
The Swap Dealer De Minimis Exception Preliminary Report and ABA
comment letter are available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1634. Capital One stated that it
enters into swaps with its commercial banking customers so that
those customers can hedge risks associated with the financial terms
of the related loans, and that it enters into swaps with customers
in order to help them hedge their other interest rate, FX, and NFC
risks arising from their business operations. The Commission also
notes that, as discussed in the Swap Dealer De Minimis Exception
Preliminary Report, comments in response to the SD Definition
Proposing Release indicated that small and mid-sized banks were
primarily dealers in the IRS market because of their focus on
lending activities. See Swap Dealer De Minimis Exception Preliminary
Report at 43.
\61\ See id. See also Citizens, M&T, and Regions comment letter.
Citizens generally supported the IDI De Minimis Provision, stating
that the IDI Swap Dealing Exclusion is too restrictive and is
difficult to interpret in certain instances, particularly with
respect to IRS. M&T indicated that the IDI De Minimis Provision
better aligns the regulatory framework with the risk mitigation
demands of bank customers, particularly with respect to IRS. Regions
agreed that one benefit of the IDI De Minimis Provision is to
provide greater flexibility for borrowers to hedge commodity price
risks with IDIs.
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The Commission has also considered the potential that IDIs might
respond to the IDI De Minimis Provision by engaging in more swap
dealing activity.\62\ Because swap dealing under the IDI De Minimis
Provision must be connected to customer loan origination, future growth
in swap dealing by unregistered IDIs is partially limited by growth in
the related customer lending business. The Commission believes that
customer swap dealing is complementary to the customer loan business,
and is not the sole determinative factor in the overall growth of the
customer loan business.\63\ The Commission believes that the requisite
direct relationship between the swap and the origination of a loan will
prevent IDIs from engaging in swap dealing activity not related to
loans to customers. Therefore, the Commission believes that the swap
dealing activity by IDIs that may occur under the IDI De Minimis
Provision, taken together with swap dealing activity that may occur
under other provisions of the De Minimis Exception, is ``sufficiently
modest in light of the total size, concentration and other attributes
of the applicable markets'' to not warrant SD registration, because it
would not appreciably affect the systemic risk, counterparty
protection, and market efficiency considerations of regulation.\64\ The
Commission is of the view that the IDI De Minimis Provision will not
lead to a significant expansion of swap dealing activity by
unregistered entities, as compared to the overall size of the swap
market. As noted, growth in swap dealing by IDIs is partially limited
by growth in the related customer lending business. This lending
business, in turn, is driven in part by macroeconomic factors such as
interest rates and economic growth. These factors may be expected to
constrain the ability of IDIs to substantially increase their loan
origination-related swaps activity--such as during the onset of a
recession when default risk increases--simply because of this change to
the De Minimis Exception. Additionally, constraints from prudential
supervision,\65\ capital requirements, and the need to post margin on
certain transactions will also act as limits on an IDI's swap dealing
activities.\66\
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\62\ In determining the scope of the de minimis exception, it is
important to consider not only the current state of the swap and
security-based swap markets, but also to account for how those
markets may evolve in the future. 77 FR at 30628.
\63\ See, e.g., Capital One and Regions comment letters. Capital
One stated that its commercial banking business ``primarily
originates loans (and participates in loans originated by other
banks) for its commercial banking customers. In connection with the
origination of (or participation in) these loans, Capital One enters
into swaps with its commercial banking customers so that those
customers can hedge risks associated with the financial terms of the
related loans.'' Regions stated the IDI De Minimis Provision removes
``overly restrictive definitions of swaps tied to lending activity
and better reflect[s] the way that traditional regional banking
organizations . . . interact with their commercial customers.''
\64\ See 77 FR at 30626, 30629. As noted in the SD Definition
Adopting Release, implementing the de minimis exception requires a
careful balancing that considers the regulatory interests that could
be undermined by an unduly broad exception as well as those
regulatory interests that may be promoted by an appropriately
limited exception. Id. at 30628.
\65\ For example, loan loss provisioning requirements should act
as a constraint on the size of the IDI's loan portfolio, which would
also serve to constrain the IDI's loan-related swaps. See, e.g., The
Office of the Comptroller of the Currency, Comptroller's Handbook:
Allowance for Loan and Lease Losses (June 1996-May 1998) (still
applicable as of May 17, 2012).
\66\ The Commission also notes that ABA submitted a study that
evaluated the costs and benefits of SD registration for member
banks, prepared by NERA Economic Consulting (``NERA''). NERA
estimated regulatory coverage for several different scenarios,
including for: (1) An AGNA threshold; and (2) an AGNA threshold in
conjunction with a modified exception for IDI loan-related swaps
that eliminated the date restrictions related to the IDI Swap
Dealing Exclusion. Although the assumptions and analytical
methodology differed from the Commission's approach, NERA's analysis
also estimated only a limited decrease in regulatory coverage in the
scenario that evaluated an AGNA threshold with a modified exception
for IDI loan-related swaps--with $138,383 billion of swaps activity
covered--as compared to the scenario that evaluated just an AGNA
threshold--with $138,406 billion of swaps activity covered (a
decrease of 0.017 percent). See ABA comment letter (attaching NERA
study).
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1. Generally
Almost all commenters that addressed the IDI De Minimis Provision
expressed general support for the proposed amendment.\67\ Commenters
often compared the IDI De Minimis Provision to the IDI Swap Dealing
Exclusion. In that regard, commenters stated that the IDI De Minimis
Provision: (1) Better aligns the regulatory framework with the risk
mitigation demands of bank customers; \68\ (2) allows IDIs to more
accurately address the needs of loan customers seeking to access cost-
effective and tailored hedges for their loans; \69\ (3) provides the
benefit of reduced risk and more efficient use of loan collateral
through more tailored swaps; \70\ and (4) removes overly restrictive
definitions of swaps tied to lending activity and better reflects how
traditional regional banks interact with their commercial
customers.\71\
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\67\ See ABA, BDA, Capital One, CDEU, Citizens, Frost Bank, IIB,
ISDA/SIFMA, JBA, M&T, and Regions comment letters.
\68\ See M&T comment letter.
\69\ See Capital One and Frost Bank comment letters.
\70\ See Frost Bank comment letter.
\71\ See Regions comment letter.
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ABA suggested that the Commission amend the first sentence in
proposed paragraph (4)(i)(C) to clarify that the IDI
[[Page 12456]]
De Minimis Provision applies to both the $8 billion threshold and the
special entity $25 million threshold by replacing the term ``the
aggregate gross notional amount threshold'' with the term ``any
aggregate gross notional amount threshold.'' \72\ The Commission is
modifying paragraph (4)(i)(C) to read ``the $8 billion aggregate gross
notional amount threshold'' to reflect that the IDI De Minimis
Provision would only apply to swaps that would otherwise be counted
towards the $8 billion threshold. The Commission stated in the NPRM
that the special entity threshold was outside of the scope of the
Proposal.\73\ Accordingly, the Commission cannot make changes that
would affect the special entity threshold at this time.
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\72\ See ABA comment letter.
\73\ 83 FR at 27445 n.14.
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Additionally, ABA and Citizens stated that the Commission should
permit IDIs to exclude swaps that meet the provisions of the IDI De
Minimis Provision retroactively for a 12-month period from the date on
which the regulation becomes effective.\74\ In response, the Commission
takes the position that swaps that were executed prior to the effective
date of this release do not qualify for the IDI De Minimis Provision.
The applicability of provisions in the De Minimis Exception is
generally determined at the time of execution of the swap (or at the
time a life cycle event occurs, if applicable), and accordingly, swaps
executed prior to the effective date did not qualify for the exception
at the time of execution and cannot be retroactively qualified under
these amendments.
---------------------------------------------------------------------------
\74\ See ABA and Citizens comment letters.
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Further, as discussed in the Proposal, the Commission is of the
view that swaps entered into in connection with non-synthetic lending
arrangements that are commonly known in the market as ``loans'' would
generally not need to be counted towards an IDI's de minimis
calculation if the other requirements of the IDI De Minimis Provision
are also met.\75\ As noted, the Commission's regulations in part 75
(regarding ``Proprietary Trading and Certain Interests in and
Relationships with Covered Funds'') define a loan as any loan, lease,
extension of credit, or secured or unsecured receivable that is not a
security or derivative,\76\ and the Commission is of the view that this
definition would also apply for purposes of the IDI De Minimis
Provision.\77\ Generally, allowing swaps entered into in connection
with other forms of financing commonly known as loans not to be counted
towards the de minimis threshold calculation better reflects the
breadth of lending products and credit financings that borrowers often
utilize and thereby advances the policy objectives of the de minimis
exception noted above.\78\
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\75\ See 83 FR at 27461-62.
\76\ 17 CFR 75.2(s).
\77\ See 83 FR at 27461-62. As stated in the Proposal, the
Commission recognizes the common law definition of the term ``loan''
cited in the SD Definition Adopting Release, and the Commission does
not at this time assess any individual category of transactions to
determine whether they qualify as loans. See id. at 27461.
\78\ See id.
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The Commission addresses the comments regarding the specific
requirements of the IDI De Minimis Provision below.
2. Timing of Execution of Swap
The Commission is adopting as proposed new paragraph (4)(i)(C)(1)
of the De Minimis Exception. Paragraph (4)(i)(C)(1) provides that a
swap must be entered into no earlier than 90 days before execution of
the loan agreement, or before transfer of principal to the customer,
unless an executed commitment or forward agreement for the applicable
loan exists. In that event, the 90-day restriction does not apply.
The IDI Swap Dealing Exclusion in paragraph (5) of the SD
Definition requires that a swap must be entered into no more than 90
days before or 180 days after the date of execution of the loan
agreement (or date of transfer of principal to the customer).\79\ The
IDI De Minimis Provision does not include the 180-day restriction.
Therefore, an IDI would not have to count towards its de minimis
calculation any swap entered into in connection with a loan after the
date of execution of the loan agreement (or date of transfer of
principal).
---------------------------------------------------------------------------
\79\ 17 CFR 1.3, Swap dealer, paragraph (5)(i)(A).
---------------------------------------------------------------------------
As discussed in the Proposal, the timing restrictions in the IDI
Swap Dealing Exclusion limit the ability of IDIs that want to remain
below the AGNA threshold from providing fairly common hedging solutions
to end-user borrowers. Depending on market conditions or business
needs, it is not uncommon for a borrower to wait for a period of time
greater than 180 days after a loan is originated to enter into a
hedging transaction. Given that many of the entities that the
Commission expects to utilize the IDI De Minimis Provision are small
and mid-sized banks, not including this timing restriction could lead
to increased swap availability for the borrowing customers that rely on
such IDIs for access to swaps (and thereby advance a policy objective
of the de minimis exception).\80\ Additionally, as noted by Capital
One, efforts to comply with the IDI Swap Dealing Exclusion have
resulted in end-users entering into swaps on an unfavorable date to
their business, or incurring higher costs or the additional
administrative burden of entering into swaps with counterparties other
than the lender bank.\81\ Further, Citizens stated that the proposed
timing provision would lead to increased swap capacity for customers,
adding that customers do not always enter into swaps to hedge loan-
related risks at the inception of a loan, but may instead hedge all or
portions of the loan at strategic intervals during the term of the
loans.\82\
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\80\ See 83 FR at 27460. See generally Citizens, Frost Bank,
M&T, and Regions comment letters.
\81\ See Capital One comment letter.
\82\ See Citizens comment letter.
---------------------------------------------------------------------------
M&T supported the requirement that the swap be entered into 90 days
before loan funding, unless an executed commitment or forward agreement
for the loan exists. M&T noted that the provision in proposed paragraph
(4)(i)(C)(1) referencing ``executed commitment'' or ``forward
agreement'' sufficiently reflects market practice regarding how swaps
may be entered into in connection with a loan in advance of the loan
being executed.\83\ On the other hand, three commenters recommended
removing the 90-day restriction because it would be detrimental to the
IDIs and/or borrowers.\84\ BDA noted that it is not uncommon for a
borrower to enter into a swap more than 90 days before entering in a
loan to lock-in interest rates in anticipation of refinancing current
loans, and stated many banks have policies prohibiting them from
providing forward underwriting or commitments longer than 90 days,
which would effectively restrict their ability to utilize that aspect
of the exception.\85\ CDEU stated that the restriction would constrain
an IDI's ability to provide cost-effective pricing for loan-related
swaps, especially for complex, longer-term financing transactions where
funding might take longer than 90 days and be memorialized in an
unexecuted term sheet.\86\ ISDA/SIFMA stated that the 90-day
requirement is an arbitrary limitation, and that such arbitrary
limitations could force small financial
[[Page 12457]]
institutions to incur the costs of becoming an SD.\87\
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\83\ See M&T comment letter.
\84\ See BDA, CDEU, and ISDA/SFIMA comment letters.
\85\ See BDA comment letter.
\86\ See CDEU comment letter.
\87\ See ISDA/SIFMA comment letter.
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The Commission is declining to remove the 90-day restriction for
purposes of the IDI De Minimis Provision because the Commission
believes that there should be a reasonable expectation that the loan
will be entered into with a customer in order to exclude the related
swap from the de minimis calculation. Without some prescribed time
limit, firms could exclude swaps with only the most tenuous connection
to a potential future loan origination. The Commission believes the
proposed 90-day restriction is suitable for the IDI De Minimis
Provision because it conditions availability of the exception on
whether the swap was entered into within an appropriate period of time
prior to the execution of the loan.
Additionally, the Commission notes that the 90-day restriction does
not apply if an executed commitment or forward agreement exists. Where
an executed commitment or forward agreement to loan money exists
between the IDI and the borrower prior to the 90-day limit, the
Commission believes a reasonable expectation for the loan is
demonstrated and the related swap may properly be excluded from the
AGNA threshold. With an executed commitment or forward agreement, the
parties have committed in a formal agreement that they intend to enter
into a loan. If no documentation is required, the Commission would have
no way of evaluating and enforcing the pre-loan timing requirement.
Allowing swaps entered into more than 90 days before execution of a
loan agreement to not count towards the AGNA threshold, when an
executed commitment or forward agreement exists, offers substantial
flexibility to IDIs and borrowers.
Capital One and Frost Bank suggested revisions to the ``executed
commitment'' or ``forward agreement'' exception to the 90-day
restriction.\88\ Capital One stated that the Commission should clarify
that the IDI De Minimis Provision applies in situations where the
counterparties have also agreed to and documented all of the material
loan terms (e.g., through an agreed-upon term sheet). Capital One
explained that the inclusion of ``agreed terms'' within the exception
would more accurately reflect market practice and address concerns
about ensuring that there is written evidence linking the swap and the
loan, ``without creating restrictive, defined documentation categories
of `executed commitments' or `forward agreements.' '' \89\ Frost Bank
recommended that the exception be interpreted in a manner analogous to
a ``bona fide loan commitment'' discussed in CFTC Staff Letter No. 12-
17, specifically stating that the 90-day restriction should not apply
to an executed commitment or forward agreement for a loan that is (1)
in writing, (2) subject to the satisfaction of commercially reasonable
conditions to closing or funding, and (3) was entered into for business
purposes unrelated to qualification for the IDI De Minimis
Provision.\90\
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\88\ See Capital One and Frost Bank comment letters.
\89\ See Capital One comment letter.
\90\ See Frost Bank comment letter; CFTC Staff Letter No. 12-17,
Staff Interpretations and No-Action Relief Regarding ECP Status:
Swap Guarantee Arrangements; Jointly and Severally Liable
Counterparties; Amounts Invested on a Discretionary Basis; and
``Anticipatory ECPs'' (Oct. 12, 2012), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/12-17.pdf.
---------------------------------------------------------------------------
The Commission is declining to revise the ``executed commitment or
forward agreement'' exception to the 90-day restriction.\91\ The
Commission believes that a ``term sheet'' implies that the
counterparties still retain flexibility to adjust the contractual terms
of the transaction prior to execution or walk away from the loan
altogether without any legal implications. A term sheet often simply
indicates an interest in engaging in a transaction and establishes the
general terms, but does not formalize an actual transaction, the terms
of which may be enforced in a court of law. On the other hand, the
Commission notes that an ``executed commitment or forward agreement''
is stronger evidence that a forward-settled legally binding contract
has been established, and is therefore more indicative of a reasonable
expectation that the loan will be entered into. Further, the Commission
notes that CFTC Staff Letter No. 12-17 is not an appropriate precedent
for the IDI De Minimis Provision, because it provides interpretations
and no-action relief in connection with eligible contract participant
status, and is different in purpose and meaning from the IDI De Minimis
Provision. Additionally, the Commission believes that the bona fide
loan commitment language in CFTC Staff Letter No. 12-17 is more
indicative of a term sheet, rather than an executed commitment or
forward agreement.
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\91\ For avoidance of doubt, the Commission notes that the word
``executed'' applies to both the term ``commitment'' and the term
``forward agreement,'' such that either agreement must be executed
to comply with the requirement. Accordingly, the Commission notes
that an executed commitment or forward agreement that is not legally
binding would not meet the requirements of this aspect of the IDI De
Minimis Provision.
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3. Relationship of Swap to Loan
As proposed, paragraph (4)(i)(C)(2) states that for purposes of the
IDI De Minimis Provision, a swap is ``in connection with'' a loan if:
(1) The rate, asset, liability or other term underlying such swap is,
or is related to, a financial term of such loan; or (2) if such swap is
required as a condition of the loan, either under the IDI's loan
underwriting criteria or as is commercially appropriate, in order to
hedge risks incidental to the borrower's business (other than for risks
associated with an excluded commodity) that may affect the borrower's
ability to repay the loan. As discussed below, the Commission is
adopting new paragraph (4)(i)(C)(2) of the De Minimis Exception, with
one modification. The Commission is revising paragraph (4)(i)(C)(2)(ii)
from what was proposed to read, such swap is permissible under the
IDI's loan underwriting criteria and is commercially appropriate in
order to hedge risks incidental to the borrower's business.
As explained in the SD Definition Adopting Release, the first
category of swaps in paragraph (4)(i)(C)(2) is for adjusting the
borrower's exposure to certain risks directly related to the loan
itself, such as risks arising from changes in interest rates or
currency exchange rates, and the second category is to mitigate risks
faced by both the borrower and the lender, by reducing risks that the
loan will not be repaid.\92\ Therefore, both categories of swaps are
directly related to repayment of the loan.
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\92\ SD Definition Adopting Release, 77 FR at 30622.
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This provision of the IDI De Minimis Provision would further the
policy objectives of the de minimis exception by providing flexibility
to reflect the common market practices of end-users who hedge risk with
loan-related swaps.\93\ Specifically, the first provision refers to a
``term'' rather than a ``notional item,'' and does not include the word
``directly.'' Additionally, because the second provision in paragraph
(4)(i)(C)(2) allows for swaps that are not explicitly required as a
[[Page 12458]]
condition of the IDI's underwriting criteria, it provides flexibility
for IDIs to enter into certain swaps with borrowers to hedge risks that
are determined based on the unique characteristics of the borrower, or
other factors that may not have been readily evident at the time the
loan was executed and funded, rather than being based on the standard
bank underwriting criteria. For example, in these cases, the
underwriting criteria may not explicitly require that the borrower
enter into swaps to hedge commodity price risk. This additional
flexibility facilitates the transaction as a whole (i.e., the loan and
related swaps) by allowing IDIs to enter into swaps, as commercially
appropriate, with borrowers to hedge risks (e.g., commodity price risk)
that may affect the borrower's ability to repay the loan without the
limitation that such swaps must be contemplated in the original
underwriting criteria in order not to be counted towards an IDI's de
minimis calculation.
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\93\ The IDI Swap Dealing Exclusion requires that (1) the rate,
asset, liability, or other notional item underlying such swap is, or
is directly related to, a financial term of such loan, or (2) that
such swap is required, as a condition of the loan under the IDI's
loan underwriting criteria, to be in place in order to hedge price
risks incidental to the borrower's business and arising from
potential changes in the price of a commodity (other than an
excluded commodity). See 17 CFR 1.3, Swap dealer, paragraph
(5)(i)(B); 77 FR at 30622.
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Though risk-mitigating hedges are beneficial because they may lower
credit risk and may lower the probability of default, the Commission
recognizes that they may increase an IDI's counterparty exposure if a
default does occur, particularly if the IDI enters into
uncollateralized loan-related swaps with its customers. Nonetheless,
the Commission believes that this language benefits both IDIs and
customers and serves the purposes of the de minimis exception by
allowing for greater use of swaps in effective and dynamic hedging
strategies. The Commission also believes that this aspect of the new
provision would facilitate efficient application of the SD Definition
by reducing the concern that ancillary swap dealing activity may
inadvertently subject the IDI to SD registration-related requirements.
Additionally, the Commission is of the view that prudential regulatory
oversight of an IDI's derivatives activities mitigates the concerns
associated with an IDI's increased counterparty exposure in the event
of a default.\94\ However, if a borrower enters into a swap with an IDI
for speculative or investment purposes, paragraph (4)(i)(C)(2) would
not allow the IDI to exclude such swap from its de minimis threshold
calculation.
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\94\ For example, IDIs are subject to risk management
requirements related to exposures and risks in their swaps books.
See, e.g., The Office of the Comptroller of the Currency,
Comptroller's Handbook: Risk Management of Financial Derivatives
(Jan. 1997-Feb. 1998) (still applicable as of Jan. 17, 2012).
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In response to comments, with respect to swaps addressed by
paragraph (4)(i)(C)(2)(ii)--i.e., loan repayment risk-related swaps--
the Commission is clarifying that such swaps must be permissible under
the IDI's loan underwriting criteria and be commercially appropriate.
This would replace the proposed requirement that such swaps be required
as a condition of the loan, either under the IDI's loan underwriting
criteria or as is commercially appropriate. Regions stated that the
``condition of the loan'' requirement would significantly reduce the
likelihood that the swap would qualify for the exception, which could
reduce the willingness of IDIs to offer loan-related swaps or encourage
IDIs to impose covenants on borrowers solely to allow swaps to fall
within the exception.\95\ Additionally, ABA noted that borrowers may be
reluctant to agree to include loan covenants on hedging as they seek to
maintain flexibility to manage their hedging strategies over the term
of a loan or borrowing relationship, adding that covenants relating to
hedging may include flexibility that make satisfaction of the
``condition'' requirement difficult to determine. ABA also stated that
if a risk is identified after closing, the loan would have to be
amended at such later time to incorporate a condition, which is likely
to reduce the use of the exception as borrowers seek to avoid
restrictive covenants or additional transaction costs or because it may
not be feasible to amend syndicated loan agreements involving multiple
lenders not involved in the swap.\96\
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\95\ See Regions comment letter.
\96\ See ABA comment letter. ABA also suggested that as an
alternative to removing the ``condition of the loan'' requirement,
the Commission could clarify that loan covenants that provide for a
minimum amount, maximum amount, or permitted range of hedging would
satisfy the ``condition'' requirement. The Commission believes that
the change being adopted addresses the concern and is not
considering the alternative.
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The Commission agrees with the concerns stated by the commenters.
The Commission did not intend for the ``condition of the loan''
language to require amending loan documents or lead to covenants being
imposed solely for allowing swaps to qualify for the exception.
Additionally, the restriction that the swaps hedge risks incidental to
the borrower's business (other than for risks associated with an
excluded commodity) that may affect the borrower's ability to repay the
loan provides a limit to the scope of this exception. The Commission
also stresses that the requirement that the swaps be in connection with
originating a loan places further restrictions on the ability of IDIs
to engage in swap dealing activity not related to loans to customers.
As stated above, if a borrower enters into a swap with an IDI for
speculative or investment purposes, the IDI would not be able to
exclude such swap from its de minimis threshold calculation.
ABA stated that the Commission should clarify that a hedge of an
asset supporting an asset-based or reserve-based loan would be
considered ``related to'' a ``financial term of such loan.'' \97\ The
Commission believes that a swap that hedges risks related to the
underlying collateral of a loan (such as physical assets or reserves),
can be related to ``a financial term of such loan'' under appropriate
certain facts and circumstances.\98\ The Commission also notes that the
adopted rule includes the language ``without limitation'' when
providing examples of financial terms, and therefore does not believe
the term ``borrowing base'' needs to be added to the regulatory text.
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\97\ See id.
\98\ For example, if loan proceeds are used to purchase specific
assets used as collateral for the loan, then risks associated with
those assets are sufficiently related to the loan. However, a loan
for general working capital that is not secured by any assets would
likely not be related to any assets of a borrower that could render
the borrower's assets a term of the loan for this provision.
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JBA asked that the CFTC confirm that currency swaps would qualify
for the exception.\99\ The Commission confirms that currency swaps
would qualify for the IDI De Minimis Provision, if they meet each of
the requirements of the exception.
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\99\ See JBA comment letter.
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4. Duration of Swap
The Commission is adopting as proposed new paragraph (4)(i)(C)(3)
of the De Minimis Exception, which states that the termination date of
the swap cannot extend beyond termination of the loan.
A few commenters stated that circumstances can be anticipated at
the time of loan origination that would support permitting the
termination date of the swap to extend beyond termination of the
loan.\100\ For example, loan customers may hedge risks for longer
periods with the expectation that they will continue to have debt
outstanding with the IDI, often because customers may have a practice
of refinancing every three to five years, or have outstanding loans
that amortize over a period longer than a specific loan's stated
term.\101\ Additionally, customers may request that the swap extend to
an anticipated loan maturity
[[Page 12459]]
date that extends beyond the stated maturity date--for example, as with
certain construction loans, bridge loans, credit lines, revolving
credits, variable rate demand bonds, and bank-qualified and nonbank-
qualified bonds with call dates set prior to the bonds' maturity
date.\102\ Further, borrowers may seek to hedge maturities longer than
the loan maturity to hedge inherent risks of long-dated projects, even
though the loan financing may have a shorter term than the length of
the project, because borrowers often seek to hedge the full life of the
project even when committed bank financing for equivalent length does
not exist. In such circumstances, IDIs often provide such swaps because
of acceleration or transfer provisions that are included in the hedge
arrangement to address a scenario in which the IDI does not renew or
participate in the refinancing.\103\
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\100\ See ABA, BDA, CDEU, Citizens, and M&T comment letters.
\101\ See ABA, CDEU, and Citizens comment letters.
\102\ See M&T comment letter.
\103\ See BDA comment letter.
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The Commission is declining to modify the proposed rule text to
account for the circumstances described by these commenters. The
Commission does not believe that a swap with a maturity date that is
after the maturity date of the loan should be considered ``in
connection with'' the loan. Including that much flexibility would
create a greater likelihood of abuse of the regulation, and would
increase the difficulty of policing the application of the IDI De
Minimis Provision. In addition, the Commission is of the view that the
addition of more complicated timing structures for a swap in relation
to a loan increases complexity and may potentially increase risk. In
other words, the swap becomes less connected with the origination of
the loan. Accordingly, it would be appropriate to expect the IDI to
register as an SD to the extent that the IDI is entering into such swap
arrangements in high volumes.
Additionally, in response to a question in the Proposal, a few
commenters stated that in order to qualify for the IDI De Minimis
Provision, IDIs should not be required to terminate loan-related swaps
if a loan is called, put, accelerated, or goes into default before
scheduled termination.\104\ Commenters noted that: (1) Swap agreements
between IDIs and end-user borrowers do not always include automatic
termination provisions that trigger when a related loan is terminated;
\105\ (2) IDIs should be able to use methods they deem most appropriate
for managing credit risk without being required to terminate a swap
transaction because a loan is no longer outstanding; \106\ and (3) a
mandatory cancellation provision would create significant
administrative burden, and would potentially trigger cross-defaults,
which is contrary to efforts to reduce the contagion of cross-defaults
on derivatives contracts.\107\ Commenters also pointed out that: (1)
IDIs should have the option to terminate a loan-related swap, but
should not be required to do so, as provided in standard ISDA Master
Agreements, thus preserving the IDI's ability to address a troubled
credit in the most efficient manner, particularly for a loan default
that may be waived; \108\ and (2) it is common for a swap to be
terminated by mutual agreement when a loan is repaid, but firms do not
always have termination event provisions in their ISDA Master
Agreements that would allow them to enforce this termination.\109\
Further, IIB noted that the Commission previously clarified that a swap
may continue to qualify for the IDI Swap Dealing Exclusion in paragraph
(5) of the SD Definition even if an IDI later transfers or terminates
the loan in connection with which the swap was entered into, so long as
the swap otherwise qualifies for the exception and the loan was
originated in good faith and not a sham.\110\ IIB also stated that
following a transfer of a loan, an IDI will often amend, novate, or
partially terminate the related swap to conform to changes in the terms
of the loan, and requested clarification that the swap resulting from
any such amendment, novation, or termination may also qualify for the
IDI De Minimis Provision and IDI Swap Dealing Exclusion. M&T noted that
when the underlying credit financing that is hedged with the interest
rate swap is terminated, it is common practice that such event triggers
the termination of the swap.\111\
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\104\ See ABA, BDA, Capital One, CDEU, IIB, and ISDA/SIFMA
comment letters.
\105\ See CDEU comment letter.
\106\ See BDA comment letter.
\107\ See Capital One comment letter.
\108\ See ABA comment letter.
\109\ See ISDA/SIFMA comment letter.
\110\ See IIB comment letter (citing the SD Definition Adopting
Release, 77 FR at 30623).
\111\ See M&T comment letter.
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After consideration of the comments, the Commission notes that the
IDI De Minimis Provision is tied to the origination of a loan.
Therefore, the eligibility of a swap to qualify for the IDI De Minimis
Provision should not be affected if the loan is called, put,
accelerated, or goes into default before scheduled termination. In
these circumstances, the swap would not need to be amended, adjusted,
accelerated, or terminated to remain eligible for exclusion so long as
the swap otherwise qualifies for the exception and the loan was
originated in good faith and is not a sham. Further, if an IDI, in a
manner directly related to changes in the terms of the loan, chooses to
amend, novate, or partially terminate the loan-related swap, such
amendment, novation, or termination might also qualify for the IDI De
Minimis Provision.\112\
---------------------------------------------------------------------------
\112\ Whether such an amendment, novation, or termination would
qualify for the IDI Swap Dealing Exclusion is outside of the scope
of this rulemaking.
---------------------------------------------------------------------------
5. Level of Funding of Loan
The Commission is adopting as proposed new paragraph
(4)(i)(C)(4)(i) of the De Minimis Exception, which requires an IDI to
be, under the terms of the agreements related to the loan, the source
of at least five percent of the maximum principal amount under the loan
for a related swap not to be counted towards its de minimis
calculation.\113\ The Commission is also adopting as proposed new
paragraph (4)(i)(C)(4)(ii), which states that if an IDI is a source of
less than a five percent of the maximum principal amount of the loan,
the notional amount of all swaps the IDI enters into in connection with
the financial terms of the loan cannot exceed the principal amount of
the IDI's loan in order to qualify for the IDI De Minimis Provision.
---------------------------------------------------------------------------
\113\ Moreover, as discussed below in section II.B.6.i, if the
IDI is responsible for at least five percent of a syndicated loan,
the IDI De Minimis Provision does not include a restriction that the
AGNA of swaps entered into in connection with the loan not exceed
the principal amount outstanding.
---------------------------------------------------------------------------
As discussed in the Proposal, the lower syndication threshold of
five percent provides flexibility for IDIs, particularly small and mid-
sized IDIs participating in large syndications, to enter into a greater
range of loan-related swaps without having those swaps count towards
their de minimis calculations. As the Commission noted, for loans that
are widely syndicated, lenders may not have control over their final
share of the syndication. It is not uncommon for borrowers to enter
into negotiations regarding related swaps before the underlying loan
has been executed and the allocation of loan and swap percentages to
the syndicate participants has been set.
Capital One supported the proposal to set the syndicated loan
requirement at five percent because it acknowledges that lenders in
many loan syndications do not have control over their final share of
the syndication, and that industry practice on some participations
often does fall below 10 percent (and can in some cases fall below five
[[Page 12460]]
percent).\114\ Additionally, M&T noted that it is not common for an IDI
to have as low as five percent participation in a syndicated loan and
also provide swaps in connection with the loan; rather, administrative
agent and lenders holding larger shares in the credit facility tend to
also be the swap providers.\115\
---------------------------------------------------------------------------
\114\ See Capital One comment letter.
\115\ See M&T comment letter.
---------------------------------------------------------------------------
A few commenters stated that the five percent participation
requirement should be eliminated from the IDI De Minimis
Provision.\116\ Three of these commenters stated that the five percent
participation threshold is arbitrary \117\ and could: (1) Force small
financial institutions to incur the costs of becoming an SD; \118\ (2)
lead to less liquidity for borrowers since IDIs may not control their
level of participation in a syndicated loan, whereas a borrower may
want a certain smaller group of lenders for the hedging component, for
relationship or pricing reasons; \119\ or (3) create incentives for an
agent bank to limit the offering amount of a loan syndication in small
shares in order to secure a larger portion of the hedging for
itself.\120\ ABA also stated that the requirement has no supporting
policy rationale, nor has one been asserted by the Commission.\121\
Citizens stated that the requirement should be removed because there
are instances where the total notional amount of loan-related swaps may
exceed the outstanding principal amount in connection with syndicated
loans, regardless of whether the bank holds more than five percent of
the loan.\122\
---------------------------------------------------------------------------
\116\ See ABA, BDA, Citizens, and ISDA/SIFMA comment letters.
\117\ See ABA, BDA, and ISDA/SIFMA comment letters.
\118\ See ISDA/SIFMA comment letter.
\119\ See BDA comment letter.
\120\ See id.
\121\ See ABA comment letter.
\122\ See Citizens comment letter.
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After consideration of the comments, the Commission is retaining
the requirement that the IDI be the source of at least five percent of
the maximum principal amount under the loan in order for a related swap
not to be counted towards its de minimis calculation. The Commission is
of the view that removing the minimum participation amount requirement
would allow IDIs with an immaterial ``connection'' to a loan (such as
$0.01) to provide all of the loan hedging swaps without having to count
such swaps towards their AGNA threshold. Requiring a minimum level of
loan participation provides a bright-line test so that IDIs may prove a
``connection'' to a loan origination.
The Commission also notes that IDI De Minimis Provision does not
include a requirement that the AGNA of all swaps entered into by the
customer in connection with the financial terms of the loan cannot
exceed the aggregate principal amount outstanding under the loan.\123\
As long as an IDI is the source of at least five percent of the loan,
an IDI may enter into a notional amount of swaps in excess of the
aggregate principal amount of the loan without counting the swaps
towards the IDI's de minimis calculation. The Commission believes the
final rule provides additional flexibility to IDIs to serve the hedging
needs of their loan customers while appropriately requiring that a swap
can only be excluded from the AGNA threshold if it is in connection
with originating a loan.
---------------------------------------------------------------------------
\123\ See infra section II.B.6.i.
---------------------------------------------------------------------------
6. Other Comments
(i) Total Notional Amount of Swaps
The IDI De Minimis Provision does not include the requirement from
the IDI Swap Dealing Exclusion that the AGNA of swaps entered into in
connection with the loan not exceed the principal amount
outstanding.\124\ As noted in the Proposal, it is not uncommon for a
loan by an IDI to a customer to have related swaps that hedge multiple
categories of exposure. For example, a borrower may hedge some
combination of interest rate, foreign exchange, and/or commodity risk
in connection with a loan. The AGNA of those swaps may exceed the loan
principal amount. Therefore, this restriction might unduly restrict the
ability of certain IDIs to provide loan-related swaps to their
borrowing customers to more effectively allow the customers to hedge
loan-related risks. Not including this restriction in the IDI De
Minimis Provision would thereby advance the policy objectives of the de
minimis exception noted above.
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\124\ 17 CFR 1.3, Swap dealer, paragraph (5)(i)(E). As discussed
above in section II.B.5 in connection with new paragraph
(4)(i)(C)(4)(ii), if an IDI is a source of less than a five percent
of the maximum principal amount of the loan, the notional amount of
all swaps the IDI enters into in connection with the financial terms
of the loan cannot exceed the principal amount of the IDI's loan.
---------------------------------------------------------------------------
Capital One and M&T agreed that there are circumstances where the
AGNA of loan-related swaps can exceed the outstanding principal amount
of the loan.\125\ M&T stated that in construction lending, the project
may not have advanced sufficiently such that the loan was fully funded,
yet the loan would already have been hedged with a forward starting or
accreting interest rate swap with a notional amount that anticipated
the future and higher loan balance.\126\ Capital One stated that a
customer may enter into a forward starting swap to hedge future draws
under a loan.\127\
---------------------------------------------------------------------------
\125\ See Capital One and M&T comment letters.
\126\ See M&T comment letter.
\127\ See Capital One comment letter.
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Accordingly, after consideration of the comments, the Commission is
not including a requirement that the AGNA of loan-related swaps entered
into in connection with the origination of the loan remain below a
certain level. Though there are no caps on the AGNA of swaps, the swaps
must be entered into in connection with originating a loan, and IDIs
cannot use the IDI De Minimis Provision to provide swaps to loan
customers for the loan customers' speculative or investment purposes or
to otherwise evade SD registration.
However, the Commission believes it is prudent to consider whether
the IDI De Minimis Provision should include such a requirement. For
example, the IDI De Minimis Provision could require the loan-related
swaps to not exceed 300% of the principal outstanding. Therefore,
although the Commission is not at this time adopting a restriction on
the AGNA of loan-related swaps outstanding, it is instructing the
Office of the Chief Economist (``OCE'') to conduct a study, within
three years, of whether loan-related swaps should be required to remain
below a certain level to qualify for the IDI De Minimis Provision.
After review of relevant data, the results of the OCE study, and any
related recommendations from OCE or DSIO, the Commission may consider
adding a restriction on the AGNA of loan-related swaps.
(ii) Eligibility for IDI De Minimis Provision
Two commenters stated that foreign banks should be eligible for the
IDI De Minimis Provision.\128\ IIB recommended that the IDI De Minimis
Provision cover U.S. branches and agencies of foreign banks because
excluding these entities would unnecessarily discourage foreign banks'
participation in the U.S. swap and loan markets, reducing credit
available to U.S. companies.\129\ JBA noted that the IDI De Minimis
Provision should apply to non-U.S. IDIs, particularly Japanese banks,
because such banks engage in risk management practices, under the
supervision of the Deposit Insurance Corporation of Japan, that are
equivalent to U.S. IDIs' risk
[[Page 12461]]
management practices.\130\ The Commission notes that these comments are
outside of the scope of the proposed and adopted amendments because
they relate to the definition and application of the term ``IDI,''
which the Commission did not propose to alter.
---------------------------------------------------------------------------
\128\ See IIB and JBA comment letters.
\129\ See IIB comment letter.
\130\ See JBA comment letter.
---------------------------------------------------------------------------
JBA stated that swaps in connection with loans by other banks to
U.S. customers, and swaps entered into by a third party on behalf of a
financial institution and allocated to the financial institution,
should be eligible for the IDI De Minimis Provision because such swaps
are arranged for the customer's hedging purposes.\131\ BDA stated that
where an affiliate of an IDI also falls under prudential regulation a
subsidiary of a bank holding company, or otherwise, the affiliate
should be allowed to take advantage of the IDI exclusion. For example,
certain entities may be organized where the loan is provided by the
IDI, but swaps are offered by the affiliate. BDA stated that these
swaps are still subject to regulatory oversight because of the
ownership structure of the affiliate or because the IDI accounts for
the swap in its financial and risk reporting.\132\ The Commission notes
that these comments are outside of the scope of the proposed and
adopted amendments.
---------------------------------------------------------------------------
\131\ See id.
\132\ See BDA comment letter.
---------------------------------------------------------------------------
Citizens stated that the Commission should include more efficient
procedures for determining whether certain swaps would be eligible for
the IDI De Minimis Provision or the IDI Swap Dealing Exclusion, noting
that the little guidance that exists with respect to whether
transactions qualify does not provide the certainty that market
participants need in order to run their businesses efficiently.\133\
The Commission is not establishing such procedures at this time. The
Commission believes that the Proposal and this adopting release, as
well as the SD Definition Proposing Release and SD Definition Adopting
Release, provide sufficient information regarding the requirements for
a swap to qualify for the IDI De Minimis Provision or the IDI Swap
Dealing Exclusion. In addition, the Commission notes that, as with all
of its regulations, the Commission remains open to providing guidance
to market participants who have questions of interpretation.
---------------------------------------------------------------------------
\133\ See Citizens comment letter.
---------------------------------------------------------------------------
(iii) Notification or Confirmation Requirements
In response to a question in the Proposal, three commenters stated
that the CFTC should not impose any prior notice requirement or other
conditions on the ability of IDIs to rely on the proposed IDI De
Minimis Provision.\134\ ABA and Capital One stated that there is no
benefit to requiring a bank to provide such notice to the Commission or
another party, particularly because the Commission already receives
reports of swaps transacted pursuant to parts 43 and 45 of the
Commission's regulations.\135\ M&T stated that imposing any notice
requirements for use of the IDI De Minimis Provision would be contrary
to the intention of the IDI De Minimis Provision to allow limited
ancillary dealing to clients that have a need for swaps (on a limited
basis), and to promote competition by allowing a person to engage in
limited swap dealing activity without immediately incurring the
regulatory costs associated with SD registration.\136\ The Commission
agrees with the commenters and is not adding a notification requirement
at this time.
---------------------------------------------------------------------------
\134\ See ABA, Capital One, and M&T comment letters.
\135\ See ABA and Capital One comment letters.
\136\ See M&T comment letter.
---------------------------------------------------------------------------
In response to another question in the Proposal, three commenters
stated that there should not be a requirement that swap confirmations
reference a specific loan because doing so would add operational
complexity for little or no benefit.\137\ BDA and Capital One stated
that instead, the Commission could require the IDI to notate the loan
internally.\138\ ABA stated that the banks should be permitted to
document this information in an efficient and effective manner rather
than requiring that it be included in legal documentation with a
customer.\139\ The Commission agrees with the commenters and is not
adding a requirement to reference a particular loan in the swap
confirmation for the reasons stated by the commenters. However, the
Commission notes that, as with any regulatory requirement, it would be
good practice for an IDI to notate and track all loans for which the
IDI De Minimis Provision applies to be able to demonstrate why the IDI
is not required to register if its AGNA of swap dealing activity
exceeds the threshold.
---------------------------------------------------------------------------
\137\ See ABA, BDA, and Capital One comment letters.
\138\ See BDA and Capital One comment letters.
\139\ See ABA comment letter.
---------------------------------------------------------------------------
7. Commission Authority To Amend the De Minimis Exception
Two commenters discussed whether the IDI De Minimis Provision could
be promulgated without a joint rulemaking.\140\ ABA stated that the
Commission is not required to promulgate the IDI De Minimis Provision
through joint rulemaking with the SEC because ``it is in furtherance of
the Commission's statutory authority to `promulgate regulations to
establish factors with respect to the making of this determination to
exempt' from `designation as a swap dealer an entity that engages in a
de minimis quantity of swap dealing in connection with transactions
with and on behalf of its customers.' '' \141\
---------------------------------------------------------------------------
\140\ See ABA and Better Markets comment letter.
\141\ See ABA comment letter.
---------------------------------------------------------------------------
However, Better Markets asserted that the CFTC's claim that a
``joint rulemaking is not required with respect to changes to the de
minimis exception-related factors'' is invalid and ``would
impermissibly enable the CFTC to conduct an end-run around the
statutory joint rulemaking requirement.'' In particular, Better Markets
stated that language potentially permitting unilateral action on the de
minimis threshold itself cannot be extended to permit unilateral
regulatory actions affecting core definitional issues that must be
accomplished through joint rulemaking.\142\
---------------------------------------------------------------------------
\142\ See Better Markets comment letter.
---------------------------------------------------------------------------
The Commission continues to believe that, as stated in the Proposal
that a joint rulemaking with the SEC is not required with respect to
the de minimis exception-related factors.\143\ As stated in the SD
Definition Adopting Release that was jointly adopted with the SEC--CEA
section 1a(49)(D) (like Exchange Act section 3(a)(71)(D)) particularly
states that the ``Commission'' (meaning the CFTC) may exempt de minimis
dealers and promulgate related regulations. We (the CFTC and the SEC)
do not interpret the joint rulemaking provisions of section 712(d) of
the Dodd-Frank Act to require joint rulemaking here, because such an
interpretation would read the term ``Commission'' out of CEA section
1a(49)(D) (and Exchange Act section 3(a)(71)(D)), which themselves were
added by the Dodd-Frank Act.\144\
---------------------------------------------------------------------------
\143\ 83 FR at 27458.
\144\ 77 FR at 30634 n.464.
---------------------------------------------------------------------------
Accordingly, the Commission believes that although the definition
of ``swap dealer'' requires joint action, the statute allows for the
CFTC and SEC to individually determine the threshold and factors that
exempt de minimis SDs and security-based swap dealers pursuant to
section 1a(49)(D) of the CEA and section 3(a)(71)(D) of the Securities
Exchange Act of 1934, respectively.\145\
---------------------------------------------------------------------------
\145\ As discussed, the CFTC has consulted with the SEC
regarding the IDI De Minimis Provision.
---------------------------------------------------------------------------
Better Markets also argued that the Proposal ``far exceeds the
CFTC's stated
[[Page 12462]]
objective of addressing the `quantity' of swap dealing permissible
within the de minimis exemption'' and ``effect[s] these extensive
changes through sleight of hand--a series of exclusions from the de
minimis threshold for swap-related activities that it acknowledges
constitute `dealing' under its own regulations.'' \146\
---------------------------------------------------------------------------
\146\ See Better Markets comment letter. Similarly, IATP
believes that the statutory de minimis provision ``authorizes a
quantitatively defined rule for who must register'' as an SD, but
the NPRM ``proposes to interpret the establishment of `factors' in
such a way as to greatly increase the number and kind of swaps
dealer transactions and activities that would be exempted from the
de minimis calculation.'' See IATP comment letter.
---------------------------------------------------------------------------
The Commission believes that Better Markets' claim that it is
``sleight of hand'' to use the de minimis threshold to exclude
activities that actually do constitute swap dealing is misplaced,
because the only purpose of the statutory de minimis provision is to
exempt an entity that ``engages in a de minimis quantity of swap
dealing.'' \147\ Accordingly, the SD Definition Adopting Release
explained that the De Minimis Exception applies only after a ``person
determines that it is engaged in swap dealing activity,'' stating that,
sequentially, ``the next step is to determine if the person is engaged
in more than a de minimis quantity of swap dealing.'' \148\ Thus, it is
entirely appropriate under the statute that the De Minimis Exception be
applied in a manner that excludes activity that constitutes swap
dealing.
---------------------------------------------------------------------------
\147\ See 7 U.S.C. 1a(49)(D); Better Markets comment letter.
\148\ SD Definition Adopting Release, 77 FR at 30607.
---------------------------------------------------------------------------
For this reason, the NPRM did not, and had no reason to, propose
amendments to the SD Definition.\149\ Contrary to Better Markets'
contention, there is no need ``to effect a de facto amendment to the SD
definition,'' and the Commission does not seek to do so. Nor does the
Commission seek to change the IDI Swap Dealing Exclusion or other
aspects of the SD Definition.\150\
---------------------------------------------------------------------------
\149\ For example, the NPRM stated that the Commission is not at
this time proposing to amend the IDI Swap Dealing Exclusion in
paragraph (5) of the SD Definition. 83 FR at 27458.
\150\ Id. at 27458-59.
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The Commission believes the SD Definition Adopting Release
recognized that a primary purpose of the statutory de minimis provision
is to allow limited swap dealing.\151\ For example, the SD Definition
Adopting Release explained that the CFTC and SEC believe that factors
that exclude entities whose dealing activity is sufficiently modest in
light of the total size, concentration and other attributes of the
applicable markets can be useful in avoiding the imposition of
regulatory burdens on those entities for which dealer regulation would
not be expected to contribute significantly to advancing the customer
protection, market efficiency and transparency objectives of dealer
regulation.\152\ Moreover, the SD Definition Adopting Release stated
that in connection with any future changes to the requirements of the
De Minimis Exception, the CFTC intends to pay particular attention to
whether alternative approaches would more effectively promote the
regulatory goals that may be associated with a de minimis
exception.\153\
---------------------------------------------------------------------------
\151\ Id. at 27446 (citing 77 FR at 30628-30, 30707-08).
\152\ 77 FR at 30629-30.
\153\ Id. at 30635.
---------------------------------------------------------------------------
This is what the NPRM proposed to do, notably with respect to the
dealing activity of IDI's engaged in swaps in connection with loans.
The issue relevant to the Proposal and the final rule is whether this
dealing activity is sufficiently modest in light of the total size,
concentration and other attributes of the applicable markets to qualify
for the De Minimis Exception, and whether an alternative approach would
more effectively promote the regulatory goals of the De Minimis
Exception.
Better Markets' and IATP's emphasis on the word ``quantity''
implies that the requirements for the De Minimis Exception should or
must be stated in terms of a numerical quantity of swap dealing. The
Commission does not believe that this is the case. Rather, the
Commission has applied the principles set out in the SD Definition
Adopting Release, which sought to balance the various interests
associated with a de minimis exception, as well as the benefits and
burdens associated with such an exception, in developing the factors to
implement the de minimis exceptions.\154\ Also, as noted above, the SD
Definition Adopting Release anticipated that alternative approaches to
the de minimis exception may be appropriate.
---------------------------------------------------------------------------
\154\ Id. at 30629.
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In the SD Definition Adopting Release, the Commissions considered
comments that supported the use of non-quantitative standards in
connection with the de minimis exception and the release stated that
the Commissions believe that it is more appropriate to base the
exception on an objective quantitative standard, to allow the exception
to be self-executing, and to promote predictability among market
participants and the efficient use of regulatory resources.\155\ Each
of the comments considered in this context had suggested a different,
non-quantitative approach to the de minimis standard, such as a multi-
factor test, or the application of reasoned judgment rather than
inflexible bright-line tests.\156\
---------------------------------------------------------------------------
\155\ Id. at 30632.
\156\ See the following comment letters cited in the SD
Definition Adopting Release, 77 FR at 30632 n.443, which are
available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=933: Federal Home Loan Banks (Feb. 22, 2011);
The Gavilon Group, LLC (Feb. 22, 2011); and MFX Solutions, Inc.
(June 3, 2011). See also the discussion of alternative approaches to
the de minimis exception in the SD Definition Adopting Release, 77
FR at 30627 n.389 and accompanying text.
---------------------------------------------------------------------------
The Commission continues to believe that the appropriate response
to such comments is that it is more appropriate to base the exception
on an objective quantitative standard, to allow the exception to be
self-executing and to promote predictability and efficiency. The IDI De
Minimis Provision provides objective standards that are self-executing
and could be applied predictably and efficiently. With respect to the
reference to a ``quantitative'' standard, the Commission notes that the
SD Definition Adopting Release was responding to a variety of suggested
approaches, and in that light, the word ``quantitative'' was intended
to focus the De Minimis Exception on objective standards stated in
terms of a number. However, the Commission also believes that the
statutory language directing the Commission to establish ``factors''
with respect to the de minimis exception does not mandate a single
approach, but rather the Commission may promulgate standards that take
into account the total size, concentration and other attributes of the
applicable markets as well as the various interests associated with a
de minimis exception.\157\ Within this statutory framework, the
Commission believes the preference for an ``objective quantitative
standard'' should be read in connection with the statement that the
excluded activity be ``sufficiently modest.'' \158\ In that vein, and
for the reasons given, the Commission is now adopting a limited
qualitative factor. The Commission does not believe the statute or the
SD Definition Adopting Release requires that all de minimis factors be
stated in numerical terms, so long as the impact on the regulatory
scheme for SDs established by the statute is sufficiently modest.\159\
---------------------------------------------------------------------------
\157\ See 77 FR at 30629-30.
\158\ See id.
\159\ See id.
---------------------------------------------------------------------------
Better Markets also asserted that the statutory provision regarding
the de minimis exception authorizes the CFTC
[[Page 12463]]
to issue exemptive orders for individual or similarly-situated legal
entities based upon generally applicable factors for determining
whether such entities may be involved in de minimis swap dealing
activities. Better Markets contends that it is unreasonable to conclude
that Congress intended a wholesale exemption from registration that is
divorced from the particular circumstances of any one petitioner.\160\
As noted, however, the CEA states that the Commission shall promulgate
factors, through regulation, regarding the De Minimis Exception
determination. Nothing in the statutory language prohibits the
Commission from establishing a de minimis exception that is self-
effectuating. The Commission believes that the IDI De Minimis Provision
appropriately excludes entities whose dealing activity is sufficiently
modest in light of the total size, concentration and other attributes
of the swap market and for which SD regulation would not be expected to
contribute significantly to advancing the customer protection, market
efficiency and transparency objectives of dealer regulation.\161\ The
Commission sees no basis in the record or requirement in the statute to
treat entities differently when they are similarly situated in this
respect.
---------------------------------------------------------------------------
\160\ See Better Markets comment letter.
\161\ 77 FR at 30629-30.
---------------------------------------------------------------------------
With this regulatory background in mind, the Commission concludes
that the IDI De Minimis Provision is an objective factor that should be
self-executing and promote predictability and efficiency. The swap
dealing activity that would be excluded under this provision, in the
aggregate with activity permitted under the $8 billion threshold, is
sufficiently modest in light of the total size, concentration and other
attributes of the applicable markets \162\ to be appropriately excluded
under the de minimis exception.
---------------------------------------------------------------------------
\162\ See id.
---------------------------------------------------------------------------
Lastly, the Commission notes that it consulted with the SEC and the
prudential regulators during the preparation of this adopting release.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities.\163\ As
noted in the Proposal, the regulations adopted herein affect IDIs that
engage in swap dealing activity above an AGNA of $8 billion that also
enter into loan-related swaps. That is, the regulations are relevant to
entities that engage in swap dealing activity with a relevant AGNA
measured in the billions of dollars. The Commission does not believe
that these entities would be small entities for purposes of the RFA.
Additionally, the Commission received no comments on the Proposal's RFA
discussion. Therefore, the regulations being adopted herein will not
have a significant economic impact on a substantial number of small
entities, as defined in the RFA.
---------------------------------------------------------------------------
\163\ 5 U.S.C. 601 et seq.
---------------------------------------------------------------------------
Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that these regulations will not
have a significant economic impact on a substantial number of small
entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1955 (``PRA'') \164\ imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any collection of
information, as defined by the PRA. The Commission may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid Office of Management
and Budget (``OMB'') control number. As discussed in the Proposal, the
final regulations will not impose any new recordkeeping or information
collection requirements, or other collections of information that
require approval of OMB under the PRA.
---------------------------------------------------------------------------
\164\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
The Commission notes that all reporting and recordkeeping
requirements applicable to SDs result from other rulemakings, for which
the CFTC has sought OMB approval, and are outside the scope of
rulemakings related to the De Minimis Exception.\165\
---------------------------------------------------------------------------
\165\ Parties wishing to review the CFTC's information
collections on a global basis may do so at http://www.reginfo.gov,
at which OMB maintains an inventory aggregating each of the CFTC's
currently approved information collections, as well as the
information collections that presently are under review.
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C. Cost-Benefit Considerations
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\166\ 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. In this section, the Commission considers the costs and
benefits resulting from its determinations with respect to the Section
15(a) factors.
---------------------------------------------------------------------------
\166\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
In this adopting release, the Commission is amending the De Minimis
Exception by establishing as a factor in the de minimis determination
whether a given swap has specified characteristics of swaps entered
into by IDIs in connection with loans to customers.\167\ The Proposal
requested public comment on the costs and benefits of the proposed
regulation, and specifically invited comments on: (1) The costs and
benefits to market participants associated with each change; (2) the
direct costs associated with SD registration and compliance; (3) the
indirect benefits to registering as an SD; (4) the indirect costs to
becoming a registered SD; (5) the costs and benefits to the public
associated with the proposed change; (6) how the proposed change
affects each of the Section 15(a) factors; (7) whether the Commission
identified all of the relevant categories of costs and benefits in its
preliminary consideration of the costs and benefits; and (8) whether
the costs and benefits of the proposed change, as applied in cross-
border contexts, differ from those costs and benefits resulting from
their domestic application, and, if so, in what ways and to what
extent.
---------------------------------------------------------------------------
\167\ This exception would be independent of the existing
exclusion in paragraph (5) of the SD Definition for swaps entered
into by IDIs.
---------------------------------------------------------------------------
As part of this cost-benefit consideration, the Commission will:
(1) Discuss the costs and benefits of the adopted change; and (2)
analyze the amendment as it relates to each of the 15(a) factors. The
Commission notes that this consideration of costs and benefits is based
on the understanding that the swap market functions internationally,
with many transactions involving U.S. firms occurring across different
international jurisdictions, with some prospective Commission
registrants organized outside the U.S., and other entities operating
both within and outside the U.S., and commonly following substantially
similar business practices wherever located. Where the Commission does
not specifically refer to matters of location, the discussion below of
the costs and benefits of the regulations being adopted refers to their
effects on all subject swaps activity, whether by virtue of the
activity's physical location in the United States or
[[Page 12464]]
by virtue of the activity's connection with or effect on U.S. commerce
under CEA section 2(i).
The IDI De Minimis Provision addresses concerns that there are
circumstances where swaps not covered by IDI Swap Dealing Exclusion
should be excluded from the de minimis calculation. Specifically, the
Commission proposed to add specific factors that an IDI can consider
when assessing whether swaps entered into with customers in connection
with loans to those customers must be counted towards the IDI's de
minimis threshold. The IDI could assess these factors and exclude
qualifying swaps from the de minimis calculation regardless of whether
the swaps would qualify for the IDI Swap Dealing Exclusion.
1. General Costs and Benefits
There are several policy objectives underlying SD regulation and
the de minimis exception to SD registration, which have associated with
them general costs and benefits depending on the scope of the de
minimis exception. As discussed above in section I.A.3, costs and
benefits may be associated with the primary policy objectives of SD
regulation, which include reducing systemic risk, increasing
counterparty protections, and increasing market efficiency,
orderliness, and transparency.\168\ The Commission also considers the
costs and benefits associated with the policy objectives furthered by a
de minimis exception, which include increasing efficiency, allowing
limited ancillary dealing, encouraging new participants to enter the
swap dealing market, and focusing regulatory resources.\169\
---------------------------------------------------------------------------
\168\ See also SD Definition Adopting Release, 77 FR at 30628-
30, 30707-08. To achieve these policy objectives, registered SDs are
subject to a broad range of requirements which may carry their own
costs and benefits. These requirements include, among other things,
registration, internal and external business conduct standards,
reporting, recordkeeping, risk management, posting and collecting
margin on uncleared swaps, and chief compliance officer designation
and responsibilities. However, costs associated with regulatory
requirements applicable to SDs result from other rulemakings and are
outside the scope of rulemakings related to the De Minimis
Exception.
\169\ See id.
---------------------------------------------------------------------------
As discussed, certain IDIs are restricting loan-related swaps
because of the potential that such swaps would have to be counted
towards an IDI's de minimis threshold, leading the IDI to register as
an SD and incur registration-related costs. The restrictions on loan-
related swaps by IDIs may have a market-wide cost of reduced
availability of swaps for the loan customers of these IDIs, potentially
hampering the ability of end-user borrowers to enter into hedges in
connection with their loans.
The Commission believes that the additional factors in the IDI De
Minimis Provision provide market benefits by allowing some IDIs that
are not registered SDs to provide swaps to customers in connection with
loans, because the IDIs would have a lesser concern that certain swaps
would need to be counted against the AGNA threshold. Generally, this
may decrease concentration in the markets for swaps and loans and
enhance market liquidity, which is helpful for customers of IDIs that
may not have access to larger SDs.\170\ In particular, as discussed,
the IDI De Minimis Provision would facilitate swap dealing in
connection with other client services and may encourage more IDIs to
participate in the swap market--advancing two market-related benefits
of the de minimis exception. Greater availability of loan-related swaps
may also improve the ability of customers to hedge their loan-related
exposure. The Commission also notes that the IDI De Minimis Provision
provides an opportunity for IDIs to tailor the risks of a loan to the
loan customer's and the lender's needs and promotes the risk-mitigating
effects of swaps.
---------------------------------------------------------------------------
\170\ The Commission also notes that it is possible that
bundling the swap and loan may lead to better commercial terms for
the customer.
---------------------------------------------------------------------------
Commenters generally agreed that the IDI De Minimis Provision
should lead to market benefits as it: (1) Better aligns the regulatory
framework with the risk mitigation demands of bank customers; \171\ (2)
makes it easier for IDIs to more accurately address the needs of loan
customers looking to access cost-effective and tailored hedges for
their loans; \172\ (3) should provide the benefit of reduced risk and
more efficient use of loan collateral through more tailored swaps;
\173\ and (4) better reflects how traditional regional banks interact
with their commercial customers.\174\
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\171\ See supra section II.B.1; M&T comment letter.
\172\ See supra section II.B.1; Capital One and Frost Bank
comment letters.
\173\ See supra section II.B.1; Frost Bank comment letter.
\174\ See supra section II.B.1; Regions comment letter.
---------------------------------------------------------------------------
Specifically, the Commission is adopting new paragraph (4)(i)(C)(1)
of the De Minimis Exception, which provides that a swap must be entered
into no earlier than 90 days before execution of the loan agreement, or
before transfer of principal to the customer, unless an executed
commitment or forward agreement for the applicable loan exists. In that
event, the 90-day restriction does not apply. Given that many of the
entities that the Commission expects to utilize the IDI De Minimis
Provision are small and mid-sized banks, the timing restriction in the
IDI De Minimis Provision could lead to a market benefit of increased
swap availability for the borrowing customers that rely on such IDIs
for access to swaps (and thereby advance a policy objective of the de
minimis exception).\175\ Several commenters generally agreed that this
provision would benefit end-user borrowers, stating that it more
closely reflects market practice for when loan-related swaps may be
entered into.\176\
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\175\ See supra section II.B.2; 83 FR at 27460. See generally
Citizens, Frost Bank, M&T, and Regions comment letters.
\176\ See supra section II.B.2. See also Capital One, Citizens,
and M&T comment letters.
---------------------------------------------------------------------------
Additionally, paragraph (4)(i)(C)(2), which address the
relationship of the swap to the loan, would further the policy
objectives of the de minimis exception by providing flexibility to
reflect the common market practices of end-users who hedge risk with
loan-related swaps. The Commission believes that this factor benefits
both IDIs and customers and serves the purposes of the de minimis
exception by allowing for greater use of swaps in effective and dynamic
hedging strategies, and by reducing the concern that ancillary swap
dealing activity may inappropriately subject the IDI to SD
registration-related requirements. As discussed, the Commission is of
the view that risk-mitigating hedges are beneficial because they lower
credit risk and lower the probability of default, though they may
increase an IDI's counterparty exposure if a default does occur.
However, the Commission is of the view that prudential regulatory
oversight of an IDI's derivative activities mitigates the concerns
associated with an IDI's increased counterparty exposure in the event
of a default. Additionally, the provision requires that the loan-
related swaps be permissible under the IDI's loan underwriting criteria
and be commercially appropriate, which replaces the proposed
requirement that such swaps be required as a condition of the loan,
either under the IDI's loan underwriting criteria or as is commercially
appropriate. The Commission did not intend for the proposed language to
require amendments to loan documents solely for allowing swaps to
qualify for the IDI De Minimis Provision. The Commission agrees with
the commenters that this clarification will benefit market participants
by making it more likely that IDIs will offer loan-
[[Page 12465]]
related swaps to borrowers.\177\ Further, as discussed, the restriction
that the swaps hedge risks incidental to the borrower's business (other
than for risks associated with an excluded commodity) that may affect
the borrower's ability to repay the loan provides a limit to the scope
of this exception. For example, if a borrower enters into a swap with
an IDI for speculative or investment purposes, the IDI would not be
able to exclude such swap from its de minimis threshold calculation.
---------------------------------------------------------------------------
\177\ See supra section II.B.3; ABA and Regions comment letters.
---------------------------------------------------------------------------
The Commission is also adopting paragraph (4)(i)(C)(3) of the De
Minimis Exception, which states that the termination date of the swap
cannot extend beyond termination of the loan. A few commenters stated
that circumstances can be anticipated at the time of loan origination
that would support permitting the termination date of the swap to
extend beyond termination of the loan.\178\ However, the Commission
does not believe that modifying this provision to allow for such
circumstances would benefit the market because including that much
flexibility would leave open a greater likelihood of abuse of the
regulation and would increase the difficulty of policing the
application of the regulation. In addition, as discussed, the
Commission is of the view that the addition of more complicated timing
structures for a swap in relation to a loan increases complexity and
may potentially increase risk. In other words, the swap becomes less
connected with the origination of the loan. Therefore, it would be
appropriate to expect the IDI to register as an SD to the extent the
IDI is entering into such swap arrangements in high volumes.
---------------------------------------------------------------------------
\178\ See supra section II.B.4; ABA, BDA, CDEU, Citizens, and
M&T comment letters.
---------------------------------------------------------------------------
Further, the Commission is adopting paragraph (4)(i)(C)(4)(i),
which requires an IDI to be, under the terms of the agreements related
to the loan, the source of at least five percent of the maximum
principal amount under the loan for a related swap not to be counted
towards its de minimis calculation. The Commission is also adopting
paragraph (4)(i)(C)(4)(ii), which states that if an IDI is a source of
less than a five percent of the maximum principal amount of the loan,
the notional amount of all swaps the IDI enters into in connection with
the financial terms of the loan cannot exceed the principal amount of
the IDI's loan in order to qualify for the IDI De Minimis Provision.
The Commission believes this provision benefits the market because the
syndication threshold of five percent provides additional flexibility
for IDIs, particularly small and mid-sized IDIs participating in large
syndications, to enter into a greater range of loan-related swaps
without having those swaps count towards their de minimis calculations.
Some commenters also agreed that this provision better reflects
industry practice.\179\
---------------------------------------------------------------------------
\179\ See supra section II.B.5; Capital One and M&T comment
letters.
---------------------------------------------------------------------------
Conversely, expanding the universe of swaps not required to be
counted towards the de minimis threshold also expands the number of
swaps potentially not subject to SD regulation, which could result in a
general cost of decreased customer protections. As discussed above,
however, the proposed IDI De Minimis Provision will likely benefit
mostly IDIs with a lesser AGNA of swaps activity, which mitigates the
concern that systemic risk will increase as a result of the proposed
change. Additionally, the level of activity between unregistered IDIs
and other unregistered persons is between only approximately 0.003
percent and 0.007 percent of the total AGNA of swaps activity,
depending on the range of AGNA of swaps activity being examined (at
AGNAs of between $1 billion and $50 billion).\180\ Given those low
percentages, the Commission is of the view that the general benefits of
SD regulation likely would not be significantly diminished if the
proposed IDI De Minimis Provision is adopted and some unregistered IDIs
marginally expand the number and AGNA of swaps they enter into with
customers in connection with loans to those customers. Further, though
these entities are active in the swap market, the Commission is of the
view that their activity poses less systemic risk as compared to IDIs
with a greater AGNA of swaps activity because of their limited AGNA of
swaps activity as compared to the overall size of the market.
---------------------------------------------------------------------------
\180\ See supra section II.B; 83 FR at 27459. As discussed
above, NERA estimated regulatory coverage for several different
scenarios, including for: (1) An AGNA threshold; and (2) an AGNA
threshold in conjunction with a modified exception for IDI loan-
related swaps that eliminated the date restrictions related to the
IDI Swap Dealing Exclusion. Although the assumptions and analytical
methodology differed from the Commission's approach, NERA's analysis
also estimated only a limited decrease in regulatory coverage in the
scenario that evaluated an AGNA threshold with a modified exception
for IDI loan-related swaps--with $138,383 billion of swaps activity
covered--as compared to the scenario that evaluated just an AGNA
threshold--with $138,406 billion of swaps activity covered (a
decrease of 0.017 percent). See ABA comment letter (attaching NERA
study).
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The Commission has considered, on the one hand, the significant
benefits of added market liquidity and, on the other, the costs of
potentially reduced customer protections and the potentially increased
credit risk that an IDI de minimis level SD may incur because the IDI
would be able, under the IDI De Minimis Provision, to expand its swap
dealing activities without having to register as an SD. The cost of
reduced customer protections is mitigated because such swaps would
still be required to be reported to the CFTC. Further, many of the
business conduct standards required for SDs are now part of
supplementary ISDA protocols.\181\ Last, the Commission notes that,
even without these constraints, IDIs are subject to prudential
regulatory requirements that include supervision of their credit risk
as well as capital requirements. These prudential regulatory
requirements maintain oversight of the IDI with respect to risks of
swaps entered into under the IDI De Minimis Provision.
---------------------------------------------------------------------------
\181\ See generally ISDA August 2012 DF Protocol Agreement,
available at https://www.isda.org/protocol/isda-august-2012-df-protocol/.
---------------------------------------------------------------------------
2. Section 15(a)
Section 15(a) of the CEA requires the Commission to consider the
effects of its actions in light of the following five factors:
(i) Protection of Market Participants and the Public
The IDI De Minimis Provision may expand the universe of swaps that
fall outside the scope of SD regulations, potentially increasing
systemic risk and reducing counterparty protections. However, the IDIs
would still be subject to prudential regulatory requirements,
mitigating this concern somewhat. Additionally, as noted, the activity
of IDIs that would benefit from this rule amendment poses less systemic
risk as compared to IDIs with a greater AGNA of swaps activity because
of their limited AGNA of swaps activity as compared to the overall size
of the market.
(ii) Efficiency, Competitiveness, and Financial Integrity of Markets
The efficiency, competitiveness, and financial integrity of the
markets may also be affected by the addition of the IDI De Minimis
Provision since it provides IDIs more flexibility to enter into swaps
in connection with loans without registering as SDs. With the added
flexibility, the number of IDIs
[[Page 12466]]
offering swaps in connection with loans may increase, which might have
a positive impact on the efficiency and competiveness of the market for
swaps and loans. Additionally, end-users may be able to more
efficiently enter into swaps in connection with loans, and therefore
hedge associated risks, because they will not have to establish a new
commercial relationship with a third-party swap dealer solely for this
purpose. However, the added flexibility may also result in fewer swaps
being subject to SD-related regulations.
(iii) Price Discovery
The IDI De Minimis Provision could lead to better price discovery
as small and mid-sized banks increase their level of ancillary dealing
activity, which might increase the frequency of swap transaction
pricing.
(iv) Sound Risk Management
The IDI De Minimis Provision should increase the availability of
swaps from IDIs, which could help end-users more effectively mitigate
loan-related risk, for example interest rate and currency risk. The
increased usage of swaps for risk mitigation may also reduce the risk
to IDIs resulting from the defaulting of loan customers. Additionally,
having more IDIs offering swaps in connection with loans might decrease
concentration in the market for loan-related swaps and thereby decrease
risk as well. The Commission also notes that to the extent an IDI is
not required to register as an SD, it would still be subject to the
risk management requirements of its prudential regulator.
(v) Other Public Interest Considerations
The Commission has not identified any other public interest
considerations with respect to the IDI De Minimis Provision.
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of the CEA.\182\ The Commission believes that
the public interest to be protected by the antitrust laws is generally
to protect competition.
---------------------------------------------------------------------------
\182\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission has considered this final rule to determine whether
it is anti-competitive and has identified no anti-competitive effects.
Because the Commission has determined that the final rulemaking is not
anti-competitive and has no anti-competitive effects, the Commission
has not identified any less anti-competitive means of achieving the
purposes of the CEA.
List of Subjects in 17 CFR Part 1
Commodity futures, Definitions, De minimis exception, Insured
depository institutions, Swaps, Swap dealers.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 1 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,
9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24
(2012).
0
2. In Sec. 1.3, add paragraph (4)(i)(C) to the definition of the term
``Swap dealer'' to read as follows:
Sec. 1.3 Definitions.
* * * * *
Swap dealer. * * *
(4) * * *
(i) * * *
(C) Insured depository institution swaps in connection with
originating loans to customers. Solely for purposes of determining
whether an insured depository institution has exceeded the $8 billion
aggregate gross notional amount threshold set forth in paragraph
(4)(i)(A) of this definition, an insured depository institution may
exclude swaps entered into by the insured depository institution with a
customer in connection with originating a loan to that customer,
subject to the requirements of paragraphs (4)(i)(C)(1) through (6) of
this definition.
(1) Timing of execution of swap. The insured depository institution
enters into the swap with the customer no earlier than 90 days before
execution of the applicable loan agreement, or no earlier than 90 days
before transfer of principal to the customer by the insured depository
institution pursuant to the loan, unless an executed commitment or
forward agreement for the applicable loan exists, in which event the 90
day restriction does not apply;
(2) Relationship of swap to loan. (i) The rate, asset, liability or
other term underlying such swap is, or is related to, a financial term
of such loan, which includes, without limitation, the loan's duration,
rate of interest, the currency or currencies in which it is made and
its principal amount; or
(ii) Such swap is permissible under the insured depository
institution's loan underwriting criteria and is commercially
appropriate in order to hedge risks incidental to the borrower's
business (other than for risks associated with an excluded commodity)
that may affect the borrower's ability to repay the loan;
(3) Duration of swap. The duration of the swap does not extend
beyond termination of the loan;
(4) Level of funding of loan. (i) The insured depository
institution is committed to be, under the terms of the agreements
related to the loan, the source of at least five percent of the maximum
principal amount under the loan; or
(ii) If the insured depository institution is committed to be,
under the terms of the agreements related to the loan, the source of
less than five percent of the maximum principal amount under the loan,
then the aggregate notional amount of all swaps entered by the insured
depository institution with the customer in connection with the
financial terms of the loan cannot exceed the principal amount of the
insured depository institution's loan;
(5) The swap is considered to have been entered into in connection
with originating a loan with a customer if the insured depository
institution:
(i) Directly transfers the loan amount to the customer;
(ii) Is a part of a syndicate of lenders that is the source of the
loan amount that is transferred to the customer;
(iii) Purchases or receives a participation in the loan; or
(iv) Under the terms of the agreements related to the loan, is, or
is intended to be, the source of funds for the loan; and
(6) The loan to which the swap relates shall not include:
(i) Any transaction that is a sham, whether or not intended to
qualify for the exception from the de minimis threshold in this
definition; or
(ii) Any synthetic loan.
* * * * *
Issued in Washington, DC, on March 26, 2019, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
[[Page 12467]]
Appendices to De Minimis Exception to the Swap Dealer Definition--Swaps
Entered Into by Insured Depository Institutions in Connection With
Loans to Customers
Appendix 1--Commission Voting Summary
On this matter, Chairman Giancarlo and Commissioners Quintenz
and Stump voted in the affirmative. Commissioners Behnam and
Berkovitz voted in the negative.
Appendix 2--Statement of Chairman J. Christopher Giancarlo
The Commission will today consider the final rule for the de
minimis exception for swaps entered into by Insured Depository
Institutions (``IDIs'') in connection with loans to customers.
Today's action builds upon the strong public support the CFTC has
received for providing a narrowly-tailored exception that promotes
the use of loan-related swaps in a commercially practicable and
cost-effective manner.
This final rule will increase efficiencies and reduce the
burdens for banks, particularly small and regional banks, to enter
into swaps with their end-user loan customers without the added
burden of unnecessary regulation and associated compliance costs.
But this proposal is far more important than that. This proposal
will allow small and medium size commercial borrowers--
manufacturers, home builders, agricultural cooperatives, community
hospitals and small municipalities--to conduct prudent risk
management that is difficult for them under the current rule.
I recently telephoned senior executives of several regional
banks to hear about their commercial lending and swaps hedging
practices.
One executive serving clients in the Mid Atlantic explained that
his firm was the only bank service provider to most of his small and
medium sized business clients. If his regional bank could not offer
these smaller businesses a fixed interest rate swap to hedge their
floating rate loan borrowing, then these borrowers had no means to
hedge their exposure to rising interest rates on their loans.
Another executive with a South Eastern bank explained that
regulatory limitations on his bank's ability to offer swap hedging
facilities to commercial borrowers meant that they remained exposed
to rising interest rates, putting them at risk of having to curtail
operations or lay off workers if rates rose. In effect, the current
situation is pushing risk down into the real economy, rather than
mitigating it as derivatives market reforms were intended.
Another executive with a Midwestern bank said that greater
regulatory flexibility would allow his bank to be there for its
clients not only in good times, but also in times of greater
volatility. It would allow his bank to provide properly hedged
lending to support good jobs, healthy communities and safe
retirements in towns throughout the Midwest.
I specifically asked these executives if they would engage in
more swaps dealing to compete with Wall Street. Each of them said
that they had no intention whatsoever to engage in that type of
swaps dealing or speculate in swaps markets. They said that their
prudential bank regulator would not allow them to do so. They made
clear that their intention was to enable business borrowers to use
swaps to mitigate the risk of floating rate commercial loans
invested in their local communities. I was impressed with their
commitment to serving the risk management needs of their regional
clients.
The preamble to the rule directs the CFTC Office of Chief
Economist to conduct a study after three years of implementation.
This study will examine future trading data to see how the market
operates under the rule. It will assist a future Commission in
considering whether there is a need for limitations on swap
activity, and if so, at what levels. This study is the result of a
discussion with a fellow Commissioner who suggested adding limits to
the notional size of swaps entered into in connection with the
principal balance of related loans. The final rule before us does
not set such limits, but does not preclude the Commission from doing
so in the future if considered appropriate based upon the study. I
believe imposing such limits at this time would be inappropriate
without data on which to base such limits and supportive public
comments. As I have said many times before, I believe that CFTC
policy is best when it is driven by data and not assumptions.
I take seriously, however, the concern about potential misuse of
this provision in ways that are not intended. The preamble makes it
clear that the Commission expects that the swaps entered into by
IDIs are in connection with and related to the originating loan. For
instance, a swap with a borrower entering into it for speculative or
investment purposes not related to the loan would not be excepted by
the IDI from the de minimis calculation. And IDIs, as depository
institutions, remain subject to prudential supervision for all of
their activities, including swaps dealing. Finally, this rule does
not remove the core Dodd-Frank Act swaps requirements of clearing,
post-trade reporting, and mandatory trade execution, which I fully
support.
Again, I am pleased to see this rule finalized. I do not intend
to put before the Commission any other de minimis exception during
my remaining time at the CFTC. Nevertheless, staff continues to
study possible alternative metrics for the calculation of the swap
dealer de minimis threshold, including possible risk-based
approaches. I expect that the results of their work will be reviewed
by the Commission under the next Chairman and considered for further
action.
In conclusion, today's proposed rulemaking is about much more
than legal technicalities, joint rule making or even relief for
regional American banks--as important as those things are. Today's
rule is about prudent risk management by America's small business
borrowers and job creators. It is about investment in local
communities in the real economy. It is about increasing prosperity
and employing our fellow Americans. Frankly, things just don't get
more important than that.
Appendix 3--Supporting Statement of Commissioner Brian D. Quintenz
I support today's final rule to amend the de minimis exception
to swap dealer registration to include IDI loan-related factors. The
amendments facilitate IDIs' provision of hedging swaps to end-user
borrowers trying to mitigate the myriad risks--interest rate,
currency, commodity price--facing their businesses in connection
with their loans. When Congress adopted the definition of ``swap
dealer'' in the Commodity Exchange Act, it recognized that small and
medium-sized banks play a critical role in providing credit and risk
mitigation services to end-user borrowers.\1\
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\1\ 156 Cong. Rec. S5922 (daily ed. July 15, 2010)(statement of
Sen. Lincoln)(``In addition, we made it clear that a bank that
originates a loan with a customer and offers a swap in connection
with that loan shouldn't be viewed as a swap dealer.'').
---------------------------------------------------------------------------
In my view, today's amendments further Congressional intent,
better align the Commission's swap dealer registration framework
with the risk mitigation needs of bank customers, and more
accurately reflect current market practices between IDIs and their
borrowers. By amending the de minimis exception from swap dealer
registration, the Commission is providing small and regional banks
with greater flexibility to serve their customers' needs and greater
regulatory clarity about the types of de minimis swap dealing
activity they can engage in without triggering registration. I am
also pleased that the amendments today were completed with full
coordination with the Securities and Exchange Commission.\2\
---------------------------------------------------------------------------
\2\ Joint Statement from Chairmen Giancarlo and Clayton on the
IDI Exception to the Swap Dealer Definition (Dec. 13, 2018), https://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement121318
(citing the Commissions' interpretation that the Dodd-Frank Act does
not require a joint rulemaking between the two agencies with respect
to the de minimis exception to the swap dealer definition).
---------------------------------------------------------------------------
Today's amendments also contain important limitations that
prevent IDIs from entering into an unlimited amount of swap dealing
transactions with customers without needing to register as a swap
dealer. The swap must have a direct relationship with the
origination of the loan with the IDI. For example, the rate or term
underlying the swap must be related to a financial term of the loan
or the swap must be permissible under the IDI's loan underwriting
criteria and commercially appropriate to hedge risks incidental to
the borrower's business. These conditions inherently limit the
amount of swap dealing activity IDIs can engage in with customers
and still qualify for the de minimis exception. Moreover, the
preamble of today's rule makes absolutely clear that if an IDI
entered into a swap with an end-user for the end-user's speculative
purposes, that transaction would not qualify for the de minimis
exception.
These amendments are absolutely essential to helping to
rationalize the de minimis threshold and ensure that end-users and
Main Street businesses don't suffer from an overly prescriptive,
punitive, and far-reaching regulatory regime that was only
[[Page 12468]]
meant to target the largest financial entities.\3\ The Commission's
no-action letter to a Main Street bank this past August demonstrates
the need to remedy the inadequacies of the current de minimis regime
to ensure that legitimate client hedging activity is not
artificially constrained.\4\ Since that time, the Commission has
received similar requests for no-action relief from other banks in
order to meet their customers' needs. These needs are especially
acute in light of a rising interest rate environment. Many
businesses who have received credit over the last several years may
not have felt a need to hedge their interest rates given that rates
were low and stable. However, in a rising rate environment, banks
should have the flexibility to offer their customers hedging
services on those prior extensions of credit without artificially
falling into a swap dealer registration regime. I believe that
today's final rule appropriately addresses these concerns.
---------------------------------------------------------------------------
\3\ Hearing to Review Implementation of Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act Before the H.
Comm. on Agric. and the Subcomm. on General Farm Commodities and
Risk Management, 112th Cong. 14 (Feb. 10, 2011), https://archives-agriculture.house.gov/sites/republicans.agriculture.house.gov/files/transcripts/112/112-1.pdf.
\4\ CFTC Staff No-Action Letter 18-20 (August 28, 2018), https://www.cftc.gov/PressRoom/PressReleases/7775-18.
---------------------------------------------------------------------------
However, as I said at the outset, today's amendments are but one
of many improvements to the de minimis threshold contemplated by the
June 2018 proposal which must be finalized. As I have said
repeatedly, notional value is a poor measure of activity and a
meaningless measure of risk. Identifying a de minimis quantity of a
meaningless number will always still yield another meaningless
number. By itself, notional value is an incredibly deficient
registration metric by which to impose large costs and achieve
substantial policy objectives, but yet it is the one that the CFTC
has repeatedly and inexplicably embraced in this context.
I am supportive of the Office of the Chief Economist's (OCE)
efforts to rationalize notional amounts into an entity-netted
notional (ENNs) measurement that more accurately reflects an
entity's swap activity from both a size and risk perspective. In
February 2019, OCE issued a report converting the gross notional
amounts of the IRS, FX, and CDS markets into ENNs.\5\ That study
found that, when measured with ENNs, the notional amounts of the
IRS, FX, and CDS markets considered went from $225 trillion, $57
trillion, and $5.5 trillion, respectively, to $15.4 trillion, $17
trillion, and $2 trillion, respectively. In other words, the entire
market of those three swap asset classes shrunk from $290 trillion
to $34 trillion. When measured against this adjusted (and smaller)
market size, the current $8 billion de minimis threshold still only
constitutes .0002--two ten-thousandths--of that figure.
---------------------------------------------------------------------------
\5\ ENNs for Corporate and Sovereign CDS and FX Swaps, Office of
the Chief Economist (Feb. 2019), https://www.cftc.gov/sites/default/files/files/ENNs%20for%20Corporate%20CDS%20and%20FX%20Derivatives%20-%20ADA.pdf.
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Given the irrationality of arguing over de minimis quantities to
the ten-thousandth increment, I believe the Commission has plenty of
flexibility to make further adjustments to this exception that would
be consistent with Congress' intent to exempt a de minimis quantity
of swap dealing activity. I would note that the Commission, in its
vote on the November 2018 final rule, only rejected reducing the de
minimis threshold to $3 billion and did not state at any point that
amounts greater than $8 billion exceeded a ``de minimis quantity of
swap dealing.'' If the rule had taken that view, I would have voted
against it. Additionally, the November 2018 rule specifically
contemplated further Commission action on additional amendments to
the de minimis exception, nullifying any after-the-fact attempt to
recast that vote as the Commission's final say on the matter.\6\
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\6\ De Minimis Exception to the Swap Dealer Definition, 83 FR
56666, 56677, 56679, 56681 (Nov. 13, 2018) (noting that data
analysis indicates that increasing the de minimis threshold up to
$100 billion ``may have a limited adverse effect on the systemic
risk and market efficiency policy considerations of SD regulation.
Additionally, a higher threshold could enhance the benefits
associated with a de minimis exception, for example by allowing
entities to increase ancillary dealing activity'').
---------------------------------------------------------------------------
Lastly, I am encouraged that, following the Chairman's specific
and public direction, staff continues to study both additional
adjustments to notional value that would better account for
differences between various products, and alternative risk-based
registration metrics that could better align the criteria of the de
minimis threshold with the costs of swap dealer regulation,
particularly the largest costs tied to mitigating systemic risk such
as capital and margin requirements.\7\ The results of this staff
report will be critical to the Commission's continued consideration
of a more risk-sensitive swap dealer registration threshold.
---------------------------------------------------------------------------
\7\ Statement of Chairman J. Christopher Giancarlo Regarding the
Final Rule on Swap Dealer De Minimis Calculation, (Nov. 5, 2018),
https://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement110518.
---------------------------------------------------------------------------
I would like to commend DSIO staff for their hard work on
finalizing these amendments and their ongoing, tireless efforts to
produce data analyses the Commission can use to further inform
necessary improvements to our swap dealer registration regime.
Appendix 4--Dissenting Statement of Commissioner Rostin Behnam
Introduction
I respectfully dissent from the Commodity Futures Trading
Commission's (the ``Commission'' or ``CFTC'') decision today
regarding the application of the swap dealer definition to insured
depository institutions (``IDIs''). The Commission's eagerness to
bypass clear Congressional intent in order to address longstanding
concerns with the original implementation of the statutory exclusion
from the swap dealer definition for IDIs, only to the extent they
offer to enter swaps transactions in connection with originating
customer loans (the ``IDI Swap Dealing Exclusion''), creates risks
and uncertainties that may harm the very financial institutions that
the new rule purports to help. By exercising its De Minimis
Exception Authority \1\ to create as a ``factor'' whether a given
swap has specified characteristics of swaps entered into by IDIs in
connection with customer loans, the Commission is creating a new
regulatory exemption that intentionally and entirely subsumes the
IDI Swap Dealing Exclusion in defiance of conferred regulatory
authority. Moreover, not only does this novel exercise in agency
discretion undermine the swap dealer definition, but it exemplifies
the current Commission's rush to implement sweeping changes to the
regulation of swap dealers without regard for the long term
consequences of its capricious interpretation of the law and
arbitrary analysis of risk.
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\1\ See 17 CFR 1.3 swap dealer, paragraph (4)(v), providing that
the Commission may by rule or regulation change the requirements of
the de minimis exception described in paragraphs (4)(i) through (iv)
(``De Minimis Exception Authority'').
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During the proposal for today's final rule,\2\ I expressed grave
concerns with the Commission's use of its De Minimis Exception
Authority to redefine swap dealing activity absent a meaningful
collaboration and joint rulemaking with the Securities and Exchange
Commission (``SEC''), as required by the Dodd-Frank Act.\3\ I was
concerned that the Commission's decision put it at risk of
challenge, and concerned that the introduction of an IDI De Minimis
Provision that de facto defines the universe of swap dealing
activity for all IDIs and then wholly exempts such activity from
counting towards only one of two applicable aggregate gross notional
registration thresholds was neither efficient nor fair when compared
to the absolute protections that could be provided by an
appropriately amended IDI Swap Dealing Exclusion.
---------------------------------------------------------------------------
\2\ De Minimis Exception to the Swap Dealer Definition, 83 FR
27444, 27481-2 (proposed June 12, 2018) (``Notice of Proposed
Rulemaking'' or ``NPRM'').
\3\ See The Dodd-Frank Wall Street Reform and Consumer
Protection Act, Public Law 111-203 section 712(a) and (d), 124 Stat.
1376, 1644 (2010) (the ``Dodd-Frank Act'').
---------------------------------------------------------------------------
During the Notice of Proposed Rulemaking and through the
finalization of the rule setting the de minimis exception at an
aggregate gross notional amount (AGNA) threshold of $8 billion in
swap dealing activity, I urged the Commission to act within our
delegated authority and work with the SEC to amend the IDI Swap
Dealing Exclusion.\4\ Instead, under the guise of harmonization
efforts, in December 2018, the Chairmen of our two independent
agencies independently and irrespectively of their fellow
Commissioners' views issued a joint statement regarding the ``IDI
Exception to the Swap Dealer Definition.'' \5\ In purporting to
[[Page 12469]]
provide greater clarity, they stated, in part, that, ``[O]ur
Commissions have not interpreted the joint rulemaking provisions of
the Dodd-Frank act to require joint rulemaking with respect to the
de minimis exception to the swap dealer definition, including an
exception for a de minimis quantity of swaps entered into by IDIs in
connection with loans.'' \6\ While I agree that the CFTC has
delegated authority to exercise its De Minimis Exception Authority
under section 1a (49)(D) of the Commodity Exchange Act (``CEA'' or
the ``Act''), this authority is not open-ended and cannot be
interpreted to conflict with the clear Congressional directives
regarding the exclusion set forth in the swap dealer definition in
CEA section 1a(49)(A). Congress clearly did not confer the authority
in CEA section 1a(49)(D) so that the CFTC would have free-flowing
regulatory authority to determine the scope of the Dodd-Frank Act's
regulatory coverage with regard to an entire segment of the swap
dealing population.\7\ Moreover, by viewing CEA section 1a(49)(D) as
a blank-check for creating exemptions and exceptions that de facto
alter the swap dealer definition, the Chairmen--and now the
Commissions--are depriving IDIs of legal certainty and benefits of
an exclusion.\8\
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\4\ See, e.g. De Minimis Exception to the Swap Dealer
Definition, 83 FR 56666, 56691 (Nov. 13, 2018).
\5\ J. Christopher Giancarlo, Chairman, CFTC and Jay Clayton,
Chairman, SEC, Joint Statement from Chairmen Giancarlo and Clayton
on the IDI Exception to the Swap Dealer Definition (Dec. 13, 2018),
https://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement121318.
\6\ Id.
\7\ Congress clearly understood that IDIs are subject to
prudential regulation and anticipated that depository institutions
generally could be required to register as swap dealers regardless
of such status. See 7 U.S.C. 6s(c)(1) (providing that any person
that is required to be registered as a swap dealer shall register
with the CFTC regardless of whether the person also is a depository
institution or is registered with the SEC as a security-based swap
dealer).
\8\ For example, given the default presumption of full swap
dealer designation, it is unclear as to whether and how the CFTC
might exercise its authority to grant a limited purpose swap dealer
designation under CEA section 1a(49)(B) and CFTC regulation 1.3 Swap
dealer, paragraph 3 to an IDI that is required to register as a swap
dealer for swap dealing activities that do not meet the IDI De
Minimis Provision, but may meet the IDI Swap Dealing Exclusion. See
Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' 77 FR 30596,
30644-46, (May 23, 2012) (``SD Definition Adopting Release'').
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I believe that IDIs deserve the fullest application of the
exclusion provided by Congress in CEA section 1a(49)(A); not an
exemption or exception that puts them within the crosshairs of
future Commission action should political headwinds or shifting
policy dispose it to again alter the rules or its interpretation of
the CEA. I think the Commission should have worked with the SEC to
jointly amend the IDI Swap Dealing Exclusion to more accurately
address swap activities inherent to credit risk management
encompassed by loan origination in the commercial lending space.\9\
And, I think the Commission should have considered alternative forms
of relief that neither disturb the IDI Swap Dealing Exclusion nor
require use of the De Minimis Exception Authority to reduce
regulatory burdens of IDIs.\10\ By prioritizing shifting policy over
regulatory implementation, the Commission acted impulsively,
inviting risk and depriving IDIs and other affected parties the
legal certainty and clarity intended by Congress.
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\9\ For example, the Commissions could have, in consultation
with the prudential regulators, reconsidered their interpretation of
what Congress meant by ``loan origination'' in the context of the
credit risk management relationship and extended, conditioned, or
removed the IDI Swap Dealing Exclusion's requirement that an IDI
enter into a swap within 180 days after the execution of the loan
agreement (or date of transfer of principal to the customer) (17 CFR
1.3 Swap dealer, paragraph (5)(i)(A)) to more accurately address how
customers actively manage loan-related risk. Similarly, the
Commissions could have more fully analyzed whether and under what
circumstances permitting the termination date of a swap to extend
beyond the termination date of the related loan could bear an
appropriate relationship to loan origination.
\10\ For example, the CFTC could consider permitting IDIs that
register as swap dealers to demonstrate compliance with their
prudential regulatory requirements as a substitute for comparable
CFTC swap dealer regulations.
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IDIs Shall Not Be Considered Swap Dealers . . .
Section 1a(49)(A) of the CEA generally defines the term ``swap
dealer'' to mean:
[A]ny person who--(i) holds itself out as a dealer in swaps;
(ii) makes a market in swaps; (iii) regularly enters into swaps with
counterparties in the ordinary course of business for its own
account; or (iv) engages in any activity causing the person to be
commonly known in the trade as a dealer or market maker in swaps,
provided however, in no event shall an insured depository
institution be considered to be a swap dealer to the extent it
offers to enter into a swap with a customer in connection with
originating a loan with that customer.\11\
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\11\ 7 U.S.C. 1a(49)(A) (emphasis added).
As recognized by the Commission when first interpreting this
language in a joint rulemaking with the SEC in 2012, as required by
the Dodd-Frank Act,\12\ the statute ``does not exclude any category
of persons from coverage of the dealer definitions; rather it
excludes certain activities from the dealer analysis.'' \13\
Consistent with this understanding, in analyzing the breadth of the
language relevant to IDIs, the CFTC and SEC recognized that the
statute's direct reference to ``originating'' the loan precluded it
from ``constru[ing] the exclusion as applying to all swaps entered
between an IDI and a borrower at any time during the duration of the
loan,'' explaining, ``If this were the intended scope of the
statutory exclusion, there would be no reason for the text to focus
on swaps in connection with `originating' a loan.'' \14\
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\12\ Dodd-Frank Act at section 712(d).
\13\ SD Definition Adopting Release, 77 FR at 30619-20. As
acknowledged by the two Commissions: ``In this regard, it is
significant that the exceptions in the dealer definitions depend on
whether a person engages in certain types of swap or security-based
swap activity, not on other characteristics of the person. That is,
the exceptions apply for swaps between an insured depository
institution and its customers in connection with originating loans,
swaps or security-based swaps entered into not as a part of a
regular business, and swap or security-based swap dealing that is
below a de minimis level.'' SD Definition Adopting Release, 77 FR at
30619.
\14\ SD Definition Adopting Release, 77 FR at 30621-2.
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The CFTC and SEC understood that the Dodd-Frank Act did not
entirely carve IDIs out from coverage of the swap dealer definition.
Rather, Congress intended that, to the extent IDIs engage in certain
swap activities with their customers related to loan origination, as
interpreted by the CFTC jointly with the SEC,\15\ such activities
would not be included in determining whether an individual IDI is a
swap dealer. Critical to today's decision, the Commissions
understood that Congress clearly and specifically stated that the
swap activities of IDIs with their customers in connection with
originating loans were to be addressed by the Commissions jointly,
and through an exclusion from the dealer definition, and not through
each agency's authority with respect to de minimis levels of swap
dealing activity.\16\ The plain meaning is that the CFTC is not free
to interpret its De Minimis Exception Authority as a means to
unilaterally redefine IDI swap activities with customers in
connection with loan origination as dealing activities to be wholly
``factored'' out of the $8 billion AGNA de minimis threshold
calculation.\17\ The CFTC does not have a blank check.\18\
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\15\ See Dodd-Frank Act, supra note 3.
\16\ See SD Definition Adopting Release, 77 FR at 30619, supra
note 13 (in addition to recognizing that the statutory exceptions to
the dealer definitions are activities-based, the CFTC and SEC also
understood the differentiation between the exceptions available for
swaps between an IDI and its customers in connection with
originating loans and for swap or security-based swap dealing that
is below a de minimis level).
\17\ See Larry M. Eig, Cong. Research Serv., 97-589, Statutory
Interpretation: General Principles and Recent Trends 18 (2014) (it
is assumed that Congress speaks to major issues directly: ``Congress
. . . does not alter the fundamental details of a regulatory scheme
in vague terms or ancillary provisions--it does not . . . hide
elephants in mouseholes.'' (quoting Whitman v. American Trucking
Ass'ns, Inc., 531 U.S. 457, 468 (2001))).; See also, e.g. Lamie v.
U.S. Trustee, 540 U.S. 526, 538 (2004) (``There is a basic
difference between filling a gap left by Congress' silence and
rewriting rules that Congress has affirmatively and specifically
enacted.'' (quoting Mobil Oil. Corp. v. Higginbottom, 468 U.S. 618,
625 (1978))).
\18\ See, e.g. Neomi Rao, Address at the Brookings Institution:
What's next for Trump's regulatory agenda: A conversation with OIRA
Administrator Neomi Rao (Jan. 26, 2018), Transcript at 10 (``. . .
agencies should not act as though they have a blank check from
congress to make law.''), available at https://www.brookings.edu/wp-content/uploads/2018/01/es_20180126_oira_transcript.pdf.
---------------------------------------------------------------------------
Put simply, in this context where the CFTC is seeking to address
swap dealing activities by IDIs, section 712(d) of the Dodd-Frank
Act only authorizes the CFTC to act independently when determining
which IDIs to exempt from a swap dealer designation based solely on
the quantity of dealing activity outside of such activity that falls
within CEA section 1a(49)(A), and to establish factors in connection
with establishing this quantitative determination. Congress clearly
intended for the de minimis exemption to be a quantity based
exemption,
[[Page 12470]]
and not an exemption that also considers the characteristics of swap
dealing activity as a means to create categorical exclusions, which
is what the Commission is doing today for swaps entered by IDIs in
connection with commercial loans.
The CFTC's newly minted interpretation of the De Minimis
Exception Authority in CEA section 1a(49)(D) in support of its
unilateral ability to address swap activities as ``factors'' in a
quantitative determination of de minimis swap dealing activity for
registration purposes is a clever attempt to justify its decision to
avoid productively collaborating with the SEC. However, this new
interpretation is as an inexplicable departure from prior Commission
interpretation and unsupported by the plain language of the
statute.\19\
---------------------------------------------------------------------------
\19\ See 83 FR at 56692-3.
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Inefficiencies
Not only is the CFTC legally hamstrung from its chosen path, but
its action today creates redundancy and inefficiencies in our rules.
Because swap activities between IDIs and their customers in
connection with originating loans were never intended to be swap
dealing activity warranting swap dealer registration, it is odd to
say that swap activities between IDIs and their customers in
connection with originating loans are exceptions to the threshold
test for swap dealer registration.\20\ The IDI De Minimis Provision
created today presupposes that what it exempts from counting towards
the $8 billion AGNA de minimis threshold calculation are activities
that are otherwise within the scope of the swap dealer definition.
But, the Commission created the need for the exception, i.e. it
defined ``swap dealing'' activities, when it determined to treat the
IDI Swap Dealing Exclusion as immutable.\21\ The CFTC and SEC could
have dodged further interpretive risk and inefficient application of
the swap dealer definition and avoided considering the application
of a de minimis threshold to the swaps activities at issue had the
agencies jointly addressed the existing conditions of the IDI Swap
Dealing Exclusion that fail to address the spectrum of swap
activities typically engaged in with respect to the ongoing credit
risk management associated with loan origination.
---------------------------------------------------------------------------
\20\ See, e.g., Frederick Schauer, Exceptions, 58 U. Chi. L.
Rev. 871, 874-5 877 (1991) (explaining the expectation that
exceptions are generally built into the meaning of a primary
technical term such that it is odd to say, for example, that foul
balls are exceptions to the rule defining home runs because foul
balls are not home runs in the first place).
\21\ Not only is this far from efficient, it is a burden. In
determining how to exercise its authority, a federal agency should
not create solutions in search of problems. See, e.g. Neomi Rao,
supra note 18 at 10.
---------------------------------------------------------------------------
Risk Beyond Inefficiencies
Beyond the procedural and interpretive issues that call the
Commission's action into question, several requirements of the IDI
De Minimis Provision push its coverage well beyond swap dealing
activities in connection with loan origination that it purports to
address. Rather, the Commission drafted the IDI De Minimis Provision
to encompass any and all swaps entered into with customers in
connection with loans to those customers with the effect that,
despite classifying such swaps as dealing activity, they--and the
market facing swaps used to hedge them--need not be counted towards
the $8 billion AGNA de minimis threshold calculation. The end result
being that IDIs, contrary to Congressional intent, will not have to
register as swap dealers to the extent they engage in swaps with
their loan customers during the lifetime of the loan. To be clear,
had Congress wanted the prudential regulators to provide the sole
oversight for IDIs to the extent they engaged in swap dealing
activities with customers, it would not have included the
exclusionary language for IDIs in CEA section 1a(49)(A) and would
have clearly articulated this intent elsewhere in the Dodd-Frank
Act.\22\
---------------------------------------------------------------------------
\22\ See Larry M. Eig, supra note 17 at 3, 14-15 (explaining the
basic principles that statutory language should be construed to give
effect to all its provisions).
---------------------------------------------------------------------------
With the purported goal of promoting greater use of swaps in
hedging strategies to reduce business risk, and ultimately reducing
the need for banks to turn away end-user client demand for swaps
that would cut into their adjusted gross notional ancillary swap
dealing activity subject to the $8 billion AGNA de minimis
threshold, the IDI De Minimis Provision: (1) Includes no timing
restrictions following loan execution or commitment on when a swap
must be entered to be in connection with originating a loan; (2)
requires only that a swap be permissible under the IDIs loan
underwriting criteria so as to permit greater use of swaps in
``effective and dynamic hedging strategies'' during the borrowing
relationship,\23\ as opposed to mirroring the statute's clear intent
of addressing swaps in connection with loan origination; and (3)
permits an unlimited adjusted gross notional amount of loan-related
swaps to be entered, regardless of the principal loan amount
outstanding. These requirements--or lack thereof--will permit IDIs
to engage in an unlimited and indeterminate level of swap dealing
with customers throughout the lifetime of a loan and without having
to count such activities towards the $8 billion AGNA de minimis
threshold.
---------------------------------------------------------------------------
\23\ See Final Rule, De Minimis Exception to the Swap Dealer
Definition--Swaps Entered into by Insured Depository Institutions in
Connection with Loans to Customers, section II.B.3. (to be codified
at 17 CFR pt. 1).
---------------------------------------------------------------------------
While the Commission believes that the swap dealing activity to
be covered by the IDI De Minimis Provision in total does not raise
systemic risk concerns, it has made no effort to quantify or qualify
how this indeterminate level of swap dealing activity may affect the
risk profile of the individual IDIs who each would potentially be
subject to swap dealer registration. The Commission simply assumes
that the overall risk attributed to the community of small and mid-
sized IDIs it has currently identified does not and will not in the
future raise systemic risk concerns. With this in mind, it is worth
articulating that despite suggestions that this relief is surgically
targeted to help ``small and midsize'' banks, it can in fact be
utilized by banks of all sizes, including those that may be
systemically risky. I do not mean to suggest at all that size should
be deterministic of which financial entities can avail themselves of
relief intended for all IDIs; however, taken in context of the
unrestricted nature of the rule before the Commission today, as it
relates to the relationship between swaps activity and loan
origination, I am extremely concerned about what systemic risks may
arise as a result from these unrestricted activities.
The Commission, in part, is punting to prudential regulatory
oversight and supervision to ensure that the IDI De Minimis
Provision will not lead to a significant expansion of swap dealing
activity by unregistered entities, as compared to the overall size
of the swap market and not on an individual IDI basis. The
Commission should always consider and rely on the risk mitigating
effects of prudential oversight when evaluating its approach to swap
dealer regulation. However, where Congress clearly dictated that the
CFTC primarily regulate certain swap dealing activities, the
Commission cannot be so quick to completely defer.\24\ Indeed, it is
astonishing that the IDI De Minimis Provision lacks any requirements
to demonstrate compliance or adherence to the Provision with respect
to any particular swap or otherwise.\25\ As the current swap data
reporting rules (parts 43 and 45 of the Commission's regulations) do
not require IDIs or any entity to indicate whether a particular swap
is within the IDI Swap Dealing Exclusion or will be subject to the
IDI De Minimis Provision, the Commission will ultimately rely on its
enforcement authority to determine whether an IDI can demonstrate
why it is not required to register if its adjusted gross notional
[[Page 12471]]
amount of swap dealing activity appears to exceed the $8 billion
AGNA de minimis threshold. This cannot be the most efficient use of
anyone's resources.
---------------------------------------------------------------------------
\24\ Similarly, it is not clear to me that supplementary ISDA
protocols are an appropriate substitute for the customer protections
afforded under the external business conduct rules applicable to
swap dealers. See Final Rule, De Minimis Exception to the Swap
Dealer Definition--Swaps Entered into by Insured Depository
Institutions in Connection with Loans to Customers, section III.C.1.
(to be codified at 17 CFR pt. 1).
\25\ This seems inconsistent with the Commission's treatment of
exemptions in other registration categories. For example, CFTC
regulation 4.13(a)(3) provides an exemption from commodity pool
operator (CPO) registration for an operator that, among other
requirements, meets one of two ``de minimis'' tests with respect to
each individual pool for which it claims an exemption. To claim the
exemption, the CPO must file an initial electronic notice of
exemption with the National Futures Association. Thereafter, the CPO
must annually reaffirm its reliance on the exemption. See 17 CFR
4.13(b). Among other things, CFTC regulation 4.13(c) requires each
person who has filed a notice of exemption from registration to make
and keep records and submit to special calls by the Commission to
demonstrate compliance with the applicable criteria for the
exemption. In contrast, with regard to the IDI De Minimis Provision,
the Commission suggests that ``it would be good practice for an IDI
to note and track all loans for which the IDI De Minimis Provision
applies to be able to demonstrate'' compliance. Final Rule, De
Minimis Exception to the Swap Dealer Definition--Swaps Entered into
by Insured Depository Institutions in Connection with Loans to
Customers, section II.C.6.(iii) (to be codified at 17 CFR pt. 1).
---------------------------------------------------------------------------
Missed Opportunities and Alternatives
In its efforts to avoid improving the swap dealer definition for
the limited purpose of addressing longstanding concerns with the IDI
Swap Dealing Exclusion, the Commission missed an opportunity to
engage with the SEC and prudential regulators to strategically fix
those aspects of the Exclusion that fail to address the realities
and practicalities of the IDI swap activities connected to loan
origination, which Congress intended our agencies to address. In
reviewing the record, it is clear, for example, that the timing
parameters in subparagraph (i)(A) of the IDI Swap Dealing Exclusion
may be too restrictive and do not correspond to the reality of an
ongoing relationship between an IDI and a customer commonly
associated with loan origination. Historically, and in comments to
the IDI De Minimis Proposals, IDIs have provided compelling
arguments in support of permitting the termination date of a swap to
extend beyond the termination date of the related loan.\26\ The
Commission declined to include ``that much flexibility'' in the
duration requirement of IDI De Minimis Provision due to the added
complexity and potential for abuse.\27\ However, it seems that the
Commission could have sought--and may still seek--the expertise of
the prudential regulators to evaluate the merits of these arguments
for consideration in amending the IDI Swap Dealing Exclusion.
---------------------------------------------------------------------------
\26\ See, e.g. Swap Dealer De Minimis Exception Final Staff
Report at 17 (Aug.15, 2016), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@swaps/documents/file/dfreport_sddeminis081516.pdf; Final Rule, De Minimis Exception to
the Swap Dealer Definition--Swaps Entered into by Insured Depository
Institutions in Connection with Loans to Customers, section II. B.
4. (to be codified at 17 CFR pt. 1).
\27\ Id.
---------------------------------------------------------------------------
In response to Chairman Giancarlo's statement that Commission
staff would consider no-action relief for IDIs pending formal
Commission action on the proposal for the IDI De Minimis
Provision,\28\ the Commission received at least two requests. I
believe these requests presented opportunities for a consensus path
forward. Given current market uncertainties, data challenges, legal
risks, and ambitious policy changes, Commission staff could have:
(1) Granted temporary no-action relief consistent with the
parameters of the requests--none of which were so inconsistent with
the NPRM or policy considerations at issue as to raise additional
concerns; (2) committed to completing a data-driven, economic
analysis of the foreseeable impacts of the various requirements of
the IDI de Minimis Provision and any related systemic risks; and (3)
proceeded to engage with the SEC and prudential regulators towards a
joint rulemaking to amend the IDI Swap Dealing Exclusion as directed
by Congress.
---------------------------------------------------------------------------
\28\ 83 FR at 56690.
---------------------------------------------------------------------------
Conclusion
Albert Einstein said that, ``A clever person solves a problem. A
wise person avoids it.'' There is no doubt that the Commission was
clever in choosing to address longstanding concerns that the IDI
Swap Dealing Exclusion is unnecessarily restrictive, lacks clarity,
and limits the ability of IDIs to serve their loan customers through
the unilateral exercise of its authority with respect to the de
minimis exception. However, there is also little doubt in my mind
that being clever does not make one correct. The uncertainties
embodied in the IDI De Minimis Provision deprive IDIs and their
customers the legal certainty and clarity intended by Congress, and
may result in increased risk for market participants and uncertain
impact on systemic risk to the financial system. The Commission
would have been wise to avoid creating this rambling IDI exemption
that will now sit awkwardly beside the IDI Swap Dealing Exclusion in
the Commission regulations. These regulations are a marker of our
inability to engage and harmonize with our fellow regulators towards
a more practical and legally sound solution. As an independent
agency, the Commission should use its expertise to act within its
authority; and not abuse ill-defined powers to create loopholes. Our
agencies are better than that. And more importantly, our
stakeholders deserve it.
Appendix 5--Dissenting Statement of Commissioner Dan M. Berkovitz
I respectfully dissent from today's rulemaking, which excludes
from counting toward the de minimis threshold swaps entered into by
insured depository institutions (``IDIs'') in connection with loans
(``Final Rule'').
The Final Rule violates both substantive and procedural
provisions of the Dodd-Frank Act. Substantively, the unlimited
amount of swap dealing allowed under this provision is not the ``de
minimis quantity'' that Congress intended for the Commission to
permit without triggering swap dealer registration. Nor should such
an unlimited amount of unregistered dealing be permitted by the
Commission.
Procedurally, the Final Rule evades the requirement imposed by
Congress that the term ``swap dealer'' be defined or amended only
through joint rulemakings with the Securities and Exchange
Commission (``SEC''). The Final Rule expands the provision in the
swap dealer definition that provides that swaps entered into by an
IDI in connection with a loan are not considered swap dealing (``IDI
Swap Dealing Exclusion'').\1\ It does this not by amending the IDI
Swap Dealing Exclusion itself, but rather by awkwardly stuffing this
new expanded exclusion into the de minimis provision. The
transparent purpose of this drafting sleight-of-hand is to
circumvent the will of Congress that ``swap dealer'' be defined only
through joint rulemakings with the SEC.
---------------------------------------------------------------------------
\1\ 17 CFR 1.3, definition of Swap dealer, paragraph (5).
---------------------------------------------------------------------------
I am not opposed to considering reasonable, incremental changes
to the current IDI Swap Dealing Exclusion if they serve the intended
public policy goals and are accomplished in the manner prescribed by
law. The IDI Swap Dealing Exclusion effectively prevents swap dealer
registration from impeding the ability of IDIs to engage in limited
swap dealing as a part of their core loan origination business. But
experience has shown \2\ that some of the conditions in the IDI Swap
Dealing Exclusion may be too restrictive and are not achieving the
goals set by Congress.\3\
---------------------------------------------------------------------------
\2\ CFTC Staff Letter No. 18-20, No-Action Relief for Excluding
Certain Loan-Related Swaps from Counting toward the Swap Dealer
Registration De Minimis Threshold (``NAL 18-20'') (Aug. 28, 2018),
available at https://www.cftc.gov/sites/default/files/idc/groups/public/%40lrlettergeneral/documents/letter/2018-08/18-20.pdf.
\3\ For example, the time period within which swaps can be
entered into in connection with the loan may need to be expanded.
---------------------------------------------------------------------------
The Final Rule, however, is not a limited expansion of the IDI
Swap Dealing Exclusion that primarily will aid smaller banks, but
rather a wholesale expansion that primarily will benefit larger
banks. The provision is a wolf in sheep's clothing. In the guise of
helping small and mid-size banks, it opens the door for large banks
to undertake an unlimited amount of swap dealing with loan customers
without registering as swap dealers. This change both violates the
clear intent behind regulating swap dealers and carelessly
introduces risk into the financial system by allowing non-de minimis
unregulated swap dealing.
I am concerned that smaller banks will be negatively impacted by
the Final Rule. The larger banks that will benefit most from this
rule--likely large regional and some national commercial banks--
compete with smaller banks for loan business from main street
companies. The larger institutions have the resources to develop
expansive swap dealing capabilities. The smaller banks, which
typically operate in one state and may only have a few branches, do
not have the resources to establish competitive swap businesses. The
larger banks that do may crowd out their smaller brethren. The end
result could be less competition and more concentration in local
lending markets.
I. Not De Minimis Swap Dealing By Any Measure
A. No Limit on Notional Amount of Swap Activity
In defining the term ``swap dealer,'' Congress directed the CFTC
and the SEC to jointly further define swap dealer (more on that
later), and excepted from registration entities engaging in a de
minimis quantity of swap dealing. CEA section 1a(49)(D) provides:
The Commission shall exempt from designation as a swap dealer an
entity that engages in a de minimis quantity of swap dealing in
connection with transactions with or on behalf of its customers. The
Commission shall promulgate regulations to establish factors with
respect to the making of this determination to exempt.\4\
---------------------------------------------------------------------------
\4\ 7 U.S.C. 1a(49)(D) (emphasis added).
---------------------------------------------------------------------------
The CTFC, together with the SEC, jointly further defined the
term ``swap dealer.'' \5\ As directed, the Commissions created
paragraph (4), dedicated solely to establishing the de
[[Page 12472]]
minimis quantity of swap dealing activity in which an entity may
engage without having to register as a swap dealer (the ``De Minimis
Exception'').\6\
---------------------------------------------------------------------------
\5\ 17 CFR 1.3, definition of Swap dealer.
\6\ 17 CFR 1.3, definition of Swap dealer, paragraph (4).
---------------------------------------------------------------------------
In November 2018, the Commission unanimously approved setting
this maximum de minimis quantity threshold at $8 billion. This $8
billion threshold basically applied to all types of dealing swaps.
Now, less than four months later, the Final Rule removes this
threshold limitation for one particular class of swaps--swaps
entered into by IDIs with customers in connection with loans. Under
the Final Rule, an IDI can enter into an unlimited quantity of swaps
with its borrowers and not be required to register as a swap
dealer.\7\ That is not what Congress intended when it provided an
exemption from registration for a ``de minimis quantity of swap
dealing.''
---------------------------------------------------------------------------
\7\ In the preamble to the Final Rule, the Commission
acknowledges that having no relationship to the loan amount is
problematic. When discussing the 5% minimum on syndicated loan
participations, the Commission rejects commenters' requests to
remove the minimum on the grounds that allowing IDIs with an
``immaterial `connection' to the loan (such as $0.01)'' would be
inappropriate. See Final Rule, Preamble at 40. Yet the Commission
sees no such minimum connection required for loans made directly by
an IDI. Although the sham provision in the Final Rule would
hopefully prevent this from happening in the worst cases, any
meaningful loan amount likely would not be viewed as a sham.
---------------------------------------------------------------------------
The preamble to the Final Rule reveals the true nature of the
new ``IDI De Minimis Provision.'' It is an unlimited exclusion from
counting towards dealing, rather than a de minimis provision that
counts the amount of swaps against a pre-defined maximum limit
(i.e., a de minimis quantity as specified by the statute). The
preamble states, ``[a]ny swap that meets the requirements of the IDI
Swap Dealing Exclusion would also meet the requirements of the IDI
De Minimis Provision.'' \8\ This conflation of the two provisions
makes it clear that the Final Rule is in fact a full exclusion. A
so-called ``de minimis'' exception for a particular class of swaps
that does not contain a numerical limit on the quantity of swaps
excepted amounts to a full exclusion of that class of swaps.
---------------------------------------------------------------------------
\8\ Final Rule, Preamble at section II.A.1.
---------------------------------------------------------------------------
The Commission provides no distinct rationale separate from the
purpose for the IDI Swap Dealing Exclusion for why the $8 billion
aggregate threshold it enacted four months ago is no longer
applicable to these swaps executed by IDIs. Although a federal
agency has the discretion to change its rules and regulations in
light of new information, the agency must provide a reasoned
explanation for a change in course.\9\ It must study the problem
before it issues the regulation.\10\ Here, the Commission has
provided no reasoned explanation for why this particular class of
swaps presents any different or lesser risk than any other type of
swap that is subject to a numerical aggregate limit. The Commission
has not provided any analysis or reasoned estimate of the aggregate
amount of swap dealing activity that would be excluded under the new
IDI De Minimis Provision. In the absence of any estimate of the
aggregate amount of activity that would be excluded under this new
provision, it is arbitrary for the Commission to declare that such
activity can be considered ``de minimis.''
---------------------------------------------------------------------------
\9\ See, e.g., New York v. United States Dep't of Commerce, 351
F. Supp. 3d 502, 518 (S.D.N.Y. 2019) (``[T]he [Administrative
Procedure Act (``APA'')] does not say . . . that an agency cannot
adopt new policies or otherwise change course. But the APA does
require that before an agency does so, it must consider all
important aspects of a problem; study the relevant evidence and
arrive at a decision rationally supported by that evidence; comply
with all applicable procedures and substantive laws; and articulate
the facts and reasons--the real reasons--for that decision.'').
\10\ Id. As noted below, in this instance the Commission has
committed to study the issue after it issues the regulation.
---------------------------------------------------------------------------
In explaining this shift, the preamble to the Final Rule
introduces a ``qualitative'' standard, which it asserts meets
Congress's requirement that the CFTC define a de minimis
``quantity'' of swap dealing.\11\ It suggests that ``not all de
minimis factors [shall] be stated in numerical terms, so long as the
impact on the regulatory scheme for [swap dealers] is sufficiently
modest.'' \12\ The preamble then claims that the amount of swap
dealing that will be permitted by the Final Rule can be considered
de minimis because it is ``sufficiently modest in light of the total
size, concentration and other attributes of the applicable markets''
and ``would not appreciably affect the systemic risk, counterparty
protection, and market efficiency considerations of regulation.''
\13\
---------------------------------------------------------------------------
\11\ See Final Rule, Preamble at section II.B.7.
\12\ Id. at section II.B.7, see also id. at section II.B.
(citing SD Adopting Release) (reiterating the conclusion reached in
the preamble to the SD Adopting Release that ``[t]he de minimis
exception should allow amounts of swap dealing activity that are
sufficiently small that they do not warrant registration to address
concerns implicated by SD regulations.'') (emphasis added).
\13\ Id. at section II.B.
---------------------------------------------------------------------------
This rationale is deficient for several reasons. First, the
Commission has presented no quantitative estimate of the total
amount of swap dealing, either by IDIs singly or by all IDIs in the
aggregate, that could be excluded from swap dealing regulation under
the Final Rule.\14\ The Commission has presented data only on the
current amount of IDI loan-related activity that would fall under
the IDI Swap Dealing Exclusion provision in the Final Rule.\15\ In
the absence of any estimate as to the additional amount of swap
dealing that would be excluded under the Final Rule, the Commission
has no basis to conclude the total excluded amount of swap dealing
is ``sufficiently modest,'' whether on an absolute or relative
basis, for any particular IDI, or all IDIs in the aggregate. To
address this problem, the preamble states that the Commission's
Office of the Chief Economist will, within three years, study
whether the swaps should be capped to qualify for the de minimis
provision. This approach is tantamount to studying where the cows
have gone after opening the barn door.
---------------------------------------------------------------------------
\14\ The de minimis clause in the statute references a de
minimis quantity by ``an entity,'' not in the aggregate across the
entire industry.
\15\ As part of its comment letter, the American Bankers
Association (ABA) submitted an analysis prepared by NERA Economic
Consulting, ``Cost-Benefit Analysis of the CFTC's Swap Dealer De
Minimis Exception Definition.'' NERA estimated that removing the
date restrictions on the IDI Exclusion would result in an additional
15% of swaps transaction notional volume. NERA did not provide an
estimate of the increase in volume that would result from the
``permissible'' expansion of the provision to include swaps to hedge
the borrower's business risks that may affect the borrower's ability
to repay the loan, which is discussed in the next section.
---------------------------------------------------------------------------
Second, this approach is inconsistent with the approach taken
four months ago in the de minimis rule, where the Commission
determined that registration was warranted for entities engaged in
$8 billion or more of swap dealing activity. This Final Rule will
allow an entity to engage in more than $8 billion of swap dealing
activity, yet not register as a swap dealer. The rationale that is
proffered in today's rulemaking--that the total amount of
unregistered dealing that will be permitted is modest in light of
the total size of the market--was rejected in the prior de minimis
rulemaking when suggested by commenters who advocated raising the de
minimis level to $20 billion, $50 billion, or $100 billion.\16\ To
the extent that the Commission relies on policy considerations based
on the IDI Swap Dealing Exclusion for excluding IDI swaps from
counting as dealing swaps, then the policy exception appropriately
belongs as part of that IDI Swap Dealing Exclusion--which must be
accomplished through joint rulemaking.
---------------------------------------------------------------------------
\16\ Adopting Release, De Minimis Exception to the Swap Dealer
Definition, 83 FR 56666, 56677-56678 (Nov. 13, 2018).
---------------------------------------------------------------------------
The preamble to the Final Rule further states that the amendment
``(1) supports a clearer and more streamlined application of the De
Minimis Exception; (2) provides greater clarity regarding which
swaps need to be counted towards the [notional] threshold; and (3)
accounts for practical considerations relevant to swaps in different
circumstances.'' \17\ Yet the Final Rule does none of these things.
The Final Rule replaces one IDI provision with two--an IDI Swap
Dealing Exclusion, which excludes swaps from being considered
dealing, and a new IDI De Minimis Provision, which considers the
swaps as dealing but then says that if the swaps meet various
criteria and conditions, they don't count toward the de minimis
threshold. Is that more clear or streamlined? I don't think so.
---------------------------------------------------------------------------
\17\ Final Rule, Preamble at section II.
---------------------------------------------------------------------------
B. Contrary to Swap Dealer Registration Requirements and De Minimis
Exception
The Final Rule fails to advance the policy goals set forth in
the Dodd-Frank Act for regulating swap dealers. Congress recognized
that over the counter swaps contributed significantly to the 2008
financial crisis.\18\ In the Dodd-Frank Act Congress directed the
CFTC to implement a regime of swap dealer
[[Page 12473]]
registration and regulation to manage the risks arising from swap
dealer activities.
---------------------------------------------------------------------------
\18\ See generally Financial Crisis Inquiry Report: Final Report
of the National Commission on the Causes of the Financial and
Economic Crisis in the United States, Financial Crisis Inquiry
Comm'n (2010).
---------------------------------------------------------------------------
The Commission has adopted a variety of requirements to
implement this statutory mandate.\19\ CFTC swap dealer regulations
require registered swap dealers to have detailed risk management
programs for their swap activities; pay or collect both initial and
variation margin to offset exposures on swaps; must follow numerous
customer facing rules such as providing disclosures and meeting swap
documentation requirements; and must follow numerous internal
business conduct standards designed to reduce risk, increase
transparency and protect counterparties.
---------------------------------------------------------------------------
\19\ See 17 CFR part 23.
---------------------------------------------------------------------------
None of these requirements or market protections will apply to
an unregistered IDI engaged in loan-related swap dealing under the
Final Rule, no matter how much loan-related swap dealing is done by
the IDI. It is entirely possible that IDIs that are currently
registered as swap dealers may de-register and then continue to
conduct their loan-related dealing activities in an unregistered
status under this exception.
To appreciate how the Final Rule undermines the current
regulatory structure, consider the extensive swaps activity an IDI
will be able to undertake under the Final Rule. Let's start with
subparagraph (4)(i)(C)(2)(i).
Subparagraph (4)(i)(C)(2)(i) states:
Relationship of swap to loan. The rate, asset, liability or
other term underlying such swap is, or is related to, a financial
term of such loan, which includes, without limitation, the loan's
duration, rate of interest, the currency or currencies in which it
is made and its principal amount. . . .
Although this provision is essentially identical to the
completely separate paragraph (5)(B)(1) of the existing IDI Swap
Dealing Exclusion, the notional value of swaps entered into under
that Exclusion in connection with originating a loan currently is
capped at 100% of the amount of the loan outstanding. Under the
Final Rule, there is no cap. Therefore, under subparagraph
(4)(i)(C)(2)(i), an IDI could enter into an interest rate swap, a
currency swap, and a swap that effectively changes the duration of
the loan, and each one could have a notional amount greater than the
amount of the loan.
Furthermore, the language of the Final Rule could be read to
permit an IDI to offer unlimited swaps to the borrower so long as
they meet the loose standard of being ``related to a financial term
of such loan.'' This standard could potentially allow a host of
other types of swaps that can be quite sophisticated in nature. For
example, under the Final Rule, a loan customer could enter into a
yield curve flattener or steepener swap for the rate on the loan in
addition to the other swaps, or could execute many swaps over time
on relative changes in the payment currencies for the loan with no
notional amount limit.\20\ The IDI and borrower could enter into
swaps with notional amounts that are multiples of the amount of the
loan. There is no limit; it could be ten times the loan amount or
more. These swaps can be executed at any time between the signing of
a commitment for the loan and the maturity date for the loan.
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\20\ Thankfully, the majority has clarified that swaps for
speculative and investment purposes would not be includable under
paragraph (4)(i)(C)(2). See Final Rule, Preamble at section II.B.3.
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Turning to subparagraph (4)(i)(C)(2)(ii), it states:
Relationship of swap to loan. . . . Such swap is permissible
under the insured depository institution's loan underwriting
criteria and is commercially appropriate in order to hedge risks
incidental to the borrower's business (other than for risks
associated with an excluded commodity) that may affect the
borrower's ability to repay the loan.\21\
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\21\ Note that this paragraph is expressly limited to hedging
swaps. The lack of such language in paragraph (4)(C)(2)(i)
illustrates that non-hedging swaps are intended to be permitted
under that provision.
Subparagraph (4)(i)(C)(2)(ii) omits the language that is in the
existing IDI Swap Dealing Exclusion that the swaps must be
``required'' as a condition of the loan, which provides a clear
connection to the origination of the loan. Instead, under
subparagraph (4)(i)(C)(2)(ii) of the Final Rule, the swaps must
merely be (1) permissible under the IDI's loan underwriting
criteria, and (2) commercially reasonable to hedge risks incidental
to the borrower's business that may affect the ability to repay the
loan.
Under this provision, any legal swap related to a risk that is
not an excluded commodity; that is not expressly prohibited in the
IDI's loan underwriting criteria; and that is a hedge of any risk
incidental to the business that arises at any time subsequent to
entering into the loan, would not be counted toward the de minimis
threshold. There also is no requirement that the amount of these
types of hedging swaps bear any rational relationship to the
outstanding amount of the loan. As an example, an IDI could make a
ten-year $10 million loan to an airline and then, two years later,
enter into a five-year jet fuel swap with the airline for a notional
amount of $5 billion. Similarly, an IDI could make a loan to an
integrated oil and gas company for the construction of a new office
building, and then enter into commodity swaps, without limit, to
hedge the company's global oil and gas exploration, production and
sales. Because these risks are incidental to the borrower's business
and could affect its ability to repay its obligations, including the
loans, under the Final Rule none of these swaps would be counted
toward the de minimis threshold.
In addition, the Final Rule is not limited to IDIs with
commercial end-user customers. An IDI can claim the exception for
swaps in connection with loans to financial entities customers such
as hedge funds and commodity pools, among others.
In response to the above analysis of paragraphs (4)(i)(C)(2)(i)
and (ii), it may be asserted that most IDIs primarily offer loans to
commercial firms, not financial firms, and would enter into hedging
swaps only in very limited amounts directly related to the amounts
of the loans. If, indeed, this is standard commercial practice and
sound risk management by IDIs, then I would prefer the CFTC's
regulation to reflect such sound risk management practices rather
than rely on the self-restraint of IDIs to limit their loan-related
swap risks. This is the fundamental purpose of swap dealer
regulation. We have learned our lesson the hard way that industry
self-regulation does not always work.
C. No Demonstrated Need for This Provision
The Final Rule goes beyond what IDIs have stated they need. In
response to the question in the notice of proposed rulemaking \22\
as to whether the aggregate notional amount of loan-related swaps
could exceed the amount of the loan, a few commenters described
specific circumstances regarding loans where swaps could exceed the
outstanding amount of the loan.\23\ The circumstances presented were
very limited and involved construction or other types of loans in
which the full loan amount is disbursed in increments over time, but
an interest rate swap is executed at the initial disbursement in a
notional amount equal to the full amount of the loan.\24\ The Final
Rule presents no actual facts, data, or comments justifying the
removal of the notional amount cap in the IDI Swap Dealing
Exclusion, particularly in the context of the de minimis swap
dealing provision.
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\22\ Notice of proposed rulemaking, De Minimis Exception to the
Swap Dealer Definition, 83 FR 27444 (June 12, 2018) (``Proposal'').
\23\ See, e.g., comment letter from Citizens Financial Group,
Inc., at 6 (Aug. 10, 2018); comment letter from Capital One
Financial Corporation, at 3 (Aug. 13, 2018) (``[A] customer may
enter a forward starting swap to hedge future draws under a loan. In
these cases, the notional amount of the forward starting swap will
exceed the principal amount of the loan until future draws are made
on that loan.''); and comment letter from M&T Bank, at 3 (Aug. 10,
2018) (``This circumstance could arise in construction lending when
the project had not advanced sufficiently such that the loan was
fully funded, yet the loan had been hedged with a forward-starting
or accreting interest rate swap having a notional amount that
anticipated the future and higher loan balance.''). These and other
comment letters submitted in response to the Proposal are available
at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=2885.
\24\ See Final Rule, Preamble, section II.B.6.
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In fact, the record before the Commission in this rulemaking is
to the contrary. As previously noted, comments to the Proposal
informed the Commission of limited circumstances in which the
notional amount of interest rate swaps could exceed the outstanding
amount of a loan, not the full amount of the loan. The preamble to
the Final Rule does not address why it is necessary for the rule to
go beyond the circumstances presented by the commenters, in response
to a specific request by the Commission for any such information.
Additionally, the no-action relief currently in effect for one
IDI pertaining to swap activity in connection with originating a
loan contains several significant limitations that are not found in
the Final Rule.\25\ Two of the specific restrictions in NAL-18-20
are: (1) The client of the IDI ``must be a small or medium-sized
commercial entity, which for purposes of the relief is an entity
with annual
[[Page 12474]]
revenues of under $750 million''; and (2) the aggregate amount of
the loans that can be excluded under the relief may not exceed $1.5
billion at any time during the relief period.\26\ In other words,
NAL-18-20 provides a cap of $1.5 billion on the aggregate notional
amount of IDI loan-related swaps permitted by the letter that may be
outstanding at any one time. There is no indication in the public
record that the IDI operating under NAL-18-20 is unduly constrained
by these limitations.
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\25\ See NAL-18-20.
\26\ Id.
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II. Joint Rulemaking Is Required
In addition to its various substantive infirmities, I cannot
vote today to adopt this rule because it violates a mandate from
Congress to define the term ``swap dealer'' jointly with the SEC. By
wholly excluding all IDI De Minimis Provision swaps from counting
towards the de minimis threshold, the CFTC is in effect amending the
definition of the term ``swap dealer.'' Under our Congressional
mandate, neither the CFTC nor the SEC can alone amend this
definition.\27\ For the reasons discussed below, the Final Rule may
not be adopted unilaterally by the CFTC.
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\27\ The heads of the two agencies are also not free to decide
between themselves when joint rulemaking is required. See Joint
Statement from Chairmen Giancarlo and Clayton on the IDI Exception
to the Swap Dealer Definition (Dec. 13, 2018), https://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement121318; see also Bd.
of Trade of City of Chicago v. SEC, 677 F.2d 1137, 1142 n.8 (7th
Cir. 1982) (``While this case was pending, the CFTC and SEC filed
with us a copy of a news release announcing their provisional
agreement purportedly resolving the jurisdictional dispute at issue
in this case. . . . Although Congress has provided that the CFTC
`maintain communications' with the SEC regarding CFTC activities
that `relate' to SEC responsibilities . . . and that the CFTC `may
cooperate' with the SEC . . . the two agencies cannot thereby
enlarge or relinquish their statutory jurisdictions. . . . The role
of the agencies remains basically to execute legislative policy;
they are no more authorized than are the courts to rewrite acts of
Congress.'')
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A. Congressional Definition of ``Swap Dealer''
Congress recognized that implementing the Dodd-Frank Act could
only be accomplished with coordination amongst the multiple federal
financial agencies involved. Title VII of the Dodd-Frank Act
directed these financial agencies to consult with one another and,
in specific circumstances, engage in joint rulemaking.\28\
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\28\ See, e.g., Dodd-Frank Act, Hearing on H.R. 4173, H.R. Rep.
No. 111-517 at 358 (June 24, 2010) (Senator Gregg: ``[W]e should try
and push these various entities to joint activity because they have
such overlap in their responsibilities. So to get the SEC and the
CFTC and the Federal Reserve in the same room on these issues is
really critical.''); id. at 357 (Senator Reed: [I]f . . . [the CFTC]
decides a swap is different than what it is today, then that changes
definitions that have been jointly arrived at, or definitions or
jurisdiction or responsibility to the SEC.'').
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The direction from Congress is clear that the term ``swap
dealer'' must be defined jointly by the CFTC and SEC, and that any
amendments to that definition must be accomplished through joint
rulemaking as well. Section 712(d)(1) of the Dodd-Frank Act
specifies that the CFTC and the SEC--jointly, and in consultation
with the Board of Governors--``shall further define'' the term
``swap dealer,'' among others. Section 712(d)(2) provides that the
CFTC and SEC must jointly adopt ``such other rules regarding such
definitions'' as the CFTC and SEC determine are necessary, in the
public interest, and for the protection of investors.
B. Joint Definition of ``Swap Dealer''
In accordance with Section 712(d)(1), the CFTC and the SEC
jointly adopted the CFTC Regulation further defining the term swap
dealer, among other terms. As directed by CEA section 1a(49)(D), the
Commissions together drafted paragraph (4)--the De Minimis
Exception--to establish the quantity of swap dealing activity in
which a person may engage without having to register as a swap
dealer.\29\ Although implemented jointly, the Commissions provided
that the CFTC, alone, could ``by rule or regulation change the
requirements of the De minimis exception described in paragraphs
(4)(i) through (iv) of this definition.'' \30\ The two Commissions
also adopted paragraph (5), the IDI Swap Dealing Exclusion.\31\
Unlike paragraph (4), the IDI Swap Dealing Exclusion in paragraph
(5) does not contain any language permitting the CFTC to amend it
unilaterally.
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\29\ 17 CFR 1.3, definition of Swap dealer, paragraph (4).
\30\ 17 CFR 1.3, definition of Swap dealer, paragraph (4)(v)
(emphasis added).
\31\ 17 CFR 1.3, definition of Swap dealer, paragraph (5).
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C. Inconsistent With Congressional Intent
Today, the Commission majority evades the joint rulemaking
requirement by improperly shoehorning changes to the IDI Swap
Dealing Exclusion, which cannot be done singly, into the De Minimis
Exception. A comparison of the Final Rule text with that of
paragraph (5) confirms that the new IDI De Minimis Provision is an
amendment to the IDI Swap Dealing Exclusion under another name.\32\
The preamble to the Final Rule explicitly acknowledges that ``any
swap that meets the requirements of the IDI Swap Dealing Exclusion
would also meet the requirements of the IDI De Minimis Provision.''
\33\ But calling it a different name--i.e., de minimis--does not
alter its essential nature as an exclusion for IDI swaps.
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\32\ The Final Rule adds a section to the De Minimis Exception
that tracks the precise structure and language of paragraph (5)'s
IDI Swap Dealing Exclusion, only it revises key words that
significantly broaden the exclusion.
\33\ Final Rule, Preamble at section II.A.2.
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This drafting hocus-pocus is inconsistent with the CEA, which
requires changes to the IDI exclusion to be accomplished through
joint rulemakings with the SEC.\34\
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\34\ The Commission majority's intent to use the de minimis
provision as an end-run around the joint rulemaking requirement is
evident from the language in the Proposal. The Proposal states:
``The Commission is not at this time proposing to amend the IDI Swap
Dealing Exclusion in paragraph (5) of the SD Definition. As
discussed above, pursuant to requirements of section 712(d)(1) of
the Dodd-Frank Act, the CFTC and SEC jointly adopted the IDI Swap
Dealing Exclusion in paragraph (5) as part of the definition of what
constitutes swap dealing activity. Rather than proposing to revise
the scope of activity that constitutes swap dealing, the Commission
is proposing to amend paragraph (4) of the SD Definition, which
addresses the de minimis exception.'' Proposal, 83 FR at 27458-59.
The Commission then makes it abundantly clear that this de minimis
exception is in fact an expansion of the IDI Swap Dealing Exclusion:
``The IDI De Minimis Provision would have requirements that are
similar to the IDI Swap Dealing Exclusion, but would encompass a
broader scope of loan-related swaps.'' Id. at 27459.
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The preamble claims that this legerdemain is permissible because
the amendments are only ``factors'' for determining which swaps need
to be counted towards an IDI's de minimis calculation \35\ and the
CFTC may unilaterally set such ``factors.'' This is a smokescreen.
The CFTC may only promulgate regulations individually to ``establish
factors with respect to the making of this determination to
exempt.'' The words ``this determination'' refer to the quantity
determination in the preceding sentence of the subsection: ``[t]he
Commission shall exempt from designation as a swap dealer an entity
that engages in a de minimis quantity of swap dealing in connection
with transactions with or on behalf of its customers.'' \36\ In
other words, the ``factors'' referred to in the second sentence are
factors to be used by the Commission to determine the numerical
quantity for the exemption created in the first sentence. The
direction to establish factors does not create a distinct directive
authorizing the CFTC to independently determine what constitutes
swap dealing.\37\ If it did, the de minimis provision could swallow
the whole swap dealer definition.
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\35\ Final Rule, Preamble at section II.A.2.
\36\ 7 U.S.C. 1a(49)(D).
\37\ See also Statement of Commissioner Dan M. Berkovitz, De
Minimis Exception to the Swap Dealer Definition, 83 FR 56666, 56692-
93 (Nov. 13, 2018).
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For these reasons, the De Minimis Exception to the swap dealer
definition is an improper vehicle through which to expand the type
of IDI swaps that are considered to have been made in connection
with originating loans to a customer. This expansion can be done
only through a joint rulemaking with the SEC.
D. Lack of Consultation
The failure to adopt the Final Rule jointly is not the only
procedural defect. Section 712(a)(1) of the Dodd-Frank Act also
requires that prior to the commencement of any rulemaking, the
``Commission'' shall ``consult and coordinate'' to the extent
possible with the SEC and the prudential regulators to ensure the
consistency and comparability that Congress envisioned when creating
the new swap regulatory framework. The preamble to the Final Rule
claims that the ``Commission'' consulted with the SEC and the
prudential regulators during the preparation of this adopting
release.\38\ However, the ``Commission'' is a five-member body, each
member of which votes to approve CFTC rulemakings, enforcement
actions, and other activities as specified by
[[Page 12475]]
the CEA. The Commission itself was not informed of, and did not
participate in, the substantive contents of any such consultation in
connection with this rulemaking. This does not appear to conform
with the spirit of the Dodd-Frank consultation requirement.
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\38\ Final Rule, Preamble at section II.B.7.
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III. Conclusion
Voltaire famously commented ``[t]his body which was called and
which still calls itself the Holy Roman Empire was in no way holy,
nor Roman, nor an empire.'' \39\ Likewise, the provision that the
Commission majority calls the ``IDI De Minimis Provision'' is not an
IDI Provision and is in no way de minimis.
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\39\ Voltaire, ``An essay on universal history, the manners, and
spirit of nations, from the reign of Charlemaign to the age of Lewis
XIV,'' Chapter 70 (1756).
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Following the rule of law is critical to maintaining a robust,
safe, and integrated financial regulatory system that inspires
confidence for both market participants and the public at large. The
rule of law applies no less to us as regulators than to the persons
we regulate. The Final Rule adopted by the Commission today is
inconsistent with the requirements of the Commodity Exchange Act for
the regulation of swap dealers and violates the Dodd-Frank Act as to
the process for amending those regulations. I therefore dissent.
[FR Doc. 2019-06109 Filed 3-29-19; 8:45 am]
BILLING CODE 6351-01-P