request or demand of counterparties on a continuous basis in order
for the person to be a market maker in swaps and, therefore, a swap
dealer.
---------------------------------------------------------------------------

    It is appropriate, in response to comments asking for further
guidance regarding what activities constitute making a market in swaps,
to describe some of the activities indicative of whether a person is
routinely standing ready to enter into swaps at the request or demand
of a counterparty. Such activities include routinely: (i) Quoting bid
or offer prices, rates or other financial terms for swaps on an
exchange; (ii) responding to requests made directly, or indirectly
through an interdealer broker, by potential counterparties for bid or
offer prices, rates or other similar terms for bilaterally negotiated
swaps; (iii) placing limit orders for swaps; or (iv) receiving
compensation for acting in a market maker capacity on an organized
exchange or trading system for swaps.\193\ These examples are not
exhaustive, and other activities also may be indicative of making a
market in swaps if the person engaging in them routinely stands ready
to enter into swaps as principal at the request or demand of a
counterparty.
---------------------------------------------------------------------------

    \193\ In addition, section 619 of the Dodd-Frank Act (the
``Volcker Rule'') generally prohibits banking entities from engaging
in proprietary trading, but contains an exception for certain market
making-related activities. The Commissions have proposed an approach
to the Volcker Rule under which a person could seek to avoid the
Volcker Rule in connection with swap activities by asserting the
availability of that market making exception. See SEC, Board, Office
of the Comptroller of the Currency (``OCC''), and Federal Deposit
Insurance Corporation (``FDIC''), Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships
With, Hedge Funds and Private Equity Funds; Proposed Rule, 76 FR
68846 (Nov. 7, 2011); CFTC, Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships
With, Hedge Funds and Private Equity Funds; Proposed Rule, 77 FR
8332 (Feb. 14, 2012). Under this approach, such a person would
likely also be required to register as a swap dealer (unless the
person is excluded from the swap dealer definition, such as by the
exclusion of certain swaps entered into in connection with the
origination of a loan). The SEC has proposed to adopt the same
approach with respect to the interplay of the Volcker Rule and the
definition of the term ``security-based swap dealer.'' See note 272,
infra.
---------------------------------------------------------------------------

    In determining whether a person's routine presence in the market
constitutes market making under these four factors, the dealer-trader
interpretative framework may be usefully applied.\194\ Under the
dealer-trader distinction, seeking to profit by providing liquidity to
the market is an indication of dealer activity.\195\ Thus, in applying
these four factors, it is useful to consider whether the person is
seeking, through presence in the market, compensation for providing
liquidity, compensation through spreads or fees, or other compensation
not attributable to changes in the value of the swaps it enters
into.\196\ If not, such activity would not be indicative of market
making.
---------------------------------------------------------------------------

    \194\ We recognize that routine presence in the swap market is
not necessarily indicative of making a market in swaps. For example,
persons may be routinely present in the market in order to engage in
swaps for purposes of hedging, to advance their investment
objectives, or to engage in proprietary trading.
    \195\ See note 265, infra, and accompanying text.
    \196\ In this case, the spread from which a person profits may
be between two or more swaps, or it may be between a swap and
another position or financial instrument. In contrast, entering into
swaps in order to obtain compensation attributable to changes in the
value of the swaps is indicative of using swaps for a hedging,
investment or trading purpose.
---------------------------------------------------------------------------

    Some commenters suggested that, in order to be a market maker in
swaps, a person must make a two-way market in swaps.\197\ Nonetheless,
it is possible for a person making a one-way market in swaps to be a
maker of a market in swaps and, therefore, within the swap dealer
definition. This may be true, for example, where a person routinely

stands ready to enter into swaps on a particular side of the market--
say, routinely bidding for floating exposures on a swap trading
platform--while entering into transactions on the other side of the
market in other instruments (such as futures contracts). The relevant
indicator of market maker status is the willingness of the person to
routinely stand ready to enter into swaps at the request or demand of a
counterparty (as opposed to entering into swaps to accommodate one's
own demand or desire to participate in a particular market), be it on
one or both sides of the market, and then to enter into offsetting
positions, either in the swap market or in other markets.
---------------------------------------------------------------------------

    \197\ See letters cited in notes 52 to 58, supra. Although swaps
are notional contracts requiring the performance of agreed upon
terms by each party, it is possible to describe swap users in
practical terms as being on either ``side'' of a market. For
example, for many swaps the party paying a fixed amount is on one
``side'' of the market and the party paying a floating amount is on
the other ``side.''
---------------------------------------------------------------------------

    The Commissions disagree with the commenters who said that swaps
executed on an exchange should not be considered in determining if a
person is a market maker in swaps and thus a swap dealer.\198\ First,
the statutory definition of the term ``swap dealer'' makes no
distinction between swaps executed on an exchange and swaps that are
not, suggesting that the same protections should apply regardless of
the method of executing the swap. Second, from the perspective of an
end user seeking to execute a swap on an exchange, the important
consideration under our analysis is whether a market maker is ready to
enter into swaps, not whether the market maker is aware of the
counterparty's identity. A market maker in swaps routinely stands ready
to enter into swaps at the request or demand of a counterparty,
regardless of whether the counterparty and the market maker meet on a
disclosed basis through bilateral negotiations or anonymously through
an exchange.\199\ Similarly, the issue of whether a person is a
registered FCM or broker-dealer is not necessarily relevant to whether
the person is a maker of a market in swaps, if the person is routinely
standing ready to enter into swaps at the request or demand of a
counterparty. Third, we believe it would be inappropriate to disregard
swaps executed on exchanges in order, as some commenters
suggested,\200\ to encourage market participants to use, or to provide
liquidity to, exchanges. Finally, variety of exchanges, markets, and
other facilities for the execution of swaps are likely to evolve in
response to the requirements of the Dodd-Frank Act, and there is no
basis for any bright-line rule excluding swaps executed on an exchange,
given the impossibility of obtaining information about how market
participants will interact and execute swaps in the future, after the
requirements under the Dodd-Frank Act are fully in effect. For all
these reasons, we have determined that it is inappropriate to restrict
the ``making a market in swaps'' prong of the swap dealer definition
(i.e., routinely standing ready to enter into swaps at the request or
demand of a counterparty) to swaps that are not executed on an
exchange.\201\
---------------------------------------------------------------------------

    \198\ See, e.g., letters cited in note 62, supra.
    \199\ As discussed above, in many cases routine presence in the
swap market, without more, would not constitute market making
activity. Nevertheless, the CFTC will, in connection with
promulgation of final rules relating to capital requirements for
swap dealers and major swap participants, consider institution of
reduced capital requirements for entities or individuals that fall
within the swap dealer definition and that execute swaps only on
exchanges, using only proprietary funds. Similarly, the CFTC also
will consider the applicability to such entities or individuals of
the other requirements imposed on swap dealers (e.g., internal
business conduct standards, external business conduct standards with
counterparties), and may adjust those swap dealer requirements as
appropriate.
    \200\ See, e.g., letters cited in note 66, supra. Since the
structures of the markets on which swaps will be executed are still
in development, and market obligations have not been established,
there is little support for comments asserting that market makers
should be defined as only those persons who receive benefits from
the market (such as reduced trading fees) in return for the
obligation to transact when the market requires liquidity.
    \201\ By contrast, it may be appropriate, over time, to tailor
the specific requirements imposed on swap dealers depending on the
facility on which the swap dealer executes swaps. For example, the
application of certain business conduct requirements may vary
depending on how the swap is executed, and it may be appropriate, as
the swap markets evolve, to consider adjusting certain of those
requirements for swaps that are executed on an exchange or through
particular modes of execution.
---------------------------------------------------------------------------

d. Exception for Activities Not Part of ``a Regular Business''
    The final rule includes the provisions in the proposed rule that
incorporate the provisions of the statutory definition regarding
activities that are not part of ``a regular business'' of entering into
swaps. One provision states that the term ``swap dealer'' includes a
person that ``regularly enters into swaps with counterparties as an
ordinary course of business for its own account''; the other provision
states that the term ``swap dealer'' does not include a person that
``enters into swaps for such person's own account, either individually
or in a fiduciary capacity, but not as a part of a regular business.''
\202\
---------------------------------------------------------------------------

    \202\ Final CFTC Regulation Sec.  1.3(ggg)(2) is modified from
the proposal to include the word ``a'' before the words ``regular
business,'' to conform the text of the rule to the text of the
statute. See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C).
    As stated in the Proposing Release, we interpret the reference
in the definition of the term ``swap dealer'' to a person entering
into swaps ``with counterparties * * * for its own account'' to
refer to a person who enters into a swap as a principal, and not as
an agent. A person who enters into swaps as an agent for customers
(i.e., for the customers' accounts) would be required to register as
either an FCM, introducing broker, commodity pool operator or
commodity trading advisor, depending on the nature of the person's
activity.
---------------------------------------------------------------------------

    The Commissions continue to believe, as stated in the Proposing
Release, that the phrases ``ordinary course of business'' and ``a
regular business'' are, for purposes of the definition of ``swap
dealer'' essentially synonymous. In this context, we interpret these
phrases to focus on activities of a person that are usual and normal in
the person's course of business and identifiable as a swap dealing
business. It is not necessarily relevant whether the person conducts
its swap-related activities in a dedicated subsidiary, division,
department or trading desk, or whether such activities are a person's
``primary'' business or an ``ancillary'' business, so long as the
person's swap dealing business is identifiable.\203\
---------------------------------------------------------------------------

    \203\ We recognize, as noted by one commenter (see letter from
ISDA I), that the ``regular business'' exclusion is not limited
solely to the ``ordinary course of business'' test of the swap
dealer definition. Our interpretations of the other three tests are,
and should be read to be, consistent with the exclusion of
activities that are not part of a regular business.
---------------------------------------------------------------------------

    We have taken into consideration comments seeking additional
guidance regarding the types and levels of activities that constitute
having ``a regular business'' of entering into swaps.\204\ In this
regard, any one of the following activities would generally constitute
both entering into swaps ``as an ordinary course of business'' and ``as
a part of a regular business'': \205\ (i) Entering into swaps with the
purpose of satisfying the business or risk management needs of the
counterparty (as opposed to entering into swaps to accommodate one's
own demand or desire to participate in a particular market); (ii)
maintaining a separate profit and loss statement reflecting the results
of swap activity or treating swap activity as a separate profit center;
or (iii) having staff and resources allocated to dealer-type activities
with counterparties, including activities relating to credit analysis,
customer onboarding, document negotiation, confirmation generation,
requests for novations and amendments, exposure monitoring and
collateral calls, covenant monitoring, and reconciliation.\206\
---------------------------------------------------------------------------

    \204\ See, e.g., letters from BG LNG I, COPE I, IECA-Credit I,
Shell Trading I, WGCEF I and Vitol (stating that the proposed
approach was overly subjective and requesting guidance as to the
specific activities that are covered by the statutory definition).
    \205\ These activities are inconsistent with entering into a
swap to hedge a physical position as defined in Sec.
1.3(ggg)(6)(iii). As discussed below, such hedging is not dealing
activity.
    \206\ The three indicators of being engaged in ``a regular
business'' of entering into swaps described here are set forth in
the alternative. Any one of these indicators may be sufficient,
based on a facts and circumstances analysis, to reach a conclusion
that an entity is engaged in ``a regular business'' of entering into
swaps.

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

    The Commissions see merit in the comments saying that ``a regular
business'' of entering into swaps can be characterized by entering into
swaps to satisfy the business or risk management needs of the other
party to the swap, and so incorporate this element into our
interpretation of the rule.\207\ Also, an objective indicator of a
person being engaged in ``a regular business'' of entering into swaps
is when the person accounts for the results of its swap activities
separately, by maintaining a separate profit and loss statement for
those activities or treating them as a separate profit center. Our
interpretation incorporates this indicator of activity that is ``a
regular business'' of entering into swaps.
---------------------------------------------------------------------------

    \207\ This element of the interpretation reflects our agreement
with those commenters who said that ``a regular business'' of
entering into swaps is characterized by having a business of
accommodating demand or facilitating interest in swaps (see letter
from IECA-Credit I), and those commenters who said that ``a regular
business'' does not encompass the use of swaps to serve a person's
own business needs, as opposed to serving the business needs of the
counterparty (see letters cited in note 71, supra).
---------------------------------------------------------------------------

    Other comments suggesting specific criteria to identify ``a regular
business'' also were helpful. We agree with commenters \208\ that ``a
regular business'' of entering into swaps can be characterized by
having staff and resources allocated to the types of activities in
which swap dealers must engage with their counterparties, such as those
noted above (e.g., credit analysis, confirmation generation, collateral
calls, and covenant monitoring). However, we understand that some end
users of swaps engage in some of these activities and, in certain
circumstances, may have staff and resources available for these
activities. Therefore, this element of the definition should be applied
in a reasonable manner, taking all appropriate circumstances into
account. This element does not depend on whether a specific amount or
percentage of expenses or employee time are related to these swap
activities. Instead, it is appropriate to objectively examine a
person's use of staff and resources related to swap activities. Using
staff and resources to a significant extent in conducting credit
analysis, opening and monitoring accounts and the other activities
noted above, is an indication that the person is engaged in ``a regular
business'' of entering into swaps.
---------------------------------------------------------------------------

    \208\ See letters cited in note 80, supra.
---------------------------------------------------------------------------

    Regarding the commenters' assertion that the activity of entering
into swaps in connection with a person's physical commodity business
cannot constitute ``a regular business'' of the person, we believe that
while in most cases this is not dealing activity,\209\ a per se
exclusion of this type is not appropriate because it is possible that
in some circumstances a person might enter into swaps that are
connected to a physical commodity business but also serve market
functions characteristic of the functions served by swap dealers. Also,
again, the statutory definition does not contain any such exclusion,
but rather includes any person who ``regularly enters into swaps with
counterparties as an ordinary course of business for its own account,''
without regard to the person's particular type of business.
---------------------------------------------------------------------------

    \209\ See CFTC Regulation Sec.  1.3(ggg)(6)(iii) (swaps entered
into for hedging physical positions as defined in the rule are not
considered in the determination of whether a person is a swap
dealer).
---------------------------------------------------------------------------

    Consistent with the statutory definition, we interpret ``a regular
business'' of entering into swaps in a manner that applies equally to
all market participants that engage in the activities set forth in the
statutory definition. This will ensure that all participants in the
swap markets are regulated in a fair and consistent manner, regardless
of whether their underlying business is primarily physical or financial
in nature.\210\
---------------------------------------------------------------------------

    \210\ Regulation of firms engaged in an underlying physical
business is also consistent with regulatory practices outside the
U.S. For example, non-financial entities register with the Financial
Services Authority in the U.K. as ``Oil Market Participants'' and
``Energy Market Participants.'' See Financial Services Authority
Handbook EMPS and OMPS, available at http://fsahandbook.info/FSA/html/handbook.
---------------------------------------------------------------------------

    Finally, as noted above, the manner in which persons negotiate,
execute and use swaps is likely to evolve in response to the
requirements of the Dodd-Frank Act and the other forces that will shape
the swap markets going forward. For this reason, it would be
inappropriate to craft per se exclusions from the swap dealer
definition at a time when the only available information about the use
of swaps relates to the period prior to implementation of the Dodd-
Frank Act.\211\
---------------------------------------------------------------------------

    \211\ For the same reasons, we do not believe it would be
appropriate, in determining whether a person has a ``regular
business'' of entering into swaps, to consider whether a person
engages in activities normally associated with financial
institutions, as some commenters suggested. See letters cited in
note 76, supra.
---------------------------------------------------------------------------

e. Interim Final Rule Excluding Swaps Entered Into for Hedging Physical
Positions
    We note that some commenters said that swaps used to hedge or
mitigate commercial risks should not be considered in determining
whether a person is a swap dealer.\212\ We understand that swaps are
used to hedge risks in numerous and varied ways, and we expect that the
number of persons covered by the definition will be very small in
comparison to the thousands of persons that use swaps for hedging.
---------------------------------------------------------------------------

    \212\ See, e.g., letters cited in note 72, supra.
---------------------------------------------------------------------------

    In terms of the statutory definition of the term ``swap dealer,''
the CFTC notes as an initial matter that there is no specific provision
addressing hedging activity. Thus, the statutory definition leaves the
treatment of hedging swaps to the CFTC's discretion; it neither
precludes consideration of a swap's hedging purpose, nor does it
require an absolute exclusion of all swaps used for hedging.\213\
---------------------------------------------------------------------------

    \213\ In this regard, the statutory definition of the term
``swap dealer'' stands in contrast to the statutory definition of
the term ``major swap participant'' which, as discussed further
below, explicitly provides that positions in swaps held for hedging
or mitigating commercial risk are to be excluded in certain parts of
that definition. See CEA section 1a(33)(A)(i)(1), 7 U.S.C.
1a(33)(A)(i)(1). The absence of any explicit requirement in the
``swap dealer'' definition to exclude swaps held for hedging or
mitigating commercial risk does not support the view that Congress
intended to categorically exclude all swaps that may serve as hedges
in determining whether a person is covered by the definition.
    Similarly, the absence of any limitation in the statutory
definition of the term ``swap dealer'' to financial entities, when
such limitation is included elsewhere in Title VII, indicates that
no such limitation applies to the swap dealer definition. CEA
section 2(h)(7), 7 U.S.C. 2(h)(7), specifically limits the
application of the clearing mandate, in certain circumstances, to
only ``financial entities.'' That section also provides a detailed
definition of the term ``financial entity.'' See CEA section
2(h)(7)(C), 7 U.S.C. 2(h)(7)(C). That such a limitation is included
in this section, but not in the swap dealer definition, does not
support the view that the statutory definition of the term ``swap
dealer'' should encompass only financial entities.
---------------------------------------------------------------------------

    In general, entering into a swap for the purpose of hedging is
inconsistent with swap dealing.\214\ The practical

difficulty lies in determining when a person has entered into a swap
for the purpose of hedging, as opposed to other purposes for entering
into swaps, such as accommodating demand for swaps or as part of making
a market in swaps, and in distinguishing a swap with a hedging purpose
from a swap with a hedging consequence. In view of these uncertainties,
the CFTC believes it is appropriate to adopt an interim final rule that
draws upon the principles of bona fide hedging that the CFTC has long
applied to identify when a financial instrument is used for hedging
purposes, and excludes from the swap dealer analysis swaps entered into
for the purpose of hedging physical positions that meet the
requirements of the rule.
---------------------------------------------------------------------------

    \214\ For example, under the dealer-trader distinction, the
Commissions would expect persons that use security-based swaps to
hedge their business risks, absent other activity, likely would not
be dealers. See part II.A.5.b, infra. Under the CFTC's interpretive
guidance, making a market in swaps is appropriately described as
routinely standing ready to enter into swaps at the request or
demand of a counterparty, and the indicia of swap dealing as a
``regular business'' include entering into swaps to satisfy the
business or risk management needs of the counterparty. Entering into
swaps for the purpose of hedging one's own risks generally would not
be indicative of this form of swap activity. See also, e.g., joint
letter from Senator Stabenow and Representative Lucas (the final
rule should distinguish using swaps for hedging from swap dealing).
---------------------------------------------------------------------------

    Specifically, the CFTC is adopting as an interim final rule CFTC
Regulation Sec.  1.3(ggg)(6)(iii), which provides that the
determination of whether a person is a swap dealer will not consider a
swap that the person enters into, if:
    (i) The person enters into the swap for the purpose of offsetting
or mitigating the person's price risks that arise from the potential
change in the value of one or several (a) assets that the person owns,
produces, manufactures, processes, or merchandises or anticipates
owning, producing, manufacturing, processing, or merchandising; (b)
liabilities that the person owns or anticipates incurring; or (c)
services that the person provides, purchases, or anticipates providing
or purchasing;
    (ii) the swap represents a substitute for transactions made or to
be made or positions taken or to be taken by the person at a later time
in a physical marketing channel;
    (iii) the swap is economically appropriate to the reduction of the
person's risks in the conduct and management of a commercial
enterprise;
    (iv) the swap is entered into in accordance with sound commercial
practices; and
    (v) the person does not enter into the swap in connection with
activity structured to evade designation as a swap dealer.\215\
---------------------------------------------------------------------------

    \215\ See CFTC Regulation Sec.  1.3(ggg)(6)(iii). All five
requirements set forth in the regulation must be met with respect to
the swap, in order for the swap to be excluded from the swap dealer
determination by the regulation.
---------------------------------------------------------------------------

    Thus, although the CFTC is not incorporating the bona fide hedging
provisions of the CFTC's position limits rule here, the exclusion from
the swap dealer analysis draws upon language in the CFTC's definition
of bona fide hedging.\216\ For example, the exclusion expressly
includes swaps hedging price risks arising from the potential change in
value of existing or anticipated assets, liabilities, or services, if
the hedger has an exposure to physical price risk. And, as in the bona
fide hedging rule, the exclusion utilizes the word ``several'' to
reflect that there is no requirement that swaps hedge risk on a one-to-
one transactional basis in order to be excluded, but rather they may
hedge on a portfolio basis.\217\ For these reasons, swaps that qualify
as enumerated hedging transactions and positions are examples of the
types of physical commodity swaps that are excluded from the swap
dealer analysis if the rule's requirements are met.\218\
---------------------------------------------------------------------------

    \216\ See CFTC Regulation Sec.  151.5(a)(1). The definition of
bona fide hedging in CFTC Regulation Sec.  1.3(z), which applies for
excluded commodities, is not relevant here, because it does not
contain the requirement that the swap represents a substitute for a
transaction made or to be made or a position taken or to be taken in
a physical marketing channel, as required by CFTC Regulation Sec.
1.3(ggg)(6)(iii)(B). We believe that this requirement is an
important aspect of how principles from the bona fide hedging
definition are useful in identifying swaps that are entered into for
the purpose of hedging as opposed to other purposes.
    \217\ See CFTC, Position Limits for Futures and Swaps; Final
Rule, 76 FR 71626, 71649 (Nov. 18, 2011).
    \218\ The swaps that qualify as enumerated hedging transactions
and positions are those listed in CFTC Regulation Sec.  151.5(a)(2)
and appendix B to part 151. These examples are illustrative of the
types of ``assets,'' ``liabilities,'' and ``services'' contemplated
in CFTC Regulation Sec.  1.3(ggg)(6)(iii), because the price risk
arising from changes in their value could be offset or mitigated
with a swap that represents a substitute for transactions made or to
be made or positions taken or to be taken by the person at a later
time in a physical marketing channel. To be clear, notwithstanding
that a swap does not fit precisely within such examples, it may
still satisfy CFTC Regulation Sec.  1.3(ggg)(6)(iii).
     Regarding commenters' queries about dynamic hedging, which one
commenter described as the ability to modify the hedging structure
related to physical assets or positions when relevant pricing
relationships applicable to that asset change (see joint letter from
WGCEF and CMC), we note that qualification as bona fide hedging has
never been understood to require that hedges, once entered into,
must remain static. We expect that entites would move to update
their hedges periodically when pricing relationships or other market
factors applicable to the hedge change.
---------------------------------------------------------------------------

    This provision in the final rule is consistent with our overall
interpretive approach to the definition of the term ``swap dealer.''
The interpretations of the statutory dealer definitions by both
Commissions focus on a person's activities in relation to its
counterparties and other market participants.\219\ As noted above, for
example, one indicator that a person enters into swaps as part of ``a
regular business'' is that the person does so to satisfy the business
or risk management needs of the counterparty. This aspect of the swap
dealer analysis turns on the accommodation of a counterparty's needs or
demands. If a person enters into swaps for the purpose of hedging a
physical position as defined in CFTC Regulation Sec.  1.3(ggg)(6)(iii),
by contrast, then the swap can be identified as not having been entered
into for the purpose of accommodating the counterparty's needs or
demands.\220\ Also, a person's activity of seeking out swap
counterparties in order to hedge a physical position as defined in the
rule generally would not warrant regulations to promote market
stability and transparency or to serve the other purposes of dealer
regulation.\221\
---------------------------------------------------------------------------

    \219\ See parts II.A.4.e and II.A.5.a, infra. For example, the
conclusion that a person's relationship with its counterparties can
lead to associated obligations is consistent with the ``shingle
theory,'' which implies a duty of fair dealing when a person hangs
out its shingle to do business. See note 260, infra.
    \220\ In this way, the exclusion from the swap dealer analysis
of swaps hedging physical positions as defined in CFTC Regulation
Sec.  1.3(ggg)(6)(iii) is similar to the exclusions, discussed
below, of swaps between affiliates and swaps between a cooperative
and its members. See CFTC Regulation Sec.  1.3(ggg)(6)(i)(ii); see
also part II.C, infra. However, to the extent a person engages in
dealing activities involving swaps, the presence of offsetting
positions that hedge those dealing activities would not excuse the
requirement that the person register as a swap dealer.
    \221\ Thus, the CFTC's interpretation of the swap dealer
definition in this regard draws upon principles in the dealer-trader
distinction. See part II.A.4.a. Additional authority for CFTC
Regulation Sec.  1.3(ggg)(6)(iii) is provided by subparagraph (B) of
the swap dealer definition. This subparagraph provides that a person
``may be designated as a swap dealer for a single type or single
class or category of swap or activities and considered not to be a
swap dealer for other types, classes, or categories of swaps or
activities.'' CEA Section 1a(49)(B), 7 U.S.C. 1a(49)(B). It thereby
authorizes a review of a person's various activities with respect to
swaps, and a determination that some of the person's activities are
covered by a designation as a swap dealer, while other of the
person's activities are not. Thus, a person who enters into some
swaps for hedging physical positions as defined in CFTC Regulation
Sec.  1.3(ggg)(6)(iii), and also enters into other swaps in
connection with activities covered by the swap dealer definition,
could be designated as a swap dealer only for the latter activities.
---------------------------------------------------------------------------

    At the same time, however, there may be circumstances where a
person's activity of entering into swaps is encompassed by the
statutory definition of the term ``swap dealer,'' notwithstanding that
the swaps have the effect of hedging or mitigating the person's
commercial risk.\222\ Although these swaps could, in theory, be
excluded from the swap dealer analysis, we believe that a broader, per
se exclusion for all swaps that hedge or mitigate commercial risk is

inappropriate for the swap dealer definition.
---------------------------------------------------------------------------

    \222\ For example, ``pay floating/receive fixed'' swaps entered
into by a swap dealer with long exposure to the floating side of a
market would have the effect of hedging the dealer's exposure.
---------------------------------------------------------------------------

    First, the hedging exclusion that we are adopting is in the nature
of a safe harbor; i.e., it describes activity that will not be
considered swap dealing activity. As such, the CFTC believes that it is
appropriate that the interim final rule not be cast broadly.\223\ This
does not mean that other types of hedging activity that do not meet the
requirements of the interim final rule are necessarily swap dealing
activity. Rather, such hedging activity is to be considered in light of
all other relevant facts and circumstances to determine whether the
person is engaging in activity (e.g., accommodating demand for swaps,
making a market for swaps, etc.) that makes the person a swap dealer.
---------------------------------------------------------------------------

    \223\ While we recognize that a rule delineating the swap
activities that do not constitute swap dealing would simplify and
make more certain, at least in some contexts, the application of the
swap dealer definition, there are also reasons for caution in
incorporating a categorical exclusion for hedging.
---------------------------------------------------------------------------

    Second, the usefulness of an exclusion of all swaps that hedge or
mitigate commercial risk for certain aspects of the major swap
participant definition \224\ is not a reason to use the same exclusion
in the swap dealer definition, since the swap dealer definition serves
a different function. The definition of the term ``major swap
participant,'' which applies only to persons who are not swap
dealers,\225\ is premised on the prior identification, by the swap
dealer definition, of persons who accommodate demand for swaps, make a
market in swaps, or otherwise engage in swap dealing activity. The
major swap participant definition performs the subsequent function of
identifying persons that are not swap dealers, but hold swap positions
that create an especially high level of risk that could significantly
impact the U.S. financial system.\226\ Only for this subsequent
function is it appropriate to apply the broader exclusion of swaps held
for the purpose of hedging or mitigating commercial risk.\227\
---------------------------------------------------------------------------

    \224\ See part IV.C, infra.
    \225\ See CEA Sec.  1a(33)(A)(i), 7 U.S.C. 1a(33)(A)(i).
    \226\ See CEA Sec.  1a(33)(B), 7 U.S.C. 1a(33)(B).
    \227\ We do not believe that the differences between the
exclusion in the major participant definitions for swaps held for
the purpose of hedging or mitigating commercial risk and the
exclusion in the swap dealer definition for certain swaps entered
into for the purpose of hedging risks related to physical positions
mean that the Commissions, or the CFTC in particular, have
implemented two different definitions of hedging. In fact, neither
of these exclusions define the term ``hedging.'' Rather, the
differences between the two exclusions reflect differences in the
parameters that must be satisfied in order to ensure that hedging
swaps are appropriately excluded from the two different definitions.
---------------------------------------------------------------------------

    The CFTC believes that since the over-the-counter swap markets have
operated largely without regulatory oversight and encompass swaps used
for a wide variety of commercial purposes, no method has yet been
developed to reliably distinguish, through a per se rule, between: (i)
Swaps that are entered into for the purpose of hedging or mitigating
commercial risk; and (ii) swaps that are entered into for the purpose
of accommodating the counterparty's needs or demands or otherwise
constitute swap dealing activity, but which also have a hedging
consequence.\228\ In contrast, the CFTC notes that it has set forth and
modified standards for bona fide hedging transactions and granted
exemptions in compliance with such standards for decades.\229\ These
historically-developed standards form the basis of the interim final
rule excluding from the swap dealer analysis certain swaps that hedge
the risks associated with a physical position.
---------------------------------------------------------------------------

    \228\ As noted in the preceding paragraph, it is not necessary
to make this distinction for purposes of the major swap participant
definition.
    \229\ See, e.g., 42 FR 42751 (Aug. 8, 1977). Although the latest
formulation of the definition of bona fide hedging--CFTC Regulation
Sec.  151.5(a)--was recently adopted, see CFTC, Position Limits for
Futures and Swaps; Final Rule and Interim Final Rule, 76 FR 71626
(Nov. 18, 2011), the bona fide hedging test has been in use for
decades.
---------------------------------------------------------------------------

    The exclusion in CFTC Regulation Sec.  1.3(ggg)(6)(iii) depends not
on the effect or consequences of the swap, but on whether the purpose
for which a person enters into a swap is to hedge a physical position
as defined in the rule. If so, then the swap is excluded from the
dealer analysis because using swaps for that purpose is inconsistent
with, and is not, dealing activity.\230\ On the other hand, if, at the
time the swap is entered into, the person's purpose for entering into
the swap is not as defined in CFTC regulation Sec.  1.3(ggg)(6)(iii),
or if it is unclear whether the swap is for such purpose, then the fact
that the swap hedges the person's exposure in some regard does not
preclude consideration of that swap in the dealer analysis.\231\ In
this latter case, all relevant facts and circumstances regarding the
swap and the person's activity with respect to the swap would be
relevant in the determination of whether the person is a swap
dealer.\232\
---------------------------------------------------------------------------

    \230\ To be clear, the swaps a person enters into for hedging
physical positions as defined in CFTC Regulation Sec.
1.3(ggg)(6)(iii) are not indicative of dealing activity under any of
the prongs of the swap dealer definition.
    \231\ In this regard, CFTC Regulation Sec.  1.3(ggg)(6)(iii) is
different from certain of the CFTC's rules regarding bona fide
hedging, where a person's purpose in entering into a swap may not be
relevant.
    \232\ We believe that, in practice, the difficulty of
distinguishing, in applying the swap dealer definition, swaps
entered into for the purpose of hedging from other types of swaps
will be resolvable when the facts and circumstances of a person's
swap activities are taken into consideration in light of our
interpretive guidance.
---------------------------------------------------------------------------

    We believe that, based on the CFTC's experience in applying bona
fide hedging principles with respect to swaps hedging risks related to
physical positions, the exclusion in CFTC Regulation Sec.
1.3(ggg)(6)(iii) at this time is the best means of providing certainty
to market participants regarding which swaps may be disregarded in the
dealer analysis. However, commenters presented a range of views as to
the exclusions from the dealer analysis that may be appropriate in this
regard.\233\ Accordingly, the CFTC is implementing this exclusion on an
interim rule basis and is seeking comments on all aspects of the
interim rule, including any adjustments that may be appropriate in the
rule or accompanying interpretive guidance.
---------------------------------------------------------------------------

    \233\ See, e.g., letters cited in note 141, supra.
---------------------------------------------------------------------------

    The CFTC also seeks comments on whether a different approach to
swaps entered into for the purpose of hedging risk is appropriate to
implement the statutory definition of the term ``swap dealer.''
    For example, the CFTC invites commenters to address whether any
exclusion of hedging swaps from the swap dealer analysis is
appropriate, and if so, how swaps that are entered into for purposes of
hedging may be identified and distinguished from other swaps.
Commenters are encouraged to address whether it is relevant to
distinguish swaps entered into for purposes of hedging from swaps that
have a consequential result of hedging, and if so, how such swaps may
be distinguished. Also, commenters may address whether the exclusion
should be limited to swaps hedging risks related to physical positions
or extended to encompass swaps hedging financial risks or other types
of risks.
    Commenters should address whether the exclusion in CFTC Regulation
Sec.  1.3(ggg)(6)(iii) should be consistent with the exclusion in CFTC
Regulation Sec.  1.3(kkk). If so, why, and if not, why not? If the two
exclusions should be consistent, does consistency require that that
exclusions be identical, or would there be variations in application of
the two exclusions? Are there market participants whose swap positions
would be classified as held for the purpose of hedging or mitigating
commercial risk under CFTC Regulation

Sec.  1.3(kkk) but would not qualify for the exclusion under CFTC
Regulation Sec.  1.3(ggg)(6)(iii)? If so, specifically identify the
types of market participants and swaps. If the CFTC were to apply in
the swap dealer definition the exclusion in CFTC Regulation Sec.
1.3(kkk) in lieu of the exclusion in CFTC Regulation Sec.
1.3(ggg)(6)(iii), would there be negative market impacts? If so, what
are they? Would there be positive market impacts? If so, what are they?
In particular, what type(s) of swaps that ``hedge or mitigate
commercial risk,'' but that are not excluded under the interim rule,
may constitute dealing activity in light of the rules and interpretive
guidance regarding the swap dealer definition set forth in this
Adopting Release?
    Comments regarding the costs and benefits related to the interim
final rule and any alternative approaches, including in particular the
quantification of such costs and benefits, are also invited.
    Commenters are encouraged, to the extent feasible, to be
comprehensive and detailed in providing their approach and rationale.
The comment period for the interim final rule will close July 23, 2012.
f. Swaps Entered Into by Persons Registered as Floor Traders
    Commenters discussed whether the swap dealer definition encompasses
the activity of entering into swaps on or subject to the rules of a DCM
or SEF, and submitted for clearing to a derivatives clearing
organization (``DCO''), particularly when firms engage in that activity
using only proprietary funds.\234\ Because Title VII of the Dodd-Frank
Act amended the definition of floor trader specifically to encompass
activities involving swaps,\235\ the CFTC believes that it would lead
to potentially duplicative regulation if floor traders engaging in
swaps in their capacity as floor traders were also required to register
as swap dealers. Accordingly, the CFTC believes that it is appropriate
not to consider such swaps when determining whether a person acting as
a floor trader, as defined under CEA section 1a(23),\236\ and
registered with the CFTC under CFTC Regulation Sec.  3.11, is a swap
dealer if the floor trader meets certain conditions. Specifically, the
final rule provides that, in determining whether a person is a swap
dealer, each swap that the person enters into in its capacity as a
floor trader as defined by CEA section 1a(23) or on a SEF shall not be
considered for the purpose of determining whether the person is a swap
dealer, provided that the person:
---------------------------------------------------------------------------

    \234\ See letter from Trading Coalition. One commenter
specifically discussed floor traders and floor brokers and the
regulatory regime that should apply to them following implementation
of the Dodd Frank Act. See letter from Christopher K. Hehmeyer.
    We note that other commenters suggested that all swaps cleared
on an exchange should be excluded from the dealer definitions. See
letters cited in note 138, supra. However, the discussion here is
limited to persons who are registered as floor traders and meet
other conditions. Also, the final rule provision discussed here does
not exclude floor traders from the definition of the term ``swap
dealer;'' rather, it provides that if the stated conditions are met,
certain swaps entered into by floor traders are excluded from the
swap dealer analysis.
    \235\ See section 721(a)(11) of the Dodd-Frank Act (amending the
definition of the term ``floor trader'' in CEA section 1a(23)). The
Exchange Act does not have an equivalent regulatory category to
floor trader under the CEA, and thus Congress did not make a similar
amendment to the Exchange Act.
    \236\ The definition of the term ``floor trader'' includes a
person entering into swaps on a ``contract market.'' See CEA section
1a(23). This exclusion also encompasses swaps that a registered
floor trader enters into on or subject to the rules of a SEF, in
addition to on or subject to the rules of a DCM, so long as the swap
meets the conditions stated in the exclusion.
---------------------------------------------------------------------------

    (i) Is registered with the CFTC as a floor trader pursuant to CFTC
Regulation Sec.  3.11;
    (ii) enters into swaps solely with proprietary funds for that
trader's own account on or subject to the rules of a DCM or SEF, and
submits each such swap for clearing to a DCO;
    (iii) is not an affiliated person of a registered swap dealer;
    (iv) does not directly, or through an affiliated person, negotiate
the terms of swap agreements, other than price and quantity or to
participate in a request for quote process subject to the rules of a
DCM or SEF;
    (v) does not directly or through an affiliated person offer or
provide swap clearing services to third parties;
    (vi) does not directly or through an affiliated person enter into
swaps that would qualify as hedging physical positions pursuant to CFTC
Regulation Sec.  1.3(ggg)(6)(iii) or hedging or mitigating commercial
risk pursuant to CFTC Regulation Sec.  1.3(kkk), with the exception of
swaps that are executed opposite a counterparty for which the
transaction would qualify as a bona fide hedging transaction;
    (vii) does not participate in any market making program offered by
a DCM or SEF; and
    (viii) complies with the record keeping and risk management
requirements of CFTC Regulation Sec. Sec.  23.201, 23.202, 23.203, and
23.600 with respect to each such swap as if it were a swap dealer.\237\
---------------------------------------------------------------------------

    \237\ See CFTC Regulation Sec.  1.3(ggg)(6)(iv).
---------------------------------------------------------------------------

    This rule permits floor traders who might otherwise be required to
register as a swap dealer to be registered solely as floor traders with
the CFTC. Given the limitations on the scope of the rule, the
requirements for floor traders using the relief to comply with
recordkeeping and risk management rules applicable to swap dealers as a
condition of the relief, and the fact that swaps subject to the rule
are traded on a DCM or SEF and cleared through a DCO, the CFTC believes
it is not necessary to have floor traders subject to this rule register
as both floor traders and swap dealers as a result of swaps activities
covered by the rule.\238\
---------------------------------------------------------------------------

    \238\ The Commissions note the rule applies only to CFTC-
registered floor traders engaging in swaps on DCMs or SEFs and
cleared through DCOs. As noted above, the SEC does not have a
regulatory category under the Exchange Act equivalent to floor
trader under the CEA and none of these provisions apply in the
context of security-based swap dealers or any entity regulated under
the Exchange Act. Any person engaging in security-based swap
transactions, whether or not these activities are similar to those
engaged in by floor traders, will need to independently consider
whether they need to register as security-based swap dealers as a
result of their activities.
---------------------------------------------------------------------------

g. Additional Interpretive Issues Relating to the ``Swap Dealer''
Definition
    As noted above, the Commissions, in consideration of comments
received, are making certain modifications to the interpretive guidance
concerning the definition of the term ``swap dealer'' set out in the
Proposing Release. However, the Commissions are retaining certain
elements of their proposed interpretation of the term ``swap dealer,''
as discussed below.
    First, with respect to the comments asserting that the proposed
interpretive approach is overly broad,\239\ we note that the statute
provides that the term ``swap dealer'' means ``any person'' who engages
in the activities described in any of the four prongs of the
definition, subject to the exceptions and qualifications set out in the
statute. In view of this statutory text, these comments effectively
assert that the statute should be interpreted to include preconditions
to swap dealer status that are not set forth in the statute. For
example, the assertion that the swap dealer definition must be limited
to persons who enter into swaps on both sides of the market would
impose a requirement that does not exist in the statute. Similarly, the
comments to the effect that swap dealers are only those persons who
seek to profit by intermediating between swap market participants adds
a requirement not set forth in the statute.
---------------------------------------------------------------------------

    \239\ See letters cited at notes 83 to 84, supra.
---------------------------------------------------------------------------

    We believe, though, that the activities that cause a person to be
covered by the

swap dealer definition should be addressed in the context of the four
prongs of the statutory definition. That is, the relevant question is
whether a person engages in any of the types of activities enumerated
in the statute, and not whether the person meets any additional,
supposedly implicit preconditions to swap dealer status.
    Second, the Commissions continue to believe, as stated in the
Proposing Release, that accommodating demand and facilitating interest
are appropriately used as factors in identifying swap dealers. As noted
by commenters, however, the mere fact that a person entering into a
particular swap has the effect of ``accommodating demand'' or
``facilitating interest'' in swaps does not conclusively establish that
the person is a swap dealer. Instead, the person's overall activities
in the swap market (or particular sector of the swap market if the
person is active in a variety of sectors) should be compared against
these factors. If, in the context of its overall swap activities, a
person fulfills a function of accommodating demand or facilitating
interest in swaps for other parties, then these factors would be
significant in the analysis and the person is likely to be a swap
dealer.\240\
---------------------------------------------------------------------------

    \240\ The language of the four statutory tests for swap dealer
status (which refer to a person who holds itself out as a dealer, is
commonly known as a dealer, makes a market in swaps or regularly
enters into swaps with counterparties) contemplate that a dealer is
a person who, through its swap activities, functions to create legal
relationships that transfer risk between independent persons. See
CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
    See also Proposing Release, 75 FR at 80177 (describing swap
dealers as those persons whose function is to serve as the points of
connection in the swap markets); letter from COPE I at 4 (``Simply
stated, dealers are in the regular business of being a point of
connection to the market for others that need access to the market
to hedge risk.''): Roundtable Transcript at 21 (remarks of Richard
Ostrander, Morgan Stanley; ``a dealer is someone who is out there
willing to enter into trades'').
---------------------------------------------------------------------------

    Third, as discussed above, we have adopted some of the objective
criteria suggested by commenters with respect to the indicia of holding
oneself out as a dealer or being commonly known as a dealer, market
making, and the ``regular business'' prongs of the swap dealer
definition.\241\ For instance, allocating staff and technological
resources to swap activity, deriving revenue and profit from swap
activity, or responding to customer-initiated orders for swaps can all
be indicative of having ``a regular business'' of entering into swaps
and, therefore, indicative of being a swap dealer. In addition,
activities such as providing advice about swaps or offering oneself as
a point of connection to other parties needing access to the swap
market are indicative of a person holding itself out as a swap dealer,
if the person also enters into swaps in conjunction with such
activities.
---------------------------------------------------------------------------

    \241\ See part II.B.2.d.iii, supra.
---------------------------------------------------------------------------

    The guidance we have provided about these indicia is responsive to
concerns expressed by commenters about the application of the swap
dealer definition to energy markets. As described above, some
commenters stated that in energy markets, unlike in some other markets,
end-users often enter into swaps directly with each other, on both
sides of the market, without the involvement of a separate category of
businesses serving as intermediaries.\242\ As a result, according to
these commenters, energy swap market participants often engage in some
of the activities that are indicative of swap dealer status. Some of
these commenters contended that our activity-based interpretation of
the swap dealer definition could therefore result in the inappropriate
inclusion of energy market participants in the coverage of the
definition of the term ``swap dealer.'' \243\
---------------------------------------------------------------------------

    \242\ See parts II.A.2.f.ii and iii, supra.
    \243\ See letters cited in note 117, supra. Comments expressing
concern that the definition of the term ``swap dealer'' could
include physical commodities businesses also were presented to
Congress during consideration of legislation leading to passage of
the Dodd-Frank Act. See Proposed Legislation by the U.S. Department
of the Treasury Regarding the Regulation of Over-The-Counter
Derivatives Markets: Hearing Before the H. Comm. On Agriculture,
111th Cong. 103 (2009) (submitted report on behalf of the Working
Group of Commercial Energy Firms). However, as noted above, there is
no exclusion in the statutory definition for such businesses.
---------------------------------------------------------------------------

    We believe that the language of the statutory ``swap dealer''
definition supports our activity-based interpretation and does not
support categorical exclusions of particular types of persons from the
``swap dealer'' definition based on the general nature of their
businesses. Further evidence that such a categorical exclusion is
unwarranted is provided by the fact that a number of energy market
participants--BP Plc., Cargill, Incorporated, Centrica Energy Limited,
ConocoPhillips, EDF Trading Limited, GASELYS, Hess Energy Trading
Company, LLC, Hydro-Quebec, Koch Supply & Trading, LP, RWE Supply &
Trading GmbH, Shell Energy North America (US), L.P., STASCO, Totsa
Total Oil Trading S.A., and Vattenfall Energy Trading Netherlands
N.V.--have voluntarily joined ISDA as primary dealers.\244\ As
previously noted, any business organization that ``deals in derivatives
shall be eligible for election to membership in the Association as a
primary member, provided that no person or entity shall be eligible for
membership as a Primary Member if such person or entity participates in
derivatives transactions solely for the purpose of risk hedging or
asset or liability management.'' \245\ Hence, a categorical exclusion
from the ``swap dealer'' definition based on any particular type of
business or general market activity also would be inconsistent with
current industry structure and practice.
---------------------------------------------------------------------------

    \244\ The list of ISDA Primary Members is available at http://www.isda.org/membership/isdamemberslist.pdf.
    \245\ See note 188, supra.
---------------------------------------------------------------------------

    At the same time, however, the fact that a person engages in some
swap activities that are indicative of swap dealer status does not, by
itself, mean that the person is covered by the definition of the term
``swap dealer.'' The ``not as part of a regular business'' exception
and our guidance about its meaning address the issue of swap market
participants that engage to some extent in the activities
characteristic of swap dealers. The guidance we have provided here
therefore provides the appropriate approach to addressing these issues
in energy markets as elsewhere.
    Although several commenters attempted to articulate bright-line
tests that would differentiate swap dealers from other swap market
participants, the suggested bright-line tests generally could not be
applied across the board to all types of swap market activity. For
example, some commenters suggested that swap dealers can be identified
as those who profit from entering into swaps on both sides of the
market (and under the interpretive approach set forth in this Adopting
Release, such activity may be an indicator of swap dealing).\246\ But
other commenters said that, in certain circumstances, entering into
swaps on both sides of the market is not necessarily indicative of swap
dealing.\247\
---------------------------------------------------------------------------

    \246\ See letters cited in note 84, supra.
    \247\ See letters cited in note 86, supra. As noted above in the
discussion of market making, a swap dealer may in some circumstances
enter into swaps on only one side of the market.
---------------------------------------------------------------------------

    The ways in which participants throughout the market use swaps are
simply too diverse for swap dealer status to be resolved with a single,
one-factor test. This is reflected in the statutory definition of the
term ``swap dealer'' itself. Focused as it is on types of activities,
with four prongs set forth in the alternative to cover different types
of swap dealing activity, the statutory swap dealer definition is not
susceptible to the bright-line test that

some commenters seek. For these reasons, we continue to believe that it
is appropriate to apply the multi-factor interpretive approach set
forth in this Adopting Release.
    In closing, we emphasize that the purpose of in this part IV.A.4 is
to provide guidance as to how the rules further defining the term
``swap dealer'' will be applied in particular, complex situations where
a person's status as a swap dealer may be uncertain. Even though
bright-line tests and categorical exclusions are inappropriate, we
recognize that the large majority of market participants use swaps for
normal course hedging, financial, investment or trading purposes and
are not swap dealers.
5. Final Rules and Interpretation--Definition of ``Security-Based Swap
Dealer''
a. General Reliance on the Dealer-Trader Distinction
    As discussed above, we are adopting a rule under the Exchange Act
that defines ``security-based swap dealer'' in terms of the four
statutory tests and the exclusion for security-based swap activities
that are not as part of a ``regular business.'' \248\ Also, we believe
that the dealer-trader distinction \249\--which already forms a basis
for identifying which persons fall within the longstanding Exchange Act
definition of ``dealer''--in general provides an appropriate framework
for interpreting the meaning of ``security-based swap dealer.'' \250\
While there are differences in the structure of those two statutory
definitions,\251\ we believe that their parallels--particularly both
definitions' exclusions for activities that are ``not part of a regular
business''--warrant analogous interpretive approaches for
distinguishing dealers from non-dealers.
---------------------------------------------------------------------------

    \248\ See Exchange Act rule 3a71-1(a), (b).
    \249\ See note 31, supra.
    \250\ The principles embedded within the ``dealer-trader
distinction'' are not solely useful for distinguishing persons who
constitute dealers from active ``traders,'' but also are applicable
to distinguishing dealers from non-dealers such as hedgers or
investors. The ``dealer-trader'' nomenclature has been used for
decades. See Loss, Securities Regulation 722 (1st ed. 1951) (``One
aspect of the `business' concept is the matter of drawing the line
between a `dealer' and a trader--an ordinary investor who buys and
sells for his own account with some frequency.'').
    \251\ For example, while the ``dealer'' definition encompasses
certain persons in the business of ``buying and selling''
securities, the ``security-based swap dealer'' definition does not
address either ``buying'' or ``selling.'' As we noted in the
Proposing Release, we do not believe that the lack of those terms in
the ``security-based swap dealer'' definition leads to material
interpretive distinctions, as the Dodd-Frank Act amended the
Exchange Act definitions of ``buy'' and ``purchase,'' and the
Exchange Act definitions of ``sale'' and ``sell,'' to encompass the
execution, termination (prior to its scheduled maturity date),
assignment, exchange or similar transfer or conveyance of, or
extinguishing of rights or obligations under, a security-based swap.
See Proposing Release, 75 FR at 80178 n.26 (citing Dodd-Frank Act
sections 761(a)(3), (4), which amend Exchange Act sections 3(a)(13),
(14)).
    At the same time, we note that the ``dealer'' definition
requires the conjunctive ``buying and selling''--which connotes a
degree of offsetting two-sided activity. In contrast, the
``security-based swap dealer'' definition (particularly the
``regularly enters into security-based swaps'' language of the
definition's third test) lacks that conjunctive terminology.
---------------------------------------------------------------------------

    As discussed above,\252\ the Commissions note that interpretations
of the applicability of the dealer-trader distinction to the ``swap
dealer'' definition under the CEA do not affect existing, or future,
interpretations of the dealer-trader distinction under the Exchange
Act--both with regard to the ``security-based swap dealer'' definition,
and with regard to the ``dealer'' definition.
---------------------------------------------------------------------------

    \252\ See note 171, supra.
---------------------------------------------------------------------------

    In interpreting the security-based swap dealer definition in terms
of the dealer-trader distinction, the Commissions have been mindful
that some commenters expressed the view that we instead should rely on
other interpretive factors that were identified in the Proposing
Release (e.g., accommodating demand). We believe, nonetheless, that the
dealer-trader distinction forms the basis for a framework that
appropriately distinguishes between persons who should be regulated as
security-based swap dealers and those who should not. We also believe
that the distinction affords an appropriate degree of flexibility to
the analysis, and that it would not be appropriate to seek to codify
the distinction.
    At the same time, the Commissions recognize that the dealer-trader
distinction needs to be adapted to apply to security-based swap
activities in light of the special characteristics of security-based
swaps and the differences between the ``dealer'' and ``security-based
swap dealer'' definitions. Relevant differences include:
     Level of activity--Security-based swap markets are marked
by less activity than markets involving certain other types of
securities (while recognizing that some debt and equity securities are
not actively traded). This suggests that in the security-based swap
context concepts of ``regularity'' should account for the level of
activity in the market.
     No separate issuer--Each counterparty to a security-based
swap in essence is the ``issuer'' of that instrument; in contrast,
dealers in cash market securities generally transact in securities
issued by another party. This distinction suggests that the concept of
turnover of ``inventory'' of securities, which has been identified as a
factor in connection with the dealer-trader distinction, is inapposite
in the context of security-based swaps. Moreover, this distinction--
along with the fact that the ``security-based swap dealer'' definition
lacks the conjunctive ``buying and selling'' language of the ``dealer''
definition \253\--suggests that concepts of two-sided markets at times
would be less relevant for identifying ``security-based swap dealers''
than they would be for identifying ``dealers.'' \254\
---------------------------------------------------------------------------

    \253\ See note 251, supra.
    \254\ The analysis also should account for the fact that a party
to a security-based swap can use other derivatives or cash market
instruments to hedge the risks associated with the security-based
swap position, meaning that two-way trading is not necessary to
maintain a flat risk book.
---------------------------------------------------------------------------

     Predominance of over-the-counter and non-standardized
instruments--Security-based swaps thus far are not significantly traded
on exchanges or other trading systems, in contrast to some cash market
securities (while recognizing that many cash market securities also are
not significantly traded on those systems).\255\ These attributes--
along with the lack of ``buying and selling'' language in the security-
based swap dealer definition, as noted above--suggest that concepts of
what it means to make a market need to be construed flexibly in the
context of the security-based swap market.\256\
---------------------------------------------------------------------------

    \255\ Even though we expect trading of security-based swaps on
security-based swap execution facilities or exchanges following the
implementation of Title VII, we expect there to remain a significant
amount of over-the-counter activity involving security-based swaps.
    \256\ For example, the definition of ``market maker'' in
Exchange Act section 3(a)(38)--which is applicable for purposes of
the Exchange Act ``unless the context otherwise requires'' (see
Exchange Act section 3(a))--defines the term ``market maker'' to
mean ``any specialist permitted to act as a dealer, any dealer
acting in the capacity of block positioner, and any dealer who, with
respect to a security, holds himself out (by entering quotations in
an inter-dealer communications system or otherwise) as being willing
to buy and sell such security for his own account on a regular or
continuous basis.'' That definition is useful in the context of
systems in which standardized securities are regularly or
continuously bought and sold, but would not be apposite in the
context of non-standardized securities or securities that are not
regularly or continuously transacted.
---------------------------------------------------------------------------

     Mutuality of obligations and significance to ``customer''
relationship--In contrast to a secondary market transaction involving
equity or debt securities, in which the completion of a purchase or
sale transaction can be expected to terminate the mutual obligations of
the parties to the

transaction, the parties to a security-based swap often will have an
ongoing obligation to exchange cash flows over the life of the
agreement. In light of this attribute, some market participants have
expressed the view that they have ``counterparties'' rather than
``customers'' in the context of their swap activities.
    It also is necessary to use the dealer-trader distinction to
interpret the security-based swap dealer definition so that the
statutory provisions that will govern security-based swap dealers are
applied in an effective and logical way. Those statutory provisions
added by the Dodd-Frank Act advance financial responsibility (e.g., the
ability to satisfy obligations, and the maintenance of counterparties'
funds and assets) associated with security-based swap dealers'
activities,\257\ other counterparty protections,\258\ and the promotion
of market efficiency and transparency.\259\ As a whole, the relevant
statutory provisions suggest that we should apply the dealer-trader
distinction to interpret the security-based swap dealer definition in a
way that identifies those persons for which regulation is warranted
either: (i) Due to the nature of their interactions with
counterparties; \260\ or (ii) to promote market stability and
transparency, in light of the role those persons occupy within the
security-based swap markets.\261\
---------------------------------------------------------------------------

    \257\ E.g., capital and margin requirements (Exchange Act
section 15F(e)), and requirements for segregation of collateral
(Exchange Act section 3E).
    \258\ E.g., requirements with respect to business conduct when
transacting with special entities (Exchange Act sections 15F(h)(2),
(h)(4), (h)(5)); disclosure requirements (Exchange Act section
15F(h)(3)(B)); requirements for fair and balanced communications
(Exchange Act section 15F(h)(3)(C)); other requirements related to
the public interest and investor protection (Exchange Act section
15F(h)(3)(D)); and conflict of interest provisions (Exchange Act
section 15F(j)(5)).
    \259\ E.g., reporting and recordkeeping requirements (Exchange
Act section 15F(f)); daily trading records requirements (Exchange
Act section 15F(g)); regulatory standards related to the
confirmation, processing, netting, documentation and valuation of
security-based swaps (Exchange Act section 15F(i)); position limit
monitoring requirements (Exchange Act section 15F(j)(1)); risk
management procedure requirements (Exchange Act section 15F(j)(2));
and requirements related to the disclosure of information to
regulators (Exchange Act section 15F(j)(3)).
    \260\ The conclusion that a person's relationship with its
counterparties can lead to associated obligations is consistent with
the ``shingle theory,'' which implies a duty of fair dealing when a
person hangs out its shingle to do business. See Securities and
Exchange Commission, Report of the Special Study of Securities
Market Part I at 238 (1963) (``An obligation of fair dealing, based
upon the general antifraud provisions of the Federal securities
laws, rests upon the theory that even a dealer at arm's length
impliedly represents when he hangs out his shingle that he will deal
fairly with the public.''; footnote omitted); Weiss, Registration
and Regulation of Brokers and Dealers 171 (1965) (``the solicitation
and acceptance by a broker-dealer of orders from customers and the
confirmation of transactions do constitute a representation by the
broker-dealer that he will deal fairly with his customers and that
such transactions will be handled promptly in the usual manner, in
accordance with trade custom'').
    \261\ The importance of regulating dealers due to the centrality
of their market role was illustrated by the Government Securities
Act of 1986. When Congress provided for the regulation of government
securities dealers, Congress specifically cited the lack of
regulation as contributing to the failures of several unregulated
government securities dealers. See S. Rep. No. 99-426 (1986), as
reprinted in 1986 U.S.C.C.A.N. 5395, 5400-04. The resulting statute
provided for a definition of ``government securities dealer'' that
in relevant part is parallel to the definitions of ``dealer'' and
``security-based swap dealer,'' particularly with regard to sharing
an exclusion for activities that are not part of a ``regular
business.'' See Exchange Act section 3(a)(44).
---------------------------------------------------------------------------

b. Principles for Applying the Dealer-Trader Distinction to Security-
Based Swap Activity
    In light of the statutory security-based swap dealer definition,
statutory provisions applicable to security-based swap dealers and
market characteristics addressed above, the Commissions believe that
the factors set forth below are relevant for identifying security-based
swap dealers and for distinguishing those dealers from other market
participants. This guidance seeks to address commenter requests that we
further clarify the scope of the security-based swap dealer definition,
and the Commissions believe that these factors provide appropriate
guidance without being inflexible or allowing the opportunity for
evasion that may accompany a bright-line test. At the same time, the
determination of whether a person is acting as a security-based swap
dealer ultimately depends on the relevant facts and circumstances. In
light of the overall context in which a person's activity occurs, the
absence of one or more of these factors does not necessitate the
conclusion that a person is not a security-based swap dealer.\262\
---------------------------------------------------------------------------

    \262\ Similarly, depending on the relevant facts and
circumstances, the presence of certain of the illustrative
activities described here does not necessitate the conclusion that
the entity is a dealer.
---------------------------------------------------------------------------

     Providing liquidity to market professionals or other
persons in connection with security-based swaps. A market participant
might manifest this indication of dealer activity by accommodating
demand or facilitating interest expressed by other market
participants,\263\ holding itself out as willing to enter into
security-based swaps, being known in the industry as being available to
accommodate demand for security-based swaps, or maintaining a sales
force in connection with security-based swap activities.\264\
---------------------------------------------------------------------------

    \263\ This is to be distinguished from an entity entering into
security-based swaps for other business purposes, such as to gain
economic exposure to a particular market.
    \264\ A sales force, however, is not a prerequisite to a person
being a security-based swap dealer. For example, a person that
enters into security-based swaps in a dealing capacity can fall
within the dealer definition even if it uses an affiliated entity to
market and/or negotiate those security-based swaps (e.g., the person
is a booking entity). Depending on the applicable facts and
circumstances, the affiliate that performs the marketing and/or
negotiation functions may fall within the Exchange Act's definition
of ``broker'' (which was not revised by Title VII). See Exchange Act
section 3(a)(4)(A).
---------------------------------------------------------------------------

     Seeking to profit by providing liquidity in connection
with security-based swaps. A market participant may manifest this
indication of security-based swap dealer activity--which is consistent
with the definition's ``regular business'' requirement--by seeking
compensation in connection with providing liquidity involving security-
based swaps (e.g., by seeking a spread, fees or other compensation not
attributable to changes in the value of the security-based swap).\265\
The Commissions do not believe that this necessarily requires that a
person be available to take either side of the market at any time, or
that a person continuously engage in this type of activity, to be a
security-based swap dealer. Although one commenter expressed the view
that the security-based swap dealer definition requires that a person
be consistently available to take either side of the market,\266\ in
our view such an approach would be underinclusive.\267\
---------------------------------------------------------------------------

    \265\ Indicia of this objective may include, but would not be
limited to, maintaining separate profit/loss statements in
connection with this type of activity, and/or devoting staff and
resources to this type of activity.
    In this regard, we believe that the issue of whether a person
tends to take the prices offered in the market, rather than helping
to set those prices (such as by providing quotes, placing limit
orders, or otherwise accommodating demand), can be relevant as a
factor for distinguishing security-based swap dealers from non-
dealers. At the same time, we are mindful that a dealer may also
accept the market price as part of its dealer activity (such as when
a person enters into a security-based swap to offset the risk it
assumes in connection with its security-based swap dealing
activity); as a result, the fact that a person regularly takes the
market price as part of its security-based swap transactions does
not foreclose the possibility that the person may be a security-
based swap dealer.
    \266\ See letter from ISDA I.
    \267\ It is possible for a dealer to be compensated for
providing liquidity by entering into sequential offsetting
positions, or by hedging the security-based swap position by using a
different type of security-based swap, a swap or some other
financial instrument. Accordingly, a rule of decision that permitted
a person to avoid dealer regulation by providing liquidity in
connection with security-based swaps, and laying off the associated
risk using a different type of security-based swap, a swap or a
different instrument entirely, would be susceptible to abuse.
Moreover, as noted above, the definition of ``security-based swap
dealer'' does not contain the ``buying and selling'' language found
in the general Exchange Act definition of ``dealer.'' Thus, while
being regularly willing to enter into either side of the security-
based swap market would suggest that a person is engaged in dealing
activity, the absence of such activity should not necessarily lead
to an inference that a person is not acting as a dealer.
     We also note that some commenters have stated that two-way
quoting by itself should not necessarily be enough to make a person
a dealer, and some of those commenters specifically stated that a
person may use two-sided quotes as part of the price discovery
process or to elicit trading interest. See, e.g., letter from MFA I.
Here too, it is important to consider whether the activity also has
a dealing business purpose, such as seeking to profit by providing
liquidity. Moreover, all participants in the security-based swap
market, whether or not security-based swap dealers, should be
mindful of the potential application of the antifraud and anti-
manipulation provisions of the federal securities laws to such
activities. Section 10(b) of the Exchange Act and Exchange Act rule
10b-5 particularly prescribe the use of any manipulative or
fraudulent device in connection with the purchase or sale of any
security, which includes manipulative trading. See Terrance
Yoshikawa, Securities Exchange Act Release No. 53731 (Apr. 26,
2006), 87 SEC Docket 2924, 2930-31 & n.19 (citing Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 199 (1976)). The SEC has characterized
manipulation as ``the creation of deceptive value or market activity
for a security, accomplished by an intentional interference with the
free forces of supply and demand.'' See Swartwood, Hesse, Inc., 50
S.E.C. 1301, 1307 (1992) (citing Hochfelder, 425 U.S. at 199;
Schreiber v. Burlington Northern, Inc., 472 U.S. 1 (1985); Feldbaum
v. Avon Products, Inc., 741 F.2d 234 (8th Cir. 1984)).

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

     Providing advice in connection with security-based swaps
or structuring security-based swaps. Advising a counterparty as to how
to use security-based swaps to meet the counterparty's hedging goals,
or structuring security-based swaps on behalf of a counterparty, also
would indicate security-based swap dealing activity. It particularly is
important that persons engaged in those activities are appropriately
regulated so that their counterparties will receive the protections
afforded by certain of the statutory business conduct rules (e.g.,
special entity requirements and communication requirements) \268\
applicable to security-based swap dealers.\269\ The Commissions
recognize commenter concerns that end-users may also develop new types
of security-based swaps,\270\ but also recognize that the activities of
end-users related to the structuring of security-based swaps for
purposes of hedging commercial risk are appreciably different than
being in the business of structuring security-based swaps on behalf of
a counterparty.
---------------------------------------------------------------------------

    \268\ The SEC has proposed rules to implement Title VII
provisions relating to external business conduct standards for
security-based swap dealers (as well as major security-based swap
participants). See Exchange Act Release No. 64766 (June 29, 2011),
76 FR 42396 (July 18, 2011).
    \269\ This factor would also reasonably take into account
whether a preexisting relationship involving other types of
securities or other financial instruments is present. For example,
to the extent a person has an existing broker or dealer relationship
with a counterparty in connection with other types of securities,
and also enters into a security-based swap with that counterparty, a
reasonable inference would be that the person entered into the
security-based swap in a dealer capacity. Any other approach would
invite abuse, as persons could seek to leverage existing
relationships of trust while avoiding regulation as a security-based
swap dealer.
    \270\ See letter from FSR I.
---------------------------------------------------------------------------

     Presence of regular clientele and actively soliciting
clients. These dealer-trader factors would reasonably appear to be
applicable in the security-based swap context, just as they are
applicable in the context of other types of securities, as indicia of a
business model that seeks to profit by providing liquidity. The
Commissions are mindful that some industry participants have
highlighted a distinction between ``counterparties'' and ``customers''
in connection with swaps, and have suggested that they have no
``customers'' in the swap context. We do not believe such points of
nomenclature are significant for purposes of identifying security-based
swap dealers, however.\271\
---------------------------------------------------------------------------

    \271\ For purposes of the dealer-trader analysis, as it applies
in the context of security-based swaps or any other security, we
would not expect contractual provisions stating that the
counterparty is not relying on the person's advice to have any
significance.
---------------------------------------------------------------------------

     Use of inter-dealer brokers. As with activities involving
other types of securities, the Commissions would expect that a person's
use of an inter-dealer broker in connection with security-based swap
activities to be an indication of the person's status as a dealer.
     Acting as a market maker on an organized security-based
swap exchange or trading system. Acting in a market maker capacity on
an organized exchange or trading system for security-based swaps would
indicate that the person is acting as a dealer.\272\ While the
Commissions recognize that some commenters have expressed the view that
persons who solely enter into security-based swaps on an organized
security-based swap exchange or trading system should not be regulated
as security-based swap dealers,\273\ in our view such an approach would
be contrary to the express language of the definition. This is not to
say, of course, that the presence of an organized exchange or trading
system is a prerequisite to being a market maker for purposes of the
security-based swap dealer definition.\274\ Moreover, acting as a
market maker is not a prerequisite to being a security-based swap
dealer.\275\ On the other hand, being a member of an organized exchange
or trading system for purposes of trading security-based swaps does not
necessarily by itself make a person a security-based swap dealer.\276\
---------------------------------------------------------------------------

    \272\ Under the proposal of the SEC, the Board, the OCC and the
FDIC to implement the provisions of section 619 of the Dodd-Frank
Act (also known as the ``Volcker Rule''), a person who claims the
benefit of the market maker exception to that section's prohibitions
and restrictions on proprietary trading in connection with security-
based swap activities would be required to register with the SEC as
a security-based swap dealer, unless the person is exempt from
registration or is engaged in a dealing business outside the U.S.,
and is subject to substantive regulation in the jurisdiction where
the business is located. See Securities Exchange Act Release No.
65545, 76 FR 68846, 68947 (Nov. 7, 2011) (proposed implementing rule
Sec.  ------.4(b)(2)(iv)(C)).
    \273\ See, e.g., letter from Traders Coalition.
    \274\ Given the current nature of the security-based swap
market, including the present level of activity and the present lack
of significant trading of security-based swaps on exchanges or
organized trading systems, we believe that it would negate the
legislative intent to interpret the definition's use of market
making concepts to require the same use of quotation media that are
incorporated into the interpretation of market making concepts in
the context of securities that are actively traded on an organized
exchange or trading system. At the same time, we recognize that
routine activity in the security-based swap market is not
necessarily indicative of making a market in security-based swaps.
For example, persons may routinely be active in the market for
purposes of hedging, to advance their investment objectives, or to
engage in proprietary trading.
    \275\ The definition of ``security-based swap dealer'' contains
four alternative tests, only two of which use market making
terminology. Moreover, the third test of the security-based swap
dealer definition--which addresses persons who regularly enter into
security-based swaps as an ordinary course of business for their own
account--appears particularly inapt as a proxy for market making
activity. Transacting with customers is not an element of this
alternative test. A person thus may be a security-based swap dealer
even if it transacts exclusively with other market professionals.
Cf. OCC, ``Risk Management of Financial Derivatives'' 3-4 (1997)
(stating that OCC has classified banks as ``Tier I'' dealers if they
act as market makers by ``providing quotes to other dealers and
brokers, and other market professionals''). Compare letter from ISDA
I (taking the view that the dealer definition should be interpreted
in the context of market-making concepts).

    \276\ The analysis of the status of members of such exchanges
and trading systems in part may be influenced by the final Exchange
Act rules that govern such systems, as well as the internal rules of
such systems.
---------------------------------------------------------------------------

As with the current application of the dealer-trader distinction to the
Exchange Act ``dealer'' definition, the question of whether a person is
acting as a security-based swap dealer ultimately will turn upon the
relevant facts and circumstances, as informed by these criteria.
c. Additional Interpretive Issues
    Activity by hedgers. As noted above, a number of commenters raised
concerns that an overbroad ``security-based swap dealer'' definition
would inappropriately encompass persons

using security-based swaps for hedging purposes.\277\ As we stated in
the Proposing Release, however, under the dealer-trader distinction the
Commissions would expect persons that use security-based swaps to hedge
their business risks, absent other activity, likely would not be
dealers.\278\ We maintain that view. In other words, to the extent that
a person engages in security-based swap activity to hedge commercial
risk, or otherwise to hedge risks unrelated to activities that
constitute dealing under the dealer-trader distinction (particularly
activities that have the business purpose of seeking to profit by
providing liquidity in connection with security-based swaps), the
Commissions would not expect those hedging transactions to lead a
person to be a security-based swap dealer.\279\ Of course, to the
extent a person engages in dealing activities involving security-based
swaps, the presence of offsetting positions that hedge those dealing
activities would not excuse the requirement that the person register as
a security-based swap dealer.\280\
---------------------------------------------------------------------------

    \277\ See, e.g., letter from Church Alliance.
    \278\ See Proposing Release, 75 FR at 80178 n.27. The Proposing
Release also noted that if a person's other activities satisfy the
definition of security-based swap dealer, the person must comply
with the applicable requirements with regard to all of its security-
based swap activities, absent an order to the contrary. We further
noted in the Proposing Release that we would expect end-users to use
security-based swaps for hedging purposes less commonly than they
use swaps for hedging purposes.
    \279\ In addition, consistent with the exclusion from the dealer
analysis of activities involving majority-owned affiliates, see part
II.C, infra, to the extent that a person engages in activities to
hedge positions subject to the inter-affiliate exclusion, absent
other activity, the Commission would not expect those hedging
transactions to lead a person to be a security-based swap dealer.
Conversely, security-based swap activities connected with the
indicia of dealing discussed above (e.g., seeking to profit by
providing liquidity in connection with security-based swaps)
themselves would suggest security-based swap dealing activity.
    \280\ For example, if a person were to use other instruments to
hedge the risks associated with its security-based swap dealing
activity, that hedging would not undermine the obligation of the
person to register as a security-based swap dealer, notwithstanding
the fact that it could be asserted that the dealing positions happen
to hedge those other positions.
---------------------------------------------------------------------------

    No predominance test. As discussed in the Proposing Release, the
Commissions do not believe that the security-based swap dealer analysis
should appropriately turn upon whether a person's dealing activity
constitutes that person's sole or predominant business. The separate de
minimis exemption, however, may have the effect of excusing from dealer
regulation those persons whose security-based swap dealing activities
are relatively modest.
    Presence or absence of a customer relationship. Although commenters
have expressed the view that a person that engages in security-based
swap activities on an organized market should not be deemed to be a
dealer unless it engages in those activities with customers,\281\ we do
not agree. It is true that having a customer relationship can
illustrate a business model of seeking to profit by providing
liquidity, and thus provide one basis for concluding that a person is
acting as a security-based swap dealer. Nonetheless, the presence of
market making terminology within the definition is inconsistent with
the view that a security-based swap dealer must have ``customers.''
Also, Title VII requirements applicable to security-based swap dealers
address interests apart from customer protection.\282\ Accordingly, to
the extent that a person regularly enters into security-based swaps
with a view toward profiting by providing liquidity--rather than by
taking directional positions--that person may be a security-based swap
dealer regardless of whether it views itself as maintaining a
``customer'' relationship with its counterparties.\283\
---------------------------------------------------------------------------

    \281\ See letters from ISDA I and Traders Coalition.
    \282\ Particularly in light of the view expressed by some market
participants that they only have ``counterparties'' in the swap
markets, and not ``customers,'' any interpretation of the
``security-based swap dealer'' definition that is predicated on the
existence of a customer relationship may lead to an overly narrow
construction of the definition.
    \283\ For example, a person's activity involving entering into
security-based swaps on a SEF may cause it to be a security-based
swap dealer even in the absence of a customer relationship with any
of its counterparties.
---------------------------------------------------------------------------

    Criteria associated with ``holding self out'' as a dealer or being
``commonly known in the trade'' as a security-based swap dealer. The
Proposing Release articulated a number of activities that could satisfy
the definition's tests for a person ``holding itself out'' as a dealer
or being ``commonly known in the trade'' as a dealer.\284\ Several
commenters criticized those proposed criteria, largely on the grounds
that those criteria would inappropriately encompass end-users who seek
to use security-based swaps for hedging purposes, or otherwise would be
overbroad or irrelevant.\285\ The Commissions recognize the
significance of the concerns those commenters raised, and agree that
these activities need to be considered within the context of whether a
person engages in those activities with the purpose of facilitating
dealing activity. While we do not believe that any of those activities
by themselves would necessarily indicate that a person is acting as a
security-based swap dealer, under certain circumstances they may serve
as an indicia of a business purpose of seeking to profit by providing
liquidity in connection with security-based swaps.\286\
---------------------------------------------------------------------------

    \284\ As noted above, these were: contacting potential
counterparties to solicit interest; developing new types of swaps or
security-based swaps and informing potential counterparties of their
availability and of the person's willingness to enter into the swap
or security-based swap; membership in a swap association in a
category reserved for dealers; providing marketing materials
describing the type of swaps or security-based swaps the party is
willing to enter into; and generally expressing a willingness to
offer or provide a range of products or services that include swaps
or security-based swaps. See Proposing Release, 75 FR at 80178.
    \285\ See part II.A.2.a, supra.
    \286\ While the Proposing Release identified ``membership in a
swap association in a category reserved for dealers'' as a factor in
connection with the ``holding out'' and ``commonly known'' tests, we
recognize that, depending on the applicable facts and circumstances,
such membership may not be sufficient to cause a person to be a
security-based swap dealer if the person does nothing else to cause
it to be considered a dealer.
---------------------------------------------------------------------------

6. Requests for Exclusions From the Dealer Definitions
    Certain commenters have sought to exclude entire categories of
persons from the dealer definitions, notwithstanding that some persons
in those categories may engage in the activities set forth in the
statutory definition (as further defined by the Commissions).\287\ The
final rules nonetheless do not incorporate categorical exclusions of
persons from the dealer definitions because the statutory definitions
provide that ``any person'' who engages in the activities enumerated in
the definitions is covered by the dealer definitions, unless the
person's activities fall within one of the statutory exceptions.\288\
In this regard, it is significant that the exceptions in the dealer
definitions depend on whether a person engages in certain types of swap
or security-based swap activity, not on other characteristics of the
person. That is, the exceptions apply for swaps between an insured
depository institution and its customers in connection with originating
loans,\289\ swaps or security-based swaps entered into not as a part of
a regular business,\290\ and swap or security-based swap dealing that
is below a de minimis

level.\291\ The Dodd-Frank Act does not exclude any category of persons
from the coverage of the dealer definitions; rather, it excludes
certain activities from the dealer analysis.
---------------------------------------------------------------------------

    \287\ See part II.A.2.f, supra.
    \288\ See CEA section 1a(49), 7 U.S.C. 1a(49); Exchange Act
section 3(a)(71), 15 U.S.C. 78c(a)(71).
    \289\ See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
    \290\ See CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C); Exchange
Act section 3(a)(71)(C), 15 U.S.C. 78c(a)(71)(C).
    \291\ See CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D); Exchange
Act section 3(a)(71)(D), 15 U.S.C. 78c(a)(71)(D).
---------------------------------------------------------------------------

    Given that the statutory dealer definitions focus on a person's
activity, the Commissions believe that it is appropriate to determine
whether a person meets any of the tests set forth in those statutory
definitions, and thus is acting as a swap dealer or security-based swap
dealer, on a case-by-case basis reflecting the applicable facts and
circumstances.\292\ If a person's swap or security-based swap
activities are of a nature to be covered by the statutory definitions,
and those activities are not otherwise excluded, then the person is
covered by the definitions. The contrary is equally true--a person who
is not engaged in activities covered by the statutory definitions, or
whose activities are excluded from the definition, is not covered by
the definitions.\293\ The per se exclusions requested by the commenters
have no foundation in the statutory text, and have the potential to
lead to arbitrary line drawing that may result in disparate regulatory
treatment and inappropriate competitive advantages.\294\
---------------------------------------------------------------------------

    \292\ The Commissions believe that a facts and circumstances
approach is particularly appropriate here, where the broad terms of
the statutory dealer definitions indicate that the Commissions
should apply their expertise and discretion to interpret the
statutory text.
    \293\ For example, a manufacturer, producer, processor, or
merchant that enters into swaps to hedge its currency or interest
rate risk, absent any facts and circumstances establishing dealing
activity, is not a swap dealer.
    \294\ In response to the commenters concerns, the Commissions
have adopted certain tailored exclusions of certain types of swaps
and security-based swaps in the final rule.
---------------------------------------------------------------------------

    The final rules particularly do not include any exclusions for
aggregators of swaps or other persons that use swaps in connection with
the physical commodity markets, including swaps in connection with the
generation, transmission and distribution of electricity. It is likely,
though, that a significant portion of the financial instruments used
for risk management by such persons are forward contracts in
nonfinancial commodities that are excluded from the definition of the
term ``swap.'' \295\ Such forward contracts are not relevant in
determining whether a person is a swap dealer.
---------------------------------------------------------------------------

    \295\ A coalition of not-for-profit power utilities and electric
cooperatives has advised that it plans to submit a request for an
exemption for transactions between entities described in section
201(f) of the Federal Power Act, as contemplated by section 722(f)
of the Dodd-Frank Act. See letter from NFPEEU. Separately, some
regional transmission organizations and independent systems
operators have expressed interest in submitting an exemption
application to the CFTC as well. See generally section 722(e) of the
Dodd-Frank Act. Such exemptions, if granted after notice and comment
pursuant to CEA section 4(c), 7 U.S.C. 6(c), could further address
commenters' concerns in this regard.
---------------------------------------------------------------------------

B. ``Swap Dealer'' Exclusion for Swaps in Connection With Originating a
Loan

1. Proposed Approach
    The statutory definition of the term ``swap dealer'' excludes an
insured depository institution (``IDI'') ``to the extent it offers to
enter into a swap with a customer in connection with originating a loan
with that customer.'' \296\ This exclusion does not appear in the
definition of the term ``security-based swap dealer.''
---------------------------------------------------------------------------

    \296\ See CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).
---------------------------------------------------------------------------

    Proposed CFTC Regulation Sec.  1.3(ggg)(5) would implement this
statutory exclusion by providing that an IDI's swaps with a customer in
connection with originating a loan to that customer are disregarded in
determining if the IDI is a swap dealer. In order to prevent evasion,
the proposed rule further provided that the statutory exclusion does
not apply where the purpose of the swap is not linked to the financial
terms of the loan; the IDI enters into a ``sham'' loan; or the
purported ``loan'' is actually a synthetic loan such as a loan credit
default swap or loan total return swap.
1. Commenters' Views
    Nearly all the commenters on this issue were IDIs seeking a broad
interpretation of the exclusion. The commenters addressed four primary
issues: (i) The type of swaps that should be covered by the exclusion;
(ii) the time period during which parties would be required to enter
into the swap in order for the swap to be considered to be ``in
connection with originating a loan;'' (iii) which transactions should
be deemed to be ``loans'' for purposes of the exclusion; and (iv) which
entities should be included within the definition of IDI.
    First, regarding the type of swap that should be covered by the
exclusion, as proposed, Sec.  1.3(ggg)(5) would require that the rate,
asset, liability or other notional item underlying the swap be, or be
directly related to, a financial term of the loan (such as the loan's
principal amount, duration, rate of interest or currency). Some
commenters agreed with the principle of limiting the exclusion to swaps
that are connected to the financial terms of the loan, stating that the
exclusion should cover any swap between a borrower and the lending IDI,
so long as the swap's notional amount is no greater than the loan
amount, the swap's duration is no longer than the loan's duration, and
the swap's index and payment dates match the index and payment dates of
the loan.\297\ Another commenter, agreeing with the proposed approach,
said that there is no basis to extend the loan origination exclusion to
swaps related to the borrower's business risks, as opposed to the
financial terms of the loan.\298\
---------------------------------------------------------------------------

    \297\ See letters from Branch Banking & Trust Company (``BB&T'')
dated February 3, 2011 (``BB&T I''), B&F Capital Markets, Inc.
(``B&F Capital'') dated February 18, 2011 (``B&F Capital I''),
Capital One Financial Corporation (``Capital One'') and Capstar Bank
(``Capstar''); see also joint letter from Atlantic Capital Bank,
Cobiz Bank, Cole Taylor Bank, Commerce Bank, N.A., East West Bank,
First Business Bank, First National Bank of Pennsylvania, Heartland
Financial USA, Inc., Old National Bancorp, Peoples Bancorp of North
Carolina, Inc., Susquehanna Bank, The PrivateBank and Trust Co, The
Savannah Bank, N.A., The Washington Trust Company, Trustmark
National Bank, UMB Financial Corporation, Valley National Bank,
Webster Bank NA, WesBanco Bank (``Regional Banks'') (general support
for limitation to swaps connected to financial terms of the loan).
    \298\ See letter from Better Markets I.
---------------------------------------------------------------------------

    Other commenters, though, said that this limitation to swaps
connected to the financial terms of the loan was inappropriate or
inconsistent with the Dodd-Frank Act, and that any swap required by the
loan agreement or required by the IDI as a matter of prudent lending
should be covered by the exclusion.\299\ Some of the commenters arguing
for the broader exclusion emphasized that the exclusion should be
available for any swap with the lending IDI which reduces the
borrower's risks, such as a commodity swap the borrower uses for
hedging, because reduction of commodity price risks faced by the
borrower also reduces the risk that the loan will not be repaid to the
IDI.\300\ Commenters said that if the exclusion does not apply to swaps
hedging the borrower's commodity price risks, then only IDIs that are
able to create a separately capitalized affiliate will be able to offer
commodity swaps (because section 716 of the Dodd-Frank Act limits the
ability of IDIs to offer commodity swaps), thereby reducing the
availability of commodity swaps to

borrowers that are smaller companies.\301\
---------------------------------------------------------------------------

    \299\ See letters from BOK dated February 18, 2011 (``BOK II''),
FSR I, ISDA I, Midsize Banks, OCC Staff at 6 (noting that ``[l]oan
underwriting criteria for community and mid-size banks * * * may
require, as a condition of the loan, that the borrower be hedged
against the commodity price risks incidental to its business'') and
White & Case LLP (``White & Case'') and joint letter from Senator
Stabenow and Representative Lucas.
    \300\ See letters from BOK II, FSR I, OCC Staff and White &
Case.
    \301\ See letters from ABA I and BOK I. Other commenters
addressed the relationship between the swap dealer definition and
section 619 of the Dodd-Frank Act (the ``Volcker Rule''). See joint
letter from Capital One, Fifth Third Bancorp and Regions Financial
Corporation.
---------------------------------------------------------------------------

    Second, regarding timing, the proposed rule requested comment on
whether this exclusion should apply only to swaps that are entered into
contemporaneously with the IDI's origination of the loan (and if so,
how ``contemporaneously'' should be defined for this purpose), or
whether this exclusion also should apply to swaps entered into during
part or all of the duration of the loan. In response, commenters said
that the exclusion should apply to swaps entered into in anticipation
of a loan or at any time during the loan term.\302\ Commenters said
that application of the exclusion throughout the duration of the loan
would give IDIs and borrowers flexibility as to when to fix interest
rates in fixed/floating swaps relating to loans and would allow
borrowers to make other hedging decisions over a longer time
period.\303\ Commenters also said that loans such as construction
loans, equipment loans and committed loan facilities may allow for
draws of loan principal over an extended period of time, and that swaps
entered into by the borrower and lending IDI through the course of such
a loan should be covered by the exclusion.\304\
---------------------------------------------------------------------------

    \302\ See letters from BB&T I, B&F Capital I, BOK II, Capital
One, Capstar, FSR I, Midsize Banks, Manufacturers and Traders Trust
Company (``M&T'') dated June 3, 2011 (``M&T I'') and September 28,
2011 (``M&T II''), Peoples Bank Co. (``Peoples Bank''), Regional
Banks and White & Case.
    \303\ See letters from B&F Capital I, BOK II, Capital One,
Capstar and M&T I and M&T II.
    \304\ See letters from FSR dated October 17, 2011 (``FSR VI''),
M&T II and Wells Fargo Bank, N.A. (``Wells Fargo'') dated August 16,
2011 (``Wells Fargo II'').
---------------------------------------------------------------------------

    Third, as to which transactions should be deemed ``loans'' for
purposes of the exclusion, the proposal said that the exclusion should
be available in connection with all transactions by which an IDI is a
source of funds to a borrower, including, for example, loan
syndications, participations and refinancings. Commenters agreed that
the exclusion should be available for IDIs that are in a loan
syndicate, purchasers of a loan, assignees of a loan or participants in
a loan.\305\ On loan syndications and participations in particular, one
commenter said that the exclusion should be available even if the
notional amount of the swap is more than the amount of the loan tranche
assigned to the IDI, so long as the swap notional amount is not more
than the entire amount of the loan.\306\ Another commenter said that
the exclusion should not be available if the IDI's participation in the
loan drops below a minimum level (such as 20 percent) because such use
of the exclusion by minimally-participating IDIs would invite
abuse.\307\
---------------------------------------------------------------------------

    \305\ See letters from BB&T I, Midsize Banks, Regional Banks and
White & Case; see also letter from Loan Market Association
(providing background information on loan participations).
    \306\ See letter from Regional Banks.
    \307\ See letter from Better Markets I.
---------------------------------------------------------------------------

    Some commenters said that other types of transactions also should
be treated as ``loans'' for purposes of the exclusion. The transactions
cited by commenters in this regard include leases, letters of credit,
financings documented as sales of financial assets, bank qualified tax
exempt loans and bonds that are credit enhanced by an IDI.\308\ Other
commenters said the exclusion should apply where entities related to an
IDI provide financing, such as loans or financial asset purchases by
bank-sponsored commercial paper conduits where the IDI provides
committed liquidity,\309\ and transactions where a special purpose
entity formed by an IDI is the source of financing and enters into the
swap.\310\ Some commenters said the exclusion should encompass all
transactions where an IDI facilitates a financing,\311\ or all
extensions of credit by an IDI,\312\ or all transactions where an IDI
provides risk mitigation to a borrower.\313\
---------------------------------------------------------------------------

    \308\ See letters from BB&T I, Capital One, FSR I, M&T I,
Midsize Banks and Regional Banks.
    \309\ See letter from FSR I.
    \310\ See letter from Midsize Banks.
    \311\ See letters from Pacific Coast Bankers' Bancshares
(``PCBB'') and Regional Banks.
    \312\ See letters from FSR I and Midsize Banks.
    \313\ See letter from PCBB.
---------------------------------------------------------------------------

    Fourth, with respect to the types of financial institutions that
are eligible for the loan origination exclusion, three commenters said
that IDIs, for purposes of this exclusion, encompass more than banks or
savings associations with federally-insured deposits. The Farm Credit
Council said the exclusion should be extended to Farm Credit System
institutions because one of these institutions enters into interest
rate swaps with borrowing customers identical in function to those
offered by commercial banks and savings associations in connection with
loans, and the institutions are subject to similar regulatory
requirements and covered by a similar insurance regime.\314\ Another
commenter said that the exclusion should be extended to other regulated
financial institutions, such as insurers, so as not to create an
unlevel playing field.\315\ And the Federal Home Loan Banks said that
the exclusion should be available to them because they are subject to
similar regulatory oversight and capital standards and engage in a
similar function of extending credit as do commercial banks and savings
associations.\316\ In addition, some commenters said the exclusion
should be broadly construed as a general matter, to encourage
competition in the swap market between smaller and larger banks and to
increase borrowers' choice among potential swap providers.\317\
---------------------------------------------------------------------------

    \314\ Consequently, the Farm Credit Council argued, disallowing
these institutions from using the exclusion would give commercial
banks and savings associations a competitive advantage in
agricultural lending. See letters from Farm Credit Council I and
dated February 17, 2012 (``Farm Credit Council II''). Another
commenter argued that, to the contrary, making Farm Credit System
institutions eligible for the exclusion would confer an
inappropriate competitive advantage on those institutions. See
letter from ABA dated February 14, 2012 (``ABA II''). This commenter
said that Farm Credit System institutions have certain advantages
over other IDIs, and the commenter asserted that Farm Credit System
institutions were left out of the statutory language of the
exclusion in order that they would not receive additional
competitive advantages. See id.
    \315\ See letter from NAIC.
    \316\ See letter from FHLB I. The Credit Union National
Association said that the Federal Home Loan Banks should not be
covered by the swap dealer definition because they do not enter into
swaps for their own account as part of a regular business. See
letter from CUNA.
    \317\ See letters from BB&T I, B&F Capital dated June 1, 2011
(``B&F Capital II''), Capital One, Capstar, M&T I and Peoples Bank.
---------------------------------------------------------------------------

    Two commenters asked for clarification of the following technical
points in the proposed rule: (i) Whether a swap would be covered by the
exclusion even if it does not hedge all the risks under the loan, (ii)
whether a swap that is within the exclusion could continue to be
treated as covered by the exclusion by an IDI if the IDI transfers the
loan, and (iii) whether an IDI should count swaps covered by the
exclusion in determining if its dealing activity is above the de
minimis thresholds.\318\ Another commenter asked whether an IDI with
swaps that are covered by the exclusion could be a swap dealer based on
other dealing activity.\319\ And others asked whether the exclusion
would cover swaps used by an IDI to hedge its risks arising from a loan
(i.e., a swap which the IDI enters into with a party other than the
loan borrower).\320\
---------------------------------------------------------------------------

    \318\ See letters from FSR VI and Midsize Banks.
    \319\ See letter from Better Markets I.
    \320\ See letters from B&F Capital I, FSR I, ISDA I, M&T I and
Midsize Banks.
---------------------------------------------------------------------------

3. Final Rule
    The CFTC believes that the extent of this exclusion should be
determined by

the language of the statutory definition, which relates to an IDI that
``offers to enter into a swap with a customer in connection with
originating a loan with that customer.'' The expansive interpretation
of the exclusion advanced by some commenters, however, would read the
statute to exclude almost any swap that an IDI enters into with a loan
customer. That is not the exclusion that was enacted. Instead, we
interpret the statutory phrase ``enter into a swap with a customer in
connection with originating a loan with that customer'' to mean that
the swap is directly connected to the IDI's process of originating the
loan to the customer.
    Because of the statute's direct reference to ``originating'' the
loan, it would be inappropriate to construe the exclusion as applying
to all swaps entered into between an IDI and a borrower at any time
during the duration of the loan. If this were the intended scope of the
statutory exclusion, there would be no reason for the text to focus on
swaps in connection with ``originating'' a loan. The CFTC recognizes
the concern expressed by commenters that: (i) there be flexibility
regarding when the IDI and borrower enter into a swap relating to a
loan, and (ii) the expectation when an IDI originates a loan with a
customer is often that the customer will enter into a swap with the IDI
when there is a subsequent advance, or a draw, of principal on the
loan. We do not believe, however, that the statutory term
``origination'' can reasonably be stretched to cover the entire term of
every loan that an IDI makes to its customers. At some point, the
temporal distance renders the link to loan origination too attenuated,
and the risk of evasion too great, to support the exclusion. In order
to balance these competing and conflicting considerations, the final
rule applies the exclusion to any swap that otherwise meets the terms
of the exclusion and is entered into no more than 90 days before or 180
days after the date of execution of the loan agreement, or no more than
90 days before or 180 days after the date of any transfer of principal
to the borrower from the IDI (e.g., a draw of principal) pursuant to
the loan, so long as the aggregate notional amount of the swaps in
connection with the financial terms of the loan at any time is no more
than the aggregate amount of the borrowings under the loan at that
time.\321\
---------------------------------------------------------------------------

    \321\ We note that because the exclusion is available within the
specified time period around the execution of the loan agreement and
any draw of principal under the loan, any amendment, restructuring,
extension or other modification of the loan will, in itself, neither
preclude application of the exclusion nor expand application of the
exclusion.
---------------------------------------------------------------------------

    Since a loan involves the repayment of funds to the IDI on
particular terms, a swap that relates to those terms of repayment
should be covered by the exclusion. In addition, we recognize that, as
stated by commenters, requirements in an IDI's loan underwriting
criteria relating to the borrower's financial stability are an
important part of ensuring that loans are repaid.\322\ Therefore, the
final rule modifies the proposed rule to provide that the exclusion
applies to swaps between an IDI and a loan borrower that are connected
to the financial terms of the loan, such as, for example, the loan's
duration, interest rate, currency or principal amount, or that are
required under the IDI's loan underwriting criteria to be in place as a
condition of the loan in order to hedge commodity price risks
incidental to the borrower's business.\323\ The first category of swaps
generally serve to transform the financial terms of a loan for purposes
of adjusting the borrower's exposure to certain risks directly related
to the loan itself, such as risks arising from changes in interest
rates or currency exchange rates. The second category of swaps mitigate
risks faced by both the borrower and the lender, by reducing risks that
the loan will not be repaid. Thus, both types of swaps are directly
related to repayment of the loan. Although some commenters said that
this exclusion should also apply to other types of swaps, we believe it
would be inappropriate to construe this exclusion as encompassing all
swaps that are connected to a borrower's other business activities,
even if the loan agreement requires that the borrower enter into such
swaps or otherwise refers to them.\324\ In contrast to a swap that
transforms the financial terms of a loan or is required by the IDI's
loan underwriting criteria to reduce the borrower's commodity price
risks, other types of swaps serve a more general risk management
purposes by reducing other risks related to the borrower or the loan.
If the purpose of the exclusion were to cover the broad range of swaps
cited by some commenters (such as all swaps reducing a borrower's
business risks), then the terms of the statute limiting the exclusion
to swaps that are ``in connection with originating a loan with that
customer'' would be superfluous.\325\ To give effect to the statutory
text, the exclusion is limited to a swap that is connected to the
financial terms of the loan or is required by the IDI's loan
underwriting criteria to to be in place as a condition of the loan in
order to hedge commodity price risks incidental to the borrower's
business.
---------------------------------------------------------------------------

    \322\ See letter from OCC Staff.
    \323\ The final rule provides that the second category of swaps
must hedge a price risk related to a commodity other than an
excluded commodity because if the price risk relates to an excluded
commodity (such as an interest rate) the swap must be connected to
the financial terms of the loan in order to be covered by the
exclusion.
    \324\ On the other hand, there is no requirement that the loan
agreement reference a swap in order for the swap to be excluded, if
the swap otherwise qualifies for the exclusion.
    \325\ Also, we believe that the broader range of swaps serving
general risk management purposes are more likely to involve concerns
regarding market transparency and appropriate business conduct
practices addressed by swap dealer regulation than are the narrower
range of swaps that are encompassed by the exclusion.
---------------------------------------------------------------------------

    Regarding the types of transactions that will be treated as a
``loan'' for purposes of the exclusion, courts have defined the term
``loan'' in other statutory contexts based on the settled meaning of
the term under common law. This definition encompasses any contract by
which one party transfers a defined quantity of money and the other
party agrees to repay the sum transferred at a later date.\326\ Rather
than examine at this time the many particularized examples of financing
transactions cited by some commenters, the term ``loan'' for purposes
of this exclusion should be interpreted in accordance with this settled
legal meaning.\327\
---------------------------------------------------------------------------

    \326\ See, e.g., In Re Renshaw, 222 F.3d 82, 88 (2d Cir. 2000)
(``Because Congress did not define the term ``loan'' for [11 U.S.C.]
Sec.  523(a)(8), we must interpret it according to its settled
meaning under common law. The classic definition of a loan [is] * *
* as follows: To constitute a loan there must be (i) a contract,
whereby (ii) one party transfers a defined quantity of money, goods,