2012-16496

Federal Register, Volume 77 Issue 134 (Thursday, July 12, 2012)[Federal Register Volume 77, Number 134 (Thursday, July 12, 2012)]

[Proposed Rules]

[Pages 41213-41242]

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

[FR Doc No: 2012-16496]

[[Page 41213]]

Vol. 77

Thursday,

No. 134

July 12, 2012

Part II

Commodities Futures Trading Commission

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17 CFR Part 1

Cross-Border Application of Certain Swaps Provisions of the Commodity

Exchange Act; Proposed Rule

Federal Register / Vol. 77 , No. 134 / Thursday, July 12, 2012 /

Proposed Rules

[[Page 41214]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Chapter I

RIN 3038-AD57

Cross-Border Application of Certain Swaps Provisions of the

Commodity Exchange Act

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed interpretive guidance and policy statement.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

``CFTC) is publishing for public comment this proposed interpretive

guidance and policy statement regarding the cross-border application of

the swaps provisions of the Commodity Exchange Act (``CEA'') that were

enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer

Protection Act, and the Commission's regulations promulgated

thereunder. Specifically, this proposed interpretive guidance and

policy statement describes the following: The general manner in which

the Commission will consider whether a person's swap dealing activities

or swap positions may require registration as a swap dealer or major

swap participant, respectively, and the application of the related

requirements under the CEA to swaps involving such persons; and the

application of the clearing, trade execution, and certain reporting and

recordkeeping provisions under the CEA, to cross-border swaps involving

one or more counterparties that are not swap dealers or major swap

participants. This proposed interpretive guidance and policy statement

also generally describes the policy and procedural framework under

which the Commission may permit compliance with a comparable regulatory

requirement of a foreign jurisdiction to substitute for compliance with

the requirements of the CEA.

DATES: Comments must be received on or before August 27, 2012.

ADDRESSES: You may submit comments, identified by RIN number 3038-AD57,

by any of the following methods:

The agency's Web site: at http://comments.cftc.gov. Follow

the instructions for submitting comments through the Web site.

Mail: David A. Stawick, Secretary of the Commission,

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

Street NW., Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments.

Please submit your comments using only one method.

All comments must be submitted in English, or if not, accompanied

by an English translation. Comments will be posted as received to

www.cftc.gov. You should submit only information that you wish to make

available publicly. If you wish the Commodity Futures Trading

Commission to consider information that you believe is exempt from

disclosure under the Freedom of Information Act, a petition for

confidential treatment of the exempt information may be submitted

according to the procedures established in Sec. 145.9 of the

Commission's regulations.\1\

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\1\ 17 CFR 145.9.

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Throughout this proposed interpretive guidance, the Commission

requests comment in response to specific questions set out herein. For

convenience, the Commission has numbered each of these requests for

comment. The Commission asks that, in submitting responses to these

requests for comment, commenters kindly identify the specific number of

each request to which their comments are responsive.

The Commission reserves the right, but shall have no obligation, to

review, pre-screen, filter, redact, refuse or remove any or all of your

submission from www.cftc.gov that it may deem to be inappropriate for

publication, such as obscene language. All submissions that have been

redacted or removed that contain comments on the merits of the proposal

will be retained in the public comment file and will be considered as

required under the Administrative Procedure Act \2\ and other

applicable laws, and may be accessible under the Freedom of Information

Act.\3\

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\2\ 5 U.S.C. 551, et seq.

\3\ 5 U.S.C. 552.

FOR FURTHER INFORMATION CONTACT: Carlene S. Kim, Assistant General

Counsel, Office of General Counsel, (202) 418-5613, [email protected]; Gary

Barnett, Director, Division of Swap Dealer and Intermediary Oversight,

(202) 418-5977, [email protected]; Jacqueline H. Mesa, Director, Office

of International Affairs, (202) 418-5386, [email protected]; Commodity

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

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NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. The Dodd-Frank Wall Street Reform and Consumer Protection Act

B. Scope of the Proposed Interpretive Guidance and Policy

Statement

II. Consideration of Whether a Non-U.S. Person Is a Swap Dealer or

Major Swap Participant

A. Analysis of Section 2(i)

B. Interpretation of the Term ``U.S. Person''

C. Definitions and Registration Thresholds

1. Background

2. Swap Dealer

i. Aggregation of Swaps

ii. Regular Business

3. Major Swap Participant

i. Aggregation of Positions

4. Relevance of Guarantees

5. Summary

D. Branches, Agencies, Affiliates and Subsidiaries of U.S. Swap

Dealers and U.S. Branches, Agencies, Affiliates, and Subsidiaries of

Non-U.S. Swap Dealers

III. Cross-Border Application of the CEA's Swap Provisions

A. Principles of International Comity

B. Application of Swap Provisions to Non-U.S. Swap Dealers and

Foreign Branches, Agencies, Subsidiaries and Affiliates of U.S. Swap

Dealers

1. Regulatory Categories

2. Entity-Level Requirements

i. Capital Requirements

ii. Chief Compliance Officer

iii. Risk Management

iv. Swap Data Recordkeeping

v. Swap Data Reporting

vi. Physical Commodity Swaps Reporting

3. Transaction-Level Requirements

i. Clearing and Swap Processing

ii. Margin and Segregation Requirements for Uncleared Swaps

iii. Mandatory Trade Execution

iv. Swap Trading Relationship Documentation

v. Portfolio Reconciliation and Compression

vi. Real-Time Public Reporting

vii. Trade Confirmation

viii. Daily Trading Records

ix. External Business Conduct Standards

4. Application of the Entity-Level Requirements

5. Application of the Transaction-Level Requirements

i. Clearing and Swap Processing, Margin (and Segregation), Trade

Execution, Swap Trading Relationship Documentation, Portfolio

Reconciliation and Compression, Real-Time Public Reporting, Trade

Confirmation, and Daily Trading Records

ii. External Business Conduct Standards

C. Substituted Compliance

1. Entity-Level Requirements

2. Transaction-Level Requirements

D. Application of Entity-Level and Transaction-Level

Requirements to Branches, Agencies, Affiliates, and Subsidiaries of

U.S. Swap Dealers

1. Foreign Branches and Agencies of U.S. Swap Dealers

2. Foreign Affiliates and Subsidiaries of U.S. Swap Dealers

IV. Process for Comparability Determinations

A. Overview

1. Scope of Review

[[Page 41215]]

2. Process

3. Clearing

V. Cross-Border Application of the CEA's Swap Provisions to

Transactions Involving Other (Non-Swap Dealer and Non-MSP) Market

Participants

A. Cross-Border Transactions With U.S. Persons

B. Clearing, Trade Execution, Real-Time Public Reporting, Large-

Trader Reporting, SDR Reporting, and Swap Data Recordkeeping

I. Background

A. The Dodd-Frank Wall Street Reform and Consumer Protection Act

In the fall of 2008 a series of large financial institution

failures triggered a financial and economic crisis that threatened to

freeze U.S. and global credit markets. As a result, unprecedented

governmental intervention was required to ensure the stability of the

U.S. financial system.\4\ These failures revealed the vulnerability of

the U.S. financial system and economy to wide-spread systemic risk

resulting from, among other things, poor risk management practices of

financial firms, the lack of supervisory oversight for certain

financial institutions as a whole, and the interconnectedness of the

global swap business.\5\

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\4\ On October 3, 2008, President Bush signed the Emergency

Economic Stabilization Act of 2008, which was principally designed

to allow the U.S. Treasury and other government agencies to take

action to restore liquidity and stability to the U.S. financial

system (e.g., the Troubled Asset Relief Program--also known as

TARP--under which the U.S. Treasury was authorized to purchase up to

$700 billion of troubled assets that weighed down the balance sheets

of U.S. financial institutions). See Public Law 110-343, 122 Stat.

3765 (2008).

\5\ See Financial Crisis Inquiry Commission, ``The Financial

Crisis Inquiry Report: Final Report of the National Commission on

the Causes of the Financial and Economic Crisis in the United

States,'' Jan. 2011, at xxvii, available at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.

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American International Group (``AIG'') is a prime example of how

the stability of a large financial institution could be undermined by

its activities abroad and how the entire U.S. financial system could be

threatened as a result.\6\ AIG was a regulated U.S. insurance company

nearly undone by its collateral posting obligations under swaps entered

into by its subsidiary, AIG Financial Products (``AIGFP''). AIGFP was

headquartered in Connecticut and had major operations in London, with

trades routed through Banque AIG, a French bank. AIGFP suffered

enormous losses from credit default swaps that it issued on certain

underlying securities, which, because AIGFP's performance on such

credit default swaps had been guaranteed by its parent, caused credit

agencies to downgrade the credit rating of the entire AIG corporation.

The downgrade triggered collateral calls and resulted in a liquidity

crisis at AIG, which ultimately necessitated over $85 billion of

indirect assistance from the Federal Reserve Bank of New York to

prevent AIG's default.

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\6\ See, e.g., Gretchen Morgenson, ``Behind Insurer's Crisis,

Blind Eye to a Web of Risk,'' N.Y. Times, Sept. 27, 2008. Corrected

version published Sept. 30, 2008, available at http://www.nytimes.com/2008/09/28/business/28melt.html?pagewanted=all.

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The Lehman Brothers Holding Inc. (``LBHI'') bankruptcy offers

another stark lesson on how risks can spread quickly across the

affiliated entities of a multinational financial institution,

ultimately causing the collapse of the entire financial institution.

LBHI was a U.S.-based multinational corporation, with various

affiliates and subsidiaries operating globally, including Lehman

Brothers International (Europe) (``LBIE'').

The Lehman global business and operations relied on ``highly

integrated, trading and non-trading relationships across the group.''

\7\ The affiliates and subsidiaries within the group provided each

other with more than equity investments and capital. They provided each

other with treasury functions, custodial arrangements, depository

functions, trading facilitation, swaps, funding, management,

information technology and other operational services. Most notably,

many of LBIE's obligations under its swaps with certain counterparties

were guaranteed by the ultimate holding company, LBHI. In fact, at the

time of default, LBIE had an estimated 130,000 OTC derivatives trades

outstanding, most of which were guaranteed by LBHI.\8\

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\7\ ``The global nature of the Lehman business with highly

integrated, trading and non-trading relationships across the group

led to a complex series of inter-company positions being outstanding

at the date of Administration. There are over 300 debtor and

creditor balances between LBIE and its affiliates representing

$10.5B of receivables and $11.0B of payables as at September 15

2008.'' See Lehman Brothers International (Europe) in

Administration, Joint Administrators' Progress Report for the Period

15 September 2008 to 14 March 2009, available at: http://www.pwc.co.uk/assets/pdf/Ibie-progress-report-14049.pdf.

\8\ Id.

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There are other parallels. In the many events leading up to the

2008 crisis, Citigroup, like many other financial institutions,

utilized numerous structured investment vehicles (``SIVs'') to shift

certain activities off balance sheets and manage both capital

requirements and reported accounting.\9\ Citigroup stood behind these

vehicles through liquidity puts, a form of a guarantee. When the SIVs'

funding was exhausted, Citigroup ultimately assumed approximately $49

billion of debt directly onto its balance sheet.\10\ Similarly, in

2007, Bear Stearns found itself exposed to the failings of two overseas

hedge funds, Bear Stearns High-Grade Structured Credit Strategies

Master Fund, Ltd. and Bear Stearns High-Grade Structured Credit

Strategies Enhanced Leverage Master Fund, Ltd.\11\ The funds were

incorporated in the Cayman Islands as exempted liability companies,

with registered offices in the Cayman Islands. However, when the funds

collapsed under the weight of their significant investments in subprime

mortgages, Bear Stearns bailed out the funds.

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\9\ See, e.g., Andrew Bary, ``Of Citi and SIVs: Can Banks Plug

the Leak?,'' Barron's, Oct. 22, 2007, available at http://online.barrons.com/article/SB119284238641065650.html.

\10\ See, e.g., Financial Times, Citi launches $49bn SIV rescue

(Dec. 14, 2007), available at http://www.ft.com/intl/cms/s/0/6626b45e-a9dd-11dc-aa8b-0000779fd2ac.html#axzz1yMOOB81bMarketWatch MarketWatch.

Citigroup says it will absorb SIV assets (Dec. 14, 2007), available

at http://articles.marketwatch.com/2007-12-14/news/30679845_1_sivs-citigroup-ceo-vikram-pandit.

\11\ See In Re: Bear Sterns High-Grade Structured Credit

Strategies Master Funds, LTC, 374 B.R. 122 (Bankr. S.D.N.Y. 2007),

available at http://www.nysb.uscourts.gov/opinions/brl/158971_25_opinion.pdf.

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A decade before the AIG and Lehman collapses, a hedge fund advised

by Long-Term Capital Management L.P. (``LTCM'') nearly failed, leading

a number of creditors to provide LTCM substantial financial assistance

under the supervision of the Federal Reserve Bank of New York. LTCM was

based in Greenwich, Connecticut but managed trades in Long-Term Capital

Portfolio LP, a partnership registered in the Cayman Islands. This

hedge fund, with approximately $4 billion in capital and a balance

sheet of just over $100 billion, had a swap book in excess of $1

trillion notional. More recently, J.P. Morgan Chase & Co. (``J.P.

Morgan''), the largest U.S. bank, has disclosed a multi-billion dollar

trading loss stemming from its Chief Investment Office located in

London.\12\ The significant reported losses at J.P. Morgan are a

reminder of a key lesson from the failures of AIG and Lehman: A

regulatory gap or lapse within any part of a financial institution can

lead to the failure of the entire institution.

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\12\ See ``Lehman Brothers International (Europe) in

Administration, Joint Administrators' Progress Report for the Period

15 September 2008 to 14 March 2009,'' available at: http://www.pwc.co.uk/assets/pdf/Ibie-progress-report-14049.pdf.

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As these examples illustrate, corporate structures and inter-

affiliate obligations may cause the activity, regardless of where that

activity takes place, to have a direct and significant connection with

activities in, or effect

[[Page 41216]]

on, commerce in the U.S. In many of the largest financial institutions,

the overall business operates as a tightly integrated network of

business lines and services conducted through various branches or

affiliated legal entities which are under the unified management of the

parent entity.\13\ These large financial institutions effectively

operate their businesses as a single business, by virtue of the

relationship with the parent company and to each other, with the

constituent parts inextricably linked to each other. The interconnected

nature of the relationships among the affiliated entities within a

corporate group means that a risk in any part of this group, whether in

the United States or abroad, can quickly spread throughout the

organization and jeopardize the financial integrity of the entire

group.

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\13\ Typically, the various business lines and services--while

conducted out of separate legal entities--are highly integrated and

inter-dependent. Key strategic and operational decisions are

centralized and informed by the firm's global, group-wide

perspective. The individual legal entities affiliates and

subsidiaries share common corporate support functions, such as

treasury, custodial, brokerage and depository services and related

infrastructures. The affiliated entities within the corporate group

may also provide funding or credit support for each other and enter

into trades with each other. In large part, this consolidated

structure is necessary to allow the firm to address and manage

customer needs, funding opportunities, capital and other regulatory

requirements, financial accounting and tax planning, among other

things.

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Congress sought to address the deficiencies in the regulatory

system that contributed to the financial crisis through the enactment

of the Dodd-Frank Wall Street Reform and Consumer Protection Act

(``Dodd-Frank Act''), which was signed by President Obama on July 21,

2010.\14\ Title VII of the Dodd-Frank Act amended the CEA \15\ to

overhaul the structure and oversight of the over-the-counter

derivatives market that previously had been subject to little or no

oversight. One of the cornerstones of this legislation is the

establishment of a new statutory framework for comprehensive regulation

of financial institutions that participate in the swaps market as swap

dealers or major swap participants (``MSPs''), which must register and

are subject to greater oversight and regulation.\16\ A key goal of this

new framework for swap dealers and MSPs is to minimize the potential

for the recurrence of the type of financial and operational stresses

that contributed to the 2008 financial crisis.

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\14\ Public Law 111-203, 124 Stat. 1376 (2010). The text of the

Dodd-Frank Act may be accessed at http://www.cftc.gov/idc/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf.

\15\ 7 U.S.C. 1, et seq.

\16\ In this proposed interpretative guidance and policy

statement, the provisions of the CEA relating to swaps that were

enacted by Title VII of the Dodd-Frank Act are also referred to

herein as ``the Dodd-Frank requirements.''

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Efforts to regulate the swaps market are underway not only in the

United States, but also abroad in the wake of the 2008 financial

crisis. In 2009, leaders of the Group of 20 (``G20'') whose membership

includes the European Union (``EU''), the United States, and 18 other

countries--agreed that: (i) OTC derivatives contracts should be

reported to trade repositories; (ii) all standardized OTC derivatives

contracts should be cleared through central counterparties and traded

on exchanges or electronic trading platforms, where appropriate, by the

end of 2012; and (iii) non-centrally cleared contracts should be

subject to higher capital requirements. In line with the G20

commitment, much progress has been made to coordinate and harmonize

international reform efforts, but the pace of reform varies among

jurisdictions and disparities in regulations remain due to differences

in cultures, legal and political traditions, and financial systems.\17\

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\17\ Legislatures and regulators in a number of foreign

jurisdictions are undertaking significant regulatory reforms over

the swaps market and its participants. See CFTC and SEC, Joint

Report on International Swap Regulation Required by Section 719(c)

of the Dodd-Frank Wall Street Reform and Consumer Protection Act,

Jan. 31, 2012, at 23, available at http://www.cftc.gov/idc/groups/public/@swaps/documents/file/dfstudy_isr_013112.pdf.

For example, the European Parliament adopted the substance of

the European Market Infrastructure Regulation (``EMIR'') on March

29, 2012. See Proposal for a Regulation of the European Parliament

and of the Council on OTC derivatives, central counterparties and

trade repositories--Outcome of the European Parliament's first

reading (Brussels, 28 to 29 March 2012), available at http://register.consilium.europa.eu/pdf/en/12/st06/st06399.en12.pdf.

In December 2010, the European Commission released a public

consultation on revising the Markets in Financial Instruments

Directive (``MiFID''). See ``European Commission Public

Consultation: Review of the Markets in Financial Instruments

Directive,'' Dec. 8, 2010, available at http://ec.europa.eu/internal_market/consultations/docs/2010/mifid/consultation_paper_en.pdf.

In October 2011, the European Commission released two public

consultations, one to revise MiFID and the other for creating a new

regulation entitled the Markets in Financial Instruments Regulation

(``MiFIR''). See ``European Commission Proposal for a Directive of

the European Parliament and of the Council on markets in financial

instruments repealing Directive 2004/39/EC of the European

Parliament and of the Council,'' COM (2011) 656 final (Oct. 20,

2011), available at http://ec.europa.eu/internal_market/securities/docs/isd/mifid/COM_2011_656_en.pdf; ``European Commission

Proposal for a Regulation of the European Parliament and of the

Council on markets in financial instruments and amending regulation

[EMIR] on OTC derivatives, central counterparties and trade

repositories,'' COM (2011) 652 final (Oct. 20, 2011), available at

http://ec.europa.eu/internal_market/securities/docs/isd/mifid/COM_2011_652_en.pdf.

The Japanese legislature passed the Amendment to the Financial

Instruments and Exchange Act (``FIEA'') in May 2010. See Outline of

the bill for amendment of the Financial Instruments and Exchange

Act, May 2010, available at http://www.fsa.go.jp/en/refer/diet/174/01.pdf.

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B. The Scope of the Proposed Interpretative Guidance and Policy

Statement

In light of the global nature of the swap market, the extent to

which the Dodd-Frank Act's requirements will apply to cross-border

activities is critically important. U.S. market participants regularly

enter into swaps with other market participants that are domiciled

outside of the U.S. or incorporated in non-U.S. jurisdictions.\18\ Many

U.S. and non-U.S. domiciled or incorporated financial institutions

conduct their swaps business across multiple jurisdictions, with swaps

that are negotiated and executed by a branch or affiliate in one

jurisdiction while the actual counterparty to the swap is an entity in

another jurisdiction.

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\18\ See Bank of International Settlements (BIS), Committee on

the Global Financial System, No. 46, The macro financial

implications of alternative configurations for access to central

counterparties in OTC derivatives markets, Nov. 2011, at 1,

available at http://www.bis.org/publ/cgfs46.pdf (``The configuration

of access must take account of the globalized nature of the market,

in which a significant proportion of OTC derivatives trading is

undertaken across borders.'').

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The Commission received numerous comments during the Dodd-Frank Act

rulemaking process from interested parties concerning the application

of Title VII of the Dodd-Frank Act and the Commission's implementing

regulations thereunder to the cross-border activities of non-U.S. and

U.S. market participants.\19\ The key issues raised by

[[Page 41217]]

the commenters include (i) the nature of the connections to the United

States that would require a non-U.S. person to register as a swap

dealer or MSP under the CEA and the Commission's regulations; \20\ (ii)

which Dodd-Frank Act requirements apply to the swap activities of non-

U.S. persons, U.S. persons, and their branches, agencies, subsidiaries

and affiliates outside of the United States; \21\ and (iii) to the

extent that Title VII of the Dodd-Frank requirements would apply, the

circumstances under which the Commission would consider permitting a

non-U.S. person to comply with the regulatory regime of its foreign

jurisdiction instead of complying with the Dodd-Frank Act and the

Commission's regulations promulgated thereunder.\22\

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\19\ See, e.g., Institute of International Bankers (``IIB'')

(Jan. 10, 2011); International Swaps and Derivatives Association

(``ISDA'') (Feb. 22, 2011), Securities Industry and Financial

Markets Association (``SIFMA'') (Feb. 3, 2011), Cleary Gottlieb

Steen & Hamilton LLP (``Cleary'') (Sept. 20, 2011), and Barclays

Bank PLC, BNP Paribas S.A., Credit Suisse AG, Deutsche Bank AG,

HSBC, Nomura Securities International, Inc., Rabobank Nederland,

Royal Bank of Canada, The Royal Bank of Scotland Group PLC,

Soci[eacute]t[eacute] G[eacute]n[eacute]rale, The Toronto-Dominion

Bank, and UBS AG (``Twelve Foreign Banks'') (Feb. 17, 2011). In

total, the Commission received approximately 120 comment letters

(submitted in response to various proposed rules implementing the

Dodd-Frank Act) that addressed or raised issues related to cross-

border swap activities. These letters, received by the Commission in

response to various Commission rulemakings, may be found on the

Commission's Web site at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/index.htm.

In addition, the Commission and the Securities and Exchange

Commission (``SEC'') held a joint public roundtable on August 1,

2011 on international issues relating to the implementation of Title

VII of the Dodd-Frank Act (``Roundtable''). During the Roundtable,

commenters discussed the impact of the various requirements on their

cross-border activities. A copy of the transcript from the

Roundtable can be found on the Commission's Web site at http://www.cftc.gov/idc/groups/public/@swaps/documents/dfsubmission/dfsubmission21_080111-trans.pdf.

\20\ Commenters agreed generally that non-U.S. persons engaged

in swap dealing activity directly with U.S. counterparties should be

registered with the Commission as swap dealers. See, e.g., Cleary

(Sept. 20, 2011). On the other hand, according to commenters, swap

dealing conducted outside of the U.S. between non-U.S. persons is

not sufficiently connected to the U.S. to warrant swap dealer

registration. See, e.g., Twelve Foreign Banks (Feb. 17, 2011); SIFMA

(Feb. 3, 2011). Commenters also said that a non-U.S. person that

limits its U.S. swap activity to U.S. persons that are registered as

swap dealers should not have to register, because regulation of the

U.S. registered swap dealer is sufficient. See Bank of Tokyo-

Mitsubishi UFJ Ltd., Mizuho Corporate Bank Ltd., Sumitomo Mitsui

Banking Corporation (``Japanese Banks'') (May 5, 2011) and Twelve

Foreign Banks (Feb. 17, 2011).

\21\ See, e.g., Cleary (Sept. 20, 2011) IIB (Jan. 10, 2011) and

SIFMA (Feb. 3, 2011). Generally speaking, these commenters urged

that the Commission adopt a framework that preserves the strengths

of existing market practices and home country supervision, while

avoiding regulatory duplication, unrealistic extraterritorial

supervisory responsibilities, and fragmentation of the swap markets.

See, e.g., IIB (Jan. 10, 2011) and SIFMA (Feb. 3, 2011). According

to these commenters, entities outside the United States should

comply with rules adopted under the Dodd-Frank Act with respect to

requirements applicable to specific swaps, but should be subject to

home country supervision by their home country regulators with

respect to requirements applicable at the entity level. On the other

hand, other commenters said that a U.S. entity must not be able to

conduct swap business with non-U.S. persons free from regulation

under the Dodd-Frank Act by establishing a non-U.S. affiliate and

conducting the swap business through the affiliate. See Better

Markets, Inc. (Jan. 24, 2011).

\22\ See, e.g., Seven Foreign Banks (Jan. 11, 2011) and Hess

(Jan. 24, 2011). Commenters stated that deference to comparable home

country regulation accords with principles of international comity

and is consistent with the approach taken by U.S. banking regulators

with respect to non-U.S. banks. See, e.g., FSR (Feb. 22, 2011), IIB

(April 11, 2011), Cleary (Sept. 20, 2011). Numerous commenters also

recommended that comparability should be determined based on whether

the home country entity-level requirements are reasonably designed

to achieve the same policy objectives as the corresponding

requirements under the Dodd-Frank Act. See Cleary (Sept. 20, 2011).

Commenters said that the Commission should defer to the home

country, entity-level requirements only when they are comparable.

Commenters also discussed Dodd-Frank Act requirements that

potentially apply to all swap market participants, not just

registered swap dealers and MSPs. For instance, commenters said that

when a non-U.S. person executes or clears a swap on a U.S.-

registered facility, the non-U.S. person should be subject to the

Commission's swap position limit requirements. See US Banks (Feb.

22, 2011). Commenters said that clearing requirements should not

apply to swaps between two non-U.S. persons, and that the regulators

in various countries should work together to recognize comparably-

regulated clearinghouses. See SIFMA (Feb. 3, 2011) and Seven Foreign

Banks (Jan. 11, 2011).

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In this proposed interpretive guidance and policy statement

(``proposed interpretive guidance''), the Commission addresses the key

issues raised by the commenters with respect to the application of

Title VII of the Dodd-Frank Act and the Commission's rules promulgated

thereunder to cross-border swaps and activities. Following the

background discussion in Section I, the Commission sets out its

proposed interpretive guidance in the subsequent three sections.

Section II sets forth the Commission's proposed interpretation of its

authority to apply the Dodd-Frank Act and its regulations

extraterritorially under section 2(i) of the CEA.\23\ Section II also

describes the general manner in which the Commission proposes to

consider the following: (i) Whether a non-U.S. person's swap dealing

activities are sufficient to require registration as a ``swap dealer,''

as further defined in a joint release adopted by the Commission and the

SEC (collectively, the ``Commissions''); (ii) whether a non-U.S.

person's swap positions are sufficient to require registration as a

``major swap participant,'' as further defined in a joint release

adopted by the Commissions; and (iii) the treatment for registration

purposes of foreign branches, agencies, affiliates, and subsidiaries of

U.S. swap dealers and of U.S. branches of non-U.S. swap dealers.\24\

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\23\ 7 U.S.C. 2(i).

\24\ See Further Definition of ``Swap Dealer,'' ``Security-Based

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

Swap Participant'' and ``Eligible Contract Participant''; Final

Rule, 77 FR 30596, May 23, 2012.

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Section III sets forth the manner in which the Commission proposes

to interpret section 2(i) of the CEA as it applies to the requirements

under Title VII of the Dodd-Frank Act and the Commission's regulations

promulgated thereunder to swaps and activities of non-U.S. swap

dealers, non-U.S. MSPs and foreign branches, agencies, affiliates, and

subsidiaries of U.S. swap dealers. In section III, the Commission also

proposes to permit a non-U.S. swap dealer or non-U.S. MSP to comply

with comparable foreign regulatory requirements in order to satisfy

applicable statutory and regulatory requirements under Title VII of the

Dodd-Frank Act.\25\ In section IV, the Commission generally describes a

process by which a non-U.S. applicant for swap dealer or MSP

registration may seek the Commission's recognition of substituted

compliance with a comparable foreign regulatory requirement and the

general scope of Commission review in making the requisite

comparability finding. Section V sets forth the manner in which the

Commission proposes to interpret section 2(i) of the CEA as it applies

to the clearing, trading, and certain reporting requirements under the

Dodd-Frank Act with respect to swaps between counterparties that are

not swap dealers or MSPs.

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\25\ This proposed interpretative release does not address the

scope of the Commission's authority under CEA section 2(i) over non-

swap agreements, contracts, transactions or markets within the

Commission's jurisdiction or persons who participate in or operate

those markets.

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The Commission clarifies that this proposed interpretive guidance

does not establish or modify any person's rights and obligations under

the CEA or the Commission's regulations promulgated thereunder. The

Commission notes that the proposed interpretive guidance does not limit

the applicability of any CEA provision or Commission regulation to any

person, entity or transaction except as provided herein.

II. Consideration of Whether a Non-U.S. Person Is a Swap Dealer or

Major Swap Participant

A. Section 2(i) of the CEA

Section 722(d) of the Dodd-Frank Act amends section 2 of the CEA

\26\ to add a new paragraph (i) entitled ``Applicability,'' which

consists of two subsections. Specifically, section 2(i) states that the

provisions added to the CEA by Title VII of the Dodd-Frank Act shall

not apply to activities outside the United States unless those

activities--

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\26\ 7 U.S.C. 2.

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(1) have a direct and significant connection with activities in, or

effect on, commerce of the United States; or

(2) contravene such rules or regulations as the Commission may

prescribe or promulgate as are necessary or appropriate to prevent the

evasion of any provision of this Act that was enacted by the Wall

Street Transparency and Accountability Act of 2010.\27\

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\27\ 7 U.S.C. 2(i).

Section 2(i) provides the Commission with express authority over

activities outside the United States when such swaps and activities

have a ``direct and significant'' connection with activities

[[Page 41218]]

in, or effect on, commerce of the United States or when they contravene

such rules as the Commission may promulgate to prevent evasion of the

provisions of Title VII of the Dodd-Frank Act.\28\ Section 2(i) does

not, however, require the Commission to extend its reach to the outer

bounds of that authorization. Rather, in exercising its authority with

respect to swap activities outside the United States, the Commission

will be guided by consideration of international comity principles. The

subsections that follow address the general manner in which the

Commission will determine the cross-border application of the CEA's

swap provisions, consistent with section 2(i) of the CEA.

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\28\ A primary purpose of Title VII of the Dodd-Frank Act is to

address risk to the U.S. financial system created by

interconnections in the swaps market. Senator Blanche Lincoln, then

Chairman of the Senate Agriculture Committee, noted: ``In 2008, our

Nation's economy was on the brink of collapse. America was being

held captive by a financial system that was so interconnected, so

large, and so irresponsible that our economy and our way of life

were about to be destroyed.'' Congressional Record S5818, July 14,

2010, available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-14/pdf/CREC-2010-07-14.pdf. Senator Jeanne Shaheen stated: ``We need to put

in place reforms to stop Wall Street firms from growing so big and

so interconnected that they can threaten our entire economy.''

Congressional Record S5888, July 15, 2010, available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-15/pdf/CREC-2010-07-15-senate.pdf. Senator Debbie Stabenow opined: ``For too long the over-

the-counter derivatives market has been unregulated, transferring

risk between firms and creating a web of fragility in a system where

entities became too interconnected to fail.'' Congressional Record

S5905, July 15, 2010, available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-15/pdf/CREC-2010-07-15-senate.pdf. As these legislative

records indicate, Congress sought to ensure that the Commission

would be able to effectively regulate activities in the swaps

marketplace, wherever those activities may occur, that are

significantly connected with or affect the U.S. financial system.

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B. Proposed Interpretation of the Term ``U.S. Person''

For purposes of this interpretive guidance, the Commission proposes

to interpret the term ``U.S. person'' by reference to the extent to

which swap activities or transactions involving one or more such person

have the relevant effect on U.S. commerce. For example, this

interpretation would help determine whether non-U.S. persons engaging

in swap dealing transactions with ``U.S. persons'' in excess of the de

minimis level would be required to register and regulated as a swap

dealer. In addition, for the same reasons, the term ``U.S. person'' can

be helpful in determining the level of U.S. interest for purposes of

analyzing and applying principles of international comity when

considering the extent to which U.S. transaction-level requirements

should apply to swap transactions.

Specifically, as proposed, the term ``U.S. person'' would include,

but not be limited to: (i) Any natural person who is a resident of the

United States; (ii) any corporation, partnership, limited liability

company, business or other trust, association, joint-stock company,

fund, or any form of enterprise similar to any of the foregoing, in

each case that is either (A) organized or incorporated under the laws

of the United States or having its principal place of business in the

United States \29\ (``legal entity'') or (B) in which the direct or

indirect owners thereof are responsible for the liabilities of such

entity and one or more of such owners is a U.S. person; (iii) any

individual account (discretionary or not) where the beneficial owner is

a U.S. person; (iv) any commodity pool, pooled account, or collective

investment vehicle (whether or not it is organized or incorporated in

the United States) of which a majority ownership is held, directly or

indirectly, by a U.S. person(s); (v) any commodity pool, pooled

account, or collective investment vehicle the operator of which would

be required to register as a commodity pool operator under the CEA;

(vi) a pension plan for the employees, officers, or principals of a

legal entity with its principal place of business inside the United

States; and (vii) an estate or trust, the income of which is subject to

United States income tax regardless of source.

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\29\ The term ``United States'' means the United States, its

states, the District of Columbia, Puerto Rico, the U.S. Virgin

Islands, and any other territories or possessions of the United

States government, its agencies or instrumentalities.

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Under this interpretation, the term ``U.S. person'' generally means

that a foreign branch or agency of a U.S. person would be covered by

virtue of the fact that it is a part, or an extension, of a U.S.

person. By contrast, a foreign affiliate or subsidiary of a U.S. person

would be considered a non-U.S. person, even where such an affiliate or

subsidiary has certain or all of its swap-related obligations

guaranteed by the U.S. person.

Request for Comment

Q1. Please provide specific comments regarding the Commission's

proposed interpretation of the term ``U.S. person.''

Q1a. In the Commission's view, the concerns regarding risks

associated with the affiliate group structure are heightened where a

U.S. person guarantees (or provides similar support) to a foreign

affiliate or subsidiary. In such situations, the risk of the swaps

executed abroad are effectively transferred to or incurred by the U.S.

person. Or stated differently, the risk of the affiliate's swap

transactions have a direct and significant connection to, or effect on,

the U.S. person that is the guarantor. Under these circumstances,

notwithstanding that the U.S. person may be subject to a robust

regulatory regime, its financial stability may be put at risk by

activities outside the firm. Accordingly, the Commission is

considering, and seeks comments on, whether the term ``U.S. person''

should be interpreted to include a foreign affiliate or subsidiary

guaranteed by a U.S. person.

Q1b.Several commenters have suggested that the Commission adopt the

definition of ``U.S. person'' in the SEC's Regulation S.\30\ Should the

Commission interpret the term ``U.S. person'' in a similar manner

notwithstanding that Regulation S has a different focus?

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\30\ See 17 CFR 230.902(k); SEC Release No. 33-6863, 55 FR

18306, May 2, 1990.

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Q1c. As an alternative to the proposed interpretation of the term

``U.S. person,'' should the Commission interpret the term to include a

concept of control under which a non-U.S. person who is controlled by

or under common control with a U.S. person would also be considered a

U.S. person? If so, how should the Commission define the term

``controlled by or under common control?''

Q1d. Are there other examples of persons or interests that should

be specifically identified as a ``U.S. person'' in the final

interpretive guidance?

C. The Definitions and Registration Thresholds

1. Background

The Commission adopted its final rulemaking further defining the

terms ``swap dealer'' and ``major swap participant'' jointly with the

SEC on April 18, 2012 (``Final Entities Rulemaking'').\31\ In the Final

Entities Rulemaking, the Commissions, among other things, adopted final

rules and interpretive guidance implementing the statutory definitions

of the terms ``swap dealer'' and ``major swap participant'' in CEA

sections 1a(49) and 1a(33).\32\ The final rules and interpretive

guidance delineate the activities that cause a person to be a swap

dealer and the level of swap positions that cause a person to be an

MSP. In addition, the

[[Page 41219]]

Commissions adopted rules concerning the statutory exceptions from the

definition of swap dealer, including a de minimis exception.\33\

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\31\ Further Definition of ``Swap Dealer,'' ``Security-Based

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

Swap Participant'' and ``Eligible Contract Participant;'' Final

Rule, 77 FR 30596, May 23, 2012.

\32\ 7 U.S.C. 1a(49) and 1a(33).

\33\ Section 1a(49)(D) of the CEA (7 U.S.C. 1a(49)(D)) provides

that ``[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. The Commission shall promulgate regulations to establish

factors with respect to the making of this determination to

exempt.'' This provision is implemented in section 1.3(ggg)(4) of

the Commission's regulations.

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Section 1.3(ggg)(4) of the Commission's regulations sets forth a de

minimis threshold of swap dealing, which takes into account the

notional amount of a person's swap dealing activity over the prior 12

months.\34\ When a person engages in swap dealing transactions above

that threshold, such person meets the definition of a swap dealer under

section 1a(49) of the CEA,\35\ and is required to register as a swap

dealer with the Commission under CEA section 4s(b).\36\ Sections

1.3(jjj)(1) and 1.3(lll)(1) of the Commission's regulations set forth

swap position thresholds for the MSP definition.\37\ When a person

holds swap positions above those thresholds, such person meets the

definition of an MSP under section 1a(33) of the CEA,\38\ and is

required to register as an MSP with the Commission under CEA section

4s(b).\39\

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\34\ The limitations associated with the de minimis exception

apply only in connection with a person's dealing activities. See

Final Entities Rulemaking at Part II.D. As used in this release, the

meaning of the term ``swap dealing'' is consistent with that used in

the Final Entities Rulemaking.

\35\ 7 U.S.C. 1a(49).

\36\ 7 U.S.C. 6s(b). See also Registration of Swap Dealers and

Major Swap Participants, Final Rule 77 FR 2613, 2616, Jan. 19, 2012

(``Final Registration Rule'').

\37\ See Final Entities Rulemaking at Parts IV.B. and IV.E.

\38\ 7 U.S.C. 1a(33).

\39\ 7 U.S.C. 6s(b). See also Final Registration Rule at 2616,

Jan. 19, 2012, available at http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2012-792a.pdf.

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Once required to register as a swap dealer or MSP, the person

becomes subject to all of the requirements imposed on swap dealers or

MSPs under Title VII, respectively, including but not limited to

sections 2(a)(13), 4r, and 4s of the CEA,\40\ which require swap

dealers and MSPs to comply with various prudential, business conduct,

reporting, clearing, and trading requirements. Unless a swap dealer or

MSP applies for and is granted a limited designation, all of the swap

dealer's or MSP's swap activities are subject to such requirements, not

only the swap activities that trigger the registration requirement.

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\40\ 7 U.S.C. 2(a)(13), 6r, and 6s.

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The statutory definitions of swap dealer and MSP do not contain any

geographic limitations and do not distinguish between U.S. and non-U.S.

swap dealers or non-U.S. MSPs.\41\ Similarly, the Final Entities

Rulemaking does not contain any such limitations or distinctions. In

this proposed interpretive guidance, the Commission interprets section

2(i) of the CEA as it applies to the provisions in the CEA related to

swap dealers and MSPs and, accordingly, proposes the general manner in

which the swap dealer and MSP registration and related requirements

apply to the activities of non-U.S. persons, and to the foreign

branches, agencies, subsidiaries and affiliates of U.S. persons and

U.S. branches of non-U.S. persons.

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\41\ The statutory definition of MSP in CEA section 1a(33)(B) (7

U.S.C. 1a(33)(B)) does state, however, that the Commission should

consider the impact on ``the financial system of the United States''

in defining what constitutes a ``substantial position'' for purposes

of the definition. The Commission believes that this proposed

interpretative guidance, which focuses on a non-U.S. person's swap

positions with U.S. persons, is consistent with this statutory

directive.

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2. Swap Dealer

In enacting the swap dealer definition and the associated

requirements for swap dealers Congress sought to ensure that those

entities that engage in more than a de minimis level of swap dealing be

considered swap dealers, register, and be regulated as swap

dealers.\42\ In the Final Entities Rulemaking, the Commission

established a notional threshold for determining whether a person

engages in more than a de minimis level of swap dealing and therefore

must register as a swap dealer. The Commission proposes that the level

of swap dealing that is substantial enough to require a person to

register as a swap dealer when conducted by a U.S. person also

constitutes a ``direct and significant connection'' within the meaning

of section 2(i)(1) of the CEA when such dealing activities are

conducted by a non-U.S. person with U.S. persons as counterparties.

Accordingly, consistent with this interpretation and the Commission's

Final Entities Rulemaking, the Commission proposes that non-U.S.

persons who engage in more than a de minimis level of swap dealing with

U.S. persons would be required to register as swap dealers.\43\

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\42\ The Commission does not believe it is necessary for

purposes of this proposed interpretive guidance to determine whether

such swaps or activities between a non-U.S. person and a U.S. person

are located within or outside of the United States. Regardless of

whether the location of any particular swap or activity is within or

outside the United States, the Commission proposes that it is the

aggregate notional amount of such swap dealing activities that is

relevant for registration. Accordingly, the consideration of such

swaps within the meaning of CEA section 2(i) for the purposes of

this proposed guidance does not necessarily mean that the Commission

considers such activities to be outside of the United States. See

Final Entities Rulemaking at Part II.B.4. for what constitutes

``swap dealing activities.''

\43\ In the Final Entities Rulemaking, the Commissions codified

exclusions from the dealer definition for swaps and security-based

swaps between majority-owned affiliates. The Commission construes

section 2(i) to apply such inter-affiliates exclusion to swaps

between a non-U.S. person and its U.S. affiliate or between two

affiliated non-U.S. persons. See section 1.3(ggg)(6)(i) of the

Commission's regulations.

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The Commission does not propose, however, that a non-U.S. person

should include, in determining whether the de minimis threshold is met,

the notional value of dealing transactions with foreign branches of

registered U.S. swap dealers. This is intended to address the concerns

of non-U.S. persons who may be required to register as a swap dealer,

notwithstanding the fact that their dealing activities with U.S.

persons as counterparties are limited to foreign branches of registered

U.S. swap dealers. In such cases, the Dodd-Frank Act transactional

requirements (or comparable requirement) would nevertheless apply to

swaps with those foreign branches and, thus, there is little concern

that this exclusion could be used to engage in swap activities outside

of the Dodd-Frank Act (comparable) requirements. Accordingly, the

Commission believes that it would be appropriate and consistent with

section 2(i) to allow non-U.S. persons to conduct swap dealing

activities with registered U.S. swap dealers outside the United States

(through their foreign branches), without triggering registration as a

swap dealer as a result.

i. Aggregation of Swaps

The Commission notes that section 1.3(ggg)(4) of the Commission's

regulations requires that a person include, in determining whether its

swap dealing activities exceed the de minimis threshold, the aggregate

notional value of swap dealing transactions entered into by its

affiliates under common control. It is the Commission's view that this

provision would require that a non-U.S. person, in determining whether

its swap dealing transactions exceed the de minimis threshold, include

the aggregate notional value of any swap dealing transactions between

U.S. persons and any of its non-U.S. affiliates under common control,

and any swap dealing transactions of any of its non-U.S. affiliates

under common control where

[[Page 41220]]

the obligations of such non-U.S. affiliates are guaranteed by U.S.

persons.\44\

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\44\ See Final Entities Rulemaking at Part II.D.4.

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The Commission is not proposing, however, that a non-U.S. person

should include, in this determination, the notional value of dealing

transactions in which its U.S. affiliates engage. Again, the

Commission's proposed interpretation is that a direct and significant

connection with activities in, or effect on, U.S. commerce, in these

circumstances, exists when non-U.S. persons conduct more than a de

minimis level of swap dealing activities with U.S. persons. In the case

of an affiliated group of non-U.S. persons under common control, the

Commission believes that all of the affiliated non-U.S. persons should

aggregate the notional value of their swap dealing transactions with

U.S. persons (and their swap dealing transactions with non-U.S. persons

in which such person's obligations are guaranteed by U.S. persons), in

order to determine, in effect, the level of swap dealing activities

conducted by the affiliated group of non-U.S. persons in the aggregate.

However, since the focus is on the level of activity conducted by non-

U.S. persons, swap dealing transactions of affiliated U.S. persons

should not be included.\45\

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\45\ See also 77 FR at 2616.

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ii. Regular Business

As stated in the Final Entities Rulemaking, a person is required to

apply the de minimis test only if it determines it is engaged in swap

dealing activity under the rule further defining the term ``swap

dealer,'' which excludes swap activities that are not part of ``a

regular business.'' A person that is not engaged in swap dealing as

part of ``a regular business'' is not required to apply the de minimis

test and is not a swap dealer under the CEA.

The Commission proposes that a non-U.S. person without a guarantee

from a U.S. person applying the swap dealer definition should determine

first whether its swap activities with respect to U.S. persons as

counterparties qualify as swap dealing activity under the rule further

defining the term ``swap dealer'' and the exclusion of swap activities

that are not part of ``a regular business.'' Thus, for example, a non-

U.S. person without a guarantee that determines it is not engaged in

swap dealing as part of ``a regular business'' with respect to U.S.

persons as counterparties is not required to apply the de minimis test

or to register as a swap dealer. This would be true even if the non-

U.S. person were engaged in swap dealing as part of ``a regular

business'' with respect to non-U.S. persons as counterparties.

The determination of whether a person is engaged in swap dealing

activity involves application of the interpretive guidance in Part

II.A.4. of the Final Entities Rulemaking, which provides for

consideration of the relevant facts and circumstances. Similarly, the

Commission proposes that the determination by a non-U.S. person without

a guarantee of whether it is engaged in swap dealing as part of ``a

regular business'' with respect to U.S. persons as counterparties (as

opposed to its swap dealing activity with respect to non-U.S. persons

as counterparties) will depend on consideration of the relevant facts

and circumstances in light of the interpretive guidance in the Final

Entities Rulemaking.

Request for Comment

Q2. Do commenters agree that in determining whether it is a swap

dealer, a non-U.S. person without a guarantee from a U.S. person should

consider whether it is engaged in swap dealing as part of ``a regular

business'' only with respect to U.S. persons (as opposed to non-U.S.

persons)? Why or why not? In such an analysis, would it generally be

feasible for the non-U.S. person to distinguish swap dealing activities

with U.S. persons from swap dealing activities with non-U.S. persons

and are there any practical difficulties in this approach?

3. Major Swap Participant

The MSP definition and associated requirements for MSPs reflect

Congress' direction that any entity that holds swap positions above a

level that could, among other things, ``significantly impact the

financial system of the United States,'' be considered an MSP and

register and be regulated as an MSP.\46\ In the Final Entities

Rulemaking, the Commission further defined MSP to clarify when a person

must register. The Commission believes that the level of swap positions

that is substantial enough to require a person to register as an MSP

when held by a U.S. person, also constitutes a ``direct and significant

connection'' within the meaning of section 2(i) of the CEA when such

positions reflect swaps between a non-U.S. person and U.S. persons.

Consistent with this interpretation and the Commission's Final Entities

Rulemaking, a non-U.S. person who holds swap positions where a U.S.

person is a counterparty above the specified MSP thresholds would

qualify and register as an MSP.

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\46\ CEA section 1a(33)(B), 7 U.S.C. 1a(33)(B). As is the case

with respect to swap dealers, the Commission does not believe it is

necessary, for purposes of this proposed interpretative guidance, to

determine whether such swaps or activities between a non-U.S. person

and a U.S. person are located within or outside of the United

States.

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i. Aggregation of Positions

In determining whether it is an MSP, a non-U.S. person would

``count'' all of its swap positions where its counterparty is a U.S.

person, but would not ``count'' any swap position where its

counterparty is a non-U.S. person. As with swap dealing transactions, a

swap between a non-U.S. person and a U.S. person, or a swap between a

non-U.S. person and another non-U.S. person under which the first non-

U.S. person's obligations are guaranteed by a U.S. person, in and of

itself may have a direct and significant connection with activities in,

or effect on, commerce of the United States within the meaning of

section 2(i) of the CEA. Similarly, for purposes of applying section

2(i) of the CEA to the MSP definition and associated requirements, the

Commission believes the appropriate focus is on whether in the

aggregate such swaps have a direct and significant connection with

activities in, or effect on, U.S. commerce, rather than whether each

particular swap has such a connection or effect.

4. Relevance of Guarantees

In the event of a default or insolvency of a non-U.S. swap dealer

with more than a de minimis level of swap dealing with U.S. persons or

a non-U.S. MSP with more than the threshold level of swap positions

with U.S. persons, the swap dealer's or MSP's U.S. counterparties could

be adversely affected. Such an event may adversely affect numerous

persons engaged in commerce within the United States, disrupt such

commerce, and increase risks of a widespread disruption to the

financial system in the United States. For that reason, the Commission

has a significant regulatory interest in ensuring that the swap dealer

or MSP is managing the risks of such swaps appropriately and ensuring

that its U.S. counterparties receive the appropriate protections under

the CEA.

Similar effects on U.S. persons and on the U.S. financial system

may occur in the event of a default or insolvency of a non-U.S. person

with respect to a non-de minimis level of swap dealing transactions, or

swap positions above the MSP threshold, of the non-U.S. person that are

guaranteed by a U.S. person. In these circumstances, and regardless of

whether the non-U.S. person's counterparty is a U.S. person or

[[Page 41221]]

a non-U.S. person, the risk of default by the non-U.S. person with

respect to its guaranteed swaps ultimately rests with a U.S. person. If

there is a default by the non-U.S. person, the U.S. person would be

held responsible to settle those obligations. However, the Commission's

interpretive guidance with respect to guarantees differs slightly for

swap dealers and MSPs.\47\ We therefore discuss the two cases

separately here.

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\47\ For purposes of this interpretive guidance, references to a

guarantee are intended to refer not only to traditional guarantee of

payment or performance of the related swaps, but would also include

other formal arrangements to support the non-U.S. person's ability

to pay or perform its obligations, including without limitation,

liquidity puts and keepwell agreements.

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Accordingly, the Commission proposes to interpret CEA section 2(i)

as requiring a non-U.S. person to register with the Commission as a

swap dealer when the aggregate notional value of its swap dealing

activities with U.S. persons, or of its swap dealing activities with

non-U.S. persons where the dealing non-U.S. person's obligations are

guaranteed, or its ability to pay or perform its obligations thereunder

are otherwise formally supported, by a U.S. person, exceed the de

minimis level of swap dealing as set forth in section 1.3(ggg)(4) of

the Commission's regulations. The Commission believes that when the

aggregate level of swap dealing by a non-U.S. person, considering both

swaps directly with U.S. persons and swaps with non-U.S. persons under

which the dealing non-U.S. person's obligations are guaranteed by a

U.S. person, exceeds the de minimis level of swap dealing, the dealing

non-U.S. person's activities have the requisite ``direct and

significant connection with activities in, or effect on, commerce of

the United States.''

With respect to whether a person is an MSP, the Commission's

interpretive guidance in the Final Entities Rulemaking provides that a

person's swap positions are attributed to a parent, other affiliate or

guarantor to the extent that the counterparties to those positions

would have recourse to the other entity in connection with the position

unless the first person is itself subject to capital regulation by the

CFTC or SEC (e.g., including where the first person is a swap dealer or

MSP) or is a U.S. entity regulated as a bank in the United States.\48\

In accordance with this guidance, the Commission proposes that swap

positions between a non-U.S. person, where the obligations of such non-

U.S. person thereunder are guaranteed by a U.S. person, should be

attributed to the U.S. person (and not the non-U.S. person) in

determining whether either person is an MSP. In other words, the

Commission proposes to interpret CEA section 2(i) as requiring non-U.S.

persons to register with the Commission as MSPs when their swaps with

U.S. persons, disregarding any such positions where their obligations

thereunder are guaranteed by U.S. persons, exceed a relevant MSP

threshold as set forth in the Final Entities Rulemaking.

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\48\ See Final Entities Rulemaking at part IV.H.

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5. Summary

This proposed interpretation may be summarized as follows. In

determining whether a non-U.S. person is engaged in more than a de

minimis level of swap dealing, the person should consider the aggregate

notional value of:

Swap dealing transactions between it (or any of its non-

U.S. affiliates under common control) and a U.S. person (other than

foreign branches of U.S. persons that are registered swap dealers); and

Swap dealing transactions (or any swap dealing

transactions of its non-U.S. affiliates under common control) where its

obligations or its non-U.S. affiliates' obligations thereunder are

guaranteed by U.S. persons.

In determining whether a non-U.S. person holds swap positions above

the MSP thresholds, the person should consider the aggregate notional

value of:

Any swap position between it and a U.S. person (but its

swap positions where its obligations thereunder are guaranteed by a

U.S. person generally should be attributed to that U.S. person and not

included in the non-U.S. person's determination); and

Any swap between another non-U.S. person and a U.S.

person, where it guarantees the obligations of the non-U.S. person

thereunder.

D. Foreign Branches, Agencies, Affiliates, and Subsidiaries of U.S.

Swap Dealers and U.S. Branches, Agencies, Affiliates, and Subsidiaries

of Non-U.S. Swap Dealers

1. Foreign \49\ Branches and Agencies of U.S. Swap Dealers

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\49\ In this release, the term ``foreign'' is used

interchangeably with the term ``non-U.S.''

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The Commission understands that branches and agencies are not

separate legal entities; rather, a branch or agency is a corporate

extension of its principal entity.\50\ Given that a foreign branch or

agency has no legal existence separate from a U.S. principal entity

that is the legal counterparty to swaps, the Commission would apply the

Dodd-Frank Act registration requirements to a U.S. person and its

foreign branches and agencies on an entity-wide basis.\51\ Under this

approach, the Commission would require the U.S. person (principal

entity) to register as the swap dealer. Although certain duties and

obligations may be performed by the foreign branches and agencies, the

U.S. person (principal entity) would remain responsible for compliance

with all of the applicable responsibilities.\52\

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\50\ See, e.g., Federal Reserve Bank of New York, Foreign Banks

and the Federal Reserve, at http://www.ny.frb.org/aboutthefed/fedpoint/fed26.html (last visited Feb. 26, 2012). See also Federal

Reserve Board, ``Policy Statement on the Supervision and Regulation

of Foreign Banking Organizations,'' Feb. 23, 1979, Federal Reserve

Regulatory Service 4-835; Federal Reserve Board Supervisory Letter

SR 08-09 re: Consolidated Supervision of Bank Holding Companies and

the Combined U.S. Operations of Foreign Banking Organizations, Oct.

16, 2008. See also Institute of International Bankers, Comment

Letter at 15-16, Jan. 10, 2011 (acknowledging the principal-agency

relationship and advocating for the Commission to adopt a

registration regime predicated on the intermediating activities of

U.S. branches and agencies).

\51\ The Commission notes that the supervisory authority of the

Office of the Comptroller of the Currency extends to foreign branch

offices of national banks under its jurisdiction.

\52\ Under this model, the foreign branch or agency of the U.S.

person would not register separately as a swap dealer.

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2. Foreign Affiliates or Subsidiaries of U.S. Persons

A number of large financial institutions operate a ``central

booking'' model under which swaps are solicited or negotiated through

their branches, agencies, affiliates or subsidiaries but are booked,

directly or indirectly, in a single legal entity (typically the parent

company) for balance sheet and financial reporting purposes.\53\ In

some cases, the affiliate which has negotiated the swap may be acting

as a principal and may transfer the exposure to the central booking

entity by back-to-back transactions or other arrangements. In other

cases, the affiliate that has arranged or negotiated the trade may be

acting as an agent for the central booking entity, in which case the

central booking entity may enter into the swap transaction so that the

central booking entity is, as a contractual matter, directly facing the

third-party counterparty in the swap transaction. Given these various

ways of implementing a central booking arrangement, the question arises

as to how the Dodd-Frank Act registration

[[Page 41222]]

requirement would apply to the affiliate facing the third party

counterparty and the central booking entity or guarantor. The following

subsection addresses which entity must register as a swap dealer in

such central ``booking'' model.

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\53\ See Seven Foreign Banks (``Many foreign banks operate and

manage their global swaps businesses out of a single entity * * *.

[T]his entity is the central booking vehicle, acting as principal to

counterparties in the U.S. and other jurisdictions.'') (Jan. 11,

2011); IIB (Jan. 10, 2011). These comment letters are available on

the Commission's Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=903.

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The Commission proposes to interpret section 2(i) of CEA so that

the U.S. person who books the swaps would be required to register as a

swap dealer, regardless of whether the swaps were directly booked by

the U.S. person (by such person becoming a party to the swap) or

indirectly transferred to the U.S. person (by way of a back-to-back

swap or other arrangement). In either case, the affiliate may also be

required to register as a swap dealer if by its activities it

independently meets the definition of swap dealer.

3. U.S. Branches, Agents, Affiliates, or Subsidiaries of Non-U.S.

Persons

A similar analysis applies when a non-U.S. person is the booking

entity (i.e., the legal counterparty) to swaps.\54\ Under these

circumstances, even if the U.S. branch, agency, affiliate, or

subsidiary of a non-U.S. person engages in solicitation or negotiation

in connection with the swap entered into by the non-U.S. person, the

Commission proposes to interpret section 2(i) of CEA such that the

Dodd-Frank Act requirements, including the registration requirement,

applicable to swap dealers also apply to the non-U.S. person.

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\54\ As further described below (in subsection E), a number of

commenters urge the Commission to treat a branch of a non-U.S. bank

as a separate legal entity. Extending this logic to the registration

context, these commenters support the registration and regulation of

the branch. The Commission notes CEA section 1a(39) (7 U.S.C.

1a(39)) states that the term ``prudential regulator'' shall mean the

Board of Governors of the Federal Reserve System in the case of a

swap dealer, MSP, security-based swap dealer, or major security-

based swap participant that is--

(v) any bank holding company [citation omitted], any foreign

bank (as defined in section 1(b)(7) of the International Banking Act

of 1978 (12 U.S.C. 3101(b)(7)) that is treated as a bank holding

company under section 8(a) of the International Banking Act of 1978

(12 U.S.C. 3106(a)), and any subsidiary of such a company or foreign

bank (other than a subsidiary that is described in subparagraph (A)

or (B) or that is required to be registered with the Commission as a

swap dealer or major swap participant under this Act or with the

[SEC] as a security-based swap dealer or major security-based swap

participant).

Clearly, Congress contemplated that foreign banks that become

bank holding companies by virtue of the presence of a branch or a

subsidiary in the United States may be regulated as swap dealers.

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Request for Comment

Q3. Please provide comments regarding all aspects of the

Commission's proposed interpretation, including particular alternative

interpretations the Commission should consider in assessing whether a

non-U.S. person should be required to register as a swap dealer or MSP.

Q3a. Do commenters agree that the Commission should determine

whether a non-U.S. person, without a guarantee from a U.S. affiliate,

is a swap dealer based solely upon the aggregate notional amount of

swap dealing activities with U.S. persons as counterparties? Why or why

not?

Q3b. Do commenters agree that the Commission should determine

whether a non-U.S. person is a swap dealer based on the aggregate

notional amount of swap dealing activities when the swap dealing

obligations of such non-U.S. person are guaranteed by a U.S. person?

Why or why not?

Q3c. Do commenters agree that in determining whether a non-U.S.

person is a swap dealer, the notional amount of swap dealing activities

conducted by it and all of its non-U.S. affiliates under common control

should be aggregated together? Why or why not? Should the Commission

further interpret the phrase ``under common control'' and, if so, how

should the Commission define ``common control'' for aggregation

purposes? Should the notional amount of swap dealing activities

conducted by its U.S. affiliates also be included?

Q3d. Are any other aspects of a swap--such as, for example, the

place of execution or clearing--relevant to the determination of

whether a non-U.S. person is a swap dealer?

Q3e. Do commenters agree that the Commission should determine

whether a non-U.S. person is an MSP based solely on its swap positions

with U.S. persons as counterparties? If not, why?

Q3f. Do commenters agree that, in determining whether a non-U.S.

person is an MSP, its swap positions guaranteed by a U.S. person should

be attributed to such U.S. person and not the non-U.S. person? If not,

why? How should the Commission's determination change when some but not

all of the non-U.S. person's swap obligations are guaranteed by a U.S.

person?

Q3g. Are any other aspects of a swap--such as the place of

execution or clearing--relevant to the determination of whether a non-

U.S. person is an MSP?

Q4. As noted above, the Commission does not propose that a non-U.S.

person should include, in determining whether the swap dealer de

minimis threshold is met, the notional value of swap dealing

transactions with foreign branches of U.S. swap dealers. Noting the

risk-based, as opposed to activities-based, nature of the MSP

registration category and related calculations, the Commission seeks

comment on whether a non-U.S. person should include, in determining

whether it is required to register as an MSP, its swap positions with

foreign branches of U.S. swap dealers.

Q5. Under the aggregation description above, a non-U.S. person, in

determining whether the de minimis threshold is met, must include the

notional value of dealing swaps by its non-U.S. affiliates under common

control. The Commission requests comments on whether, to the extent

that any such non-U.S. affiliate is registered with the Commission as a

swap dealer, the notional value of dealing swaps entered into by such

registered swap dealer should not be aggregated with the notional value

of dealing swaps entered into by the other non-U.S. affiliates under

common control.\55\

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\55\ Thus, within an affiliated group of firms, the dealing

activities of any affiliates that are registered with the Commission

as swap dealers would not be included in considering whether any of

the other affiliates are required to register as a swap dealer.

However, all non-U.S. affiliates under common control that are not

so registered would have to aggregate the notional value of any swap

dealing transactions with U.S. persons (or where the obligations of

such non-U.S. affiliates are guaranteed by U.S. persons) to

determine if such swap dealing transactions exceed the de minimis

threshold of swap dealing activity.

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Q7. Should the Commission consider any other types of swap dealing

transactions by non-U.S. persons to determine whether a non-U.S. person

is a swap dealer? If so, which ones?

Q8. Do commenters agree that the Commission should exclude the swap

dealing transactions of a non-U.S. person from the determination of

whether such non-U.S. person qualifies as a swap dealer, where the

counterparty to such dealing swaps are non-U.S. persons (guaranteed or

not)? Should the Commission exclude swap obligations in excess of a

capped guaranty provided by a U.S. person (i.e., a guaranty that limits

the U.S. person's liability to a capped or maximum amount)? How should

the Commission account for the reduced risks assumed by a U.S. person

guaranteeing certain or all swaps of a particular non-U.S. person under

that non-U.S. person's master agreements with non-U.S. counterparties,

where the U.S. person's liability under the guarantee is limited?

Q9. Can a limited designation registration as provided for in the

statutory definitions of the terms ``swap dealer'' and ``major swap

participant'' be used to address the Commission's regulatory interests

under the Dodd-Frank Act with respect to cross-border swap activities?

If so, how?

[[Page 41223]]

III. Cross-Border Application of the CEA's Swap Provisions and

Implementing Regulations

A non-U.S. person who meets or exceeds the de minimis threshold for

swap dealers or the position thresholds for MSPs would be required to

register with the Commission as a swap dealer or MSP, respectively,

pursuant to the procedures prescribed in Part 3 of the Commission's

regulations.\56\ Once registered, the non-U.S. swap dealer or non-U.S.

MSP would become subject to all of the substantive requirements under

Title VII of the Dodd-Frank Act that apply to registered swap dealers

or MSPs, including but not limited to sections 2(a)(13), 4r, and 4s of

the CEA, with respect to all of their swap activities. In other words,

the requirements under Title VII of the Dodd-Frank Act related to swap

dealers and MSPs apply to all registered swap dealers and MSPs,

irrespective of where such dealer or MSP is based. In exercising its

authority over non-U.S. swap dealers, non-U.S. MSPs, or cross-border

activities, however, the Commission will be informed by canons of

statutory construction regarding the application of its authority in a

manner consistent with principles of international comity. A brief

discussion of these principles follows.

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\56\ See 7 U.S.C. 6s(b)(1). See also 77 FR 2613, 2616, Jan. 19,

2012.

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A. Principles of International Comity

The Supreme Court has held that ``an act of Congress ought never to

be construed to violate the law of nations if any other possible

construction remains.'' \57\ Jurisdiction is generally construed, ``to

avoid unreasonable interference with the sovereign authority of other

nations.'' \58\ The most relevant Supreme Court precedents addressing

the application of international comity concepts in determining the

extraterritorial applicability of federal statutes come from

antitrust.\59\ In these cases, the Supreme Court has noted that the

principles in the Third Restatement of Foreign Relations Law are

relevant to the interpretation of U.S. law:

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\57\ Hartford Fire Ins. Co. et al., 509 U.S. 764, 817 (1993); F.

Hoffmann-La Roche, Ltd., 542 U.S. 155, 164 (2004).

\58\ F. Hoffmann-La Roche, Ltd., 542 U.S. at 164.

\59\ See notes 82-84, supra.

This rule of construction reflects principles of customary

international law--law that (we must assume) Congress ordinarily

seeks to follow. See Restatement (Third) of Foreign Relations Law of

the United States Sec. Sec. 403(1), 403(2) (1986). * * *

This rule of statutory construction cautions courts to assume

that legislators take account of the legitimate sovereign interests

of other nations when they write American laws. It thereby helps the

potentially conflicting laws of different nations work together in

harmony--a harmony particularly needed in today's highly

interdependent commercial world.\60\

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\60\ F. Hoffmann-La Roche, Ltd., 542 U.S. at 164-65.

Specifically, section 403 of the Restatement (Third) of Foreign

Relations Law states, in relevant part:

Whether exercise of jurisdiction over a person or activity is

unreasonable is determined by evaluating all relevant factors,

including, where appropriate:

(a) The link of the activity to the territory of the regulating

state, i.e., the extent to which the activity takes place within the

territory, or has substantial, direct, and foreseeable effect upon

or in the territory;

(b) The connections, such as nationality, residence, or economic

activity, between the regulating state and the person principally

responsible for the activity to be regulated, or between that state

and those whom the regulation is designed to protect;

(c) The character of the activity to be regulated, the

importance of regulation to the regulating state, the extent to

which other states regulate such activities, and the degree to which

the desirability of such regulation is generally accepted;

(d) The existence of justified expectations that might be

protected or hurt by the regulation;

(e) The importance of the regulation to the international

political, legal, or economic system;

(f) The extent to which the regulation is consistent with the

traditions of the international system;

(g) The extent to which another state may have an interest in

regulating the activity; and

(h) The likelihood of conflict with regulation by another state.

In accordance with judicial and executive branch precedent and

guidance in interpreting statutes with cross-border application, the

Commission proposes that it should exercise its regulatory authority

over cross-border activities in a manner consistent with these

principles of statutory construction and international comity.\61\ The

Commission is therefore guided by these principles as discussed in

these precedents.\62\

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\61\ For a similar consideration of the application of

principles of international comity by federal agencies in the

enforcement of the antitrust laws, see U.S. Department of Justice

and the Federal Trade Commission, Antitrust Enforcement Guidelines

for International Operations, Apr. 1995, which is available at

http://www.justice.gov/atr/public/guidelines/internat.htm.

\62\ The Commission has a longstanding policy of considering

principles of international comity in its rulemakings and

interpretations. For example, the Commission adopted regulatory

amendments that codify its longstanding policy towards foreign

brokers. See Exemption from Registration for Certain Foreign

Persons, 72 FR 63976, 63978-79, Nov. 14, 2007. The amendments

codified a registration exemption for any foreign person functioning

as an introducing broker, commodity pool operator or commodity

trading advisor solely on behalf of customers located outside the

United States, if all commodity interest transactions are submitted

for clearing to a registered FCM. See id. at 63978-79. In addition,

the Commission amended Sec. 3.12 of the Commission's regulations to

codify a registration exemption for any individual located in the

branch office of a Commission registrant that does not solicit or

accept orders from customers located in the United States.

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B. Proposed Application of the CEA's Swap Provisions to Non-U.S. Swap

Dealers and Foreign Branches, Agencies, Affiliates, and Subsidiaries of

U.S. Swap Dealers

1. Categories of Regulatory Requirements

Title VII of the Dodd-Frank Act establishes a comprehensive new

regulatory framework for swap dealers and MSPs. This framework is an

important element of the ``improve[d] financial architecture'' that

Congress intended in enacting the Dodd-Frank Act and its goal of

reducing systemic risk and enhancing market transparency.\63\ Among

other things, a registered swap dealer or MSP must comport with certain

standards (and regulations as the Commission may promulgate) governing

risk management, internal and external business conducts, and

reporting. Further, U.S. swap dealers and MSPs, once registered, are

required to comply with all of the requirements applicable to swap

dealers and MSPs for all their swaps, not just the swaps that make them

a swap dealer or MSP.

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\63\ S. Rep. No. 111-176, at 228 (2010), available at http://www.gpo.gov/fdsys/pkg/CRPT-111srpt176/pdf/CRPT-111srpt176.pdf.

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A number of commenters recommended that the Commission, in

interpreting the cross-border applicability of the Dodd-Frank Act swap

provisions to a registered swap dealer or MSP, should distinguish

between requirements that: (i) Apply at an entity level (i.e., to the

firm as a whole); or (ii) apply at a transactional level (i.e., to the

individual transaction or trading relationship).\64\ These commenters

believed that requirements that relate to the core operations of a firm

should be applied on an entity-level basis and would include the

capital and related prudential requirements and recordkeeping, as well

as certain risk mitigation requirements (e.g., information barriers and

the designation of a chief compliance officer). The commenters stated

that other requirements, such as margin, should apply on transaction-

by-transaction basis and only to swaps with U.S. counterparties.\65\

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\64\ See, e.g., SIFMA (Feb. 3, 2011), ISDA (Jan. 24, 2011),

Cleary (Sept. 20, 2011), Seven Foreign Banks (Jan. 11, 2011), and

Twelve Foreign Banks (Feb. 17, 2011).

\65\ See SIFMA (Feb. 3, 2011).

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The Commission agrees with the commenters that the various Dodd-

Frank Act swap provisions can be conceptually divided into the

following

[[Page 41224]]

two categories: (i) Entity-Level Requirements, which apply to a swap

dealer or MSP to the firm as a whole; and (ii) Transactional-Level

Requirements, which apply to the individual swap. A discussion of the

Entity-Level Requirements is set out in the section immediately below,

followed by discussions of the Transaction-Level Requirements.

2. Entity-Level Requirements

The Entity-Level Requirements under Title VII of the Dodd-Frank Act

and the Commission's regulations promulgated thereunder relate to: (i)

Capital adequacy; (ii) chief compliance officer; (iii) risk management;

(iv) swap data recordkeeping; (v) swap data reporting (``SDR

Reporting''); and (vi) physical commodity swaps reporting (``Large

Trader Reporting''). The Entity-Level Requirements apply to registered

swap dealers and MSPs across all their swaps without distinctions as to

the counterparty or the location of the swap.

The first subcategory of Entity-Level Requirements relating to

capital adequacy, chief compliance officer, risk management, and swap

data recordkeeping relate to risks to a firm as a whole. These

requirements address and manage risks that arise from a firm's

operation as a swap dealer or MSP. Individually, they represent a key

component of a firm's internal risk controls. Collectively, they

constitute a firm's first line of defense against financial,

operational, and compliance risks that could lead to a firm's default

or failure.

At the core of a robust internal risk controls system is the firm's

capital--and particularly, how the firm identifies and manages its risk

exposure arising from its portfolio of activities.\66\ Equally

foundational to the financial integrity of a firm is an effective

internal risk management process, which must be comprehensive in scope

and reliant on timely and accurate data regarding its swap activities.

To be effective, such system must have a strong and independent

compliance function. These internal controls-related requirements--

namely, the requirements related to chief compliance officer, risk

management, swap data recordkeeping--are designed to serve that end.

Given their functions, this subcategory of Entity-Level Requirements

must be applied on a firm-wide basis to effectively address risks to

the swap dealer or MSP as a whole.

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\66\ By way of illustration, consistent with the purpose of the

capital requirement, which is intended to reduce the likelihood and

cost of a swap dealer's default by requiring a financial cushion, a

swap dealer's or MSP's capital requirements would be set on the

basis of its overall portfolio of assets and liabilities.

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The second subcategory of Entity-Level Requirements, namely, SDR

Reporting and Large Trader Reporting, relates more closely to the

Commission's market surveillance program. Among other things, data

reported to swap data repositories (``SDRs'') will enhance the

Commission's understanding of concentrations of risks within the

market, as well as promote a more effective monitoring of risk profiles

of market participants in the swaps market. Large Trader Reporting,

along with an analogous reporting system for futures contracts, is

essential to the Commission's ability to conduct effective surveillance

of the futures market and their economically equivalent swaps. Given

the functions of these reporting requirements, each must be applied

across swaps, irrespective of the counterparty or the location of the

swap, in order to ensure that the Commission has a comprehensive and

accurate picture of market activities. Otherwise, the intended benefits

of these Entity-Level Requirements would be significantly compromised,

if not undermined. Each of the Entity-Level Requirements is discussed

in the subsections that follow.

i. Capital Requirements

Section 4s(e)(3)(A) of the CEA specifically directs the Commission

to set capital requirements for swap dealers and MSPs that are not

subject to the capital requirements of prudential regulators

(hereinafter referred to as ``non-bank swap dealers or MSPs'').\67\

These requirements must: ``(1) [h]elp ensure the safety and soundness

of the swap dealer or major swap participant; and (2) [be] appropriate

for the risk associated with the non-cleared swaps held as a swap

dealer or major swap participant.'' \68\ Pursuant to section 4s(e)(3),

the Commission proposed regulations, which would require non-bank swap

dealers and MSPs to hold a minimum level of adjusted net capital (i.e.,

``regulatory capital'') based on whether the non-bank swap dealer or

MSP is: (i) Also a futures commission merchant (``FCM''); (ii) not an

FCM, but is a non-bank subsidiary of a bank holding company; or (iii)

neither an FCM nor a non-bank subsidiary of a bank holding company.\69\

The purpose of the capital requirement is to reduce the likelihood and

cost of a swap dealer's or MSP's default by requiring a financial

cushion that can absorb losses in the event of the firm's default.

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\67\ See 7 U.S.C. 6s(e)(3)(A). Section 4s(e) of the CEA

explicitly requires the adoption of rules establishing capital and

margin requirements for swap dealers and MSPs, and applies a

bifurcated approach that requires each swap dealer and MSP for which

there is a prudential regulator to meet the capital and margin

requirements established by the applicable prudential regulator, and

each swap dealer and MSP for which there is no prudential regulator

to comply with the Commission's capital and margin regulations. See

7 U.S.C. 6s(e). Further, systemically important financial

institutions (``SIFIs'') that are not futures commission merchants

would be exempt from the Commission's capital requirements, and

would comply instead with Federal Reserve Board requirements

applicable to SIFIs, while nonbank (and non-futures commission

merchant) subsidiaries of U.S. bank holding companies would

calculate their Commission capital requirement using the same

methodology specified in Federal Reserve Board regulations

applicable to the bank holding company, as if the subsidiary itself

were a bank holding company. The term ``prudential regulator'' is

defined in CEA section 1a(39) as the Board of Governors of the

Federal Reserve System, the Office of the Comptroller of the

Currency, the Federal Deposit Insurance Corporation, the Farm Credit

Administration, and the Federal Housing Finance Agency. See 7 U.S.C.

1a(39).

\68\ See 7 U.S.C. 6s(e)(3)(A).

\69\ See 7 U.S.C. 6s(e). See also Capital Requirements of Swap

Dealers and Major Swap Participants, 76 FR 27802, May 12, 2011.

``The Commission's capital proposal for [swap dealers] and MSPs

includes a minimum dollar level of $20 million. A non-bank [swap

dealer] or MSP that is part of a U.S. bank holding company would be

required to maintain a minimum of $20 million of Tier 1 capital as

measured under the capital rules of the Federal Reserve Board. [A

swap dealer] or MSP that also is registered as an FCM would be

required to maintain a minimum of $20 million of adjusted net

capital as defined under [proposed] section 1.17. In addition, a

[swap dealer] or MSP that is not part of a U.S. bank holding company

or registered as an FCM would be required to maintain a minimum of

$20 million of tangible net equity, plus the amount of the [swap

dealer's] or MSP's market risk exposure and OTC counterparty credit

risk exposure.'' See id. at 27817.

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ii. Chief Compliance Officer

Section 4s(k) requires that each swap dealer and MSP designate an

individual to serve as its chief compliance officer (``CCO'') and

specifies certain duties of the CCO.\70\ Pursuant to section 4s(k), the

Commission recently adopted Sec. 3.3, which requires swap dealers and

MSPs to designate a CCO who would be responsible for administering the

firm's compliance policies and procedures, reporting directly to the

board of directors or a senior officer of the swap dealer or MSP, as

well as preparing and filing with the Commission a certified report of

compliance with the CEA.\71\ The chief compliance function is an

integral element of a firm's risk management and oversight and the

Commission's effort to foster a strong culture of compliance within

swap dealers and MSPs.

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\70\ See 7 U.S.C. 6s(k).

\71\ See 17 CFR 3.3.

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[[Page 41225]]

iii. Risk Management

Section 4s(j) of the CEA requires each swap dealer and MSP to

establish internal policies and procedures designed to, among other

things, address risk management, monitor compliance with position

limits, prevent conflicts of interest, and promote diligent

supervision, as well as maintain business continuity and disaster

recovery programs.\72\ The Commission recently adopted implementing

sections 23.600, 23.601, 23.602, 23.603, 23.605, 23.606, and 23.607 of

its regulations.\73\ The Commission also recently adopted section

23.609 of its regulations, which requires certain risk management

procedures for swap dealers or MSPs that are clearing members of a

derivatives clearing organization (``DCO'').\74\ Collectively, these

requirements help to establish a robust and comprehensive internal risk

management program for swap dealers and MSPs, which is critical to

effective systemic risk management for the overall swaps market.

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\72\ 7 U.S.C. 6s(j).

\73\ 7 CFR 23.600, 23.601, 23.602, 23.603, 23.605, 23.606, and

23.607; see also Swap Dealer and Major Swap Participant

Recordkeeping, Reporting, and Duties Rule, Futures Commission

Merchant and Introducing Broker Conflicts of Interest Rule, and

Chief Compliance Officer Rules for Swap Dealers, Major Swap

Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3,

2012 (relating to risk management program, monitoring of position

limits, business continuity and disaster recovery, conflicts of

interest policies and procedures, general information availability,

and antitrust considerations, respectively).

\74\ 17 CFR 23.609, see also Customer Clearing Documentation,

Timing of Acceptance for Clearing, and Clearing Member Risk

Management, 77 FR 21278, Apr. 9, 2012. Also, swap dealers must

comply with Sec. 23.608, which prohibits swap dealers providing

clearing services to customers from entering into agreements that

would: (i) Disclose the identity of a customer's original executing

counterparty; (ii) limit the number of counterparties a customer may

trade with; (iii) impose counterparty-based position limits; (iv)

impair a customer's access to execution of a trade on terms that

have a reasonable relationship to the best terms available; or (v)

prevent compliance with specified time frames for acceptance of

trades into clearing.

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iv. Swap Data Recordkeeping

CEA section 4s(f)(1)(B) requires swap dealers and MSPs to keep

books and records for all activities related to their business.\75\

Section 4s(g)(1) requires swap dealers and MSPs to maintain trading

records for each swap and all related records, as well as a complete

audit trail for comprehensive trade reconstructions.\76\ Pursuant to

these provisions, the Commission adopted Sec. Sec. 23.201 and 23.203,

which require swap dealers and MSPs to keep records including complete

transaction and position information for all swap activities, including

documentation on which trade information is originally recorded.\77\

Swap dealers and MSPs also must comply with Part 46 of the Commission's

regulations, which addresses the recordkeeping requirements for swaps

entered into before the date of enactment of the Dodd-Frank Act (``pre-

enactment swaps'') and data relating to swaps entered into on or after

the date of enactment but prior to the compliance date of the swap data

reporting rules (``transition swaps'').\78\

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\75\ 7 U.S.C. 6s(f)(1)(B).

\76\ 7 U.S.C. 6s(g)(1).

\77\ 17 CFR 23.201 and 23.203; see also 77 FR 20128, Apr. 3,

2012. These requirements also require a swap dealer to provide the

Commission with regular updates concerning its financial status, as

well as information concerning internal corporate procedures.

\78\ 17 CFR 46.1 et seq.; Swap Data Recordkeeping and Reporting

Requirements: Pre-Enactment and Transition Swaps, 76 FR 22833, Apr.

25, 2011.

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v. Swap Data Reporting

CEA section 2(a)(13)(G) requires all swaps, whether cleared or

uncleared, to be reported to a registered SDR.\79\ CEA section 21

requires SDRs to collect and maintain data related to swaps as

prescribed by the Commission, and to make such data electronically

available to regulators.\80\ Swap dealers and MSPs would be required to

comply with Part 45 of the Commission's regulations, which sets forth

the specific transaction data that reporting counterparties and

registered entities must report to a registered SDR; and Part 46, which

addresses the recordkeeping requirements for pre-enactment swaps and

data relating to transition swaps. Among other things, data reported to

SDRs will enhance the Commission's understanding of concentrations of

risks within the market, as well as promote a more effective monitoring

of risk profiles of market participants in the swaps market. The

Commission also believes that there are benefits that will accrue to

swap dealers and MSPs as a result of the timely reporting of

comprehensive swap transactional data and consistent data standards for

recordkeeping, among other things. Such benefits include more robust

risk monitoring and management capabilities for swap dealers and MSPs,

which in turn will improve the monitoring of their current swap market

positions.

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\79\ 7 U.S.C. 2(a)(13)(G).

\80\ 7 U.S.C. 24a.

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vi. Physical Commodity Swaps Reporting (Large Trader Reporting)

CEA section 4t \81\ authorizes the Commission to establish a large

trader reporting system for significant price discovery swaps (of which

economically equivalent swaps subject to part 20 reporting are a

subset) in order to implement the statutory mandate in CEA section 4a

\82\ for the Commission to establish and monitor position limits, as

appropriate, for physical commodity swaps. Pursuant thereto, the

Commission adopted part 20 rules requiring swap dealers, among other

entities, to submit routine position reports on certain physical

commodity swaps and swaptions.\83\ Additionally, part 20 rules require

that swap dealers, among other entities, comply with certain

recordkeeping obligations.

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\81\ 7 U.S.C. 6t.

\82\ 7 U.S.C. 6a.

\83\ Large Trader Reporting for Physical Commodity Swaps, 76 FR

43851, July 22, 2011. The rules require regular position reporting

and recordkeeping by clearing organizations, clearing members, and

swap dealers for any principal or counterparty accounts with

reportable position in physical commodity swaps. In general, the

rules apply to swaps that are linked to either the price of any of

the 46 physical commodity futures contracts the Commission

enumerates (Covered Futures Contracts) or the price of the physical

commodity at the delivery location of any of the Covered Futures

Contracts.

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3. Transaction-Level Requirements

The Transaction-Level Requirements under Title VII of the Dodd-

Frank Act and the Commission's regulations (proposed or adopted)

include: (i) Clearing and swap processing; (ii) margining and

segregation for uncleared swaps; (iii) trade execution; (iv) swap

trading relationship documentation; (v) portfolio reconciliation and

compression; (vi) real-time public reporting; (vii) trade confirmation;

(viii) daily trading records; and (ix) external business conduct

standards.

The Transaction-Level Requirements--with the exception of external

business conduct standards--relate to both risk mitigation and market

transparency. Certain of these requirements, such as clearing and

margining, serve to lower a firm's risk of failure. In that respect,

these Transaction-Level Requirements could be classified as Entity-

Level Requirements. Other Transaction-Level Requirements--such as trade

confirmation, swap trading relationship documentation, and portfolio

reconciliation and compression--also serve important risk mitigation

functions, but are less closely connected to risk mitigation of the

firm as a whole and thus are more appropriately applied

[[Page 41226]]

on a transaction-by-transaction basis. Likewise, the requirements

related to trade execution, trade confirmation, daily trading records,

and real-time public reporting have a closer nexus to the transparency

goals of the Dodd-Frank Act, as opposed to addressing the risk of a

firm's failure.

As a result, whether a particular Dodd-Frank Act requirement should

apply on a transaction-by-transaction basis in the context of cross-

border activity for purposes of section 2(i) of the CEA requires the

Commission to exercise some degree of judgment, including

considerations of international comity. Each of the Transaction-Level

Requirements is discussed below.

i. Clearing and Swap Processing

Section 2(h) of the CEA requires a swap to be submitted for

clearing to a DCO if the Commission has determined that the swap is

required to be cleared, unless one of the parties to the swap is

eligible for an exception from the clearing requirement and elects not

to clear the swap.\84\ Clearing via a DCO eliminates the risk of

settlement for swap dealers or MSPs and their counterparties. Closely

interlocked with the clearing requirement are the following swap

processing requirements: (i) The recently finalized Sec. 23.506, which

requires swap dealers and MSPs to submit swaps promptly for clearing;

and (ii) Sec. 23.610, which establishes certain standards for swap

processing by swap dealers and MSPs that are clearing members of a

DCO.\85\ Together, the clearing and swap processing requirements

promote safety and soundness of swap dealers and MSPs, and aim to

protect their counterparties from the risk of a default.

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\84\ 7 U.S.C. 2(h)(1), (7).

\85\ 17 CFR 23.506, 23.610 and Customer Clearing Documentation,

Timing of Acceptance for Clearing, and Clearing Member Risk

Management, 77 FR 21278, Apr. 9, 2012.

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ii. Margin and Segregation Requirements for Uncleared Swaps

Section 4s(e) of the CEA requires the Commission to set margin

requirements for swap dealers (and MSPs) that trade in swaps that are

not cleared.\86\ The margin requirements aim to reduce the risk of swap

dealers, MSPs, and their counterparties taking on excessive risks posed

by uncleared swaps without having adequate financial backing to fulfill

their obligations under the swap. In addition, with respect to swaps

that are not submitted for clearing, section 4s(l) requires that a swap

dealer or MSP notify the counterparty of its right to require

segregation of funds provided as margin, and upon such request, to

segregate the funds with a third-party custodian for the benefit of the

counterparty. In this way, the segregation requirement enhances the

safety of margin and thereby provides additional financial protection

to counterparties.

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\86\ See 7 U.S.C. 6s(e). See also Margin Requirements for

Uncleared Swaps for Swap Dealers and Major Swap Participants, 76 FR

23732, 23733-40, Apr. 28, 2011. Section 4s(e) explicitly requires

the adoption of rules establishing margin requirements for swap

dealers and MSPs, and applies a bifurcated approach that requires

each swap dealer and MSP for which there is a prudential regulator

to meet the margin requirements established by the applicable

prudential regulator, and each swap dealer and MSP for which there

is no prudential regulator to comply with the Commission's margin

regulations. In contrast, the segregation requirements in section

4s(1) do not use a bifurcated approach--that is, all swap dealers

and MSPs are subject to the Commission's rule regarding notice and

third party custodians for margin collected for uncleared swaps.

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iii. Trade Execution Requirement

Integrally linked to the clearing requirement is the trade

execution requirement, which is intended to bring the trading of

mandatorily cleared swaps onto regulated exchanges. Specifically,

section 2(h)(8) of the CEA provides that unless a clearing exception

applies and is elected, a swap that is subject to a clearing

requirement must be executed on a designated contract market (``DCM'')

or swap execution facility (``SEF''), unless no such DCM or SEF makes

the swap available to trade.\87\ By requiring the trades of mandatorily

cleared swaps to be executed on an exchange--with its attendant pre-

and post-trade transparency and safeguards to ensure market integrity--

the trade execution requirement furthers the statutory goals of

financial stability, market efficiency and enhanced transparency.

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\87\ See 7 U.S.C. 2(h)(8).

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iv. Swap Trading Relationship Documentation

CEA Section 4s(i) requires each swap dealer and MSP to conform to

Commission standards for the timely and accurate confirmation,

processing, netting, documentation and valuation of swaps. Pursuant

thereto, the Commission has proposed Sec. 23.504(a) of its

regulations, which would require swap dealers and MSPs to ``establish,

maintain and enforce written policies and procedures'' to ensure that

the swap dealer or MSP executes written swap trading relationship

documentation.\88\ Under proposed Sec. Sec. 23.505(b)(1), 23.504

(b)(3), and 23.504(b)(4) of the Commission's regulations, the swap

trading relationship documentation must include, among other things:

all terms governing the trading relationship between the swap dealer or

MSP and its counterparty; credit support arrangements; investment and

re-hypothecation terms for assets used as margin for uncleared swaps,

and custodial arrangements.\89\ Further, the swap trading relationship

documentation requirement applies to all swaps with registered swap

dealers and MSPs. A robust swap documentation standard may promote

standardization of documents and transactions, which are key conditions

for central clearing, and lead to other operational efficiencies,

including improved valuation and risk management.

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\88\ See Swap Trading Relationship documentation Requirements

for Swap Dealers and Major Swap Participants, 76 FR 6715, Feb. 8,

2011.

\89\ The requirements under section 4s(i) relating to trade

confirmations is a Transaction-Level Requirement. Accordingly,

proposed section 23.504(b)(2), which requires a swap dealer's and

MSP's swap trading relationship documentation to include all

confirmations of swaps, will apply on a transaction-by-transaction

basis.

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v. Portfolio Reconciliation and Compression

CEA section 4s(i) directs the Commission to prescribe regulations

for the timely and accurate processing and netting of all swaps entered

into by swap dealers and MSPs. Pursuant to CEA section 4s(i), the

Commission proposed Sec. Sec. 23.502 and 23.503 of its regulations,

which would require swap dealers and MSPs to perform portfolio

reconciliation and compression, respectively, for all swaps.\90\

Portfolio reconciliation is a post-execution risk management tool to

ensure accurate confirmation of a swap's terms and to identify and

resolve any discrepancies between counterparties regarding the

valuation of the swap. Portfolio compression is a post-trade processing

and netting mechanism that is intended to ensure timely, accurate

processing and netting of swaps.\91\ Proposed Sec. 23.503(c) would

require all swap dealers and MSPs to participate in bilateral

compression exercises and/or multilateral portfolio compression

exercises conducted by their self-regulatory organizations (``SROs'')

or DCOs of which they are members.\92\ Further, participation in

multilateral

[[Page 41227]]

portfolio compression exercises is mandatory for dealer-to-dealer

trades.

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\90\ See Confirmation, Portfolio Reconciliation, and Portfolio

Compression Requirements for Swap Dealers and Major Swap

Participants, 75 FR 81519, Dec. 28, 2010.

\91\ For example, the reduced transaction count may decrease

operational risk as there are fewer trades to maintain, process and

settle.

\92\ See 17 CFR 23.503(c), 75 FR 81519, Dec. 28, 2010.

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vi. Real-Time Public Reporting

Section 2(a)(13) of the CEA directs the Commission to promulgate

rules providing for the public availability of swap transaction data on

a real time basis.\93\ In accordance with this mandate, the Commission

promulgated part 43 of its rules on December 20, 2011, which provide

that all ``publicly reportable swap transactions'' must be reported and

publicly disseminated.\94\ The real-time dissemination of swap

transaction and pricing data supports the fairness and efficiency of

markets and increases transparency, which in turn improves price

discovery and decreases risk (e.g., liquidity risk).\95\

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\93\ See 7 U.S.C. 2(a)(13). See also Real-Time Public Reporting

of Swap Transaction Data, 77 FR 1182, 1183, Jan. 9, 2012.

\94\ Part 43 defines a ``publicly reportable swap transaction''

as (i) any swap that is an arm's-length transaction between two

parties that results in a corresponding change in the market risk

position between the two parties; or (ii) any termination,

assignment, novation, exchange, transfer, amendment, conveyance, or

extinguishing of rights or obligations of a swap that changes the

pricing of a swap. See 77 FR 1182, Jan. 9, 2012.

\95\ See 77 FR 1182, 1183.

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vii. Trade Confirmation

Section 4s(i) of the CEA \96\ requires that each swap dealer and

MSP must comply with the Commission's regulations prescribing timely

and accurate confirmation of swaps. The Commission has proposed Sec.

23.501, which requires, among other things, a timely and accurate

confirmation of all swaps and life cycle events for existing swaps.\97\

Timely and accurate confirmation of swaps--together with portfolio

reconciliation and compression--are important post-trade processing

mechanisms for reducing risks and improving operational efficiency.\98\

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\96\ 7 U.S.C. 6s(i).

\97\ See 17 CFR 23.501; see also 75 FR 81519, Dec. 28, 2010.

\98\ In addition, the Commission notes that proposed Sec.

23.504(b)(2) requires a swap dealer's and MSP's swap trading

relationship to include all confirmations of swaps.

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viii. Daily Trading Records

Pursuant to section CEA 4s(g)(1), the Commission adopted Sec.

23.202 of its regulations, which requires swap dealers and MSPs to

maintain daily trading records, including records of trade information

related to pre-execution, execution, and post-execution data that is

needed to conduct a comprehensive and accurate trade reconstruction for

each swap. The final rule also requires that records be kept of cash or

forward transactions used to hedge, mitigate the risk of, or offset any

swap held by the swap dealer or MSP.\99\ Accurate and timely

recordkeeping regarding all phases of a swap can serve to greatly

enhance a firm's internal supervision, as well as the Commission's

ability to detect and address market abuses.

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\99\ See Swap Dealer and Major Swap Participant Recordkeeping,

Reporting, and Duties Rules; Futures Commission Merchant and

Introducing Broker Conflicts of Interest Rules; and Chief Compliance

Officer Rules for Swap Dealers, Major Swap Participants, and Futures

Commission Merchants, 77 FR 20128, Apr. 3, 2012.

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ix. External Business Conduct Standards

Pursuant to CEA section 4s(h), the Commission has adopted external

business conduct rules, which establish business conduct standards

governing the conduct of swap dealers and MSPs in dealing with their

counterparties in entering into swaps.\100\ Broadly speaking, these

rules are designed to enhance counterparty protection by significantly

expanding the obligations of swap dealers and MSPs towards their

counterparties. Under these rules, swap dealers and MSPs will be

required, among other things, to conduct due diligence on their

counterparties to verify eligibility to trade, provide disclosure of

material information about the swap to their counterparties, provide a

daily mid-market mark for uncleared swaps and, when recommending a swap

to a counterparty, make a determination as to the suitability of the

swap for the counterparty based on reasonable diligence concerning the

counterparty.

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\100\ See 7 U.S.C. 6s(h). See also Business Conduct Standards

for Swap Dealers and Major Swap Participants With Counterparties, 77

FR 9734, 9822-29, Feb. 17, 2012.

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4. Application of the Entity-Level Requirements \101\

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\101\ Appendix A in this release provides a chart describing the

application of the Entity-Level Requirements to U.S. and non-U.S.

swap dealers and MSPs.

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The Dodd-Frank Act takes a comprehensive and integrated approach to

the regulation of the swaps market. The first subcategory of Entity-

Level Requirements, relating to capital adequacy, chief compliance

officer, risk management, and swap data recordkeeping are at the heart

of such framework. Specifically, these Entity-Level Requirements ensure

that registered swap dealers and MSPs implement and maintain a

comprehensive and robust system of internal controls to ensure the

financial integrity of the firm, and in turn, the protection of the

financial system. In this respect, the Commission has strong

supervisory interests in applying the same rigorous standards, or

comparable standards, to non-U.S. swap dealers and non-U.S. MSPs whose

swaps activities or positions are substantial enough to require

registration under the CEA. Requiring such swap dealers and MSPs to

rigorously monitor and address the risks they incur as part of their

day-to-day businesses would lower the registrants' risk of default--and

ultimately protect the public and the financial system.

Therefore, the Commission proposes to interpret CEA section 2(i) so

as to require that registered non-U.S. swap dealers and non-U.S. MSPs

comply with all of the first subcategory of Entity-Level

Requirements.\102\ In consideration of principles of international

comity, the Commission further proposes to interpret CEA section 2(i)

so as to permit substituted compliance with foreign regulations for

these Entity-Level Requirements in certain circumstances. The

circumstances in which the Commission proposes to consider permitting

substituted compliance are explained below in the Section III.C. of

this proposed interpretative guidance.

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\102\ As discussed above in Section II.D of this proposed

interpretive guidance, the Commission considers foreign branches and

agencies of U.S. swap dealers to be the agents of their U.S. person.

Thus, in all instances, the U.S. swap dealer would be responsible

for complying with all Entity-Level Requirements.

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With respect to SDR Reporting, the Commission believes that direct

access to data concerning all swaps in which a registered swap dealer

or MSP enters is essential in order for the Commission to carry out its

supervisory mandates concerning, among other things, increased

transparency, systemic risk mitigation, market monitoring, and market

abuse prevention. For example, data reported to SDRs would be critical

to ensure that the Commission has a comprehensive and accurate picture

of swap dealers and MSPs that are its registrants, including the gross

and net counterparty exposures of swaps of all swap dealers and MSPs,

to the greatest extent possible. Similarly, swap data reported by swap

dealers to the Commission under Large Trader Reporting is critical to

the Commission's ability to effectively monitor and oversee the swaps

market.

For these reasons, the Commission proposes to interpret CEA section

2(i) so as to require non-U.S. swap dealers and non-U.S. MSPs to report

all of their swaps to a registered SDR \103\ and to require non-U.S.

swap dealers to report

[[Page 41228]]

all of their reportable positions under part 20. At the same time, the

Commission recognizes the interests of foreign jurisdictions with

respect to swaps between a non-U.S. swap dealer or non-U.S. MSP with a

non-U.S. counterparty and therefore, further interprets CEA section

2(i) so as to permit substituted compliance with comparable foreign

regimes for SDR Reporting and Large Trader Reporting.

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\103\ See 7 U.S.C. 2(a)(13)(G). See also 77 FR at 2197-2211.

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5. Application of the Transaction-Level Requirements \104\

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

\104\ Appendix B in this release provides charts describing the

application of the Transaction-Level Requirements to U.S. and non-

U.S. swap dealers and MSPs.

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As discussed above, Transaction-Level Requirements serve to

mitigate risks to swap dealers and MSPs and their counterparties, to

promote greater market transparency and efficiency in the U.S. swaps

market, and to provide counterparty protections. The Commission has a

strong supervisory interest in ensuring that these Dodd-Frank Act

requirements apply to swaps between a registered swap dealer or MSP

(regardless of whether they are a U.S. person or non-U.S. person) and

U.S. persons as counterparties, with a limited exception. Accordingly,

the Commission proposes to interpret section 2(i) in a manner so as to

require non-U.S. swap dealers and non-U.S. MSPs to comply with

Transaction-Level Requirements for all of their swaps with U.S.

persons, other than foreign branches of U.S. persons, as

counterparties.\105\ Consistent with the foregoing rationale, in most

cases, the Commission does not intend to permit substituted compliance

for the Transaction-Level Requirements for swaps between non-U.S. swap

dealers or non-U.S. MSPs and U.S. persons.\106\ The following

discussion provides proposed guidance on the application of the

Transaction-Level Requirements to swaps by non-U.S. swap dealers and

non-U.S. MSPs with non-U.S. counterparties.

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\105\ Moreover, the U.S. counterparties, as well as the non-U.S.

swap dealers and non-U.S. MSPs, may have an expectation that the

Dodd-Frank Act will extend to them and their swaps.

\106\ Section III.D. (below) addresses the application of the

Entity and Transaction-Level Requirements to branches, agencies,

subsidiaries, and affiliates of U.S. swap dealers.

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i. Clearing and Swap Processing, Margin (and Segregation), Trade

Execution, Swap Trading Relationship Documentation, Portfolio

Reconciliation and Compression, Real-Time Public Reporting, Trade

Confirmation, and Daily Trading Records

With respect to swaps between non-U.S. swap dealers or non-U.S.

MSPs and non-U.S. counterparties, the Commission proposes to interpret

section 2(i) so as to require non-U.S. swap dealers and non-U.S. MSPs

to comply with the clearing and swap processing and margin (and

segregation) requirements for swaps where the non-U.S. counterparty's

performance is guaranteed by (or otherwise supported by) a U.S.

person.\107\ The Commission interprets section 2(i) in this manner

because where a non-U.S. counterparty's swap obligations are guaranteed

by a U.S. person, the risk of non-performance by the counterparty rests

with the U.S. person. If the non-U.S. person defaults on its

obligations under the swaps, then the U.S. person guarantor will be

held responsible (or would bear the cost) to settle those obligations.

In circumstances in which a U.S. person ultimately bears the risk of

non-performance of a counterparty to a swap with a non-U.S. swap dealer

or non-U.S. MSP, the Commission has a strong regulatory interest in the

performance of the swap by both parties to the swap, and hence the

application of these Transaction-Level Requirements with respect to

such swaps is warranted. In consideration of international comity

principles, the Commission further interprets CEA section 2(i) so as to

permit substituted compliance for these Transaction-Level

Requirements.\108\

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\107\ As noted above in Section II.B of this proposed

interpretive guidance, risk may be imported into the U.S. In these

circumstances, and regardless of whether the non-U.S. swap dealer's

counterparty is a U.S. person or a non-U.S. person, the risk of

default by the non-U.S. swap dealer with respect to its swap dealing

transactions ultimately rests with a U.S. person.

\108\ Below (in Section IV), the Commission describes the

specific circumstances under which it proposes to permit compliance

with a foreign regulatory regime's clearing requirement for swaps

entered into by non-U.S. swap dealers, non-U.S. MSPs, and other non-

U.S. market participants in lieu of compliance with a Commission-

issued clearing requirement.

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Similarly, the requirements relating to portfolio reconciliation

and compression can serve to significantly mitigate risks to the

counterparties, and by extension, the U.S. person guaranteeing the non-

U.S. counterparty's obligations under the swap. Specifically, portfolio

reconciliation serves to diminish the risk of disputes for the

counterparties. Portfolio compression also has the effect of lowering

the risk for the counterparties by diminishing operational risks. Other

Transaction-Level Requirements--trade confirmation, swap trading

relationship documentation, and daily trading records--by ensuring that

swaps are properly documented and recorded, serve to protect the

counterparties, as well as the U.S. person that is the guarantor.\109\

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\109\ As noted above, the portfolio compression and swap trading

relationship documentation requirements apply to all swaps between

registered swap dealers. Thus, where the non-U.S. counterparty is

another U.S.-registered swap dealer, these Transaction-Level

Requirements apply. The Commission believes that this inclusive

approach is necessary given the significant role registered swap

dealers play in the swaps market.

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The Commission also proposes to interpret section 2(i) so as to

require non-U.S. swap dealers and non-U.S. MSPs to comply with the

trade execution requirement for swaps where the non-U.S. counterparty's

performance is guaranteed by a U.S. person.

The trade execution requirement is linked to the clearing

requirement and for that reason, should be treated in same manner as

the clearing requirement for regulatory purposes, which better ensures

the effectiveness of the clearing and trading mandates. Requiring swaps

to be traded on a regulated exchange provides market participants with

greater pre- and post-trade transparency. Similarly, real-time public

reporting improves price discovery by requiring that swap transaction

and pricing data be made publicly available. Together, trade execution

and real-time reporting requirements provide important information for

risk management purposes and bring greater efficiency to the

marketplace--to the benefit of the individual counterparties. As with

the other Transaction-Level Requirements, the Commission further

interprets CEA section 2(i), consistent with comity principles, so as

to permit substituted compliance with respect to these transactions.

Similar concerns regarding the flow of risk to the United States

are raised by an entity that effectively operates as a ``conduit'' for

a U.S. person to execute swaps outside the Dodd-Frank Act regime. The

Commission recognizes that such conduits may be used legitimately to

move economic risks from one person within a corporate group to another

in order to manage the group's overall swap portfolio. The Commission

also recognizes that, in many cases, the

[[Page 41229]]

conduits could be subject to prudential and risk management

requirements and may lay off the risk of its dealing activities on an

individual or portfolio basis through transactions that would be

subject to and reported under the Dodd-Frank Act.

Nevertheless, the Commission is concerned that given the nature of

the relationship between the conduit and the U.S. person, the U.S.

person is directly exposed to risks from and incurred by the conduit.

The Commission is further concerned that rather than execute a swap

opposite a U.S. counterparty, which would be subject to the Dodd-Frank

transactional requirements, a U.S. swap dealer or MSP could execute a

swap with its foreign affiliate or subsidiary, which could then execute

a swap with a non-U.S. third-party in a jurisdiction that is

unregulated or lack comparable transactional requirements. Accordingly,

the Commission proposes to apply these Transaction-Level Requirements

to swaps in which: (i) A non-U.S. counterparty is majority-owned,

directly or indirectly, by a U.S. person; (ii) the non-U.S.

counterparty regularly enters into swaps with one or more other U.S.

affiliates or subsidiaries of the U.S. person; and (iii) the financials

of such non-U.S. counterparty are included in the consolidated

financial statements of the U.S. person. Further, the Commission

interprets CEA section 2(i), consistent with comity principles, so as

to permit substituted compliance for these Transaction-Level

Requirements with respect to swaps between a non-U.S. swap dealer or

non-U.S. MSP and such affiliate conduit.

Conversely, and consistent with the foregoing rationale, the

Commission proposes to interpret section 2(i) so as to not require the

application of any of these Transaction-Level Requirements to swaps

between a non-U.S. swap dealer or non-U.S. MSP with a non-U.S.

counterparty that is not guaranteed by a U.S. person. In such

instances, the Commission recognizes that foreign regulators have a

strong supervisory interest in swaps occurring within their territories

involving their domiciles.

ii. External Business Conduct Standards

With respect to the external business conduct standards, the

Commission proposes to interpret section 2(i) to not require non-U.S.

swap dealers and non-U.S. MSPs to comply with these requirements for

swaps with a non-U.S. counterparty (whether or not guaranteed by a U.S.

person). The Commission believes that sales practice concerns related

to swaps between non-U.S. persons taking place outside the United

States implicate fewer U.S. supervisory concerns and, when weighed

together with the supervisory interests of foreign regulatory regimes,

may not warrant application of these requirements.\110\

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\110\ That is to say, just as the Commission would have a strong

supervisory interest in regulating and enforcing sales practices

associated with activities taking place within the United States,

the foreign regulators would have a similar claim to overseeing

sales practices occurring within their jurisdiction.

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C. Substituted Compliance With Respect to Particular Requirements

The Commission believes that a cross-border policy that allows for

flexibility in the application of the CEA, while ensuring the high

level of regulation contemplated by the Dodd-Frank Act and avoiding

potentially conflicting regulations is consistent with principles of

international comity. It would also advance the congressional directive

that the Commission act in order to ``promote effective and consistent

global regulation of swaps * * * as appropriate, shall consult and

coordinate with foreign regulatory authorities on the establishment of

consistent international standards with respect to regulation

(including fees) of swaps * * *.'' \111\ Practical considerations--

namely, the limitations in the Commission's supervisory resources and

its ability to effectively oversee and enforce application of the CEA

to cross-border transactions and activities--also support the

Commission applying its regulations in a manner that is focused on the

primary objectives of the CEA.

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\111\ See section 752 of the Dodd-Frank Act. As the Supreme

Court observed in Hoffmann-LaRoche, principles of international

comity ``help[ ] the potentially conflicting laws of different

nations work together in harmony--a harmony particularly needed in

today's highly interdependent commercial world.'' See Hoffmann-

LaRoche, 542 U.S. at 164-165.

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In light of the foregoing considerations, the Commission proposes

to permit a non-U.S. swap dealer or non-U.S. MSP, once registered with

the Commission, to comply with a substituted compliance regime under

certain circumstances. Substituted compliance means that a non-U.S.

swap dealer or non-U.S. MSP is permitted to conduct business by

complying with its home regulations, without additional requirements

under the CEA. Specifically, the Commission proposes to permit non-U.S.

swap dealers and non-U.S. MSPs to substitute compliance with the

requirements of the relevant home jurisdiction's law and regulations,

in lieu of compliance with the CEA and Commission's regulations, if the

Commission finds that such requirements are comparable to cognate

requirements under the CEA and Commission regulations. As discussed

below, this approach would build on the Commission's longstanding

policy of recognizing comparable regulatory regimes based on

international coordination and comity principles with respect to cross-

border activities involving futures (and options).\112\

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\112\ For example, under part 30 of the Commission's

regulations, if the Commission determines that compliance with the

foreign regulatory regime would offer comparable protection to U.S.

customers and there is an appropriate information-sharing

arrangement between the home supervisor and the Commission, the

Commission has permitted foreign brokers to comply with their home

regulations (in lieu of the applicable Commission regulations),

subject to appropriate conditions. See, e.g., 67 FR 30785 (Apr. 29,

2002); 71 FR 6759 (Feb. 9, 2001).

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The Commission proposes that it would make comparability

determinations on an individual requirement basis, rather than the

foreign regime as a whole. In the Commission's view, this would allow

for a more flexible registration process as it would permit a non-U.S.

person to become registered as a swap dealer or MSP even in the absence

of comparability with respect to all of the Dodd-Frank Act

requirements. Rather, a non-U.S. swap dealer or non-U.S. MSP may be

permitted to comply with regulations in its home jurisdiction to the

extent that the comparability standard is met but also may be required

to comply with certain of the Dodd-Frank Act requirements where

comparable home regulation(s) are lacking.\113\

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\113\ The details concerning the Commission's comparability

determinations will be discussed below in Section IV.

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In this section, the Commission broadly outlines the circumstances

under which the Commission would permit a non-U.S. swap dealer or non-

U.S. MSP to rely on foreign regulation and supervision as a substitute

for compliance by that swap dealer or MSP with some or all of the

requirements that would otherwise be applicable to it under Title VII

of the Dodd-Frank Act.

1. Entity-Level Requirements

The Commission anticipates that non-U.S. persons that will register

as swap dealers or MSPs with the Commission will likely have their

principal swap business in their home jurisdiction. The Commission

believes that it would be appropriate to permit substituted compliance

with respect to the previously-described Entity-Level Requirements

where the non-U.S. swap dealers or non-U.S. MSPs are subject to

comparable regulation in their home jurisdiction. In these

circumstances, the Commission notes that the home

[[Page 41230]]

regulator would have a primary relationship to the swap dealer or MSP,

which, coupled with the firm-wide focus of the Entity-Level

Requirements, supports permitting substituted compliance.

With respect to SDR Reporting, the Commission proposes to permit

substituted compliance with respect to swaps by non-U.S. swap dealers

and non-U.S. MSPs with non-U.S. counterparties (whether or not such

non-U.S. swap dealers or such non-U.S. MSPs are guaranteed by U.S.

persons), provided that the Commission has direct access to the swap

data for such non-U.S. swap dealers or non-U.S. MSPs that is stored at

the foreign trade repository. The Commission believes that this

approach would minimize burdens on non-U.S. swap dealers and non-U.S.

MSPs that report their swaps data to a foreign trade repository, while

ensuring that the Commission has access to information that is critical

to its oversight of these entities.

2. Transaction-Level Requirements

As discussed above, the Commission proposes to interpret section

2(i) so as to require non-U.S. swap dealers and non-U.S. MSPs to comply

with the clearing and swap processing, margining (and segregation),

trade execution, swap trading relationship documentation, portfolio

reconciliation and compression, real-time public reporting, trade

confirmation, and daily trading records requirements for all

transactions with a counterparty that is a U.S. person or is a non-U.S.

person whose swap obligations are guaranteed by a U.S. person.

The Commission would not permit substituted compliance with respect

to these Transaction-Level Requirements for a non-U.S. swap dealer's or

non-U.S. MSP's transactions with a counterparty that is a U.S. person,

with a limited exception.\114\ Generally, where swaps are executed with

U.S. persons, the Commission's supervisory interests in such

transactions, which have a direct and significant connection with

activities in, or effect on, U.S. commerce, and in ensuring the

protection of U.S. counterparties weighs in favor of applying the

requirements of the CEA, rather than permitting substituted compliance.

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\114\ The Commission, however, would continue to permit

substituted compliance with comparable home country regulations with

respect to Entity-Level Reqirements in this instance. Transactions

with a foreign branch or agency of a U.S. swap dealer are discussed

below.

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On the other hand, it may be more appropriate for the Commission to

permit substituted compliance for transactions between a non-U.S. swap

dealer or non-U.S. MSP and a non-U.S. person whose swap obligations are

guaranteed by a U.S. person. In such circumstances, the foreign

jurisdiction has a strong supervisory interest in regulating the

activities of its domiciles occurring within its territory. At the same

time, given that such transactions are guaranteed by a U.S. person, the

Commission also has a strong supervisory interest in ensuring that the

protections of the Dodd-Frank Act are extended to the U.S. guarantor.

In consideration of these factors, the Commission would permit

substituted compliance with respect to these Transaction-Level

Requirements for swaps between a non-U.S. swap dealer or non-U.S. MSP

with a non-U.S. person guaranteed by a U.S. person, as well as swaps

with non-U.S. affiliate conduits. Substituted compliance, the

Commission believes, would address its supervisory concerns while, at

the same time, minimizing the potential for conflicts with the

requirements under foreign jurisdictions.\115\

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\115\ As noted above, swaps with non-U.S. persons satisfying

each prong of the conduit test would be similarly subject to the

Transaction-Level Requirements, provided, however, that the non-U.S.

swap dealer or non-U.S. MSP executing such swaps may substitute

compliance with a comparable foreign regulatory regime in

appropriate cases.

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D. Application of Entity-Level and Transaction-Level Requirements to

Branches, Agencies, Affiliates, and Subsidiaries of U.S. Swap Dealers

1. Foreign Branches and Agencies of U.S. Swap Dealers

As discussed above, the Commission considers foreign branches and

agencies of a U.S. person to be a part of the U.S. person. Thus, the

Commission proposes that the U.S. person would be legally responsible

for complying with all applicable Entity-Level Requirements. Further,

the Commission proposes to require compliance with most of the

Transaction-Level Requirements (i.e., clearing and swap processing,

margin (and segregation) for uncleared swaps, trade execution, real-

time reporting, trade confirmation, swap trading relationship

documentation, daily trading records, and portfolio reconciliation and

compression), irrespective of whether the counterparty is a U.S. person

or non-U.S. person.\116\ This approach is appropriate in light of the

Commission's strong supervisory interests in entities that are part or

an extension of a U.S.-based swap dealer.

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\116\ For reasons stated above, with respect to external

business conduct standards, the Commission would apply such

requirements only for swaps where the counterparty is a U.S. person.

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The Commission further interprets section 2(i) to permit

substituted compliance with respect to the Transaction-Level

Requirements for swaps with certain counterparties. Specifically, the

Commission proposes to permit substituted compliance for swaps between

a foreign branch of a U.S. person and a non-U.S. person counterparty

(both whose obligations under the swap are guaranteed by a U.S. person

and those that are not). Given that the counterparty is a non-U.S.

person, coupled with the supervisory interest of the foreign

jurisdiction in the execution and clearing of trades occurring in that

jurisdiction, the Commission believes that it would be appropriate to

permit the parties to comply with comparable foreign requirements. In

doing so, the Commission notes that, as discussed in further detail

below, its recognition of substituted compliance would be based on an

evaluation of whether the requirements of the home jurisdiction are

comparable and comprehensive to the applicable requirement(s) under the

CEA and Commission regulations based on a consideration of all relevant

factors, including, among other things: (i) The comprehensiveness of

the foreign regulator's supervisory compliance program; and (ii) the

authority of such foreign regulator to support and enforce its

oversight of the registrant's branch or agency with regard to such

activities to which substituted compliance applies.

In limited circumstances where foreign regulations are not

comparable, the Commission believes that it could be appropriate to

permit foreign branches and agencies of U.S. swap dealers to comply

with the transaction-level requirements applicable to entities

domiciled or doing business in the foreign jurisdiction, rather than

the Transaction-Level Requirements that would otherwise be applicable

to the U.S. person's activities.\117\ Specifically, the Commission

understands that U.S. swap dealers' swap dealing activities through

branches or agencies in emerging markets in many cases may not be

significant but may be nevertheless an integral element of their global

business. Under the circumstances, the Commission proposes that section

2(i) should be interpreted to permit foreign branches and agencies of

U.S. swap dealers to

[[Page 41231]]

participate in the swap markets in such countries on a limited basis.

To be eligible for this exception, the aggregate notional value

(expressed in U.S. dollars and measured on a quarterly basis) of the

swaps of all foreign branches and agencies in such countries may not

exceed five percent of the aggregate notional value (expressed in U.S.

dollars and measured on a quarterly basis) of all of the swaps of the

U.S. swap dealer. However, the U.S. person relying on this exception

would be required to maintain records with supporting information to

verify its eligibility for the exception, as well as identify, define,

and address any significant risk that may arise from the non-

application of the Transaction-Level Requirements.\118\

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\117\ As noted above, the proposed interpretive guidance does

not limit the applicability of any CEA provision or Commission

regulation to any person, entity or transaction except as provided

herein.

\118\ The Commission solicits comments on all aspects of the

proposed exception, including the conditions for eligibility. In

particular, the Commission is interested in the types of risk-

mitigating measure(s) that should be imposed on a firm as a

condition to the exception.

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Further, as discussed above, the Commission proposes that the U.S.

person may task its foreign branch or agency to fulfill its regulatory

obligations with respect to the Transaction-Level Requirements. The

Commission would consider compliance by the foreign branch or agency to

constitute compliance with the Transaction-Level Requirements. The

Commission proposes, however, that the U.S. person remains responsible

for compliance with the Transaction-Level Requirements.

2. Foreign Affiliates and Subsidiaries of U.S. Swap Dealers

With respect to foreign affiliates or subsidiaries of U.S. swap

dealers, the Commission proposes that the regulatory requirements that

may apply to such affiliate or subsidiary would depend on where their

swaps are booked and whether the affiliate or subsidiary engages in

activities that trigger swap dealer registration. Where the swaps are

directly booked in the U.S. swap dealer but the foreign affiliate or

subsidiary facing the counterparty engages in swap dealing and

independently meets the definition of a swap dealer, the U.S. swap

dealer must comply with all of the swap dealer duties and obligations,

including capital-related prudential requirements. The foreign

affiliate or subsidiary would be required to separately register as a

swap dealer and comply with any Entity-Level and Transaction-Level

Requirements applicable to its swap dealing activities.

Thus, if the counterparty facing affiliate or subsidiary was acting

merely as a disclosed agent and did not meet the definition of a swap

dealer, then the Dodd-Frank Act requirements applicable to swap dealers

would not be applicable to the affiliate or subsidiary, provided that

the agency relationship was properly documented and the principal

remained primarily responsible for the actions of the affiliate. On the

other hand, if the counterparty facing affiliate or subsidiary

independently met the definition of a swap dealer, then it would be

required to register as a swap dealer and satisfy the Dodd-Frank Act

requirements applicable to swap dealers, even though all exposure to

the swaps it entered into were transferred to a central booking entity,

regardless of how those transfers were accomplished.\119\ In this

scenario, the Commission interprets section 2(i), consistent with the

principles of international comity, so as to permit substituted

compliance by the foreign affiliate or subsidiary.

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\119\ As noted earlier, the booking entity itself also would be

required to register as a swap dealer and satisfy the Dodd-Frank Act

requirements applicable to swap dealers, even though the affiliate

facing the third party counterparty also was required to register as

a swap dealer.

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Where the counterparty-facing affiliate or subsidiary and the

central booking entity are both required to comply with Dodd-Frank Act

requirements with respect to swap dealers, the question may arise as to

the allocation of responsibilities between the two entities for

obligations owed to the third-party counterparty. In such cases, the

Commission is of the view that both entities are responsible for

satisfying the Dodd-Frank Act requirements applicable to swap dealers

and with respect to the performance of an obligation owed to a third

party; satisfactory performance by one may satisfy the obligations of

both, but an unsatisfactory performance of an obligation owed to a

counterparty is a responsibility that will be borne by both entities.

In the case where non-U.S. affiliates or subsidiaries enter into

swaps that are not directly booked in a U.S. person, the Commission

proposes to interpret section 2(i) so as to require any such foreign

affiliates or subsidiaries to register as a swap dealer, assuming that

they individually or in the aggregate meet the definition of a swap

dealer. Because these affiliates or subsidiaries are domiciled in a

foreign jurisdiction and the swaps are not booked in the U.S. swap

dealer, these affiliates or subsidiaries would be treated in a manner

consistent with respect to non-U.S. swap dealers.\120\

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\120\ Accordingly, the Commission would apply the clearing and

swap processing, margining (and segregation), trade execution, swap

trading relationship documentation, portfolio reconciliation and

compression, real-time public reporting, trade confirmation, and

daily trading records requirements to transactions with a non-U.S.

person guaranteed by a U.S. person. The Commission further believes

that it is appropriate to permit a foreign affiliate or subsidiary

to comply with comparable and comprehensive regulatory

requirement(s). Substituted compliance would mitigate any burden

associated with potentially duplicative or conflicting foreign

regulations and is appropriate in light of the foreign regulator's

supervisory interests in entities domiciled and operating in its

jurisdiction. Similar concerns regarding the risk of non-performance

is not present where the non-U.S. counterparty is not guaranteed or

similarly supported by a U.S. person, and therefore, the Commission

proposes to not apply the Transaction-Level Requirements with

respect to such swaps.

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With respect to SDR Reporting, the Commission proposes to interpret

section 2(i) so as to require foreign affiliates or subsidiaries of a

U.S. swap dealer to comply with the SDR Reporting requirement but would

permit substituted compliance, provided that the Commission has direct

access to the swap data for these swaps that is stored at the foreign

trade repository. As noted above, the Commission believes that this

approach would best minimize burdens on counterparties that report

their swaps data to a foreign trade repository, while ensuring that the

Commission has direct access to the information critical to its

oversight of the swaps market.

Request for Comment

Q10. Please provide comments regarding all aspects of the

Commission's proposed grouping of requirements into Entity-Level and

Transaction-Level Requirements and application of the same to U.S. and

non-U.S. persons as discussed above.

Q11. Are there any Entity-Level Requirements that should be

reclassified as Transaction-Level Requirements, or vice versa? In

particular, the Commission is interested in comments on whether

portfolio reconciliation and compression requirements, as central risk

mitigation and back-office functions, could or should be categorized as

entity-level requirements. Similarly, the Commission is interested in

comments on whether clearing and margin and segregation for uncleared

swaps should be categorized as Entity-Level requirements.

Q11a. Should the Commission group the Entity-Level Requirements and

Transaction-Level Requirements differently for swap dealers and MSPs?

If so, how and why?

[[Page 41232]]

Q11b. Should the real-time reporting and trade execution

requirements be treated in the same manner as the external business

conduct standards?

Q12. Please provide specific comments regarding the proposed

application of the Transaction-Level Requirements to swaps with

counterparties that are U.S. persons. Should the Commission permit

substituted compliance for swaps between a non-U.S. swap dealer or non-

U.S. MSP with a U.S. person?

Q13. Please provide specific comments regarding the proposed

application of the Transaction-Level Requirements to swaps with

counterparties that are non-U.S. persons.

Q14. Market participants may not be able to determine, in certain

cases, whether their counterparties are U.S. persons, non-U.S. persons

with a guarantee from U.S. persons, or non-U.S. persons without

guarantees. How should the Commission address this issue?

Q15. Please provide comments regarding the Commission's proposed

interpretation with respect to non-U.S. swap counterparties whose swap

obligations are guaranteed by U.S. persons. Should the interpretation

for swaps between non-U.S. swap dealers or non-U.S. MSPs and non-U.S.

counterparties whose swap obligations are guaranteed by U.S. persons be

different than with respect to swaps between non-U.S. swap dealers or

non-U.S. MSPs and U.S. persons (e.g., should fewer Transaction-Level

Requirements apply)? If so, how (e.g., which Transaction-Level

Requirements should apply)? Should the Commission not permit

substituted compliance with respect to the Entity-Level and

Transaction-Level Requirements in connection with transactions with

non-U.S. persons?

Q15a. Should the Commission permit substituted compliance for some

requirements but not others? If so, which ones? Should the applicable

requirements be different for non-U.S. swap dealers as compared to non-

U.S. MSPs?

Q16. For Entity-Level Requirements, should the Commission not

permit substituted compliance for U.S. persons?

Q17. The Commission is aware that some non-U.S. swap dealers or

MSPs may be prohibited from reporting swap transaction data to an SDR

as a result of their home country's privacy laws, especially with

respect to such swap dealer's or MSP's swaps with non-U.S. persons. How

should the Commission address the application of the SDR Reporting

requirement with respect to these swaps? Should the Commission address

the application of such requirements differently with respect to non-

U.S. swap dealers and non-U.S. MSPs?

Q18. The Commission seeks comments concerning the proposed

disapplication of the external business conduct standards to swaps

involving non-U.S. persons. Would it be consistent with the

expectations of non-U.S. persons to not apply these requirements to

swaps with their local swap dealer, irrespective of whether such dealer

is a foreign- or U.S.-based person? Should such requirements apply only

to swaps involving the foreign branches or affiliates of a U.S.-based

swap dealer?

Q19. Should the Commission interpret section 2(i) so as to not

apply the Transaction-Level requirements to the foreign branches of

U.S.-swap dealers operating in the emerging markets? If so, is it

appropriate to condition eligibility for such an exception in the

manner discussed above? Should the Commission permit a higher or lower

percentage of swaps to be executed through foreign branches of U.S.

registrants in emerging market jurisdictions without comparable

regulation? If so, why and what percentage would be appropriate?

Q20. With respect to the exception for foreign branches of a U.S.

swap dealer operating in the emerging markets with respect to swaps

with a non-U.S. person guaranteed by a U.S. person, should the

Commission change the baseline from the aggregate notional value of a

firm's swap activities to $8 billion (or certain fixed numerical

threshold) so as to not disadvantage small swap dealers?

Q21. The Commission requests comment on its proposed approach of

applying the Transaction-Level Requirements to a conduit's swaps as if

counterparty were a non-U.S. person that is guaranteed by a U.S. person

(i.e., Transaction-Level Requirements will apply, with substituted

compliance permitted).

Q22. The Commission requests comment on its proposed definition of

``conduit.'' Are the three prongs of that definition appropriate? If

not, how should they be modified? Should the second prong include

language that limits application of the conduit test to ``regular''

inter-affiliate transactions moving economic risk, in whole or in part,

to the United States. Should the definition of conduit distinguish

between different types of counterparties or registration status of

such counterparties?

Q23. The Commission requests comment on: (i) The prevalence of

cross-border inter-affiliate swaps and the mechanics of moving swap-

related risks between U.S. and non-U.S. affiliated entities for risk

management and other purposes; (ii) risk implications of cross border

inter-affiliate conduit swaps for the U.S. markets; and (iii) specific

means to address the risk issues potentially presented by cross-border

conduit arrangements.

Q24. The Commission proposed anti-evasion provisions in proposed

rule 1.6 of the product definitions joint rulemaking with the SEC.\121\

To what extent would inter affiliate conduit transactions be undertaken

for purposes of evasion as described in proposed rule 1.6?

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\121\ See Further Definition of ``Swap,'' ``Security-Based

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

Security-Based Swap Agreement Recordkeeping, 76 FR 29818, May 23,

2011.

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Q25. The Commission requests comments on whether substituted

compliance should be permitted for swaps entered between a foreign

branch of a U.S. person with another foreign branch of a U.S. person.

IV. Substituted Compliance: Process for Comparability Determination

A. Overview

As noted above, the Commission will use its experience exempting

foreign brokers from registration as FCMs under its rule 30.10

``comparability'' findings in developing an approach for swaps.

However, the Commission contemplates that it will calibrate its

approach to reflect the heightened requirements and expectations under

the Dodd-Frank Act. Accordingly, the Commission will examine the

regulatory requirements to which non-U.S. swap dealers and non-U.S.

MSPs are subject. The Commission will use an outcomes based approach to

determine whether these requirements are designed to meet the same

regulatory objectives of the Dodd-Frank Act. The Commission

contemplates that its approach also will require a more robust and

ongoing process of cooperation and coordination between the Commission

and the relevant foreign regulatory authority regarding ongoing

compliance efforts.

1. Scope of Review

As noted above, the Commission would determine comparability and

comprehensiveness by reviewing the foreign jurisdiction's laws and

regulations. In making this determination, the Commission may

[[Page 41233]]

find that a jurisdiction has comparable law(s) and regulation(s) in

some, but not all, of the applicable Dodd-Frank Act provisions (and

related Commission regulations).\122\ Similar to its policy under rule

30.10, the Commission would retain broad discretion to determine that

the objectives of any program elements are met, notwithstanding the

fact that the foreign requirement(s) may not be identical to that of

the Commission.\123\ However, in cases where the foreign regulatory

regime does not achieve the objectives of the Dodd-Frank Act, the

Commission proposes to recognize substituted compliance in only those

areas that are determined to be comparable and comprehensive to the CEA

and Commission regulations.

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\122\ The Commission anticipates that it would review

comparability in the areas described above: (i) Capital

requirements; (ii) chief compliance officer (iii) clearing and swap

processing; (iv) daily trading records; (v) margin (and segregation)

requirements for uncleared swap transactions; (vi) physical

commodity swaps reporting; (vii) portfolio reconciliation and

compression; (viii) real-time public reporting; (ix) SDR Reporting;

(x) risk management; (xi) swap data recordkeeping; (xii) swap

trading relationship documentation; (xiii) trade confirmation (xiv)

trade execution.

\123\ The Commission would retain broad enforcement authority,

including anti-fraud and anti-manipulation authority, with respect

to the subject cross-border swap activities.

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In evaluating whether a particular foreign regulatory

requirement(s) is comparable and comprehensive to the applicable

requirement(s) under the CEA and Commission regulations, the Commission

would take into consideration all relevant factors, including but not

limited to, the scope and objectives of the relevant regulatory

requirement(s), and the comprehensiveness of those requirement(s), the

comprehensiveness of the foreign regulator's supervisory compliance

program, as well as the authority to support and enforce its oversight

of the non-U.S. swap dealer or non-U.S. MSP applicant. In this context,

comparable does not necessarily mean identical. Rather, the Commission

would evaluate whether the home jurisdiction's regulatory requirement

is comparable to the regulatory requirement(s) supported and enforced

by the Commission.

2. Process

The Commission may recognize the comparability of a foreign regime

and permit substituted compliance subject to such terms and conditions

as the Commission finds appropriate.\124\ Further, similar to its

policy under rule 30.10, the Commission would retain broad discretion

to determine that the objectives of any program elements are met,

notwithstanding the fact that the foreign regulations(s) may not be

identical to that of the Commission.

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\124\ The procedures described in this subsection, which are not

all-inclusive, are contemplated for applicants for substituted

compliance. The Commission further notes that non-compliance with

the comparable home country regulations would constitute a breach of

the terms and conditions of the registration with the Commission and

potentially would serve as a basis for de-registration of the non-

U.S. swap dealer or non-U.S. MSP and/or the commencement of an

enforcement action.

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A non-U.S. person may request the Commission's permission to comply

with comparable requirements of its home jurisdiction, in lieu of the

applicable Dodd-Frank Act requirements, as described above. In lieu of

a non-U.S. person requesting substituted compliance, a group of non-

U.S. persons from the same jurisdiction, or a foreign regulator, may

submit an application for substituted compliance on behalf of non-U.S.

persons subject to a foreign supervisory regime.

Such request would be made directly to the Commission in connection

with its application to register as a swap dealer or MSP.\125\ The

Commission anticipates that it would work closely with the National

Futures Association to develop the necessary procedural framework.

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\125\ After it completes its evaluation, the Commission intends

to post a finding of comparability on its Web site.

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The Commission would expect that the applicant, at minimum, state

with specificity the factual basis for requesting that the Commission

recognize comparability with respect to a particular Dodd-Frank Act

requirement as described above and include with specificity all

applicable legislation, rules and policies. \126\

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\126\ The Commission may, as it deems appropriate and necessary,

conduct an on-site examination of the applicant, as well as consult

with the applicant's home regulator. For certain matters, the

Commission may request an opinion of counsel.

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An applicant would be expected to state that it is licensed and in

good standing with the applicant's supervisor(s) in its home country.

Further, the Commission expects that, in a substituted compliance

situation, it would enter into an appropriate memorandum of

understanding (``MOU'') or similar arrangement between the Commission

and the relevant foreign supervisor(s). Existing information-sharing

and/or enforcement arrangements would be indicative of a foreign

supervisor's ability to cooperate with the Commission. However, going

forward, the Commission and relevant foreign supervisor(s) would need

to establish supervisory MOUs or other arrangements that provide for

information sharing and cooperation in the context of supervising swap

dealers and MSPs. The Commission contemplates that such a supervisory

MOU would establish the type of ongoing coordination activities that

would continue on an ongoing basis between the Commission and the

foreign supervisor(s), including topics such as, but not limited to,

procedures for confirming continuing oversight activities, access to

information,\127\ on-site visits, and notification and procedures in

certain situations.\128\

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\127\ The Commission notes that under Commission's regulation

Sec. 23.603(i), a registered swap dealer or MSP must make all

records required to be maintained in accordance with Commission

regulation 1.31 promptly upon request to representatives of the

Commission. The Commission reserves this right to access records

held by registered swap dealers and MSPs, including those that are

non-U.S. persons who may comply with the Dodd-Frank recordkeeping

requirement through substituted compliance.

\128\ In this regard, the Commission has started working with

foreign regulators to prepare for such arrangements.

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It is expected that the Commission generally may rely on prior

comparability determinations with respect to a particular jurisdiction

to facilitate its review of a subsequent applicant's request for

recognition of substituted compliance.\129\ Subsequent to registration

with the Commission, the Commission expects that a non-U.S swap dealer

or non-U.S. MSP would notify the Commission of any material changes to

information submitted in support of a comparability finding (including,

but not limited to, changes in the relevant supervisory or regulatory

regime) as the Commission's comparability determination may no longer

be valid. In order to avoid an unduly burdensome notification process,

the Commission contemplates that it would enumerate the specific

foreign requirements or category of requirements which, if changed,

would trigger a notification requirement.

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

\129\ Prior determinations of comparability under part 30.10 of

the Commission's regulations will not be determinative for those

purposes.

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

Where the Commission proposes a change to its regulations governing

swaps, the Commission will evaluate whether the proposed regulatory

change would affect the basis upon which a prior comparability finding

was made. The Commission would initiate discussions with the affected

swap dealers and MSPs and their regulator(s) to determine how to

address any possible discrepancy in requirements.

3. Clearing

In response to a number of inquiries, with regard to swaps covered

by a

[[Page 41234]]

Commission-issued clearing requirement, the Commission notes that it

expects to find comparability with foreign regulatory regimes when (i)

the swap is subject to a mandate issued by appropriate government

authorities in the home country of the counterparties to the swap,

provided that the foreign mandate is comparable and comprehensive to

the Commission's mandate; and (ii) the swap is cleared through a DCO

that is exempted from registration under the CEA.

Request for Comment

Q26. Please provide comments regarding the Commission's substituted

compliance proposal, including the appropriate standard and degree of

comparability and comprehensiveness that should be applied to make such

determination.

Q27. What are some of the factors or elements of a supervisory

program that the Commission should consider in making a comparability

finding?

Q27a. Should the Commission take a different approach with respect

to swap dealers as compared to MSPs?

Q28. How should the Commission address potential inconsistencies or

conflicts between U.S. and non-U.S. requirements with respect to the

oversight of non-U.S. swap dealers and non-U.S. MSPs?

Q29. Many foreign jurisdictions are in the process of implementing

major changes to their oversight of the swaps market. Assuming that a

foreign jurisdiction has adopted swaps legislation but has yet to

finalize implementing regulations, should the Commission develop an

interim process that takes into account the development of

``comparable'' legislation and proposed regulations?

Q30. How should the Commission ensure that prior comparability

determinations remain appropriate over time?

V. Cross-Border Application of the CEA's Swap Provisions to

Transactions Involving Other (Non-Swap Dealer and MSP) Market

Participants

A. Cross-Border Transactions With U.S. Persons 130

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

\130\ Appendix C in this release provides a chart describing the

application of the specified Dodd-Frank provisions to transactions

between counterparties that are neither a swap dealer or MSP.

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

Several of the CEA's swap provisions--namely, those relating to

clearing,\131\ trade execution,\132\ real-time public reporting,\133\

Large Trader Reporting,\134\ and SDR Reporting,\135\ and recordkeeping

\136\--also apply to persons or counterparties other than a swap dealer

or MSP. As a result, questions arise as to whether, and the extent to

which, these requirements apply to transactions outside the United

States involving U.S. and non-U.S. persons. In this section, the

Commission provides interpretive guidance concerning the application of

these Dodd-Frank Act provisions to cross-border transactions in which

neither counterparty is a swap dealer or MSP (i.e., all other market

participants including ``financial entities,'' as defined in CEA

section 2(h)(7)(C)).\137\

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

\131\ See Section III.B.3.i., supra.

\132\ See Section III.B.3.iii. supra.

\133\ See Section III.B.3.vi. supra.

\134\ See Section III.B.2.vi. supra.

\135\ See Section III.B.2.v. supra.

\136\ The Commission's part 45 rules require non-swap dealers

and non-MSPs to keep ``full, complete and systematic records'' with

respect to each swap to which they are a counterparty. See 17 CFR

45.2. Such records must include those demonstrating that the parties

to a swap are entitled to make use of the clearing exception in CEA

section 2(h)(7). Non-swap dealers and non-MSPs must also comply with

the Commission's regulations in part 46, which address the reporting

of data relating to pre-enactment swaps and data relating to

transition swaps.

\137\ Nothing in this interpretive guidance should be construed

to affect the ability of a foreign board of trade to offer swaps to

U.S. persons pursuant to part 48 of the Commission's regulations.

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

The Commission believes that U.S. persons' swap activities outside

the United States have a direct and significant connection with

activities in, or effect on, U.S. commerce. The swaps market today is

global in nature. To manage risks in a global economy, U.S. persons may

need to--and often do--transact swaps with both U.S. and non-U.S.

persons. Many such swap activities of U.S. persons, particularly those

with global operations, may be located outside the United States. In

light of the significant extent of U.S. persons' swap activities

outside the United States in today's global marketplace, and the risks

to U.S. persons and the financial system presented by such swaps

activities outside the United States with U.S. persons as

counterparties, the Commission believes that U.S. persons' swap

activities outside the United States have the requisite connection with

or effect on U.S. commerce under section 2(i) to apply the swaps

provisions of the CEA to such activities.\138\

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

\138\ In further support of this interpretation, the Commission

notes that the risks to U.S. persons and the U.S. financial system

from swap activities of U.S. persons does not depend on the location

of such swap activities of U.S. persons. Moreover, the Commission

believes that section 2(i) does not require a transaction-by-

transaction determination that a particular swap outside the United

States has a direct and significant connection with activities in,

or effect on, commerce of the United States in order to apply the

swaps provisions of the CEA to such transactions; rather, it is the

aggregate of such activities and the aggregate connection of such

activities with activities in the U.S. or effect on U.S. commerce

that warrants application of the CEA swaps provisions to all such

activities. See F. Hoffmann-La Roche, Ltd., 542 U.S. at 164 (in

response to respondents' argument that the court can take account of

comity considerations on a case by case basis, the Court held that

such approach is ``too complex to be prove workable.'').

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

Accordingly, with respect to swaps where one (or both) of the

counterparties to the swap is a U.S. person, the Commission proposes to

interpret section 2(i) in a manner so that the Dodd-Frank Act

requirements relating to clearing, trade-execution, real-time public

reporting, Large Trader Reporting, and SDR Reporting, and recordkeeping

apply to such swaps. Conversely, where a non-U.S. person enters into a

swap with another non-U.S. person outside the United States, and where

neither counterparty is required to register as a swap dealer or MSP,

the Commission would not apply the Dodd-Frank Act requirements to such

swaps.\139\

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

\139\ The exception involves Large Trader Reporting, as further

discussed below.

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

As discussed above, the Commission is concerned that a non-U.S.

affiliate or subsidiary could effectively operate as a ``conduit'' for

the U.S. person. More specifically, the Commission is concerned that

the non-U.S. affiliate or subsidiary of a U.S. person could be used to

execute swaps with counterparties in foreign jurisdictions, outside the

Dodd-Frank Act regulatory regime. The Commission is considering whether

to propose measures to address this situation. However, at this time,

the Commission makes clear that such non-U.S. affiliate or subsidiary

would not be subject to the Dodd-Frank swap provisions, except pursuant

to specific Dodd-Frank Act provisions (or Commission regulation adopted

thereunder) or Commission orders.

B. Clearing, Trade Execution, Real-Time Public Reporting, Large Trader

Reporting, and SDR Reporting, and Swap Data Recordkeeping

As described in greater detail above, the Dodd-Frank Act's clearing

requirement mitigates counterparty risks and, in turn, fosters

protection against systemic risk. In a similar vein, the trade

execution and real-time public reporting requirements serve to promote

both pre- and post-trade transparency which, in turn, enhance price

discovery and decrease risk. Together, these requirements serve an

important role in protecting U.S. market participants and the general

market against financial losses. Accordingly, the Commission interprets

section 2(i) to apply the Dodd-Frank Act's clearing, trade

[[Page 41235]]

execution, and real-time public reporting requirements to any swaps

where one of the counterparties is a U.S. person (irrespective of the

location of the transaction), without permitting substituted compliance

with a foreign regulatory regime.

The Commission's part 20 rules regarding Large Trader Reporting

require routine reports from clearing members, in addition to swap

dealers and clearing organizations, with reportable positions in

specified physical commodity swaps or swaptions. The Commission

believes that such data is essential in order for the Commission to

carry out its supervisory mandates concerning, among other things,

increased transparency, market monitoring, and market abuse prevention.

Therefore, the Commission proposes to interpret CEA section 2(i) to

require non-U.S. clearing members to report all reportable positions

under part 20. The part 20 rules also impose recordkeeping obligations

on traders with reportable positions. The Commission proposes to

interpret CEA section 2(i) so as to require non-U.S. persons with

reportable positions under part 20 to comply with such obligations.

Given the significance of these rules to the Commission's oversight of

swaps and swaptions that are closely linked to the U.S. futures

markets, the Commission would not allow substituted compliance.

With respect to transactions that are subject to the SDR Reporting

and swap data recordkeeping requirements, the Commission proposes to

interpret section 2(i) so as to permit substituted compliance, provided

that the Commission has direct access to the swap data for these

transactions that is stored at the foreign trade repository. The

Commission has a strong supervisory interest in applying the SDR

reporting and recordkeeping requirements to any transactions involving

a U.S. counterparty in order to effectively monitor the swap activities

of U.S. persons. Nevertheless, the Commission believes that substituted

compliance is warranted where it would ease the burden on the

counterparties that report their swaps data to a foreign trade

repository and the Commission is assured of prompt access to the

information critical to its oversight of the swaps market.

The Commission recognizes that applying the Dodd-Frank Act

requirements to swaps conducted outside the United States involving a

U.S. counterparty may result in two or more jurisdictions asserting

authority over these swaps--with the counterparties potentially facing

conflicting or duplicative regulatory requirements. The Commission will

continue its efforts to address these issues through close coordination

and consultation with its regulatory counterparts in other

jurisdictions. The Commission also anticipates that cooperative efforts

would be reflected in the MOU or similar arrangement (whether bilateral

and/or multilateral) discussed above which would provide a framework

for regulatory coordination where two or more jurisdictions have

authority over a swap.

Request for Comment

Q31. Please provide comments regarding all aspects of the

Commission's interpretation of CEA section 2(i) with respect to the

proposed application of the Transaction-Level Requirements. The

Commission is particularly interested in commenters' views on the

impact on U.S. persons as a result of the proposed application of the

Dodd-Frank Act's trading requirements.

Q32. What, if any, competitive or economic effects on U.S.

commerce, including U.S. persons, should the Commission consider when

interpreting CEA section 2(i)? What, if any, competitive or economic

effects on non-U.S. persons should the Commission consider when

interpreting CEA section 2(i)?

Appendix A--Entity-Level Requirements

The Entity-Level Requirements relate to the management of risks

to a swap dealer or MSP as a whole. Accordingly, these requirements

apply on a firm-wide basis, inclusive of all swaps and irrespective

of whether the counterparty is a U.S. person (or not) or where the

transactions are executed.

Capital: CEA section 4s(e) directs the Commission to set capital

requirements for swap dealers and MSPs that are not subject to the

capital requirements of prudential regulators (i.e., non-bank swap

entities). The Commission has proposed rule, Sec. 23.101, which

would apply FCM capital requirements if the nonbank swap dealer or

MSP is also registered as an FCM, and would apply other capital

requirements for those that are not also FCMs. Certain of these non-

FCM, nonbank swap entities would be required to meet capital

requirements established by the Federal Reserve Board; specifically,

SIFIs and nonbank subsidiaries of U.S. bank holding companies.\140\

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

\140\ SIFIs that are not FCMs would be exempt from the

Commission's capital requirements, and would comply instead with

Federal Reserve Board requirements applicable to SIFIs, while

nonbank (and non-FCM) subsidiaries of U.S. bank holding companies

would calculate their Commission capital requirement using the same

methodology specified in Federal Reserve Board regulations

applicable to the bank holding company, as if the subsidiary itself

were a bank holding company.

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

Chief Compliance Officer: CEA Section 4s(k) requires that each

swap dealer and MSP to designate a chief compliance officer

(``CCO'') and specify certain duties by the CCO. Pursuant to section

4s(k), the Commission adopted Sec. 3.3, which requires swap dealers

and MSPs to designate a CCO responsible for administering the firm's

compliance policies and procedures, reporting directly to the board

of directors or a senior officer of the swap dealer, as well as

preparing and filing (with the Commission) a certified report of

compliance with the CEA.

Risk Management: CEA Section 4s(j) requires each swap dealer and

MSP to establish internal policies and procedures designed to, among

other things, address risk management, monitor compliance with

position limits, prevent conflicts of interest, and promote diligent

supervision, as well as maintain business continuity and disaster

recovery programs. The Commission adopted implementing regulations

(Sec. Sec. 23.600, 23.601, 23.602, 23.603, 23.605, 23.606, and

23.607). The Commission also adopted: (A) Sec. 23.609, which

requires certain risk management procedures for swap dealers or MSPs

that are clearing members of a DCO; and (B) Sec. 23.608, which

prohibits swap dealers providing clearing services to customers from

entering into agreements that would: (i) Disclose the identity of a

customer's original executing counterparty; (ii) limit the number of

counterparties a customer may trade with; (iii) impose counterparty-

based position limits; (iv) impair a customer's access to execution

of a trade on terms that have a reasonable relationship to the best

terms available; or (v) prevent compliance with specified time

frames for acceptance of trades into clearing.

Swap Data Recordkeeping: CEA section 4s(f)(1)(B) requires swap

dealers and MSPs to keep books and records for all activities

related to their business. Section 4s(g)(1) requires swap dealers

and MSPs to maintain trading records for each swap transaction and

all related records, as well as a complete audit trail for

comprehensive trade reconstructions. Pursuant to these provisions,

the Commission adopted Sec. Sec. 23.201and 23.203, which require

swap dealers and MSPs to keep records including complete transaction

and position information for all swap activities, including

documentation on which trade information is originally recorded.

Swap dealers and MSPs also have to comply with Part 46 of the

Commission's regulations, which addresses the recordkeeping

requirements for swaps entered into before the date of enactment of

the Dodd-Frank Act (``pre-enactment swaps'') and data relating to

swaps entered into on or after the date of enactment but prior to

the part 45 compliance date (``transition swaps'').

SDR Reporting: CEA section 2(a)(13)(G) requires all swaps,

whether cleared or uncleared, to be reported to a registered swap

data repository (``SDR''). CEA section 21 requires SDRs to collect

and maintain data related to swap transactions as prescribed by the

Commission, and to make such data

[[Page 41236]]

electronically available to regulators. Swap dealers and MSPs would

be required to comply with Part 45 of the Commission's regulations,

which set forth the specific transaction data that reporting

counterparties and registered entities must report to a registered

SDR; and Part 46, which addresses the recordkeeping requirements for

pre-enactment swaps and data relating to transition swaps.

Physical Commodity Swaps Reporting (Large Trader Reporting): CEA

section 4t authorizes the Commission to establish a large trader

reporting system for significant price discovery swaps, of which the

economically equivalent swaps subject to part 20 reporting are a

subset, and in order to implement the statutory mandate in CEA

section 4a for the Commission to establish position limits, as

appropriate, for physical commodity swaps. The Commission published

part 20 rules requiring swap dealers, among other entities, to

submit routine position reports on certain physical commodity swaps

and swaptions.

Entity-Level Requirements

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

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

U.S.-Based Swap Dealer.......... Apply.

Foreign Branches/Agencies of Apply.

U.S.-Based Swap Dealer**.

Foreign Affiliates of U.S.

Person:

--Swaps Booked in U.S....... Apply.*

Foreign Affiliate of U.S.

Person:

--The Affiliate is the Legal Substituted Compliance.***

Counterparty But All Swaps

Guaranteed by U.S. Person.

Foreign Affiliate of U.S.

Person:

--Swaps Not Booked in U.S. Substituted Compliance.

(i.e., Affiliate is Legal

Counterparty); and Swaps

Not Guaranteed by U.S.

Person.

Non-U.S.-Based Swap Dealer:

--Swaps neither Booked in Substituted Compliance.

U.S. nor Guaranteed by U.S.

Person.

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

* Where swaps are solicited or negotiated by a foreign affiliate of a

U.S. person but directly booked in the U.S. person, the U.S. person

must comply with all of the swap dealer duties and obligations related

to the swaps, including registration, capital and related prudential

requirements.

** Both Entity-Level and Transaction-Level Requirements are the ultimate

responsibilities of the U.S.-based swap dealer.

*** With respect to the SDR reporting requirement, the Commission may

permit substituted compliance only if direct access to swap data is

provided to the Commission.

Appendix B--Transaction-Level Requirements

The Transaction-Level Requirements cover a range of Dodd-Frank

requirements: some of the requirements more directly address

financial protection of swap dealers (or MSPs) and their

counterparties; others address more directly market efficiency and/

or price discovery. Further, some of the Transaction-Level

Requirements can be classified as Entity-Level Requirements and

applied on a firm-wide basis across all swap transactions or

activities. Nevertheless, in the interest of comity principles, the

Commission believes that the Transaction-Level Requirements may be

applied on a transaction-by-transaction basis.

Category A: Risk Mitigation and Transparency

Clearing and Swap Processing: CEA section 2(h)(1) requires a

swap to be submitted for clearing to a derivatives clearing

organization (``DCO'') if the Commission has determined that the

swap is required to be cleared, unless one of the parties to the

swap is eligible for an exception under section 2(h)(7) from the

clearing requirement and elects not to clear the swap. Finally, the

Commission adopted Sec. 23.506, which requires swap dealers and

MSPs to submit swaps promptly for clearing and comply with Sec.

23.610, which establishes certain standards for swap processing by

swap dealers and MSPs that are clearing members of a DCO.

Margin (and Segregation) Requirement for Uncleared Swap

Transactions: Section 4s(e) explicitly requires the adoption of

rules establishing margin requirements for swap dealers and MSPs,

and applies a bifurcated approach that requires each swap dealer and

MSP for which there is a prudential regulator to meet the margin

requirements established by the applicable prudential regulator, and

each swap dealer and MSP for which there is no prudential regulator

to comply with Commission's margin regulations. In contrast, the

``segregation'' requirements in 4s(1) don't use a bifurcated

approach--all swap dealers and MSPs are subject to the Commission's

rule regarding notice and third party custodians for margin

collected for uncleared swaps.

Mandatory Trade Execution: CEA section 2(h)(8) provides that

unless a non-financial end-user exemption applies, a swap that is

subject to clearing requirement and made available to trade must be

traded on a DCM or SEF.

Swap Trading Relationship Documentation: CEA Section 4s(i)

requires each swap dealer and MSP to conform to commission standards

for the timely and accurate confirmation, processing, netting

documentation and valuation of swaps. Pursuant thereto the

Commission has proposed Sec. 23.504(a), which would require swap

dealers and MSPs to ``establish, maintain and enforce written

policies and procedures'' to ensure that the swap dealer or MSP

executes written swap trading relationship documentation. Under

proposed Sec. Sec. 23.505(b(1), 23.504 (b)(3), and 23.504(b)(4),

the swap trading relationship documentation must include, among

other things: all terms governing the trading relationship between

the swap dealer and its counterparty; credit support arrangements;

investment and rehypothecation terms for assets used as margin for

uncleared swaps and custodial arrangements.\141\ Further, the swap

trading relationship documentation requirement applies to all

transactions with registered swap dealers and MSPs.

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

\141\ The requirements under section 4s(i) relating to trade

confirmations is a Transaction-Level Requirement. Accordingly,

proposed 17 CFR 23.504(b)(2), which requires a swap dealer's and

MSP's swap trading relationship documentation to include all

confirmations of swap transactions, will apply on a transaction-by-

transaction basis.

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

Portfolio Reconciliation and Compression: CEA section 4s(i)

directs the Commission to prescribe regulations for the timely and

accurate processing and netting of all swaps entered into by swap

dealers and MSPs. Pursuant to CEA section 4s(i), the Commission

proposed regulations (Sec. Sec. 23.502 and 23.503), which would

require swap dealers and MSPs to perform portfolio reconciliation

and compression, respectively, for all swap transactions. Portfolio

reconciliation is a post-execution risk management tool to ensure

accurate confirmation of a swap's terms and to identify and resolve

any discrepancies between counterparties regarding the valuation of

the swap. Portfolio compression is a post-trade processing and

netting mechanism that is intended to ensure timely accurate

processing and netting of swaps. Proposed Sec. 23.503(c) would

require all swap dealers and MSPs to participate in bilateral

compression exercises and/or multilateral portfolio compression

exercises conducted by their SROs or DCOs of which they are members.

Further, participation in multilateral portfolio compression

exercises is mandatory for dealer to dealer trades.

Real-Time Public Reporting: CEA section 2(a)(13) directs the

Commission to promulgate rules providing for the public availability

of swap transaction data in real time basis. The Commission

promulgated part 43 rules, which provides that all ``publicly

reportable swap transactions'' must be reported and publicly

disseminated.

Trade Confirmation: CEA section 4s(i) requires that each swap

dealer and MSP must comply with the Commission's regulations

prescribing timely and accurate confirmation of transactions. The

Commission has proposed Sec. 23.501, which requires, among other

things, a timely and accurate confirmation of all swaps and life

cycle

[[Page 41237]]

events for existing swaps. In addition, proposed Sec. 23.504(b)(2)

requires a swap dealer's and MSP's swap trading relationship

documentation to include all confirmations of swap transactions.

Daily Trading Records: Pursuant to section CEA 4s(g)(1), the

Commission adopted Sec. 23.202, which requires swap dealers and

MSPs to maintain daily trading records, including records of trade

information related to pre-execution, execution, and post-execution

data that is needed to conduct a comprehensive and accurate trade

reconstruction for each swap. The final rule also requires that

records be kept of cash or forward transactions used to hedge,

mitigate the risk of, or offset any swap held by the swap dealer or

MSP.

Category B: Sales Practices

External Business Conduct Standards: Pursuant to CEA section

4s(h), the Commission has adopted external business conduct rules,

which establish business conduct standards governing the conduct of

swap dealers and MSPs in dealing with their counterparties in

entering into swaps.

Category A

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

Non-U.S. person

U.S. Person guaranteed by U.S. Non-U.S. person not guaranteed by

person ** U.S. person

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

U.S.-Based Swap Dealer.......... Apply.............. Apply............. Apply.

Foreign Affiliate/Swaps Booked Apply.............. Apply............. Apply.

in U.S.*.

Foreign Branches/Agencies of Apply.............. Substituted Substituted Compliance.***

U.S.-Based Swap Dealer. Compliance***.

Foreign Affiliate of U.S.

Person:

--The Affiliate is the Legal Apply.............. Substituted Do Not Apply.

Counterparty But All Swaps Compliance.

Guaranteed by U.S. Person.

Foreign Affiliate of U.S.

Person:

--Swaps Not Booked in U.S. Apply.............. Substituted Do Not Apply.

(i.e., Affiliate is Legal Compliance.

Counterparty); and Swaps

Not Guaranteed by U.S.

Person.

Non-U.S.-Based Swap Dealer:

--Swaps neither Booked in Apply.............. Substituted Do Not Apply.

U.S. nor Guaranteed by U.S. Compliance.

Person.

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

* Where swaps are solicited or negotiated by a foreign affiliate but directly booked in the U.S. person, the

U.S. person must comply with all of the swap dealer duties and obligations, including all Transaction-Level

Requirements. The foreign affiliate, if separately required to register as a swap dealer, must comply with

those requirements applicable to its swap dealing activities.

** The Transaction-Level Requirements apply to swaps in which: (i) a non-U.S. counterparty is majority-owned,

directly or indirectly, by a U.S. person; (ii) the non-U.S. counterparty regularly enters into swaps with one

or more U.S. affiliates or subsidiaries of the U.S. person; and (iii) the financials of such non-U.S.

counterparty are included in the consolidated financial statements of the U.S. person.

*** Under limited circumstances, where there is not a comparable foreign regulatory regime, foreign branches and

agencies of U.S. swap dealers may comply with the local transaction-level requirements rather than the

Transaction-Level Requirements, subject to specified conditions.

Notes:

1. The swap trading relationship documentation requirement applies to all transactions with registered swap

dealers and MSPs.

2. Participation in multilateral portfolio compression exercises is mandatory for dealer to dealer trades.

Category B

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

Non-U.S. person Non-U.S. person not

U.S. person guaranteed by U.S. guaranteed by U.S.

person ** person

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

U.S.-Based Swap Dealer........... Apply.................... Apply................... Apply.

Foreign Affiliate of U.S. Person:

--Swaps are Booked in U.S.*.. Apply.................... Do Not Apply............ Do Not Apply.

Foreign Branches/Agencies of U.S.- Apply.................... Do Not Apply............ Do Not Apply.

Based Swap Dealer.

Foreign Affiliate of U.S. Person:

--The Affiliate is the Legal Apply.................... Do Not Apply............ Do Not Apply.

Counterparty But All Swaps

Guaranteed by U.S. Person.

Foreign Affiliate of U.S. Person:

--Swaps Not Booked in U.S. Apply.................... Do Not Apply............ Do Not Apply.

(i.e., Affiliate is Legal

Counterparty); and Swaps Not

Guaranteed by U.S. Person.

Non-U.S.-Based Swap Dealer:

--Swaps neither Booked in Apply.................... Do Not Apply............ Do Not Apply.

U.S. nor Guaranteed by U.S.

Person.

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

* Where swaps are solicited or negotiated by an affiliate of a U.S. person but directly booked in the U.S.

person, the U.S. person must comply with all of the swap dealer duties and obligations, including all

Transaction-Level Requirements. The foreign affiliate, if separately required to register as a swap dealer,

must comply with those requirements applicable to its swap dealing activities.

** The Transaction-Level Requirements apply to swaps in which: (i) A non-U.S. counterparty is majority-owned,

directly or indirectly, by a U.S. person; (ii) the non-U.S. counterparty regularly enters into swaps with one

or more U.S. affiliates or subsidiaries of the U.S. person; and (iii) the financials of such non-U.S.

counterparty are included in the consolidated financial statements of the U.S. person.

Appendix C--All Other (Non-Swap Dealer/MSP) Market ParticipantS \*\

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

Non-U.S. person Non-U.S. person not

U.S. person guaranteed by U.S. guaranteed by U.S.

person person

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

U.S. Person...................... Apply.................... Apply................... Apply.

Non-U.S. Person Guaranteed by Apply.................... Do Not Apply............ Do Not Apply.

U.S. Person.

[[Page 41238]]

Non-U.S. Person Not Guaranteed by Apply.................... Do Not Apply............ Do Not Apply.

U.S. Person.

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

* The relevant Dodd-Frank requirements are those relating to: clearing, trade execution, real-time public

reporting, Large Trader Reporting, SDR reporting and swap data recordkeeping.

Issued in Washington, DC, on June 29, 2012, by the Commission.

David A. Stawick,

Secretary of the Commission.

Appendices to Cross-Border Application of Certain Swaps Provisions of

the Commodity Exchange Act--Commission Voting Summary and Statements of

Commissioners

Note: The following appendices will not appear in the Code of

Federal Regulations

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Sommers,

Chilton, O'Malia and Wetjen voted in the affirmative; no

Commissioner voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

I support the proposed guidance on the cross-border application

of the Dodd-Frank Wall Street Reform and Consumer Protection Act

(Dodd Frank Act). The Commission is not required to solicit public

comment on interpretive guidance, but we are particularly interested

in the public's input and look forward to comments on the proposed

guidance.

In 2008, swaps, and in particular credit default swaps,

concentrated risk in financial institutions and contributed to the

financial crisis, the worst economic crisis Americans have

experienced since the Great Depression. Eight million Americans lost

their jobs, millions of families lost their homes, and small

businesses across the country folded. Congress and the President

responded with the Dodd-Frank Act, bringing common-sense rules of

the road to the swaps marketplace.

Section 722(d) of the Dodd-Frank Act states that swaps reforms

shall not apply to activities outside the United States unless those

activities have ``a direct and significant connection with

activities in, or effect on, commerce of the United States.'' In

interpreting Section 722(d), we must not forget the lessons of the

2008 crisis and earlier. Swaps executed offshore by U.S. financial

institutions can send risk straight back to our shores. It was true

with the London and Cayman Islands affiliates of AIG, Lehman

Brothers, Citigroup and Bear Stearns. A decade earlier, it was true,

as well, with Long-Term Capital Management.

The nature of modern finance is that large financial

institutions set up hundreds, if not thousands of ``legal entities''

around the globe.

They do so in an effort to respond to customer needs, funding

opportunities, risk management and compliance with local laws. They

do so as well, though, to lower their taxes, manage their reported

accounting, and to minimize regulatory, capital and other

requirements, so-called ``regulatory arbitrage.'' Many of these far-

flung legal entities, however, are still highly connected back to

their U.S. affiliates.

During a default or crisis, the risk that builds up offshore

inevitably comes crashing back onto U.S. shores. When an affiliate

of a large, international financial group has problems, the markets

accept this will infect the rest of the group. This was true with

AIG. Its subsidiary, AIG Financial Products, brought down the

company and nearly toppled the U.S. economy. It was run out of

London as a branch of a French-registered bank, though technically

was organized in the United States.

Lehman Brothers was another example. Among its complex web of

affiliates was Lehman Brothers International (Europe) in London.

When Lehman failed, the London affiliate had more than 130,000

outstanding swaps contracts, many of them guaranteed by Lehman

Brothers Holdings back in the United States.

Yet another example was Citigroup, which set up numerous

structured investment vehicles (SIVs) to move positions off its

balance sheet for accounting purposes, as well as to lower its

regulatory capital requirements. Yet, Citigroup had guaranteed the

funding of these SIVs through a mechanism called a liquidity put.

When the SIVs were about to fail, Citigroup in the United States

assumed the huge debt, and taxpayers later bore the brunt with two

multi-billion dollar infusions. The SIVs were launched out of London

and incorporated in the Cayman Islands.

Bear Stearns is another case. Bear Stearns' two sinking hedge

funds it bailed out in 2007 were incorporated in the Cayman Islands.

Yet again, the public assumed part of the burden when Bear Stearns

itself collapsed nine months later.

A decade earlier, the same was true for Long-Term Capital

Management. When the hedge fund failed in 1998, its swaps book

totaled in excess of $1.2 trillion notional. The vast majority were

booked in its affiliated partnership in the Cayman Islands.

The recent events of JPMorgan Chase, where it executed swaps

through its London branch, are a stark reminder of this reality of

modern finance.

The proposed guidance interpreting Section 722(d),intended to be

flexible in application, includes the following key elements:

First, it provides the guidance that when a foreign entity

transacts in more than a de minimis level of U.S. facing swap

dealing activity, the entity would register under the Dodd-Frank Act

swap dealer registration requirements.

Second, it includes a tiered approach for foreign swap dealer

requirements. Some requirements would be considered entity-level,

such as for capital, chief compliance officer, swap data

recordkeeping, reporting to swap data repositories and large trader

reporting. Some requirements would be considered transaction-level,

such as clearing, margin, real-time public reporting, trade

execution, trading documentation and sales practices.

Third, entity-level requirements would apply to all registered

swap dealers, but in certain circumstances, foreign swap dealers

could meet these requirements by complying with comparable and

comprehensive foreign regulatory requirements, or what we call

``substituted compliance.''

Fourth, transaction-level requirements would apply to all U.S.

facing transactions. For these requirements, U.S. facing

transactions would include not only transactions with persons or

entities operating or incorporated in the United States, but also

transactions with their overseas branches. Likewise, this would

include transactions with foreign affiliates that are guaranteed by

a U.S. entity, as well as the foreign affiliates operating as

conduits for a U.S. entity's swap activity. Foreign swap dealers, as

well as overseas branches of U.S. swap dealers, in certain

circumstances, may rely on substituted compliance when transacting

with foreign affiliates guaranteed by or operating as conduits of

U.S. entities.

Fifth, for certain transactions between a foreign swap dealer

(including an overseas affiliate of a U.S. person) and

counterparties not guaranteed by or operating as conduits for U.S.

entities, Dodd-Frank transaction-level requirements may not apply.

For example, this would be the case for a transaction between a

foreign swap dealer and a foreign insurance company not guaranteed

by a U.S. person. There are some in the financial community who

might want the CFTC to ignore the hard lessons of the crisis and

before.

They might comment that swap trades entered into in London

branches of U.S. entities do not have a direct and significant

connection with activities in, or effect on U.S. commerce.

They might comment that affiliates guaranteed by a U.S. mother

ship do not have a direct and significant connection with activities

in, or effect on U.S. commerce.

They might comment that affiliates acting as conduits for swaps

activity back here in

[[Page 41239]]

the United States do not have a direct and significant connection

with activities in, or effect on U.S. commerce.

If we were to follow these comments, though, American jobs and

markets might move offshore, yet the risk associated with such

overseas swaps activities, particularly in times of crisis, would

still have a direct and significant connection with activities in,

or effect on U.S. commerce.

Appendix 3--Statement of Commissioner Jill Sommers

Over a year ago, the Commission finally acknowledged that we

needed to address the growing uncertainty brewing among swap market

participants who were trying to decipher the extraterritorial reach

of the Dodd-Frank Act. We held a two-day roundtable last August and

have received numerous comments since then from market participants

and other regulators asking us to consider a global approach to the

regulation of these global markets. We were encouraged to coordinate

with our foreign and domestic partners and urged not to implement

our regulatory approach in a silo.

CFTC staff has worked diligently to address the challenging

issues associated with the statutory language of Section 2(i) of the

Commodity Exchange Act (CEA). Unfortunately, when the Proposed

Interpretive Guidance and Policy Statement (``Interpretive

Guidance'') was finally shared with the rest of the Commission on

June 1, 2012, we learned that staff had been guided by what could

only be called the ``Intergalactic Commerce Clause'' of the United

States Constitution, in that every single swap a U.S. person enters

into, no matter what the swap or where it was transacted, was stated

to have a direct and significant connection with activities in, or

effect on, commerce of the United States. This statutory and

constitutional analysis of the extraterritorial application of U.S.

law was, in my view, nothing short of extra-statutory and extra-

constitutional.

While the many revisions over the last several weeks have

tempered the outer limits of our initial approach, the Interpretive

Guidance nonetheless continues to ignore the Commission's successful

history of mutual recognition of foreign regulatory regimes spanning

20-plus years. We have worked for decades to establish relationships

with our foreign counterparts built on respect and trust, and should

not be so eager and willing to disregard their capabilities. All G20

nations agreed to comprehensive regulation of swap markets and we

should rely on their regional expertise. The current document

acknowledges the concept of ``substituted compliance,'' but it is

extremely vague with respect to what the Commission will be

considering in making these determinations. In my view, a very broad

and high level review of regulatory regimes is appropriate versus a

word-for-word comparison of rule books.

While the market failures described in the ``Background''

section of the Interpretive Guidance recount why the G20 nations

together agreed to a common set of principles for regulation of a

global marketplace, recounting those market failures does not

justify the expansive view the Commission has taken of its

jurisdictional reach, and does not justify the implication that

other nations are not capable of effective regulation.

As Commissioner O'Malia points out in his concurrence, not only

have we failed to coordinate with foreign regulators on a global

cross-border approach, we have failed to coordinate with our fellow

domestic regulators. As I have said for many months, we should be

proposing a rule defining the cross-border application of Dodd-Frank

that is harmonized with the SEC's approach, both in substance and in

timing. Unfortunately we are not doing that. Instead, we are

proposing Interpretive Guidance that ultimately has the effect of a

rule. No matter what it is called, the Interpretive Guidance is so

inextricably linked to the entity definitions and the registration

rules that it is a part of those rules themselves. Because it is not

titled a ``Notice of Proposed Rulemaking,'' we skirt the

requirements of the Administrative Procedure Act and the requirement

under Section 15(a) of the CEA that the Commission conduct a cost-

benefit analysis. I believe this approach, yet again, needlessly

exposes the Commission to litigation.

Over the last two years, while considering many proposed and

final rules, I have been very clear that I cannot support an

approach that creates an un-level playing field for market

participants. I am concerned that the different compliance dates in

the Proposed Exemptive Order may unnecessarily disadvantage U.S.-

based swap dealers and MSPs from the moment the document is

published in the Federal Register. I encourage comment on this issue

and hope that if we determine to harmonize the compliance dates for

entities in the U.S. and abroad, that we can do so before too much

damage is done to U.S.-based market participants.

As I reviewed the documents currently under consideration, it

occurred to me that two choices are presented. One is that the

Commission decline to issue the Interpretive Guidance and Proposed

Exemptive Order and leave market participants in a continued state

of uncertainty. The other is that the Commission issue these

documents and provide market participants with the certainty that we

are advancing a flawed policy. Neither is appealing.

My decision to support putting these proposals out for comment

was not easily reached. From the beginning I have supported a much

simpler approach to the extraterritorial reach of Dodd-Frank. I am

hopeful that the comment letters will encourage the Commission to

adopt a final rule that will rely on mutual recognition of all

global regulatory regimes in a manner that avoids costly, burdensome

duplicative regulations.

Appendix 4--Statement of Commissioner Scott D. O'Malia

I respectfully concur with the Commodity Futures Trading

Commission's (the ``Commission'' or ``CFTC'') approval of its

proposed interpretive guidance and policy statement (``Proposed

Guidance'') regarding section 2(i) of the Commodity Exchange Act

(``CEA'') \142\ and its notice of proposed exemptive order

(``Proposed Order''). While I have strong reservations about the

statutory authority and disagree with the Commission's decision to

issue interpretive guidance instead of a formal rulemaking, I

believe that the timely release of these proposals is critical for

firms to have some sense of what U.S. standards will apply to their

cross-border transaction, and how those standards will comport with

international standards. We expect that these proposals will improve

as a result of input from market participants, as well as an open

dialogue with global regulators.

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\142\ See 7 U.S.C. 1 et seq.

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These two proposals are complementary in that the Commission's

long-awaited Proposed Guidance establishes our view of the

application of the swaps provisions of the CEA to cross-border swaps

transactions, while the Proposed Order will delay compliance with

certain entity-level and transaction-level swaps requirements in the

CEA pending the final adoption of the Proposed Guidance. The

Proposed Order also borrows definitions and concepts from the

Proposed Guidance, such as the proposed definition of ``U.S.

person.'' While I believe that the Commission's issuance of the

Proposed Guidance and the Proposed Order are overdue, I have a

number of general concerns with the former.

I have been assured that the Proposed Guidance is a draft and,

although it is not required, will follow the normal notice-and-

comment process under the Administrative Procedure Act.\143\ After

the comment period, the Commission will review public comments and

subsequently will incorporate those comments into final guidance. I

would like to make it clear that if I were asked to vote on the

Proposed Guidance as final, my vote would be no.

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\143\ See 5 U.S.C. 551 et seq.

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The Proposed Guidance

My concerns with the Proposed Guidance relate generally to the

Commission's unsound interpretation of section 2(i) of the CEA. In

particular, I believe that the Commission's analysis: (i)

Misconstrues the language of section 2(i); (ii) is inconsistently

applied to different activities; (iii) loosely considers

international law and comity; (iv) lacks meaningful collaboration

with foreign and domestic regulators; and (v) blurs the lines

between interpretive guidance and legislative or interpretive

rulemaking. I discuss each of these concerns below.

i. Statutory Misconstruction

Section 2(i) of the CEA provides, in part, that the Commission's

swap authority does not apply to foreign activities unless those

activities ``have a direct and significant connection with

activities in, or effect on, commerce of the United States * * *.''

\144\ When Congress passed the Dodd-Frank Wall Street Reform and

Consumer Protection Act (the ``Dodd-Frank Act''),\145\ it intended

that

[[Page 41240]]

section 2(i) act as a limitation on the Commission's authority.

Under section 2(i), the Commission is required to demonstrate how

and when its jurisdiction applies to activities that take place

outside of the United States. Instead, the Commission's Proposed

Guidance ignores the literal statutory construction of section 2(i)

and prejudicially switches the analysis. In other words, the

Proposed Guidance now places the burden on market participants to

explain why their foreign swaps activities are outside of the

Commission's regulatory oversight. By placing the burden on market

participants to determine whether their swaps activities are subject

to the swaps provisions of the CEA--and without providing more

guidance to these participants--the Commission inappropriately

broadens the scope of swaps activities that will fall within the

Commission's jurisdiction. The Commission could more clearly

delineate which activities it believes will have a direct and

significant connection with U.S. commerce in order to ensure that

our regulatory interests are preserved.\146\

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\144\ 7 U.S.C. 2(i) (2012).

\145\ See Dodd-Frank Wall Street Reform and Consumer Protection

Act, Public Law 111-203, 124 Stat. 1376 (2010).

\146\ For example, in the case of non-interdealer swap

transactions, the Commission could focus its analysis on the

solicitation activities of swap dealers. In the case of other swap

transactions, the Commission could examine the location of where

performance of the primary obligations under a swap agreement takes

place.

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ii. Inconsistent Application of CEA Section 2(i)

In addition, the Commission's Proposed Guidance inconsistently

applies, and sometimes ignores, its own section 2(i) analysis. For

instance, the Commission sets forth in detail its belief that ``the

level of swap dealing that is substantial enough to require a person

to register as a swap dealer when conducted by a U.S. person, also

constitutes a `direct and significant connection' within the meaning

of section 2(i)(1) of the CEA.'' \147\ As a result, a non-U.S.

person would have a direct and significant connection with the

United States and therefore have to register with the Commission as

a swap dealer only once it engages in more than the de minimis level

of swap dealing with U.S. persons.\148\ In contrast to this somewhat

extensive analysis for swap dealers, the Commission provides a

sparse explanation of why it believes each and every swap

transaction between one or more U.S. persons or counterparties other

than a swap dealer or major swap participant (``MSP'') satisfies the

direct and significant connection analysis in section 2(i).\149\

Swap transactions that fall under this analysis would be subject to

certain transaction-level swaps requirements, including clearing,

exchange trading, reporting to a swap data repository under part 45

of the Commission's regulations, real-time public reporting and

large swaps trader reporting under part 20 of the Commission's

regulations.

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\147\ The Commission's analysis in the Proposed Guidance relies

on its analysis in the final entities rule. 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 (May 23, 2012).

\148\ See 77 FR at 30634 (``[T]he Commissions believe that the

appropriate threshold for the phase-in period is an annual gross

notional level of swap dealing activity of $8 billion or less. In

particular, the $8 billion level should still lead to the regulation

of persons responsible for the vast majority of dealing activity

within the swap markets.''). The Commission ties the direct and

significant connection analysis to the crude analysis in the final

entities rule. I voted against the final entities rule for several

reasons, including its flawed reasoning. I expressed my support,

however, with respect to the positive outcome that resulted from the

establishment of the $8 billion de minimis threshold.

\149\ See section V of this Proposed Guidance (``In light of the

significant extent of U.S. persons' swap activities outside of the

United States in today's global marketplace, and the risks to U.S.

persons and the financial system presented by such swaps activities

outside of the United States with U.S. persons as counterparties,

the Commission believes that U.S. persons' swap activities outside

the United States have the requisite connection with or effect on

U.S. commerce under section 2(i) to apply the swaps provisions of

the CEA to such activities.''). In a footnote in the Proposed

Guidance, the Commission then reasons without persuasive legal

support that the aggregate of outside activities and the aggregate

connection with U.S. commerce warrant the application of the CEA

swaps provisions to all such foreign activities.

The Commission's analysis ignores and minimizes two important

points. First, it ignores the fact that multinational entities also

may have major operations and business relationships in foreign

jurisdictions and may be considered persons within those

jurisdictions. Second, its analysis minimizes the fact that there

are an appreciable number of U.S. persons who engage in a relatively

small number of swaps transactions. Even if those U.S. persons'

transactions were aggregated, it is questionable whether their swaps

in the aggregate would meet the ``significant'' element in the

section 2(i) analysis.

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Similarly, in another instance, the Commission has divined an

exception to the application of certain Commission regulations for

situations where a foreign branch of a U.S. swap dealer engages in

swap dealing activities in emerging markets or other jurisdictions

without comparable swaps regimes.\150\ Although the policy result of

this exception is well intended, its bare analysis pales in

comparison to the Commission's section 2(i) analysis in other places

of the Proposed Guidance.\151\

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\150\ See section III.D.1 of this Proposed Guidance (``To be

eligible for this exception, the aggregate notional value (expressed

in U.S. dollars and measured on a quarterly basis) of the swaps of

all foreign branches in such countries may not exceed five percent

of the aggregate notional value (expressed in U.S. dollars and

measure on a quarterly basis) of all of the swaps of the U.S. swap

dealer.'').

\151\ See, e.g., the MSP discussion in section II.C.2. of this

Proposed Guidance.

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In yet another section of the Proposed Guidance, the Commission

does not adequately explain why almost all transaction-level

requirements (i.e., clearing, margining for uncleared swaps, real-

time public reporting and certain business conduct standards)

equally satisfy the direct and significant connection analysis under

CEA section 2(i). In my view, two transaction-level requirements

related to pre- and post-trade transparency--namely, trade execution

and real-time public reporting requirements--do not raise the same

level of systemic risk concerns as clearing and margining for

uncleared swaps. I believe the Commission should better explain its

rationale for requiring foreign swap dealers transacting with non-

U.S. persons to meet the trade execution and real-time public

reporting requirements under Title VII of the Dodd-Frank Act and

Commission regulations.

iii. Loose Consideration of Principles of International Comity

Moreover, the Commission's interpretation of CEA section 2(i) is

overly broad to the point where the extent of the Commission's

jurisdiction is virtually endless. The Proposed Guidance takes the

position that all transactions involving a U.S. person fall within

the Commission's jurisdiction, regardless of the location of the

transaction or the regulations in effect within the relevant

jurisdiction.

While section 2(i) gives the Commission jurisdiction to reach

activities that take place outside of the United States, the

Commission's Proposed Guidance loosely considers principles of

international comity that are essential for determining the

extraterritorial applicability of U.S. law. Although the Proposed

Guidance expressly states that the Commission will exercise its

regulatory authority over cross-border activities in a manner

consistent with principles of international comity, the Commission's

proposed approach could be described as unilateral and dismissive of

foreign law, even when those laws may achieve the same results

sought by the Commission.\152\

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\152\ The Proposed Guidance correctly cites judicial and

executive branch precedent and guidance addressing the application

of international law and comity concepts in determining the

extraterritorial applicability of federal statutes. See section

III.A. of this Proposed Guidance. These concepts are found in

sections 403(1) and (2) of the Third Restatement of Foreign

Relations Law. See Restatement (Third) of Foreign Relations Law of

the United States Sec. Sec. 403(1), 403(2) (1986).

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I strongly believe that the Commission instead must honor these

principles in order to respect the legitimate interests of other

sovereign nations. This approach would serve to complement, and not

limit, the ability of the Commission to effectively regulate swaps

markets. The Commission does not have the resources to register and

regulate all market participants and swaps activities. By relying on

comparable foreign regulatory regimes to address the trading

activities of foreign market participants, the Commission could

better allocate resources domestically in a more effective manner.

iv. The Commission Should Engage in Real and Meaningful Cooperation

With Foreign and Domestic Regulators

The Proposed Guidance references a series of well-known large

financial institution failures--such as Lehman Brothers and Long

Term Capital Management--to support the Commission's over-expansive

interpretation and application of Title VII of the Dodd-Frank Act. I

agree that those failures had a detrimental effect on the U.S.

economy. We must not forget, however, that the swaps

[[Page 41241]]

markets are truly global and the Commission's swaps regulations will

not operate in a vacuum. For that reason, the Commission should

consider the interaction of its swaps regulations with the

regulations of other jurisdictions, all of which have legitimate

regulatory interests in the trading of swaps by multinational

organizations. Thus, the Commission's swaps regulation should be

concordant with foreign swaps regulations in order to avoid

duplication, conflict and unnecessary uncertainty.

In light of today's highly interdependent, global financial

markets, the Commission needs to engage in real cooperation with

foreign regulators and to coordinate its swaps regulations with the

regulations of other sovereign nations. Concepts of comparability

and mutual recognition are essential.

The Commission should follow the example of international

cooperation and coordination seen in the efforts of the Basel

Commission on Banking Supervision (``BCBS'') and the International

Organization of Securities Commissions (``IOSCO'') in developing

harmonized international standards for the margining of uncleared

swaps. BCBS and IOSCO plans to publish a consultation paper

outlining these standards. Notwithstanding the Commission's own

efforts to propose rules for the margining of uncleared swaps for

swap dealers and MSPs,\153\ the Commission plans to consider the

final policy recommendations set forth by BCBS and IOSCO when

adopting the Commission's final rules for the margining of uncleared

swaps and may adapt those final rules to conform with BCBS and

IOSCO's final policy recommendations. The Commission should follow

the lead of BCBS and IOSCO in harmonizing many of its other rules.

In my view, either the G20 or another international body or

consortium of nations could act as a springboard for the

coordination of swaps regulation.\154\

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\153\ See Capital Requirements of Swap Dealers and Major Swap

Participants, 76 Fed. Reg. 27802 (May 12, 2011).

\154\ On June 18-19, 2012, the leaders of the G20 convened in

Los Cabos, Mexico to reaffirm their commitments with respect to the

regulation of the over-the-counter (``OTC'') derivatives markets.

Specifically, the G20 leaders reaffirmed their commitment that all

standardized OTC derivatives be traded on exchanges or electronic

platforms and be centrally cleared by the end 2012. See the G20

Declaration (June 2012), para. 39, p. 7, at: http://www.g20.org/images/stories/docs/g20/conclu/G20_Leaders_Declaration_2012.pdf.

The Commission should follow the spirit of the G20's cooperative

efforts by working with foreign regulators to determine the

applicability of its swaps regulations to cross-border swaps.

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On June 22, 2012, European Union Commissioner Michel Barnier

echoed this position in a statement to the Financial Times.\155\ Mr.

Barnier made clear that effective international regulation involves

regulators coordinating their efforts to implement mandatory

clearing, trading and reporting of over-the-counter derivatives. A

coordinated approach would ensure that swaps do not evade

regulation. Mr. Barnier also made clear that regulatory regimes that

assert jurisdiction over trading activity already within the

jurisdiction of another competent regulator is both unnecessary and

costly. I agree with Mr. Barnier's view that our goal as regulators

should be to establish regulatory regimes that prevent swaps from

slipping through the cracks without applying our laws to activity

that is better regulated by our trusted colleagues abroad.

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\155\ See statement by Commissioner Michel Barnier of the

European Union, Financial Times, June 22, 2012 (``Where the rules of

another country are comparable and consistent with the objectives of

U.S. law, it is reasonable to expect U.S. authorities to rely on

those rules and recognize activities regulated under them as

compliant. We in the EU can do exactly the same * * * This is

reasonable because it accepts legal boundaries and the need for

regulators to trust and rely on each other. It is effective because

it achieves our common objective of mandatory clearing, trading and

reporting of OTC derivatives: no trade will escape the regulation.

It is efficient because it avoids subjecting the same trades and

businesses to two different sets of rules simultaneously and

expensively.'').

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Unfortunately, the Proposed Guidance overreaches in many

respects and, as a result, steps on the toes of other sovereign

nations. Today's Proposed Guidance will likely provoke these nations

to develop strict swaps rules in retaliation that unfairly and

unnecessarily burden U.S. firms.\156\

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\156\ Some jurisdictions have provisions that are similar to CEA

section 2(i). For example, Article 13 of European Market

Infrastructure Regulation (``EMIR'') provides that the European

Securities and Markets Authority must prescribe technical standards

specifying the contracts that are considered to have a direct,

substantial and foreseeable effect on the European Union, or in

cases where it is necessary or appropriate to prevent the evasion of

any general applicability provisions in EMIR. See Regulation of the

European Parliament and of the Council on OTC Derivatives, Central

Counterparties and Trade Repositories, European Market

Infrastructure Regulation (Mar. 29. 2012), available at: http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm. The Commission's overreaching interpretation of CEA section

2(i) may inspire ESMA and other regulators to interpret their

provisions in a similar manner.

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Interestingly, we not only fail to harmonize internationally, we

also fail to harmonize domestically. In other words, I believe that

the Commission should take a page from the Securities and Exchange

Commission's (``SEC'') playbook regarding implementation and the

application of swaps requirements to cross-border activities.

Recently, the SEC issued a statement of general policy (the ``SEC's

Statement'') on the sequencing of compliance dates for final rules

applicable to the security-based swaps market.\157\ The SEC's

Statement presents a commonsense sequencing of the compliance dates

for the SEC's final rules implementing the provisions of Title VII

of the Dodd-Frank Act to domestic and cross-border swaps activities.

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\157\ See Statement of General Policy on the Sequencing of the

Compliance Dates for Final Rules Applicable to Security-Based Swaps

Adopted Pursuant to the Securities Exchange Act of 1934 and the

Dodd-Frank Wall Street Reform and Consumer Protection Act, to be

published under 17 CFR Part 240 (June 11, 2012), available at:

http://www.sec.gov/rules/policy/2012/34-67177.pdf.

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In stark contrast, the Commission is engaging in what amounts to

high-frequency regulation. I am very critical of this regulatory

approach because it generally results in regulatory uncertainty and

unintended, adverse consequences. In my view, failure to achieve

real and meaningful harmonization of the implementation and

application of swaps and security-based swaps rules will result in

inconsistencies and added compliance challenges and costs for market

participants who trade in both markets.

v. Interpretive Guidance or an Interpretive Rule?

Several times while reading drafts of the Proposed Guidance, I

had to stop, put it down, and recall that I was reading the

Commission's proposed interpretation of CEA section 2(i)--not a

prescriptive rule. Although the Commission has taken great pains to

clarify that it is publishing guidance and a policy statement

regarding the cross-border application of the swaps provisions of

the CEA, certain elements of the Proposed Guidance are written

similar to legislative or interpretive rules instead of interpretive

guidance. For example, the Proposed Guidance states that subsequent

to registration with the Commission:

[T]he Commission expects that a non-U.S. swap dealer or non-U.S.

MSP would notify the Commission of any material changes to

information submitted in support of a comparability finding

(including, but not limited to, changes in the relevant supervisory

or regulatory regime) as the Commission's comparability

determination may no longer be valid.\158\

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\158\ Section IV.A.2 of this Proposed Guidance.

The Commission's artful use of the terms ``expect'' and

``expectation'' in the Proposed Guidance does not disguise the fact

that it is requiring applicants to satisfy significant ongoing

monitoring and compliance obligations in order to maintain its

comparability finding. If the Commission wanted to require a non-

U.S. swap dealer or non-U.S. MSP applicant to submit these

additional documents in connection with such applicant's ongoing

registration-related obligations, the Commission should have

included these requirements in the swap dealer and MSP registration

rulemaking, which the Commission finalized in January of this

year.\159\ Instead, the Commission is issuing today's Proposed

Guidance in a manner that is outside of the requirements set forth

in the Administrative Procedure Act.\160\

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\159\ See Registration of Swap Dealers and Major Swap

Participants, 77 FR 2613 (Jan. 19, 2012).

\160\ See 5 U.S.C. 551 et seq.

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The Proposed Order

Notwithstanding my general concerns with the Proposed Guidance,

I believe that the Commission's Proposed Order appropriately

provides both U.S. and foreign firms with transition periods in

which to comply with the Commission's interpretation of CEA section

2(i). As noted above, the Proposed Order would permit foreign swap

dealer and MSP registrants to delay compliance with certain entity-

level requirements and transaction-level requirements under Title

VII of the Dodd-Frank Act pending the adoption of the Commission's

final

[[Page 41242]]

interpretive guidance regarding section 2(i). My concurrence today

comes after several days of negotiations with my fellow

commissioners. I am relieved that we are protecting the

competitiveness of U.S. firms in the Proposed Order.\161\ Although I

am generally supportive of the Proposed Order, I do have a couple of

more pragmatic concerns regarding the manner in which foreign swap

dealers and MSPs will comply with the Commission's registration

requirements.

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\161\ Under the Proposed Order, U.S. swap dealers and MSPs will

only be required to register with the Commission and to meet the

requirements under parts 20 (large swap trader reporting) and 45

(swap data recordkeeping and reporting) until December 31, 2012

before other entity-level requirements will become effective.

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First, I believe the Commission should tie the expiration of

this relief to the adoption of a final exemptive order. Currently,

the Proposed Order unjustifiably ties the expiration of the relief

to the date on which the Proposed Order is published in the Federal

Register. The Proposed Order's current expiration does not make

sense in light of the fact that potential registrants will not know

the contours of the final relief until the Commission approves a

final exemptive order. If we do not tie the expiration of relief to

the publication of the final exemptive order, are we truly providing

adequate notice and a period of time in which registrants can

comply?

Second, the Proposed Order should at least include questions

regarding how the Commission proposes to address practical

considerations regarding the registration of foreign swap dealers

and MSPs. The Commission should set out its preliminary thinking

regarding how these foreign swap dealers and MSPs will register

their associated persons and principals, in addition to addressing

concerns regarding the transfer of, and withdrawal from, Commission

registration.

I have included a few questions at the end of my statement to

address these practical concerns.

Do Not Ignore the Significant Cost Implications

I would like to make one closing but important point regarding

the potential costs of today's Proposed Guidance. While I understand

that the CEA only requires the Commission to consider the costs and

benefits of its regulations and orders--not interpretive guidance--

the Proposed Guidance, once finalized will result in significant

costs to the swaps industry. The implications of the Commission's

adoption of interpretive guidance on cross-border swaps activities

will be nothing at which to laugh. Firms will incur significant

operational, legal and administrative expenses in connection with

the registration and ongoing compliance with the Commission's swaps

regulations. Not to mention, many firms that operate through

branches may feel compelled to convert into, and separately

capitalize, affiliates in order to limit the impact of the

Commission's interpretation.

Accordingly, I encourage the Commission to prepare a report

separate from its adoption of the Proposed Guidance, which analyzes

the costs attributable to the breadth of the Commission's new

authority under CEA section 2(i). This report will help inform

market participants who seek guidance as to the potential costs of

trading swaps in the United States. More importantly, the report

will help inform the Commission in connection with the issuance of

future rulemakings under Title VII of the Dodd-Frank Act.

Conclusion

I am relieved that the Commission is finally issuing today's

proposals. Commission staff has spent well over one year preparing

the proposals before us today. The publication of the Commission's

interpretation of CEA section 2(i) is crucial. I hope that the

release of these proposals will enable market participants to

determine how the international rules and expansive international

oversight of the Dodd-Frank Act might impact their activities in the

United States and internationally. I want to ensure that U.S. firms

are placed on a fair and competitive playing field that offers no

opportunity for regulatory arbitrage. I am mindful that a seamless

regulatory net can only be achieved through international

cooperation and coordination.

In summary, I believe the Commission's final interpretive

guidance should reflect: (1) Principles of international law and

comity; (2) a clear understanding of the implications of the

Proposed Guidance so that the Commission can make an informed

decision regarding the various policy alternatives; and (3) parity

to ensure that U.S. firms are not unfairly disadvantaged vis-

[agrave]-vis their foreign competitors. I fear that if we adopt the

Proposed Guidance as final, the Commission will take an

imperialistic view of the swaps market. I also remain concerned

regarding the Commission's shaky legal analysis.

I look forward to reviewing the myriad of comments submitted in

response to today's proposals. I implore market participants, as

well as domestic and foreign regulators, to share their views and

let us know how to harmonize our efforts so that we collectively can

develop an internationally consistent and complementary approach to

address the cross-border regulation of the swaps markets.

Questions

1. Please share your views regarding the Commission's proposed

effective date for the relief set forth in the Proposed Order.

Should the expiration of the effective date be extended or

shortened?

2. Should the Commission permit swap dealer and MSP registrants

to conditionally de-register following the expiration of the

effective date of the Proposed Order? If so, under what conditions

should the Commission allow de-registration?

3. Should the Commission permit swap dealer and MSP registrants

to transfer their registration to a majority-owned affiliate or

subsidiary? If so, under what circumstances should the Commission

allow such a transfer?

[FR Doc. 2012-16496 Filed 7-11-12; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: July 12, 2012