2011-24124
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Federal Register, Volume 76 Issue 182 (Tuesday, September 20, 2011)[Federal Register Volume 76, Number 182 (Tuesday, September 20, 2011)]
[Proposed Rules]
[Pages 58186-58197]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-24124]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 37, 38, and 39
RIN 3038-AD60
Swap Transaction Compliance and Implementation Schedule: Clearing
and Trade Execution Requirements under Section 2(h) of the CEA
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is proposing regulations that would establish a schedule to phase in
compliance with certain new statutory provisions enacted under Title
VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act). These provisions include the clearing requirement
under new section 2(h)(1)(A) of the Commodity Exchange Act (CEA or
Act), and the trade execution requirement under new section 2(h)(8)(A)
of the CEA. The proposed schedules would provide relief in the form of
additional time for compliance with these requirements. This relief is
intended to facilitate the transition to the new regulatory regime
established by the Dodd-Frank Act in an orderly manner that does not
unduly disrupt markets and transactions. The Commission requests
comment on the proposed compliance schedules for these clearing and
trade execution requirements.
DATES: Submit comments on or before November 4, 2011.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD60
and Swap Transaction Compliance and Implementation Schedule: Clearing
and Trade Execution Requirements under Section 2(h) of the CEA, by any
of the following methods:
Agency Web site, via its Comments Online process 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
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that may be exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the established procedures in
Sec. 145.9 of the Commission's regulations, 17 CFR 145.9.
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 http://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other
[[Page 58187]]
applicable laws, and may be accessible under the Freedom of Information
Act.
FOR FURTHER INFORMATION CONTACT: Dhaval Patel, Counsel, Office of the
General Counsel, 202-418-5125, dpatel@cftc.gov, or Camden Nunery,
Office of the Chief Economist, cnunnery@cftc.gov, 202-418-5723,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\
Title VII of the Dodd-Frank Act amends the CEA \2\ to establish a
comprehensive new regulatory framework for swaps. The legislation was
enacted to reduce risk, increase transparency, and promote market
integrity within the financial system by, among other things: (1)
Providing for the registration and comprehensive regulation of swap
dealers and major swap participants; (2) imposing clearing and trade
execution requirements on standardized derivative products; (3)
creating robust recordkeeping and real-time reporting regimes; and (4)
enhancing the rulemaking and enforcement authorities of the Commission
with respect to, among others, all registered entities and
intermediaries subject to the Commission's oversight.
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010).
\2\ 7 U.S.C. 1 et seq.
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To implement the Dodd-Frank Act, the Commission has to-date issued
55 advance notices of proposed rulemaking or notices of proposed
rulemaking, two interim final rules, 12 final rules, and one proposed
interpretive order. By the beginning of May 2011, the Commission had
published in the Federal Register a significant number of notices of
proposed rulemaking, which represented a substantially complete mosaic
of the Commission's proposed regulatory framework under Title VII of
the Dodd-Frank Act. In recognition of that fact and with the goal of
giving market participants additional time to comment on the proposed
new regulatory framework for swaps, either in part or as a whole, the
Commission reopened or extended the comment period of many of its
proposed rulemakings through June 3, 2011.\3\ In total, the Commission
has received over 20,000 comments in response to its Dodd-Frank Act
rulemaking proposals.
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\3\ See Reopening and Extension of Comment Periods for
Rulemakings Implementing the Dodd-Frank Wall Street Reform and
Consumer Protection Act, 76 FR 25274, May 4, 2011.
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To give the public an opportunity to comment further on
implementation phasing, on May 2-3, 2011, the Commission, along with
the Securities and Exchange Commission (SEC), held a joint, two-day
roundtable on issues related to implementation.\4\ In connection with
this roundtable, Commission staff proposed thirteen concepts to be
considered regarding implementation phasing, and staff asked a series
of questions based on the concepts outlined.\5\ The Commission received
numerous comments in response to both its roundtable and the staff
concepts and questions.\6\
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\4\ The transcripts from the roundtable are available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/csjac_transcript050311.pdf (``Day 1 Roundtable Tr.'') and http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/csjac_transcript050211.pdf (``Day 2 Roundtable Tr.'').
\5\ See ``CFTC Staff Concepts and Questions Regarding Phased
Implementation of Effective Dates for Final Dodd-Frank Rules,''
available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/staffconcepts050211.pdf.
\6\ Such comments are available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1000.
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These comments were submitted by a number of existing and potential
market infrastructures, including clearinghouses, trading platforms,
and swap data repositories. Comments also were submitted by entities
that may potentially be swap dealers (SDs) or major swap participants
(MSPs), as well as those financial entities that may not be required to
register with the Commission, but whose swap transactions may be
required to comply with the clearing requirement under section
2(h)(1)(A) of the CEA, and a trade execution requirement under section
2(h)(8)(A) of the CEA. The Commission also received many comments from
non-financial entities.
One of the key themes to emerge from the comments received by the
Commission is that some market participants may require more time to
bring their swap transactions into compliance with certain new
regulatory requirements.\7\ For example, one commenter requested a
``meaningful'' period after finalization of the suite of rulemakings
that is applicable to it before actual compliance will be required.\8\
Similarly, several trade associations recommended the Commission allow
``sufficient'' time for infrastructure and business practices to
develop before requiring compliance with the new requirements.\9\ A
group of international banks commented that the Commission should defer
compliance until December 31, 2012, at which point the regulatory
timetable as per the September 2009 G20 Pittsburgh statement will have
reached a conclusion.\10\ Another commenter noted that some entities
may be able to comply relatively quickly with certain documentation
requirements that are largely consistent with current business
practices while other requirements may need a longer implementation
period.\11\ Although commenters varied in their recommendations
regarding the time it would take to bring their swaps into compliance
with the new regulatory requirements,\12\ many commenters agreed on
phasing in compliance with these requirements by type of market
participant based on a variety of factors, including a market
participant's experience, resources, and the size and complexity of its
transactions.\13\ The Commission has taken these comments into
consideration in developing the proposed compliance schedules.
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\7\ E.g., Letter from Karrie McMillan, Investment Company
Institute, dated Jun. 10, 2011 at 8-11; Letter from Financial
Services Forum, Futures Industry Association, International Swaps
and Derivatives Association, and Securities Industry and Financial
Markets Association, dated May 4, 2011 at 7-9; Letter from Jeff
Gooch, MarkitSERV, dated Jun. 10, 2011 at 1-2 and 6; Letter from
Electric Trade Association, dated May 4, 2011 at 5; Letter from John
R. Gidman, Association of Institutional Investors, dated Jun. 10,
2011 at 3.
\8\ Letter from the Coalition of Physical Energy Companies,
dated Mar. 14, 2011 at 4.
\9\ Letter from the Futures Industry Association, the Financial
Services Forum, the International Swaps and Derivatives Association
and the Securities Industry and Financial Markets Association, dated
May 4, 2011 at 5.
\10\ Letter from the Bank of Tokyo-Mitsubishi UFJ, Ltd., et al.,
dated May 6, 2011 at 6.
\11\ Letter from the Financial Services Roundtable, dated May
12, 2011 at 4.
\12\ For example, Javelin stated that it could be open for
business and generally be in compliance with the clearing and trade
execution requirements within 6 months. Day 1 Roundtable Tr. at 104-
105. Citadel suggested moving towards a voluntary clearing launch
between day 180 and day 240, and eventually moving towards a
mandatory clearing date. Day 1 Roundtable Tr. at 73-74. Moreover,
the Swap Financial Group offered a different perspective stating
that it generally thought implementation of Dodd-Drank could be
accomplished in a year or two. Day 2 Roundtable Tr. at 269.
\13\ These comments are more fully discussed later in the
preamble.
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The swap transaction compliance requirements that are the subject
of this proposed rulemaking include compliance with the clearing
requirement and the corresponding trade execution requirement under
sections 2(h)(1)(A) and 2(h)(8)(A) of the CEA, respectively.\14\ The
Commission's
[[Page 58188]]
proposed compliance schedules are designed to afford affected market
participants a reasonable amount of time to bring their transactions
into compliance with such requirements. The proposed schedules also
would provide relief in the form of additional time for compliance with
these transaction compliance requirements and are further explained
below.\15\ This relief is intended to facilitate the transition to the
new regulatory regime established by the Dodd-Frank Act in an orderly
manner that does not unduly disrupt markets and transactions.
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\14\ The Commission also is proposing Swap Transaction
Compliance and Implementation Schedule: Trade Documentation and
Margining Requirements under section 4s of the CEA.
\15\ The proposed compliance schedules do not address the
effective dates of the clearing and trade execution requirements in
the Dodd-Frank Act, including the application of the Commission's
Effective Date Order to such requirements. See Effective Date for
Swap Regulation, 76 FR 42508, Jul. 19, 2011.
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II. Proposed Regulation
A. Authority to Implement Proposed Regulations
In this Notice of Proposed Rulemaking, the Commission relies on its
general authority to establish compliance dates with the rules and
regulations enacted pursuant to the Dodd-Frank Act. Section 712(f) also
authorizes the Commission to promulgate rules to prepare for the
effective dates of the provisions of the Dodd-Frank Act.\16\ In
addition, the Commission relies on section 8(a)(5) of the CEA, which
authorizes the Commission to promulgate such regulations as, in the
judgment of the Commission, are reasonably necessary to effectuate any
of the provisions or to accomplish any of the purposes of the CEA. In
accordance with this authority, the proposed regulations would amend
parts 37, 38, and 39 of the Commission's regulations to phase in
compliance dates for the clearing and trade execution requirements
under section 2(h) of the CEA.
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\16\ Section 712(f) of the Dodd-Frank Act states: ``Beginning on
the date of enactment of this Act and notwithstanding the effective
date of any provision of this Act, the [Commission] * * * may, in
order to prepare for the effective dates of the provisions of this
Act--(1) promulgate rules, regulations, or orders permitted or
required by this Act * * *.''
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B. Implementation Phasing of the Clearing Requirement under Section
2(h)(1)
1. Background on Mandatory Clearing Determinations
Section 723(a)(3) of the Dodd-Frank Act amended the CEA to provide,
under new section 2(h)(1)(A), that ``it shall be unlawful for any
person to engage in a swap unless that person submits such swap for
clearing to a derivatives clearing organization that is registered
under this Act or a derivatives clearing organization that is exempt
from registration under this Act if the swap is required to be
cleared.'' \17\ Section 2(h)(2) charges the Commission with the
responsibility for determining whether a swap is required to be
cleared, through one of two avenues: (1) Pursuant to a Commission-
initiated review; or (2) pursuant to a submission from a derivatives
clearing organization (DCO) of each swap, or any group, category, type,
or class of swaps that the DCO ``plans to accept for clearing.'' \18\
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\17\ Section 2(h)(7) of the CEA provides an exception to the
clearing requirement (``the end-user exception'') when one of the
counterparties to a swap (i) Is not a financial entity, (ii) is
using the swap to hedge or mitigate commercial risk, and (iii)
notifies the Commission how it generally meets its financial
obligations associated with entering into a non-cleared swap.
\18\ Under section 2(h)(2)(B)(ii), the Commission must consider
swaps listed for clearing by a DCO as of the date of enactment of
the Dodd-Frank Act.
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On July 26, 2011, the Commission published in the Federal Register
a final rule regarding the process for review of swaps for mandatory
clearing.\19\ Under Sec. 39.5(b)(6), the Commission will review a
DCO's submission and determine whether the swap, or group, category,
type, or class of swaps, described in the submission is required to be
cleared. This determination will be made not later than 90 days after a
complete submission has been received from a DCO, unless the submitting
DCO agrees to an extension. Under Sec. 39.5(c), Commission-initiated
reviews of swaps that have not been accepted for clearing by a DCO will
take place on an ongoing basis. However, as explained in the preamble
to the final rule, the ``Commission anticipates that the initial
mandatory clearing determinations would only involve swaps that are
already being cleared or that a DCO wants to clear.'' \20\
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\19\ 76 FR 44464, Jul. 26, 2011.
\20\ 76 FR at 44469.
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Because the Commission initially will consider mandatory clearing
determinations based on those swaps that DCOs are currently clearing or
that a DCO would like to clear, the initial sequence of mandatory
clearing determinations will be based on the market's view of which
swaps can be cleared and which asset classes are ready for clearing, as
reflected by the fact that a DCO is either currently clearing a group,
category, type, or class of swaps or is intending to do so. For
example, multiple registered DCOs currently clear interest rate,
credit, and commodity swaps. For these swaps, the Commission will begin
the review process for issuing mandatory clearing determinations in the
near term.
The Commission observes that before market participants could be
required to comply with a mandatory clearing determination, the
Commission must adopt its final rules related to the end-user exception
to mandatory clearing established by section 2(h)(7) of the CEA. In
December 2010, the Commission proposed rules governing this elective
exception to mandatory clearing.\21\ The proposed rule generally
provides that a swap otherwise subject to mandatory clearing is subject
to an elective exception from clearing if one party to the swap is not
a financial entity, is using swaps to hedge or mitigate commercial
risk, and notifies the Commission how it generally meets its financial
obligations associated with entering into non-cleared swaps (the ``end-
user clearing exception'').\22\ Because this proposed rule would
establish the process by which a non-financial entity would elect not
to clear a swap subject to a clearing requirement, this rule would need
to be finalized prior to requiring compliance with a mandatory clearing
determination.
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\21\ End-User Exception to Mandatory Clearing of Swaps, 75 FR
80747, Dec. 23, 2010.
\22\ 75 FR at 80748.
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In addition, the Commission recognizes that the swap transaction
compliance schedules that are the subject of this proposal reference
terms such as ``swap,'' ``swap dealer,'' and ``major swap participant''
that are the subject of rulemaking under sections 712(d)(1) and 721(c)
of the Dodd-Frank Act.\23\ The Commission and the SEC have proposed
rules that would further define each of these terms.\24\ As such,
[[Page 58189]]
and in a manner consistent with the temporary relief provided in the
Commission's Effective Date Order,\25\ the Commission must adopt its
final rules regarding the further definitions in question prior to
requiring compliance with a mandatory clearing determination.\26\
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\23\ Section 712(d)(1) provides: ``Notwithstanding any other
provision of this title and subsections (b) and (c), the Commodity
Futures Trading Commission and the Securities and Exchange
Commission, in consultation with the Board of Governors [of the
Federal Reserve System], shall further define the terms `swap',
`security-based swap', `swap dealer', `security-based swap dealer',
`major swap participant', `major security-based swap participant',
and `security-based swap agreement' in section 1a(47)(A)(v) of the
Commodity Exchange Act (7 U.S.C. 1a(47)(A)(v)) and section 3(a)(78)
of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(78)).''
Section 721(c) provides: ``To include transactions and entities that
have been structured to evade this subtitle (or an amendment made by
this subtitle), the Commodity Futures Trading Commission shall adopt
a rule to further define the terms `swap', `swap dealer', `major
swap participant', and `eligible contract participant'.''
\24\ Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant,'' and ``Eligible Contract Participant''; Proposed
Rule, 75 FR 80174, Dec. 21, 2010 and 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.
\25\ See Effective Date for Swap Regulation, 76 FR 42508, Jul.
19, 2011.
\26\ Notably, under section 712(f) of the Dodd-Frank Act, these
definitions would not have to be finalized for the Commission to
review swap submissions from DCOs.
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Lastly, the Commission notes that it has yet to adopt final rules
relating to the protection of cleared swaps customer contracts and
collateral. These rules are essential for establishing the customer
protection regime associated with client clearing for swaps through
Commission-registered futures commission merchants (FCMs) at DCOs.\27\
The Commission believes that finalizing the rules regarding the
segregation of customer collateral prior to requiring compliance with a
mandatory clearing determination is necessary to effectuate the
purposes of new section 4d(f) of the CEA.
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\27\ Protection of Cleared Swaps Customer Contracts and
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy
Provisions, 76 FR 33818, Jun. 9, 2011.
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2. Compliance Schedule for Clearing Requirement--Sec. 39.5(e)
Proposed Sec. 39.5(e) would provide the Commission with the
authority to phase in compliance with a clearing requirement upon
issuance of a mandatory clearing determination. The proposed compliance
schedule is based on the type of market participants entering into the
swaps subject to the clearing requirement. The triggering event for the
application of this compliance schedule would be the Commission's
issuance of a determination that the swap, or group, category, type, or
class of swaps, is required to be cleared.\28\
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\28\ See discussion below at p. 21 and above at p. 7. It would
be possible for the Commission to issue a mandatory clearing
determination but postpone the overall compliance date for all
market participants for some period of time. Additionally, market
participants may begin clearing their swap transactions as soon as a
DCO begins accepting such swaps for clearing, regardless of whether
the Commission determines that such swaps are required to be
cleared.
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In proposing phased implementation schedules for the clearing
requirement, the Commission seeks to balance several goals. First, the
Commission believes that certain market participants may require
additional time to bring their swaps into compliance with the new
regulatory requirement for mandatory clearing of a swap or class of
swaps. This is particularly true for market participants that may not
be registered with the Commission and those market participants that
may have hundreds or thousands of managed accounts, referred to as
``third-party subaccounts'' for the purposes of this proposal. Under
this proposal, these parties would be afforded additional time to
document new client clearing arrangements, connect to market
infrastructure such as DCOs, and prepare themselves and their customers
for the new regulatory requirements. As one commenter noted, ``[i]n the
context of asset managers, the account set up process has to be
multiplied over hundreds of subaccounts. Processing all of these
subaccounts will take time even for the largest and most
technologically advanced asset managers.'' \29\
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\29\ Letter from Karrie McMillan, Investment Company Institute,
dated Jun. 10, 2011 at 9-10.
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Moreover, several commenters emphasized the need to have adequate
time to educate their clients regarding the new regulatory
requirements.\30\ For instance, market participants not registered with
the Commission may not be familiar with the new regulatory
requirements. In addition, market participants with third-party
subaccounts would have to educate additional clients. Accordingly, both
types of participants should be given additional time to prepare for
compliance with the new requirements.
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\30\ See Letter from Financial Services Forum, Futures Industry
Association, International Swaps and Derivatives Association, and
Securities Industry Association, dated May 4, 2011 at 9; Letter from
Karrie McMillan, Investment Company Institute, dated Jun. 10, 2011
at 10-11.
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Another goal of the proposed compliance schedule is to have
adequate representation of market participants involved at the outset
of implementing a new mandatory clearing regime for swaps. The
Commission believes that having a cross-section of market participants
involved at the outset of formulating and designing the rules and
infrastructure under which mandatory clearing is implemented will best
meet the needs of all market participants.
Several commenters have recommended that the Commission take such
an approach. For example, one commenter emphasized the importance of
the initiation of so-called ``buy-side'' clearing access for credit
default swaps in 2009 and recommended that ``[a]t the time that a class
of products is ready for clearing, all market participants (including
buy-side participants) should be permitted (but not required) to clear
those products * * *.'' \31\ In another example, one commenter
recommended that in phasing mandatory clearing the Commission should
aim for open access to establish an ``all to all market'' with both
sides of the trade involved with the initial implementation.\32\ In
further response to these comments, the Commission notes that market
participants can begin (and continue) voluntarily clearing swaps
through eligible DCOs at any time.
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\31\ Letter from Richard H. Baker, Managed Funds Association,
dated Mar. 24, 2011 at Appendix 1, page 1 and Appendix 2, page 2.
\32\ Letter from Chris Koppenheffer, Swaps & Derivatives Market
Association, dated Jun. 1, 2011 at 2.
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C. Implementation Phasing of the Trade Execution Requirement Under
Section 2(h)(8)
1. Background on Trade Execution Requirement
Section 723 of the Dodd Frank Act amended the CEA to provide, under
new section 2(h)(8)(A), that with respect to a swap that is subject to
the clearing requirement of section 2(h)(1)(A), ``counterparties shall
(i) execute the transaction on a board of trade designated as a
contract market under section 5 [a DCM]; or (ii) execute the
transaction on a swap execution facility [SEF] registered under section
5h or a swap execution facility exempt from registration under section
5h(f) of this Act.'' Under section 2(h)(8)(B), the only exceptions to
the trade execution requirement are if no DCM or SEF ``makes the swap
available to trade'' or the swap is subject to the clearing exception
under section 2(h)(7) (i.e., the end-user exception).\33\
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\33\ Section 2(h)(1)(B).
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Based on the natural phasing provided for in the statute, a trade
execution requirement is triggered for a swap when (1) The Commission
has issued a determination that the swap is required to be cleared and
(2) any DCM or SEF has made the swap available to trade.\34\
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\34\ This rulemaking does not address the manner in which it may
be determined or established that a DCM or a SEF has made a swap
available for trading.
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The Commission observes that before market participants could be
required to comply with a trade execution requirement the Commission
must adopt final rules related to SEFs and DCMs. The Commission has
proposed rules related to the new core principles for DCMs and the
changes to the 18 original DCM core principles.\35\ While
[[Page 58190]]
none of the new rules proposed for DCMs relate directly to the trade
execution requirement under section 2(h)(8), the Commission believes
that it is necessary for DCMs to have their new policies, procedures,
and rulebooks in place prior to the DCMs making a swap available for
trading.
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\35\ Core Principles and Other Requirements for Designated
Contract Markets, 75 FR 80572, Dec. 22, 2010.
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With regard to SEFs, the Commission also observes that it would
have to adopt final rules allowing for SEF registration, including
procedures for provisional registration, prior to any SEF making a swap
that is required to be cleared available for trading.\36\ The
finalization of these rules would enable SEFs to register with the
Commission and ensure that they have developed their new policies,
procedures, and rulebooks.
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\36\ Core Principles and other Requirements for Swap Execution
Facilities, 76 FR 1214, Jan. 7, 2011. As part of the SEF rulemaking,
the Commission proposed regulation Sec. 37.10, which would require
each SEF to conduct an annual review of whether it has made a swap
available for trading and to provide a report to the Commission
regarding its assessment. Id. at 1222 and 1241.
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2. Compliance Schedule for the Trading Execution Requirement--
Sec. Sec. 37.12 and 38.11
Proposed regulations Sec. Sec. 37.12 and 38.11 provide for the
phased implementation of a trade execution requirement by setting forth
a compliance schedule tied to the schedule proposed for the clearing
requirement.
The proposed compliance schedules for the trade execution
requirement would be triggered upon the later of (1) The applicable
deadline established under the compliance schedule for the associated
clearing mandate; or (2) 30 days after the swap is made available for
trading on either a SEF or a DCM. Consequently, market participants
always will have at least thirty days after a DCM or SEF has made a
swap available for trading to comply with a trade execution
requirement. Prior to a Commission-issued mandatory clearing
determination, both DCMs and SEFs would be permitted to offer swaps for
trading by market participants on a voluntarily basis. However, those
swaps would not be required to be traded on a DCM or SEF, pursuant to
section 2(h)(8) of the CEA until the associated clearing requirement
took effect.
D. Three-Part Implementation Phasing
The Commission proposes compliance schedules for phasing
implementation that afford relief in the form of additional time for
compliance with any clearing requirement or trade execution requirement
by category of market participant. The Commission based its proposed
categorization of entities on the definition of ``financial entity'' in
section 2(h)(7)(C) of the CEA.\37\ Under this statutory provision,
Congress identified financial entities that would not be eligible to
claim an exception from a clearing requirement under section 2(h)(1) of
the CEA.
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\37\ CEA section 2(h)(7)(A)(i) limits availability of the end-
user clearing exception to counterparties to the swap that are not a
financial entity. The term financial entity is defined in CEA
section 2(h)(7)(C)(i), and includes the following eight entities:
(i) A swap dealer; (ii) a security-based swap dealer; (iii) a major
swap participant; (iv) a major security-based swap participant; (v)
a commodity pool as defined in CEA section 1a(10); (vi) a private
fund as defined in section 202(a) of the Investment Advisers Act of
1940 (15 U.S.C. 80b-2(a)); (vii) an employee benefit plan as defined
in paragraphs (3) and (32) of section 3 of the Employee Retirement
Income Security Act of 1974 (29 U.S.C. 1002); or (viii) a person
predominantly engaged in activities that are in the business of
banking or financial in nature, as defined in section 4(k) of the
Bank Holding Company Act of 1956 (12 U.S.C. 1843(k)).
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Phase 1--Category 1 Entities
The proposed compliance schedule would define ``Category 1
Entities'' to include a swap dealer, a security-based swap dealer, a
major swap participant, a major security-based swap participant, or an
active fund.
Category 1 Entities include those dealers and major participants in
the swap and security-based swap markets that will be registered with
the Commission or the Securities and Exchange Commission (SEC).\38\
Title VII of the Dodd-Frank Act requires these market participants to
register with either the CFTC or SEC as a result of their swaps or
security-based swaps activities. Based on their level of market
experience and based on their status as registrants with either the
CFTC or the SEC, the Commission believes they should be capable of
complying with a clearing requirement and a trade execution requirement
sooner than other market participants and that 90 days is a reasonable
timeframe for these entities to come into compliance with these
requirements.
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\38\ If a security-based swap dealer or a major security-based
swap participant is not yet required to register with the SEC at
such time as the Commission issues mandatory clearing determination,
then the security-based swap dealer or a major security-based swap
participant would be treated as a Category 2 Entity.
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The Commission also is proposing to include those entities it
defines as ``active funds'' in the first category of market
participants. The proposed definition of ``active fund'' would mean
``any private fund as defined in section 202(a) of the Investment
Advisors Act of 1940, that is not a third-party subaccount and that
executes 20 or more swaps per month based on a monthly average over the
12 months preceding the Commission issuing a mandatory clearing
determination under section 2(h)(2) of the Act.''\39\
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\39\ It should be noted that many commodity pools meet the
definition of private fund under section 202(a) of the Investment
Advisors Act of 1940. Such a commodity pool would only be a Category
1 Entity if it met the other criteria of an active fund.
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The Commission is relying on the definition of private fund from
section 2(h)(7)(C) of the CEA, as well as section 402 of the Dodd-Frank
Act. However, the Commission is limiting the definition in two ways.
First, the definition excludes third-party subaccounts, as discussed
further below. Second, the definition is limited to those private funds
that execute 20 or more swaps per month based on the average over the
12 months preceding the Commission's issuance of a mandatory clearing
determination.\40\ In choosing this threshold, the Commission's goal
was to ensure the involvement of a cross-section of market participants
at the outset of both clearing and trading requirement implementation.
The Commission also sought to address some commenters' concerns
regarding adequate ``buy-side'' representation early in the mandatory
clearing process. Based on a preliminary assessment, the Commission
believes the proposed numerical threshold for active funds is
appropriate because a private fund that conducts this volume of swaps
would be likely to have: (1) Sufficient resources to enter into
arrangements that comply with the clearing and trade execution
requirement earlier than other types of market participants; and (2)
sufficient market experience to contribute meaningfully to the ``buy-
side'' perspective as industry standards are being developed.\41\ In
defining ``active fund'' accordingly, the Commission believes it has
included those market participants that are likely to be among the most
experienced participants with expertise and resources needed to come
into transaction compliance quickly.
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\40\ In calculating the numerical threshold, the Commission
intends for funds to calculate all swaps it executes not just those
that are the subject of a mandatory clearing determination.
\41\ The Commission is unaware of any position-level or
transaction-level data on private fund swap activity in a publicly
available form. In order to determine private fund activity levels,
the staff consulted with academics focusing their research in this
area, with industry participants, and with groups that represent the
industry.
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The Commission proposes to phase in compliance with the mandatory
clearing requirement for any swap transaction between a Category 1
Entity and another Category 1 Entity, or any other entity
[[Page 58191]]
that desires to clear the transaction \42\ within the first 90 days
after the Commission issues any mandatory clearing determination. With
respect to the trade execution requirement, the Commission proposes to
phase in compliance with this requirement either at the same time as
the clearing requirement or thirty days after the swap is made
available for trading, whichever is later. The Commission proposes
phasing in all Category 1 Entities first because these market
participants are likely to be the most active and experienced market
participants whose involvement in the early stages of building and
rolling out the clearing and trading requirements is critical. The
Commission is attempting to include in this category those market
participants with the expertise and resources to implement mandatory
clearing and trading most quickly. The Commission also believes
Category 1 Entities likely will have the most existing connectivity to
clearinghouses and trading platforms and would be able to come into
compliance sooner than other categories of participants.
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\42\ The intent of this clause is to facilitate clearing by
counterparties that desire to comply with a clearing mandate earlier
than they would otherwise be required to under the compliance
schedule. The Commission solicits comment on whether there would be
a better way to accomplish this objective.
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Phase 2--Category 2 Entities
The proposed compliance schedule would define ``Category 2
Entities'' to include a commodity pool; a private fund as defined in
section 202(a) of the Investment Advisors Act of 1940 other than an
active fund; an employee benefit plan as defined in paragraphs (3) and
(32) of section 3 of the Employee Retirement Income and Security Act of
1974; or a person predominantly engaged in activities that are in the
business of banking, or in activities that are financial in nature as
defined in section 4(k) of the Bank Holding Company Act of 1956,
provided that the entity is not a third-party subaccount.
The Commission proposes to phase in compliance for swap
transactions between a Category 2 Entity and Category 1 Entity, another
Category 2 Entity, or any other entity that desires to clear the
transaction.\43\ The Commission is proposing to afford swap
transactions between these types of market participants 180 days to
come into compliance with a clearing requirement. With respect to the
trade execution requirement, the Commission proposes to phase in
compliance with this requirement either at the same time as the
clearing requirement or thirty days after the swap is made available
for trading, whichever is later. In providing these market participants
an additional 90 days to come into compliance, the Commission took into
consideration the fact that Category 2 Entities may not be required to
be registered with the Commission and may be less experienced and less
frequent users of the swap markets than those in Category 1.
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\43\ See footnote 42.
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Additionally, Category 2 Entities may not have the same level of
expertise and resources to bring their swaps into compliance with a
clearing requirement as quickly as Category 1 Entities. As defined for
purposes of these compliance schedules, Category 2 Entities do not
include those financial entities that are third-party subaccounts, as
described further below.
Phase 3--Third-Party Subaccounts and all Other Swap Transactions
Finally, the Commission proposes to phase in compliance for all
other swap transactions not excepted from the mandatory clearing
requirement within 270 days after the Commission issues a clearing
requirement. The Commission proposes to phase in compliance with the
trade execution requirement either at the same time as the clearing
requirement or thirty days after the swap is made available for
trading, whichever is later.
The Commission proposes to include all entities that are third-
party subaccounts in this 270-day period. This approach would give
these entities the most time to bring their swaps into compliance
because they are likely to require the most time for documentation,
coordination, and management. A third-party subaccount is afforded 270
days to bring its swaps into compliance because its portfolio is
managed by an asset manager that may have to bring numerous accounts
into compliance. The Commission also proposes to include any other swap
transaction that would be subject to a clearing requirement into
compliance within this proposed 270-day period.
Under the Commission's proposed definition, a third-party
subaccount would be a managed account that requires specific approval
by the beneficial owner of the account to execute documentation
necessary for executing, confirming, margining, or clearing swaps. By
way of non-exclusive example, if investment management firm X manages
the assets of pension fund Y, and does so in a separate account that
requires the approval of pension fund Y to execute necessary
documentation, then that account would be afforded 270 days to come
into compliance. On the other hand, if pension fund Y manages its own
assets, it would fall within Category 2 and be afforded 180 days to
come into compliance. Likewise, if investment management firm X does
not manage the assets of third parties, then it would fall within
Category 2.
The Commission is proposing to afford third-party subaccounts an
additional 90 days beyond the 180 days proposed for Category 2 because
such entities may have documentation obligations for hundreds or even
thousands of third-party subaccounts, and each such account must meet
the mandatory clearing and trading requirements. For example, according
to a statement made during the Joint SEC-CFTC Roundtable by Mr. William
DeLeon of the firm Pacific Investment Management Company, LLC (PIMCO),
PIMCO manages hundreds of third-party subaccounts, as defined
above.\44\ The proposed compliance schedules would not prohibit any
type of market participant from voluntarily complying sooner than the
compliance deadline. Indeed, the Commission would encourage market
participants that can come into compliance more quickly to move their
swaps into clearing and begin trading on trading platforms as soon as
possible in order to facilitate development of infrastructure that
takes into account the views of many types of market participants. As
one commenter noted, ``Smaller entities, for example, may have unique
issues that need to be accounted for before systems are hardwired. Many
swap market participants are small entities; it is important to ensure
that these entities and their liquidity are not squeezed out of the
swaps market.'' \45\
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\44\ Day 2 Roundtable Tr. at 62.
\45\ Investment Company Institute, Jun. 10, 2011 letter, at 12.
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E. Prospective Application of Compliance Schedules
The Commission anticipates that it will exercise its authority to
trigger the proposed compliance schedules each time it issues a
mandatory clearing determination for a new group, category, type, or
class of swaps. Under this approach, when a DCO begins offering a new
swap for clearing and it is in the same group, category, type, or class
of swaps and it meets the requirements imposed under a previously
issued mandatory clearing determination, then the proposed compliance
schedules would not be triggered. However, if the Commission issues a
mandatory clearing determination in any entirely new group, category,
type, or class of
[[Page 58192]]
swaps then the compliance schedules could once again be triggered by
the Commission. For example, if the Commission issues a mandatory
clearing determination for 5 year credit default swap products and a
new 5 year credit default swap product is offered for clearing based on
a new 5 year index, then the proposed compliance schedules may not be
triggered. If on the other hand, the Commission has not issued a
mandatory clearing determination for 10 year credit default swap
products and a new 10 year credit default swap product is offered for
clearing, then the compliance schedules could be triggered by the
Commission.
When issuing a mandatory clearing determination, the Commission
would set an effective date by which all market participants would have
to comply. In other words, the proposed compliance schedules would be
used only when the Commission believes that phasing is necessary based
on the considerations outlined in this release. The Commission will
provide the public with notice of its intent to rely upon the
compliance schedule pursuant to the process outlined in Sec.
39.5(b)(5).
The Commission solicits comment on the ongoing usefulness of the
proposed compliance schedules once market participants have established
documentation and connectivity to DCOs, DCMs, and SEFs.
F. Comment Requested
The Commission requests comment on all aspects of the proposed
compliance schedules, Sec. Sec. 37.12, 38.11 and 39.5(e). The
Commission may consider alternatives to the proposed compliance
schedules and is requesting comment on the following questions:
What, if any, other rules should have been taken into
consideration when proposing an implementation schedule regarding the
clearing and trade execution requirements? If applicable, how should
the implementation requirements of those other rules be taken into
consideration?
Should there be a presumption that the Commission will
rely on the compliance schedule for each mandatory clearing
determination that it issues, unless the Commission finds that the
compliance schedule is not necessary to achieve the benefits set forth
herein (e.g., facilitating the transition to the new regulatory
requirement established by the Dodd-Frank Act in an orderly manner that
does not unduly disrupt markets and transactions)?
What factors, if any, would prevent an entity in any of
the proposed categories from adhering to the compliance schedules
proposed by the Commission? How much additional time would be needed to
address these factors?
Are there other considerations that the Commission should
have taken into account when designing this tiered implementation
schedule? Are the timeframes outlined in this implementation schedule
adequate? If not, what alternative schedule should the Commission
consider, and why?
Assuming a situation where a swap first becomes subject to
the clearing requirement and then is made available for trading by a
DCM or SEF, is an additional thirty days after the swap becomes made
available for trading enough time for DCMs, SEFs, and market
participants to come into compliance with the trade execution
requirement? For example, would thirty days be sufficient for the
needed technological linkages to be established between (i) the DCOs,
DCMs, and SEFs and (ii) the DCMs, SEFs, and market participants.
What other entities, if any, should be included in
Category 1 or 2, and why? Should any entities be moved from Category 1
or 2 to a later category? For example, where should the Commission
place those entities described in section 2(h)(7)(C)(ii) of the CEA
(e.g., small banks, savings associations, farm credit system
institutions, and credit unions)?
What adjustments to the compliance schedule and/or other
steps could the Commission take to ensure there is adequate
representation from all market participants at the outset of clearing
and trade execution requirements?
In suggesting phasing in transactions between Category 1
or 2 Entities and ``any other entity that desires to clear the
transaction,'' the Commission intended to facilitate clearing by
counterparties that desire to comply with a clearing mandate earlier
than they would otherwise be required to under the compliance schedule.
Is there a better way to achieve this objective?
Is an entity's average monthly swap transaction activity a
useful proxy for that entity's ability to comply with the clearing and
trade execution requirements? Or whether an entity is required to be
registered with the Commission (rather than whether an entity is
already registered with the Commission)?
Is the Commission's definition of ``active fund'' overly
inclusive or under-inclusive? Should the numerical threshold for number
of monthly swap transactions be higher or lower than 20? If so, why?
Should the number of monthly swap transactions be linked to swap
activity in a particular asset class?
Should the Commission exclude from the definition of
``active fund'' any investment advisor of private funds acting solely
as an advisor to private funds with assets under management in the
United States of less than $150,000,000, as provided for in the
reporting exemption for private funds under section 408 of the Dodd-
Frank Act?
Would it be more appropriate for the Commission to measure
a market participant's level of swap activity by measuring notional
turnover and/or open exposure, as suggested by some commenters? \46\
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\46\ Letter from Adam C. Cooper, Citadel, dated June 3, 2011,
Appendix B.
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Are there any anticompetitive implications to the proposed
compliance schedules? If so, how could the proposed rules be
implemented to achieve the purposes of the CEA in a less
anticompetitive manner? If so, please quantify those costs, if
possible, and provide underlying data sources, assumptions and
calculations.
Are there additional costs or benefits associated with the
current proposal that the Commission has not already taken into
account? Please discuss any such costs in detail and quantify in dollar
terms, if possible.
Are there any assumptions, including quantitative
assumptions, underlying the Commission's cost benefit analysis that the
Commission should consider?
Should the Commission consider an alternative
implementation schedule? Would such an alternative schedule reduce the
costs market participants bear? Please describe any such alternative
implementation schedule in detail, including how it will reduce costs
and the benefits it will likely deliver. If possible, please quantify
the cost and benefits associated with any alternative. If providing
dollar values, please describe any data sources, assumptions, and
calculations used to generate them.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act requires that agencies consider
whether the rules they propose will have a significant economic impact
on a substantial number of small entities and, if so, provide a
regulatory flexibility analysis respecting the impact.\47\ The rules
proposed by the CFTC provide compliance schedules for
[[Page 58193]]
certain new statutory requirements of the Dodd Frank Act and do not by
themselves impose significant new regulatory requirements. Accordingly,
the Chairman, on behalf of the CFTC, hereby certifies pursuant to 5
U.S.C. 605(b) that the proposed rules will not have a significant
economic impact on a substantial number of small entities. The CFTC
invites public comment on this determination.
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\47\ 5 U.S.C. 601 et seq.
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B. Paperwork Reduction Act
The Paperwork Reduction Act (PRA) \48\ imposes certain requirements
on federal agencies (including the Commission) in connection with
conducting or sponsoring any collection of information as defined by
the PRA. This notice of proposed rulemaking, if approved, would not
require a new collection of information from any persons or entities.
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\48\ 44 U.S.C. 3507(d).
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C. Consideration of Costs and Benefits
Section 15(a) of the CEA \49\ requires the Commission to consider
the costs and benefits of its action before promulgating a regulation
under the CEA. Section 15(a) of the CEA specifies that the costs and
benefits shall be evaluated in light of five broad areas of market and
public concern: (1) Protection of market participants and the public;
(2) efficiency, competitiveness and financial integrity of futures
markets; (3) price discovery; (4) sound risk management practices; and
(5) other public interest considerations. The Commission may in its
discretion give greater weight to any one of the five enumerated areas
and could in its discretion determine that, notwithstanding its costs,
a particular regulation is necessary or appropriate to protect the
public interest or to effectuate any of the provisions or accomplish
any of the purposes of the Act.
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\49\ 7 U.S.C. 19(a).
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The purpose of the proposed compliance schedules is to afford
market participants adequate time to comply with the clearing
requirement under section 2(h)(1)(A) of the CEA and the trade execution
requirements under section 2(h)(8). Without the proposed compliance
schedules, market participants could be required to comply with the
clearing requirement immediately upon issuance of a mandatory clearing
determination by the Commission, and market participants could be
required to comply with the trade execution requirement when (1) The
Commission has issued a determination that the swap is required to be
cleared and (2) any DCM or SEF has made the swap available to trade.
The Commission recognizes that requiring such immediate compliance
with the clearing and trade execution requirements may impose costs on
market participants, particularly for market participants that may not
be registered with the Commission and those market participants that
have hundreds or thousands of third-party subaccounts to bring into
compliance with the new requirements under section 2(h) of the CEA.\50\
Accordingly, the Commission's proposal provides substantial benefits in
that it affords market participants additional time to document new
clearing arrangements, connect to market infrastructures, and prepare
themselves and their customers for the new regulatory requirements. The
Commission believes that such an approach will help protect the public
interest by facilitating an orderly transition to a new regulatory
environment.
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\50\ E.g., Letter from Richard H. Baker, Managed Funds
Association, dated Mar. 24, 2011 at Appendix 1, page 1.
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1. Protection of Market Participants and the Public
In devising the proposed compliance schedules, the Commission
sought to balance the goal of protecting the public by bringing market
participants into compliance with the clearing and trade execution
requirements for swaps as quickly as possible while affording market
participants adequate time to come into compliance.
Market participants in Category 1 (e.g., SDs, MSPs, and active
funds) are likely to be among the most experienced and active
participants with the resources needed to come into compliance with the
clearing and trading requirements more quickly.\51\ The swaps entered
into by these market participants are likely to represent a significant
portion of the total swap market volume. As a result, moving these
transactions into central clearing and onto trading platforms before
those of Category 2 and 3 Entities would provide additional protection
for the public by ensuring that the most active participants in the
swap market come into compliance as soon as possible, thus mitigating
risk and promoting transparency in significant portions of the swap
market.
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\51\ In a letter from the Financial Services Forum, Futures
Industry Association, International Swaps and Derivatives
Association, and Securities Industry and Financial Markets
Association, dated May 4, 2011, commenters noted that ``market
participants vary dramatically in their resources, market
sophistication and rationale for using Swaps. Swap Entities, in
general, have greater resources, access to technology and clearing
infrastructure than their end user counterparties.''
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By requiring Category 2 Entities to comply within 180 days, the
Commission is seeking to balance the needs of those market participants
that are not registered with the Commission and may not be as active in
the swap market with the public interest of bringing all market
participants into compliance as soon as possible.
The market participants in Category 2 are likely to be less
experienced and less active participants than those in Category 1. To
the extent these market participants are less active in the swap
markets the balance between moving their transactions into central
clearing and onto trading platforms and giving them additional time to
comply with the new requirements, tips in favor of the latter approach.
Additionally, these entities may not have the same level of resources
as Category 1 Entities. Therefore, they will benefit from the
opportunity to document new clearing arrangements, connect to market
infrastructures, and prepare themselves and their customers for the new
regulatory requirements by considering examples of how Category 1
Entities have met these requirements.
It should be noted that Category 2 Entities and other market
participants wanting to come into compliance before their respective
compliance schedule deadlines in order to take advantage of the risk-
mitigating benefits of central clearing and executing swaps on trading
platforms are allowed, and encouraged, to do so.
Entities that are third-party subaccounts have the additional
challenge of transitioning hundreds, and in some cases, thousands of
subaccounts into compliance with the clearing and trade execution
requirements. This process may require that these entities negotiate
and formalize new agreements with each of their customers. In order to
accomplish this they also will need to educate their customers about
how clearing and trade execution requirements will affect the costs and
processes associated with their accounts. Each of these tasks requires
time. By giving third-party subaccounts 270 days to come into
compliance, the Commission seeks to balance the need of these entities
and their customers for additional time with the benefits of reducing
risks in the swap market and protecting the public as quickly as
possible.
It may be that the Category 1 Entities that constitute the first
phase under the proposed compliance schedules will bear a larger
proportion of the ``start-up''
[[Page 58194]]
costs associated with implementing the clearing and trade execution
requirements. They are the entities likely to expend the most resources
documenting new clearing arrangements, connecting to market
infrastructures, and preparing themselves and their customers for the
new regulatory requirements. The Commission is aware of these costs and
believes that it is appropriate for the entities that are likely to be
among the most active participants in these markets to shoulder a
larger percentage of these start-up costs.
2. Efficiency, Competitiveness, and Financial Integrity of the Markets
By necessity, the first group of market participants that are
required to comply with the clearing and trade execution requirements,
along with DCOs, DCMs, and SEFs, are likely to work together to
establish methods for compliance that other market participants may
later consider. The experience with swaps that the first group of
market participants brings to this process should help to ensure the
integrity and effectiveness of their solutions. These solutions will
likely be helpful to other market participants that comply later. For
example, entities that are more experienced in the swap market, such as
those in Category 1, are likely to have greater technological expertise
and will best be able to develop the necessary technological
infrastructure.
It is critical that a cross-section of market participants is
involved in developing the solutions that become industry conventions
in order to ensure that those approaches promote the efficiency,
competitiveness, and integrity of participants on the buy-side and the
sell-side. The Commission's proposed compliance schedules address this
need. For example, Category 1 includes active funds and MSPs that are
likely to have the experience and expertise to represent ``buy-side''
interests, whereas SDs generally will represent ``sell-side''
interests.
In providing Category 1 Entities with 90 days to comply with the
clearing and trade execution requirements, the Commission would afford
these market participants additional time to identify issues and work
to develop solutions. This is likely to result in more efficient
problem-solving processes, which may reduce the system-wide start-up
costs of implementing new regulations. Moreover, it is also likely to
foster a greater degree of compatibility and interoperability among the
varied methods of compliance which, in turn, is likely to reduce the
cost and complexity of interconnectedness.\52\
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\52\ See TABB Group, ``Technology and Financial Reform: Data,
Derivatives and Decision Making'', Aug. 2011 at 12.
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Lastly, in the absence of the proposed compliance schedules, some
entities have expressed concern that they would be unable to comply
with the clearing and trading requirements and would choose to leave
the swap market or avoid the market for some period of time. If this
occurred, it could reduce liquidity and increase spreads in the market.
By providing additional time for compliance, this rule reduces the
chance that these adverse effects will occur in the swap market during
the transition period.
3. Price Discovery
The trade execution requirement is expected to facilitate price
discovery in the swap market. However, a disorderly implementation may
inhibit price discovery by creating confusion about which
counterparties are prepared to trade specific swaps and which contracts
are fungible. An orderly process, however, promotes good communication
between counterparties, which is essential to price discovery during
the transition period.
As for costs, to the extent that market participants could comply
sooner than the proposed compliance schedule in an effective and
efficient manner, this proposed schedule would delay the benefits that
would come from increased price transparency that are expected to
accompany a trade execution requirement under section 2(h)(8) of the
CEA. The Commission's proposed compliance schedule reflects that the
Commission anticipates that market participants will need additional
time, however, for an orderly implementation process.
4. Sound Risk Management Practices
To the extent that the proposed compliance schedule for the
clearing requirement would delay implementation of mandatory clearing,
the swap market could suffer costs in terms of risk management. For
example, there are risk management costs associated with not having
counterparty credit risk monitored and managed effectively by a DCO.
More prompt implementation of mandatory clearing would have the benefit
of preventing losses from accumulating over time through the settlement
of variation margin between a DCO's clearing members each day. The
settlement of variation margin each day reduces both the chance of
default and the size of any default should one occur. Delay in
implementing mandatory clearing would also postpone the use of initial
margin as a performance bond against potential future losses such that
if a party fails to meet its obligation to pay variation margin,
resulting in a default, the DCO may use the defaulting party's initial
margin to cover most or all of any loss based on the need to replace
the open position.
On the other hand, the proposed compliance schedule for the
clearing requirement would provide an orderly process for implementing
mandatory clearing of swaps, and to the extent that it does so
successfully, it will lead to overall sounder risk management practices
for the swap market and the broader financial system, particularly
during the implementation period. As noted above, in the absence of
this rule, some entities may choose not to engage in swap transactions
while they work to come into compliance with the new requirements. This
result could expose those entities to risks they would otherwise have
used swaps to mitigate. Therefore, by providing a timetable for orderly
transition, this rule encourages continued participation in the swap
markets and makes possible the continued use of swaps during the
transition period for risk mitigation purposes.
Moreover, if market participants were concerned that they might not
be able to meet the proposed compliance schedule timelines, it is
likely that they would incur additional costs associated with the
potential lack of regulatory compliance. Providing additional time for
compliance may reduce the costs that participants may incur mitigating
legal risks during the transition period, and focuses those resources
on achieving compliance.
5. Other Public Interest Considerations
There are public interest benefits to phasing in compliance using
the implementation structure proposed in this release. The proposed
implementation structure generally allows market participants to comply
with the requirements of Dodd-Frank as quickly and efficiently as
possible and thereby provides a sound basis for achieving the
overarching Dodd-Frank goals of risk reduction and increased market
transparency.
In sum, the Commission has considered the costs and benefits as
required by section 15(a) and is proposing the compliance schedules
discussed herein. The Commission invites public comment on its cost-
benefit considerations. Commenters are also invited to submit any data
or other
[[Page 58195]]
information that they may have quantifying or qualifying the costs and
benefits of the proposal with their comment letters.
List of Subjects
17 CFR Part 37
Commodity futures, Swaps, Swap execution facilities, Registration
application, Registered entities, Reporting and recordkeeping
requirements.
17 CFR Part 38
Block transaction, Commodity futures, Designated contract markets,
Reporting and Recordkeeping requirements, Transactions off the
centralized market.
17 CFR Part 39
Business and industry, Commodity futures, Reporting and
recordkeeping requirements.
For the reasons stated in the preamble, the Commission proposes to
amend 17 CFR parts 37, 38 and 39 as follows:
PART 37--SWAP EXECUTION FACILITIES
1. The authority citation for part 37 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3 and 12a, as
amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
2. Add Sec. 37.12 to read as follows:
Sec. 37.12 Trade execution compliance schedule.
(a) A swap transaction shall be subject to the requirements of
section 2(h)(8)(A) of the Act upon the later of (1) the applicable
deadline established under the compliance schedule provided under Sec.
39.5(e)(2); or (2) 30 days after the swap is first made available for
trading on either a swap execution facility registered under section 5h
of the Act or a board of trade designated as a contract market under
section 5 of the Act.
(b) Nothing in this rule shall prohibit any counterparty from
complying voluntarily with the requirements of section 2(h)(8)(A) of
the Act sooner than as provided in paragraph (a) of this section.
PART 38--DESIGNATED CONTRACT MARKETS
3. The authority citation for part 38 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,
6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as
amended by the Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
4. Add Sec. 38.11 to read as follows:
Sec. 38.11 Trade execution compliance schedule.
(a) A swap transaction shall be subject to the requirements of
section 2(h)(8)(A) of the Act upon the later of (1) the applicable
deadline established under the compliance schedule provided under Sec.
39.5(e)(2); or (2) 30 days after the swap is first made available for
trading on a swap execution facility registered under section 5h of the
Act or a board of trade designated as a contract market under section 5
of the Act.
(b) Nothing in this rule shall prohibit any counterparty from
complying voluntarily with the requirements of section 2(h)(8)(A) of
the Act sooner than as provided in paragraph (a) of this section.
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
5. The authority citation for part 39 continues to read as follows:
Authority: 7 U.S.C. 7a-1 as amended by Pub. L. 111-203, 124
Stat. 1376.
6. Amend Sec. 39.5 to add paragraph (e) to read as follows:
Sec. 39.5 Review of swaps for Commission determination on clearing
requirement.
* * * * *
(e) Mandatory clearing compliance schedule. (1) Definitions. For
the purposes of this paragraph:
Category 1 Entity means (1) a swap dealer, (2) a security-based
swap dealer; (3) a major swap participant; (4) a major security-based
swap participant; or (5) an active fund.
Category 2 Entity means (1) a commodity pool; (2) a private fund as
defined in section 202(a) of the Investment Advisors Act of 1940 other
than an active fund; (3) an employee benefit plan as defined in
paragraphs (3) and (32) of section 3 of the Employee Retirement Income
and Security Act of 1974; or (4) a person predominantly engaged in
activities that are in the business of banking, or in activities that
are financial in nature as defined in section 4(k) of the Bank Holding
Company Act of 1956, provided that, in each case, the entity is not a
third-party subaccount.
Active Fund means any private fund as defined in section 202(a) of
the Investment Advisors Act of 1940, that is not a third-party
subaccount and that executes 20 or more swaps per month based on a
monthly average over the 12 months preceding the Commission issuing a
mandatory clearing determination under section 2(h)(2) of the Act.
Third-party Subaccount means a managed account that requires
specific approval by the beneficial owner of the account to execute
documentation necessary for executing, confirming, margining, or
clearing swaps.
(2) Upon issuing a mandatory clearing determination under section
2(h)(2) of the Act, the Commission may determine, based on the group,
category, type or class of swaps subject to such determination, that
the following schedule for compliance with the requirements of section
2(h)(1)(A) of the Act shall apply:
(i) A swap transaction between a Category 1 Entity and another
Category 1 Entity, or any other entity that desires to clear the
transaction, must comply with the requirements of section 2(h)(1)(A) of
the Act no later than ninety (90) days after the effective date set by
the Commission for such mandatory clearing determination.
(ii) A swap transaction between a Category 2 Entity and a Category
1 Entity, another Category 2 Entity, or any other entity that desires
to clear the transaction, must comply with the requirements of section
2(h)(1)(A) of the Act no later than one hundred and eighty (180) days
after the effective date set by the Commission for such mandatory
clearing determination.
(iii) All other swap transactions not eligible to claim the
exception from mandatory clearing set forth in section 2(h)(7) of the
Act and Sec. 39.6, must comply with the requirements of section
2(h)(1)(A) of the Act no later than two hundred and seventy (270) days
after the effective date set by the Commission for such mandatory
clearing determination.
(3) Nothing in this rule shall be construed to prohibit any person
from voluntarily complying with the requirements of section 2(h)(1)(A)
of the Act sooner than the implementation schedule provided under
paragraph (2).
Issued in Washington, DC, on September 8, 2011, by the
Commission.
David A. Stawick,
Secretary of the Commission.
[[Page 58196]]
Appendices to Swap Transaction Compliance and Implementation Schedule:
Clearing and Trade Execution Requirements under Section 2(h) of the
CEA--Commissioners Voting Summary and Statements of Commissioners
NOTE: The following appendices will not appear in the Code of
Federal Regulations
Appendix 1--Commissioners Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn,
Sommers, and Chilton voted in the affirmative; Commissioner O'Malia
voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rule to establish schedules to phase in
compliance with the clearing and trade execution requirement
provisions in the Dodd-Frank Wall Street Reform and Consumer
Protection Act. The proposal would provide greater clarity to market
participants regarding the timeframe for bringing their swap
transactions into compliance with the clearing and trade execution
requirements. The rule also would make the market more open and
transparent, while giving market participants an adequate amount of
time to comply. The proposed rule would help facilitate an orderly
transition to a new regulatory environment for swaps.
Appendix 3--Statement of Commissioner Jill Sommers
I support this proposal to establish a schedule to phase in
compliance with certain statutory provisions under Title VII of the
Dodd-Frank Act because this will give market participants some
degree of certainty about implementation deadlines. However, I
believe the Commission should have provided a broader implementation
plan encompassing all of the rulemakings under Dodd Frank, rather
than the much narrower portion covered by today's proposed
rulemaking. In addition, the proposed rule fails to address a
critical component of the trade execution requirement in Section
2(h)(8) of the Commodity Exchange Act. That is, what does it mean to
``make a swap available to trade?''
I believe the Commission should clarify who makes the
determination that a swap is ``made available for trading'' and how
the decision is to be made, just as the Commission has done with
respect to the clearing requirement. This would provide the public
with an opportunity to comment on a proposed mechanism for such a
determination. In a consultation paper published by the European
Commission's Directorate General on Internal Markets and Services on
December 8, 2010, the European Commission put forth the idea that
the European Securities and Markets Authority, or ESMA, ``could
assess and decide when a derivative which is eligible for clearing
is sufficiently liquid to be traded exclusively'' on a trading
platform.\53\ The European Commission noted that ESMA could base its
decision on ``the frequency of trades in a given derivative and the
average size of transactions,'' and solicited comments from the
public on which criteria could determine whether a derivative is
sufficiently liquid to be required to be traded on a platform.
---------------------------------------------------------------------------
\53\ Public Consultation: Review of the Markets in Financial
Instruments Directive (MiFID) (December 8, 2010), available at
http://ec.europa.eu/internal_market/consultations/docs/2010/mifid/consultation_paper_en.pdf.
---------------------------------------------------------------------------
Both the Dodd-Frank Act and proposed regulations in the European
Union require consideration of trading liquidity, in addition to
other factors, before a determination is made that a swap is
required to be cleared. The Commission should address whether any
additional factors will be considered as part of a determination on
the trade execution requirement.
Though I support today's proposal, I believe the Commission
should clarify who makes the determination that a swap is ``made
available for trading'' and how that decision will be made.
Appendix 4-- Statement of Commissioner Scott O'Malia
I respectfully dissent from the Commission's decision today to
approve for Federal Register publication two rule proposals related
to implementation entitled ``Swap Transaction Compliance and
Implementation Schedule: Clearing and Trade Execution Requirements
under Section 2(h) of the CEA'' and ``Swap Transaction Compliance
and Implementation Schedule: Trading Documentation and Margining
Requirements under Section 4s of the CEA.'' For quite some time, I
have been asking that the Commission publish for notice and comment
a comprehensive implementation schedule that addresses the entire
mosaic of rule proposals under the Dodd-Frank Act. I believe the
Commission should have proposed a comprehensive schedule that
detailed, at a minimum:
for each registered entity (e.g., swap dealer and major
swap participants), compliance dates for each of its entity-specific
obligations (e.g., all obligations under Section 4s of the Commodity
Exchange Act) under Dodd-Frank; and
for each market-wide obligation (e.g., the clearing and
trading mandates), the entities affected (whether registered or
unregistered) along with appropriate compliance dates.
Such a schedule would have complemented and informed existing
proposals and provided structure to future determinations.
Additionally, a proposal regarding such a schedule should have
adequately analyzed the costs and benefits of alternatives,
including appropriate quantification. Unfortunately, the two rule
proposals that the Commission approved today fail to either propose
a comprehensive schedule or provide an adequate cost benefit
analysis.
The Commission's proposals also fail to request comment on a
number of issues that I believe are important considerations in
developing an implementation plan. As a result, I am encouraging
commenters to submit responses to the questions below as part of
their comments on the two rule proposals.
Swap Transaction Compliance and Implementation Schedule: Clearing
and Trade Execution Requirements under Section 2(h) of the CEA
Should the Commission provide guidance on how it will
make and communicate a mandatory clearing determination prior to
considering the first such determination? If so, what information
should be included in guidance?
As section II(E) of the proposal states: ``When issuing
a mandatory clearing determination, the Commission would set an
effective date by which all market participants would have to
comply. In other words, the proposed compliance schedules would be
used only when the Commission believes that phasing is necessary
based on the considerations outlined in this release. The Commission
will provide the public with notice of its intent to rely upon the
compliance schedule pursuant to the process outlined in Sec.
39.5(b)(5).'' To afford more certainty to market participants,
should the Commission instead create a presumption that it will rely
on the compliance schedule for each mandatory clearing determination
that it issues, unless it finds that the compliance schedule is not
necessary to achieve the benefits set forth in the proposal (e.g.,
facilitating the transition to the new regulatory regime established
by the Dodd-Frank Act in an orderly manner that does not unduly
disrupt markets and transactions)?
What, if any, other issues not addressed in current
proposed or final rulemakings should the Commission have taken into
consideration when proposing the compliance schedule? For example,
should the Commission have considered the extent to which its
clearing and trade execution requirements apply to entities and
transactions located outside the United States? Also, should the
Commission have considered the extent to which such requirements
apply to transactions between affiliates (whether domestic or cross-
border)? If applicable, how should the Commission adjust the
proposed compliance schedule to account for such issues?
What, if any, adjustments should the Commission make to
the proposed compliance schedule for trade execution requirements if
the Commission makes a determination that a group, category, type,
or class of swaps, rather than a specific swap, is subject to
mandatory clearing? Would such adjustments vary depending on the
manner in which the Commission defines group, category, type, or
class?
Swap Transaction Compliance and Implementation Schedule: Trading
Documentation and Margining Requirements under Section 4s of the
CEA
What, if any, other issues not addressed in current
proposed or final rulemakings should the Commission have taken into
consideration when proposing the
[[Page 58197]]
compliance schedule? For example, should the Commission have
considered the extent to which its documentation and margin
requirements apply to entities and transactions located outside the
United States? Also, should the Commission have considered the
extent to which such requirements apply to transactions between
affiliates (whether domestic or cross-border)? If applicable, how
should the Commission adjust the proposed compliance schedule to
account for such issues?
Finally, I want to be clear that I support completing the final
Dodd-Frank rulemakings in a reasonable time frame. I believe that
the timely implementation of such rulemakings is important. Knowing
when and how the markets are required to do what is vital to the
success of implementing the new market structure required under the
Dodd-Frank Act. When billions of dollars are at stake, you simply do
not rely on guesses and estimates based on vague conditions.
[FR Doc. 2011-24124 Filed 9-19-11; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: September 20, 2011
See Also:
