a central counterparty fail beyond the level to which such risk is
managed, however, the central counterparty would also be at risk of
failure. Cf. Basel Committee on Banking Supervision, Consultative
Document, ``Capitalisation of bank exposures to central
counterparties,'' Nov. 25, 2011 (available at: http://www.bis.org/publ/bcbs206.pdf) (proposing that the capital charge for trade
exposures to a qualifying central counterparty should carry a low
risk weight, reflecting the relatively low risk of default of the
qualifying central counterparty). In addition, as the CFTC and SEC
discussed in the Proposing Release, see 75 FR at 80192 n. 115, for
example, central counterparties that clear credit default swaps do
not necessarily become the counterparties of their members'
customers (although even absent direct privity those central
counterparties benefit customers by providing for protection of
collateral they post as margin, and by providing procedures for the
portability of customer positions in the event of a member's
default). As a result, central clearing may not eliminate the
counterparty risk that the customer poses to the member, although
required mark-to-market margining should help control that risk, and
central clearing would be expected to reduce the likelihood that an
entity's default would lead to broader market impacts.
---------------------------------------------------------------------------

    Moreover, although some commenters opposed any deduction from the
measure of potential future exposure for uncleared positions that are
margined on a daily basis,\1374\ the CFTC believes that the risk-
mitigating attributes of daily margining warrant an adjustment given
that the goal of the potential future exposure test is to account for
price movements over the remaining life of the contract.\1375\ The use
of a 0.2 factor also reflects the CFTC's expectation that the risk
mitigation associated with uncleared but margined positions would be
less than the risk mitigation associated with cleared positions.
---------------------------------------------------------------------------

    \1374\ See letter from Better Markets I; see also letter from
AFR.
    \1375\ The CFTC does not believe that it is appropriate to have
this type of discount when mark-to-market margining is done less
than daily, however.
---------------------------------------------------------------------------

    While higher or lower alternatives to the 0.1 and 0.2 factors may
also be reasonable for positions that are cleared or margined on a
daily basis, the CFTC believes that the factors of the final rules
reasonably reflects the risk mitigating (but not risk eliminating)
features of those practices. The final rules also retain and clarify
provisions addressing when daily mark-to-market margining occurs for
purposes of this discount.\1376\
---------------------------------------------------------------------------

    \1376\ The CFTC recognizes that at times, market participants
whose agreements provide for the daily exchange of variation margin
in connection with swaps in practice may not exchange collateral
daily, if the amounts at issue are relatively small (such through
the use of collateral thresholds and minimum transfer amounts). We
do not believe that such practices would be inconsistent with
providing a discount for daily margining practices. The proposed
rules sought to accommodate those practices by providing that
positions would be considered to be subject to daily mark-to-market
margining for purposes of the ``uncollateralized outward exposure''
plus ``potential outward exposure'' analysis, so long as the total
of such thresholds, and the total of such minimum transfer amounts
above $1 million are deemed to be ``uncollateralized outward
exposure'' for those purposes.
    In light of commenter concerns, which indicated that the
proposal was not fully clear about the mechanics and purpose of this
approach, the relevant rule language has been revised to clarify
that this attribution of thresholds and minimum transfer amounts is
solely for the purpose of determining whether certain positions are
subject to daily mark-to-market margining for purposes of the
analysis. In addition, the final rules have been revised from the
proposal to provide that the attribution of thresholds as
``uncollateralized outward exposure'' for these purposes will be
reduced by initial margin posted, up to the amount of the threshold.
See CFTC Regulation Sec.  1.3(jjj)(iii)(B); Exchange Act rule 3a67-
3(c)(3)(ii).
---------------------------------------------------------------------------

d. Difficulty in Applying the Major Swap Participant Calculations
    While commenters generally acknowledged that the proposed
quantitative threshold tests are objective, some said that the proposed
tests are difficult to understand and

hard to apply.\1377\ Another commenter submitted that ``[the CFTC]
should solicit feedback from market participants prior to final rule
given the complexity of tests and likely interpretive issues; proposed
tests are highly technical, and more challenging to use than may appear
at first glance; could also request volunteers to walk-through the
tests to ensure they actually function in practice.''\1378\ Several
commenters suggested means of reducing the costs of applying the
proposed tests. Some commenters requested that the CFTC adopt a ``safe
harbor'' provision in the final rules for swap users with positions
that are substantially below the thresholds.\1379\ Another commenter
opined that the rule should allow persons to rely on third-party
service providers to conduct the required calculations.\1380\ In
addition, a commenter said the rule should allow swap users to apply
standard industry practices in valuing their positions.\1381\
---------------------------------------------------------------------------

    \1377\ See, e.g., letters from Fidelity, Freddie Mac, ISDA I and
SIFMA AMG II.
    \1378\ See letter from WGCEF II at 11.
    \1379\ See letters from AII, Vanguard and SIFMA AMG II. Another
commenter submitted that swap dealers will require counterparties to
run the major swap participant calculations in order to certify that
they are not major swap participants, even in cases where it is
readily evident that they are not major swap participants. See
meeting with CalSTRS on April 15, 2011.
    \1380\ See letter from ISDA I.
    \1381\ See id.
---------------------------------------------------------------------------

    We believe that the guidance in this Adopting Release reduces the
costs of determining if a person is covered by the definition. For
example, in response to commenters' concerns we clarify that a person
may determine the value of its exposure using industry standard
practices.\1382\ Also, we believe that the daily calculation burdens
associated with the proposed thresholds will be addressed by safe
harbors that are available if a simplified calculation shows that a
person's exposure from its swap position is far below any threshold for
any particular month. The final rule includes safe harbors to reduce
unnecessary costs for entities that, because of compliance concerns,
would engage in major swap participant calculations even though it
would be very unlikely that the major swap participant thresholds would
be met.\1383\ Also, the CFTC will permit third-party service providers
to perform major swap participant calculations, although a person that
may be a major swap participant is not relieved of potential liability
for violations of the CEA if there is a calculation or other error by
the third-party.\1384\
---------------------------------------------------------------------------

    \1382\ See part IV.B.3.b, supra.
    \1383\ See part IV.M.2, supra.
    \1384\ See part IV.B.3.e, supra.
---------------------------------------------------------------------------

e. Exclusions for Particular Types of Entities
    Commenters said that exclusions from the major swap participant
definition should be available for certain entities including insurance
companies, registered investment companies, entities that maintain
legacy portfolios of swaps, ERISA plans, and sovereign wealth
funds.\1385\ Some commenters cited, as the underlying basis for
excluding these entities, the existing regulatory regime to which these
entities are subject and the potential for dual regulation if they were
covered by the definition of the term ``major swap participant.''\1386\
One commenter asserted that a lack of clarity with respect to proposed
exemptive relief will impose additional costs on market participants
due to the uncertainty in determining major swap participant
status.\1387\
---------------------------------------------------------------------------

    \1385\ See part IV.J.2, supra.
    \1386\ See id. For example, commenters said that registered
investment companies and corresponding registered investment
advisers should be excluded from the definition of major swap
participant because they are highly regulated by the SEC pursuant to
the ICA and the Investment Advisers Act of 1940, and therefore major
swap participant regulation would be duplicative. See joint letter
from ICI and SIFMA AMG.
    \1387\ See letter from MetLife.
---------------------------------------------------------------------------

    Several commenters said that sovereign wealth funds should be
excluded from the definition of major swap participant based on
international principles of comity and sovereign immunity.\1388\ These
commenters asserted that sovereign wealth funds are regulated in their
home country and do not represent the type of counterparty risk
contemplated by the Dodd-Frank Act. A commenter asserted that special
purpose vehicles for structured finance or securitization should be
exempted from the definition of major swap participant so as to not
harm liquidity in asset securitizations.\1389\ That commenter based its
recommendation on the understanding that special purpose vehicles have
limited functionality and resources and would accordingly be unable to
comply with the burden of regulation as a major swap participant.\1390\
---------------------------------------------------------------------------

    \1388\ See letters from CIC and GIC and meeting with Weil.
    \1389\ See letter from ISDA I.
    \1390\ See id.
---------------------------------------------------------------------------

    The final rule does not have specific exclusions for certain types
of entities. The CFTC believes that a more level playing field is
desirable to ensure no particular type of entity gains an unfair
competitive advantage in the market.
    The appropriate treatment of ``legacy portfolios'' (e.g., the
monoline insurers or their special purpose vehicles) will be determined
on a case-by-case basis by the CFTC. Legacy portfolio operators
specifically commented that they are in ``run-off''/wind down mode,
thereby undertaking no new swaps that would increase their risk, with
an expectation to shut down or cease operations once their portfolio
expires.\1391\ As a result, these commenters maintain that margin or
capital requirements would likely lead to their insolvency because they
do not have the assets to satisfy the proposed requirements. The CFTC
notes that many of the compliance obligations imposed by the Dodd-Frank
Act and/or the business conduct rules promulgated thereunder will not
apply to operators of legacy portfolios because such obligations will
not be applicable to swaps executed prior to the enactment of the Dodd-
Frank Act such as the swaps in legacy portfolios.\1392\ Consequently,
the CFTC expects legacy portfolio operators' primary compliance
obligation to be related to reporting and risk management.
---------------------------------------------------------------------------

    \1391\ See letters from Athilon, Berkshire Hathaway, ISDA I,
MBIA and Newedge. As noted in part IV.J.3.a, supra, the CFTC
understands that legacy portfolios are no longer entering into new
transactions other than to novate, amend and hedge their existing
positions. In connection with any potential exclusion, however,
legacy portfolios would still be required to report to SDRs
information about their swap transactions and positions. See letters
from BlackRock I and Canadian MAVs.
    \1392\ See CFTC, Swap Data Recordkeeping and Reporting
Requirements: Pre-Enactment and Transition Swaps; Final Rule, 77 FR
2136 (Jan. 13, 2012).
---------------------------------------------------------------------------

f. CEA Section 15(a) Discussion
    The costs and benefits of the rule further defining the term
``major swap participant'' are evaluated in light of the section 15(a)
five broad areas of market and public concern.
    Protection of market participants and the public. The rule helps
parties to identify when they have substantial positions or substantial
counterparty exposures in swap markets that would cause them to be
covered by the definition of major swap participant. Under the Dodd-
Frank Act, major swap participants are subject to regulations enacted
to protect market participants and the public. The costs and benefits
of the statutory and regulatory requirements for major swap
participants are addressed in the various rulemakings in which they are
promulgated.\1393\
---------------------------------------------------------------------------

    \1393\ See part VII.C.2, supra.

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

    Efficiency, competitiveness, and financial integrity of markets. To
date, potential major swap participants have engaged in swaps in an
off-exchange marketplace that has been largely unregulated. Once the
regulations required under the Dodd-Frank Act are adopted and
effective, major swap participants will be subject to CFTC oversight
and comprehensive regulation. The CFTC believes these regulations will
improve the financial integrity of swap markets and the U.S. financial
system generally. Since the number of persons that are expected to be
major swap participants is small, the CFTC believes that these
regulations will not have a significant effect on the efficiency or
competitiveness of the markets.
    Price discovery. The CFTC does not perceive any direct effect on
price discovery from the rule further defining the term ``major swap
participant.''
    Sound risk management practices. The level of the major swap
participant thresholds may discourage persons from engaging in swap
activities that might cause them to exceed the major swap participant
thresholds. This reduction in the use of swaps could be costly if other
alternatives are not as suitable for the underlying risks (e.g.,
futures might have different contract sizes or expiration, and forward
contracts introduce physical risks not present in cash settled
transactions). The CFTC notes that this concern is mitigated by the
relatively high threshold levels for major swap participant status.
    Other public interest considerations. The specific quantitative
thresholds in the rule set forth definitive tests for determining if a
person is covered by the definition of the term ``major swap
participant.'' This specific, quantitative threshold serves the public
interest by promoting efficient application of the rule. Also, as noted
above, major swap participants will be subject to CFTC oversight and
comprehensive regulation, which we believe will improve the financial
integrity of swap markets and the U.S. financial system generally.
6. Costs and Benefits of the Rules Relating to the Definition of
``Eligible Contract Participant''
a. Background
    The ECP regulations and interpretation fall within the following
six categories:
     CFTC Regulation Sec.  1.3(m)(5)(i) prevents a commodity
pool (i) in which any of the pool's direct participants is not an ECP
in its own right and (ii) that directly enters into retail forex
transactions from being an ECP under CEA section 1a(18)(A)(iv) or (v),
for purposes of retail forex transactions only. CFTC Regulation Sec.
1.3(m)(5)(ii) provides that the CFTC would look through a commodity
pool participant that directly participates in a transaction-level
commodity pool only if such direct commodity pool participant, any
entity holding an interest in such direct commodity pool participant,
or any entity in which such direct commodity pool participant holds an
interest were structured to evade subtitle A of Title VII of the Dodd-
Frank Act by permitting persons that are not ECPs to participate in
retail forex transactions. The look-through in CFTC Regulation Sec.
1.3(m)(5)(ii) does not apply to a non-commodity pool participant in a
commodity pool.
     CFTC Regulation Sec.  1.3(m)(6) excludes a commodity pool
from ECP status if it does not have total assets exceeding $5,000,000
or is not operated by a person described in CEA section
1a(18)(A)(iv)(II).\1394\
---------------------------------------------------------------------------

    \1394\ 7 U.S.C. 1a(18)(A)(iv)(II).
---------------------------------------------------------------------------

     CFTC Regulations Sec.  1.3(m)(1)-(4) define major swap
participants, swap dealers, major security-based swap participants and
security-based swap dealers, respectively, as ECPs.
     CFTC Regulation Sec.  1.3(m)(7) permits an otherwise non-
ECP to qualify as an ECP, with respect to certain swaps, based on the
collective net worth of its owners, subject to several conditions,
including that the owners are ECPs.
     CFTC Regulation Sec.  1.3(m)(8) permits a Forex Pool to
qualify as an ECP notwithstanding that it has one or more direct
participants that are not ECPs if the Forex Pool (a) is not formed for
the purpose of evading regulation under CEA sections 2(c)(2)(B) or (C)
or related rules, regulations or orders, (b) has total assets exceeding
$10 million and (c) is formed and operated by a registered CPO or by a
CPO who is exempt from registration as such pursuant to CFTC Regulation
Sec.  4.13(a)(3).
     Finally, the Commissions have provided an interpretation
to address an incorrect statutory cross-reference preventing certain
government entities from qualifying as ECPs under CEA section
1a(18)(A)(vii).\1395\
---------------------------------------------------------------------------

    \1395\ 7 U.S.C. 1a(18)(A)(vii).
---------------------------------------------------------------------------

b. Summary of Comments
    Commenters stated that commodity pools will incur costs to comply
with statutory and regulatory requirements made applicable as a result
of the Commissions' narrowing of the ECP definition.\1396\ Commenters
argued that to apply the look-through at any investment level would be
unnecessarily burdensome and disruptive to how commodity pools are
structured, with resulting costs.\1397\ One commenter advised that, if
a trading advisor cannot be sure that all pool participants are ECPs,
then it must be cautious and either register as a CPO or decide not to
engage in Retail Forex Transactions on behalf of its advised
pools.\1398\ Another commenter stated that while many existing
commodity pools have already obtained accredited investor and QEP
representations from participants, virtually none currently obtain ECP
representations from their investors.\1399\ This commenter argued that
obtaining such a representation would impose an operational burden and
additional costs, as well as require commodity pools to redeem non-
ECPs. The commenter further points out that, given the estimated $1.9
trillion of assets invested in hedge funds, the portion of those assets
that use OTC forex is likely to be substantial, and therefore
substantial time and expense would be expended in determining
eligibility requirements for the thousands of investors in funds that
use OTC forex.\1400\
---------------------------------------------------------------------------

    \1396\ See letters from AIMA I, Akin Gump, Sidley, and Willkie
Farr.
    \1397\ See id.
    \1398\ See letter from AIMA I.
    \1399\ See letter from Sidley.
    \1400\ See id.
---------------------------------------------------------------------------

    Commenters explained that there are costs to losing ECP status and
that the enumerated counterparty list is unclear and subject to
uncertainty because it relies on other regulators.\1401\ One commenter
argues that funds would incur compliance and transaction costs if
categorized as non-ECPs because they would have to enter into forex
transactions through a DCM and their operators would have to register
as CPOs.\1402\ That commenter also states that the markets for
exchange-traded futures are less liquid than OTC forex markets, and
that posting initial margin on a DCM is costly, since it cannot be used
to invest in riskier assets and a FOF would have to invest in liquid
and low risk (and, commensurately, lower yielding) assets necessary to
post variation margin. As another commenter points out, the resulting
increased expenses from the requirement to trade on a DCM and comply
with retail forex rules may result in higher expenses for hedge and
private equity funds, which

they would likely pass along to their investors.\1403\
---------------------------------------------------------------------------

    \1401\ See letters from AIMA I, Akin Gump, and Sidley.
    \1402\ See letter from Sidley.
    \1403\ See letter for Akin Gump. This commenter also said that
these increased expenses could cause funds to terminate their
foreign currency hedging, which would increase their investors'
currency risk, causing higher volatility in the investment industry.
---------------------------------------------------------------------------

    A commenter asserted that the characteristics necessary to avoid
non-ECP status may prevent free investment and could reduce liquidity
and create volatility in these markets.\1404\
---------------------------------------------------------------------------

    \1404\ See letter from AIMA I. See generally part III.B.3,
supra.
---------------------------------------------------------------------------

    With respect to CFTC Regulation Sec.  1.3(m)(6), a commenter
expressed concerns with the expected costs associated with the proposal
that commodity pools that do not qualify as ECPs under clause (A)(iv)
should not be able to qualify under clause (A)(v), stating that the
proposal would be difficult to comply with and would adversely impact
investment.\1405\
---------------------------------------------------------------------------

    \1405\ See letter from AIMA I.
---------------------------------------------------------------------------

    Two commenters agreed that the proposed addition of swap dealers,
security-based swap dealers, major swap participants, and major
security-based swap participants to the ECP definition provided a
benefit with little or no costs.\1406\ No commenter objected.
---------------------------------------------------------------------------

    \1406\ See letters from Greenberger and Sidley.
---------------------------------------------------------------------------

    With respect to CFTC Regulation Sec.  1.3(m)(7), commenters said
that non-ECPs have entered into swaps in reliance on the Swap Policy
Statement.\1407\ Commenters emphasized the importance of the Swap
Policy Statement to pass-through entities used by farmers,\1408\
operating companies \1409\ and commercial property developers,\1410\
noting that such entities may not meet the ECP criteria. According to
these commenters, these pass-through entities often are small and
medium-sized businesses that enter into interest rate swaps with
lending financial institutions in reliance on the Swap Policy
Statement.\1411\ The commenters explained that the loans usually are
guaranteed by the principals of the entity entering into the swap, and
that the borrower would qualify as an ECP if structured as a single-
level corporate entity or sole proprietorship.\1412\ Commenters said
that if these non-ECP entities were limited to swaps that are available
on or subject to the rules of a DCM, many regional bank borrowers would
lose the ability to use swaps, real estate companies would have less
flexibility in risk management, and smaller lenders would be at a
competitive disadvantage.\1413\ Another commenter said that Dodd-Frank
Act provisions such as the end-user clearing exception indicate that
Congress intended to preserve the availability of swaps used for
managing risks rather than for investment or speculation.\1414\
---------------------------------------------------------------------------

    \1407\ See letters from B&F I, CDEU and Capstar. One element of
the Swap Policy Statement required that the swap be entered into in
connection with each swap counterparty's line of business. See Swap
Policy Statement at 30697. The CFTC stated when issuing the Swap
Policy Statement that it ``reflects the [CFTC]'s view that at this
time most swap transactions, although possessing elements of futures
or options contracts, are not appropriately regulated as such under
the [CEA] and [CFTC] regulations.'' Swap Policy Statement at 30694.
    \1408\ See, e.g., letter from Rabobank, New York Branch
(relating that ``[f]or a variety of estate planning and regulatory
purposes, farmers commonly hold their ownership interests in land,
buildings and farm equipment indirectly, through a network of legal
entities'').
    \1409\ See, e.g., letter from Fifth Third Bank and Union Bank,
N.A. (advising that ``[i]t is common for an operating business to
organize a separate limited liability company (for tax and legal
reasons) to acquire * * * assets * * * and to lease these assets to
the operating company[, which] becomes the borrow[er] * * * for the
loan used to acquire those assets'' and that ``[t]he limited
liability company often does not maintain sufficient capital to
qualify as an ECP'').
    \1410\ See, e.g., letters from BB&T I, B&F I and Midsize Banks.
    \1411\ See letters from BB&T I and B&F I. Commenters said that
these businesses may intentionally maintain less than $1 million in
equity primarily for tax and legal reasons. See letters from Capital
One and Columbia State Bank (stating that over 65% of its borrowers
are structured as limited liability companies or S corporations and
intentionally maintain less than $1 million in equity at the entity
entering into the swap).
    \1412\ See letter from Columbia State Bank. See also letter from
BB&T I.
    \1413\ See letters from BB&T I, Capital One, Capstar, Columbia
State Bank, Midsize Banks, NAREIT and Wells Fargo II.
    \1414\ See letter from FSR I.
---------------------------------------------------------------------------

    To mitigate the impact of restricting non-ECPs to swaps that are
available on or subject to the rules of DCMs, some commenters said that
an entity should be able to qualify as an ECP based on the financial
qualifications of related entities, so long as various conditions
proposed by the commenters are satisfied. Some commenters said that an
entity should be eligible to be an ECP if its swap obligations are
guaranteed by an ECP,\1415\ or if its controlling entity qualifies as
an ECP under clause (A)(v) of the statutory definition.\1416\ Another
commenter suggested revisions to the ECP definition that included
looking to the ECP status or sophistication of the majority owner of an
entity in determining if the entity itself is an ECP.\1417\ Other
commenters suggested other provisions to allow non-ECPs to enter into
swaps other than on or subject to the rules of a DCM, so long as the
non-ECP meets various conditions indicating that the swap is used in
connection with its line of business.\1418\
---------------------------------------------------------------------------

    \1415\ See letters from BB&T I, Midsize Banks and Wells Fargo
II.
    \1416\ See letters from CDEU and Regional Banks.
    \1417\ See letter from NAREIT.
    \1418\ See letters from APGA, Capital One and Gavilon dated
October 28, 2010.
---------------------------------------------------------------------------

    With respect to CFTC Regulation Sec.  1.3(m)(8), several commenters
asserted that many Forex Pools are operated by sophisticated,
professional managers that do not need the protections of a retail
forex regime designed to protect non-ECPs that are engaging in retail
forex transactions.\1419\ More specifically, some commenters, based on
CFTC enforcement actions involving Forex Pools, suggested that
commodity pools of a sufficient size, and/or operated by a registered
or exempt CPO, do not pose the risks of fraud and abuse of non-ECP
customers that the statutory look-through provision is intended to
address.\1420\
---------------------------------------------------------------------------

    \1419\ See letters from Millburn and Sidley.
    \1420\ See letters from GXFD I and Sidley.
---------------------------------------------------------------------------

    As a result, commenters suggested that the look-through provision
should not apply in determining ECP status of commodity pools that meet
certain conditions. For example, commenters suggested that the look-
through not be applied to a commodity pool with $10 million in total
assets if other factors were present--e.g., not structured to
evade,\1421\ subject to regulation under the CEA \1422\ and/or
operation by a registered CPO.\1423\ Another commenter suggested
requiring the total assets or minimum initial investment of a Forex
Pool to be sufficiently large that, in general, only legitimate pools
would exceed such thresholds.\1424\ This commenter suggested a total
asset threshold of $50 million.\1425\
---------------------------------------------------------------------------

    \1421\ See letter from GFXD II.
    \1422\ See letters from GFXD II and Skadden.
    \1423\ See meeting with SIFMA on January 20, 2012.
    \1424\ See letter from Sidley.
    \1425\ See id.
---------------------------------------------------------------------------

    Separately, one commenter also claimed that the statutory look-
through, if strictly implemented, might inappropriately preclude Forex
Pools and their CPOs, many of whom are registered, from engaging in
retail forex transactions with swap dealers because swap dealers are
not Enumerated Counterparties (and some swap dealers also may not be
Enumerated Counterparties in a different capacity, such as being a U.S.
financial institution).\1426\ This commenter stated that such a result
could reduce close out netting opportunities in the event of the
insolvency of a counterparty.
---------------------------------------------------------------------------

    \1426\ See letter from GFXD I.
---------------------------------------------------------------------------

    Finally, to reduce the adverse effects on government entities that
may need to qualify as ECPs based on their swap

counterparties but that would be foreclosed from doing so due to an
erroneous reference in the definition of ECP, a commenter requested the
correction of that erroneous reference.\1427\
---------------------------------------------------------------------------

    \1427\ See letter from Wells Fargo I.
---------------------------------------------------------------------------

c. Response to Comments and Consideration of Costs and Benefits in the
Final Rule
    CFTC Regulation Sec.  1.3(m)(5)(i) reduces the number of pools that
need to determine the ECP status of their natural person participants,
and thus reduces related costs, because it limits, absent evasion, the
pools the CFTC considers for look-through purposes to transaction-level
retail forex pools. The guidance the Commissions provide in the
preamble also reduces the scope of the potential look-through, with
attendant cost-reductions, by stating expressly that a Retail Forex
Pool using retail forex transactions solely to hedge or mitigate
currency risk would not be considered structured to evade. Thus, such
hedging or mitigation would not be the basis of a look-through. In
particular, because, according to a commenter, the typical FOF uses
retail forex transactions solely to hedge currency risk related to
fluctuations in the exchange rate between non-U.S. dollar subscription
currencies and the U.S. dollar, most, if not all, FOFs would not be
covered by the look-through. To the extent other commodity pools use
retail forex transactions solely to hedge or mitigate their currency
risk, such pools also would not be subject to the CFTC Regulation Sec.
1.3(m)(5)(ii) look-through provision. Because Regulation Sec.
1.3(m)(5)(ii) provides a look through only in cases of evasion and the
Commissions' guidance narrows considerably the scope of what might
otherwise be considered evasion, the CFTC expects the CPO of the
typical pool to be able to determine at little or no cost the ECP
status of their direct participant commodity pools; such status will be
based on CEA section 1a(18)(iv), an analysis with which such CPOs are
familiar.\1428\
---------------------------------------------------------------------------

    \1428\ While the Commissions are adding additional detail
explaining the scope of CEA section 1a(18)(A)(iv)(II), the
Commissions also provide guidance on that explanation. As a result,
the CFTC does not believe that the upfront costs of determining ECP
status under CEA section 1a(18)(A)(iv) will significantly increase.
---------------------------------------------------------------------------

    While the CFTC has provided guidance to reduce the costs of
applying the rule, it estimates that each affected CPO may have to
spend between 5 and 20 hours of legal time, representing a cost between
$1,800 and $7,100,\1429\ initially to determine the ECP status of the
pools that they operate, and up to 5 hours ($1,800) of additional legal
time to determine such status upon each change to the fund's structure,
operating guidelines, etc. that might implicate ECP status. Commenters
noted that drafting ECP representations and contacting existing
participants are part of the costs of determining ECP status. While the
CFTC acknowledges such costs, CFTC Regulation Sec.  1.3(m)(5) also
provides investor protection benefits to non-ECP participants in pools
that are not ECPs by requiring such pools to enter into retail forex
transactions with an Enumerated Counterparty. This provides non-ECP
participants in such pools the protections of the retail forex regime
imposed by such counterparty's federal regulator.
---------------------------------------------------------------------------

    \1429\ The CFTC computed these totals by assuming from 5 to 20
hours of legal review by a compliance attorney at $355/hour based on
the 2010 SIFMA survey. See SIFMA, Report on Management and
Professional Earnings in the Securities Industry--2010. If we assume
that 5,000 potential commodity pools need to make this determination
and round to two significant digits, this results in a total
approximate cost of $8.9 million to $36 million. As is the case for
the application of the definitions of the terms ``swap dealer'' and
``major swap participant,'' these costs reflect a higher multiplier
because some persons may retain outside advisors to assist in making
the determinations under the rules.
---------------------------------------------------------------------------

    The CFTC also notes that the number of categories of enumerated
counterparties available as counterparties to non-ECP commodity pools
has increased since the Commissions proposed the regulations, because
other regulators have finalized their retail forex regimes, as
discussed in greater detail above. While trading with Enumerated
Counterparties will entail doing so pursuant to the retail forex
regulations of the relevant federal regulator, such regulations will
apply to the counterparties, not the CPO. While CPOs of Retail Forex
Pools generally must register as such with the CFTC, to the extent an
exemption from registration is available under the CFTC's rules, such
CPOs need not register as a result of their retail forex transactions,
further reducing the potential costs of Regulations Sec. Sec.
1.3(m)(5)(i) and (ii). Further, commodity pools will not incur any
costs to change counterparties (with the accompanying costs of, for
example, putting in place new trading documentation) to the extent they
already trade with Enumerated Counterparties. Commenters noted that
non-ECP pools would incur costs to negotiate new trading documentation
with Enumerated Counterparties to the extent that such pools do not
currently enter into retail forex transactions with Enumerated
Counterparties and wish to continue to engage in retail forex
transactions other than on or subject to the rules of a DCM. However,
Regulation Sec.  1.3(m)(5) also provides investor protection benefits
to non-ECP participants in pools that enter into retail forex
transactions by requiring such pools to trade with Enumerated
Counterparties and to be operated by registered CPOs, absent an
applicable exemption.
    To the extent that a commodity pool is precluded by CFTC Regulation
Sec.  1.3(m)(6) from achieving ECP status based on prong (A)(v) of the
ECP definition, the pool will be limited to trading swaps, if at all,
on or subject to the rules of a DCM. This could result in costs to
affected commodity pools, including margin, the costs of establishing
relationships with future commission merchants (e.g., reviewing new
account opening documentation) and opportunity costs from losing the
ability to trade swaps customized to pools' needs. Preventing commodity
pools that do not qualify under clause (A)(iv) from qualifying pursuant
to clause (v), however, closes a loophole that would allow smaller
commodity pools that are not able to satisfy the requirements of clause
(A)(iv) of the ECP definition to qualify as ECPs. Moreover, by
providing additional clarification in the preamble regarding the
meaning of CEA section 1a(18)(A)(iv)(II), the Commissions substantially
reduced the potential number of commodity pools affected by CFTC
Regulation Sec.  1.3(m)(6).
    CFTC Regulations Sec. Sec.  1.3(m)(1)-(4) define major swap
participants, swap dealers, major security-based swap participants and
security-based swap dealers, respectively, as ECPs. Stating explicitly
in regulations that these entities are ECPs avoids the potentially
anomalous result of such entities, which are some of the largest and/or
most active swap market participants, not being ECPs and is in line
with expectations in the market that these entities may engage in a
full range of swap and security-based swap activities. The CFTC
believes that these regulations will not result in any significant
economic costs or benefits.
    The CFTC is persuaded by commenters that allowing participants to
continue to rely on the line of business element of the Swaps Policy
Statement will mitigate unnecessary costs from the regulation but is
adding various conditions to retain adequate protection for market
participants and the public. As noted above, CFTC Regulation Sec.
1.3(m)(7) permits an entity,

in determining its net worth for purposes of subclause (A)(v)(III) of
the ECP definition,\1430\ to include the net worth of its owners,
solely for purposes of determining its ECP status for swaps used to
hedge or mitigate commercial risk, provided that all of its owners are
themselves ECPs (disregarding shell companies, as defined above). Under
CFTC Regulation Sec.  1.3(m)(7) as adopted, an entity seeking to
qualify under subclause (A)(v)(III) of the ECP definition in order to
enter into a swap used to hedge or mitigate commercial risk is
permitted to count the net worth of its owners in determining its own
net worth, so long as all its owners are ECPs. Accordingly, CFTC
Regulation Sec.  1.3(m)(7) will allow qualified participants the
flexibility to enter into customized swaps.
---------------------------------------------------------------------------

    \1430\ CEA section 1a(18)(A)(v)(III) provides that ``a
corporation, partnership, proprietorship, organization, trust, or
other entity * * * that (aa) has a net worth exceeding $1,000,000;
and (bb) enters into an agreement, contract, or transaction in
connection with the conduct of the entity's business or to manage
the risk associated with an asset or liability owned or incurred or
reasonably likely to be owned or incurred by the entity in the
conduct of the entity's business'' is an ECP. 7 U.S.C.
1a(18)(A)(v)(III).
---------------------------------------------------------------------------

    By limiting the line of business ECP prong to entities owned solely
by ECPs, the CFTC is preserving the intent behind the ECP requirement,
which is to limit the availability of customized swaps to market
participants of sufficient financial sophistication and with sufficient
assets or net worth to assess, appreciate and bear the implications and
risks of swap transactions. Although commenters proposed various
solutions to address the loss of the Swap Policy Statement, the CFTC
believes the approach adopted is the best approach; it substantively
preserves the ECP requirement and protects the real parties in interest
(i.e., the owners). Although banks and non-ECP borrowers might be able
to restructure or more highly capitalize borrowing entities or borrow
at a higher level in the ownership structure, this regulation will
allow banks and qualified businesses to continue to conduct their loan
arrangements as usual without incurring the costs, which could include
undesirable tax treatment, of such operational changes. Further,
because commenters focused on swap related risks, the Commissions
limited this regulation's application narrowly, i.e., it does not apply
for purposes of determining ECP status for: swaps not meeting the
conditions set forth in Regulation Sec.  1.3(m)(7); security-based
swaps; security-based swap agreements; mixed swaps; or agreements,
contracts or transactions that are not swaps (regardless of the purpose
for which they are used).
    CFTC Regulation Sec.  1.3(m)(8) permits a Forex Pool to qualify as
an ECP notwithstanding that it has one or more direct participants that
are not ECPs if the Forex Pool (a) is not formed for the purpose of
evading regulation under CEA sections 2(c)(2)(B) or (C) or related
rules, regulations or orders, (b) has total assets exceeding $10
million and (c) is formed and operated by a registered CPO or by a CPO
who is exempt from registration as such pursuant to CFTC Regulation
Sec.  4.13(a)(3). The data presented by commenters, discussed above,
demonstrate that registered CPOs \1431\ of commodity pools over a
certain size ($10 million in total assets) historically have engaged in
retail forex misconduct to a much less significant degree than other
CPOs. Only one of the 45 unique cases presented by commenters involved
a pool with more than $10 million in total assets and a registered CPO.
Only two of those cases involved a pool operated by CPOs exempt from
registration: in both of those cases, however, the CPO raised less than
$10 million.\1432\ The CFTC also recognizes that subjecting such
commodity pools to the statutory look-through provision to protect non-
ECP customers from fraud and abuse would cause them to incur higher
costs (e.g., CPO compliance costs for those CPOs required to register
as such, and redocumenting trading relationships with new
counterparties who are Enumerated Counterparties), for intangible pool
participant protections. To further protect pool participants, the
Commissions added a requirement that, to be an ECP under the line of
business prong, the Forex Pool must not be formed for the purpose of
evading CFTC regulation of Retail Forex Pools and retail forex
transactions under CEA Section 2(c)(2)(B) or (C). Accordingly, the
Commissions have tailored CFTC Regulation Sec.  1.3(m)(8) in a manner
they believe preserves its ability to effectively protect market
participants and the public, while avoiding significant costs.
---------------------------------------------------------------------------

    \1431\ CFTC Regulation Sec.  1.3(m)(8) as adopted requires that
the CPO of the Forex Pool be registered as a CPO with the CFTC. The
Commissions believe that this condition is appropriate because it
will ensure that the NFA oversees compliance by those CPOs relying
on this new regulation.
    \1432\ In addition, one of those CPOs relied on the CFTC
Regulation Sec.  4.13(a)(4) CPO registration exemption. As discussed
above, the CFTC has withdrawn that exemption.
---------------------------------------------------------------------------

    As noted above, CEA section 1a(18)(A)(vii)(cc) contains a statutory
cross-reference rendered incorrect due to a legislative drafting
oversight. Failing to address such error would inappropriately deprive
such entities of ECP status, imposing undue costs (e.g., the
opportunity costs of being unable to execute a desired hedge or trading
strategy using standardized exchange-traded swaps) on such entities.
Allowing a government entity the ability to qualify as an ECP based on
its counterparty's status will provide, at little or no cost, the
benefit of effectuating Congressional intent that government entities
satisfying the conditions of CEA section 1a(18)(A)(vii)(cc) be ECPs.
Therefore, the CFTC included in the preamble an interpretation treating
as an ECP government entities satisfying the conditions of CEA section
1a(18)(A)(vii)(cc) as if such section incorporated the correct cross-
reference. The CFTC believes that correcting this incorrect cross-
reference will not result in any significant economic costs or
benefits.
d. CEA Section 15(a) Discussion
    Protection of market participants and the public. Congress
determined to protect retail foreign exchange investors from fraudsters
by amending the ECP definition to require a pool's participants to
qualify as ECPs for the pool to be an ECP under subsection
(A)(iv).\1433\ As discussed above, this protection, as implemented by
CFTC Regulation Sec.  1.3(m)(5) may raise the costs of legitimate
foreign exchange transactions. To mitigate these potential increased
costs, CFTC Regulations Sec.  1.3(m)(5)(i) limits the look-through to
the level of the commodity pool structure that engages in retail forex
transactions, subject to CFTC Regulation Sec.  1.3(m)(5)(ii). This
limitation provides that, if any level of the pool has been structured
to evade, the CFTC would look through the transaction-level commodity
pool's direct commodity pool participants indefinitely until reaching
non-commodity pool participants. CFTC Regulation Sec.  1.3(m)(5),
therefore, protects non-ECP members of the public in appropriate
instances.
---------------------------------------------------------------------------

    \1433\ Accord letter from AIMA I.
---------------------------------------------------------------------------

    By limiting the line of business ECP prong to entities owned solely
by ECPs, the CFTC is preserving the intent behind the ECP requirement,
which is to limit the availability of customized swaps to market
participants of sufficient financial sophistication to assess and
appreciate the risk and implications of the transactions. Although
commenters proposed various solutions to address the loss of the Swap
Policy Statement, the CFTC believes the

approach adopted is the best approach because it preserves the
substance of the ECP requirement and protects the real parties in
interest (i.e., the owners).
    Because registered CPOs,\1434\ and CPOs exempt from registration,
who operate commodity pools over a certain size ($10 million in total
assets) historically have engaged in retail forex misconduct to a much
less significant degree than CPOs of commodity pools below that
threshold, the CFTC believes that imposing this size threshold
requirement as a condition of ECP status pursuant to Regulation Sec.
1.3(m)(8) provides some protection to pool participants. The additional
requirement that to be an ECP under the line of business prong the
Forex Pool must not be formed for the purpose of evading CFTC
regulation of Retail Forex Pools and retail forex transactions under
CEA Section 2(c)(2)(B) or (C) will further protect pool participants.
---------------------------------------------------------------------------

    \1434\ CFTC Regulation Sec.  1.3(m)(8) as adopted requires that
the CPO of the Forex Pool be registered as a CPO with the CFTC. This
condition is appropriate because it will ensure that the NFA
oversees compliance by those CPOs relying on this new regulation.
---------------------------------------------------------------------------

    Efficiency, competitiveness, and the financial integrity of the
market. With respect to CFTC Regulation Sec. Sec.  1.3(m)(5) and (6),
commodity pools that do not qualify as ECPs may have to use products
listed on or subject to the rules of a DCM that might not precisely (or
at all) match such parties' needs. This may reduce or eliminate a
commodity pool's ability to engage in some transactions, but these
regulations also seek to prevent unsophisticated parties from entering
into certain transactions to prevent repeated abuses and protect
members of the public. We believe CFTC Regulations Sec. Sec.
1.3(m)(1)-(8) do not significantly impact competitiveness or the
financial integrity of markets.
    Price discovery. CFTC Regulations Sec. Sec.  1.3(m)(1)-(8) only
clarify the status of entities. They do not affect price discovery.
    Sound risk management practices. CFTC Regulations Sec. Sec.
1.3(m)(5) and (6) may restrict investment opportunities for certain
non-ECPs that might have otherwise qualified as ECPs.\1435\ This may
discourage the use of some sound risk management practices and/or
investment strategies. For instance, it may become more expensive for
CPOs operating non-ECP pools to use such practices and/or strategies if
such pools must enter into swaps on or subject to the rules of a DCM or
come into compliance with a retail forex regime or choose to redeem
non-ECPs to avoid such results. On the other hand, CPOs may not incur
the increased expense of such sound risk management practices and/or
investment strategies if they are able to pass such costs on to the
participants in the pools. Also, with respect to swaps, pools that are
not ECPs due to CFTC Regulation Sec.  1.3(m)(6) can enter swaps on or
subject to the rules of a DCM to the extent an appropriate swap is
listed by such DCM.
---------------------------------------------------------------------------

    \1435\ CFTC Regulations Sec.  1.3(m)(1)-(4) and the interpretive
guidance regarding certain governmental ECPs have the opposite
effect, making investment opportunities available to certain ECPs
that might otherwise not have qualified as ECPs.
---------------------------------------------------------------------------

    In contrast, CFTC Regulations Sec. Sec.  1.3(m)(7) and (8) allow
qualified participants to engage in swaps that are not on a DCM. This
gives qualified participants more choices for their hedges, and may
provide an opportunity for better risk management.
    Other public interest considerations. CFTC Regulations Sec. Sec.
1.3(m)(1)-(4) state that major swap participants, swap dealers, major
security-based swap participants, and security-based swap dealers,
respectively, are ECPs. The interpretive guidance regarding certain
governmental ECPs remedies an incorrect statutory cross-reference with
respect to the ability of a subset of governmental entities to qualify
as ECPs under CEA section 1a(18)(A)(vii).\1436\
---------------------------------------------------------------------------

    \1436\ 7 U.S.C. 1a(18)(A)(vii).
---------------------------------------------------------------------------

VIII. Administrative Law Matters--Exchange Act Revisions (Definitions
of ``Security-Based Swap Dealer'' and ``Major Security-Based Swap
Participant'')

A. Economic Analysis

1. Overview
    The SEC is sensitive to the costs and benefits of our rules. Some
of these costs and benefits stem from statutory mandates, while others
are affected by the discretion we exercise in implementing the
mandates. We have requested comment on all aspects of the costs and
benefits of the proposal, including any effect our proposed rules may
have on efficiency, competition, and capital formation. In considering
the economic consequences of these final rules, moreover, we have been
mindful of the link between the scope of the persons who are deemed to
be dealers or major participants pursuant to these rules and the costs
and benefits associated with the regulatory requirements that are
applicable to dealers and major participants, as well as the direct
assessment costs (as defined below) these rules will impose on certain
market participants.
    As the SEC noted in the Proposing Release, the definitions of
``security-based swap dealer'' and ``major security-based swap
participant'' implicate two categories of potential costs. First, there
are costs that arise from the regulatory requirements that will apply
to those types of entities (e.g., the registration, margin, capital and
business conduct requirements that would apply to dealers and major
participants).\1437\ The Proposing Release also noted that there are
costs that entities will incur in determining whether they fall within
the definitions of ``security-based swap dealer'' and ``major security-
based swap participant.'' \1438\ Commenters that addressed these issues
discussed both types of costs.\1439\ Our consideration of these issues
has been informed by the comments we received.
---------------------------------------------------------------------------

    \1437\ See Proposing Release, 75 FR at 80206.
    \1438\ See Proposing Release, 75 FR at 80206-07.
    \1439\ See, e.g., letters from Representatives Bachus and Lucas
(``Casting an overly-broad net in defining these terms could force
some smaller participants to leave the marketplace as a result of
increased costs, or eliminate certain types of contracts used for
hedging. If either occurs, businesses will be left exposed to market
volatility and the consequences will ultimately be felt by Americans
in the forms of increased consumer costs.''); ISDA (suggesting that
imposing dealer regulation beyond persons whose business is to make
markets would be inconsistent with the Dodd-Frank Act's intent to
preserve growth and innovation in the swap markets); ABC/CIEBA
(stating that major participant thresholds will cause persons who
pose no systemic risk to incur substantial costs associated with
major participant registration and regulation); SIFMA-AMG
(addressing complexity and burden of analyzing potential status as a
major participant, and urging implementation of a calculation safe
harbor).
---------------------------------------------------------------------------

    In adopting these final rules, we have sought to take into account
the broader costs and benefits associated with the regulation of
security-based swap dealers and major security-based swap participants,
which we refer to in this section as ``programmatic'' costs and
benefits. We have also considered the direct costs that persons would
incur to assess whether they fall within the dealer or major
participant definitions or to assess the potential availability of
limited registration as a dealer or major participant. We refer to
these costs as ``assessment'' costs.\1440\ The programmatic costs and
benefits and the assessment costs raise distinct analytic issues.
---------------------------------------------------------------------------

    \1440\ We expect that the benefits resulting from the
identification and registration of dealers and major security-based
participants will likely accrue primarily at the programmatic level.
To the extent appropriate given the purposes of Title VII, we have
sought to mitigate the costs entities will incur in connection with
such identification and registration.
---------------------------------------------------------------------------

    We discuss below certain of the costs and benefits--both
programmatic and assessment-related--that we have considered in
adopting these rules. These costs and benefits have informed the policy
choices described above.

Accordingly, the analysis below includes references throughout to the
earlier discussions of the policy decisions taken by the Commissions.
    In considering the costs and benefits of these rules, we are
mindful of the various considerations that must be taken into account
in establishing the baseline against which those costs and benefits may
be evaluated. A key consideration is that the definitions, while
integral to the regulatory requirements that will be imposed on dealers
and major participants pursuant to Title VII, do not themselves
establish the scope or nature of those substantive requirements or
their related costs and benefits. In light of this consideration
associated with definitional rulemaking, the baseline we are using to
consider the costs and benefits associated with the definitions
presumes that the other Title VII rules that implement the statutory
requirements applicable to security-based swap dealers and major
security-based swap participants will be adopted (and will be the
subject of their own economic analysis), but as yet there are no
dealers or major participants subject to any of these requirements. The
costs and benefits described below are therefore those that may arise
in connection with (1) identifying a subset of current and future
market participants as either security-based swap dealers or major
security-based swap participants (i.e., the assessment costs) and (2)
subjecting that subset, through the definitional lines we are drawing,
to a complete, fully effective complement of Title VII statutory and
regulatory requirements (i.e., the programmatic costs and benefits).
    Accordingly, in determining the appropriate scope of the
definitions being adopted in these rules, we considered what type of
persons should be regulated as dealers and major participants under
Title VII, in light of the purposes of the statute, the overall
regulatory framework, and the data currently available to us. We thus
have sought to adopt regulations that would include entities within the
scope of the dealer and major participant definitions to the extent
that encompassing persons with their level of security-based swap
activities or positions would be necessary and appropriate given the
purposes of the statute (for example, because the institution may pose
market or other risks of the type addressed by Title VII). Conversely,
to the extent that we expect that the regulation of certain types of
market participants would not serve the statutory purposes, we have
sought to exclude them from the scope of the definitions, thereby
reducing unnecessary burdens on entities whose regulation may not be
necessary or appropriate to further the purposes of the statute.
    We recognize that the costs and benefits arising from these rules
will affect competition, efficiency, and capital formation in the
security-based swap market broadly, with the impact not being limited
to the specific entities that fall within the meaning of the terms
``security-based swap dealer'' and ``major security-based swap
participant.'' In the sections that follow we begin with a
consideration of the costs and benefits of the rule that affect the
regulated market participants that fall within the meaning of these
terms, and conclude with a consideration of the potential effects of
this rule on competition, efficiency, and capital formation.
2. Programmatic Costs and Benefits Associated With These Definitions'
Scope
a. Programmatic Costs
    The scope of these definitions will directly affect the number of
market participants subject to Title VII and the rules thereunder and
thus will directly affect the overall costs associated with the
regulation of dealers and major participants pursuant to Title VII.
Persons who fall within the statutory definitions of security-based
swap dealer and major security-based swap participant, as further
defined by these rules, will incur a number of upfront costs and
ongoing costs in connection with their status as dealers or major
participants. Those include, but are not limited to, costs of complying
with requirements related to: registration; reporting, recordkeeping,
confirmation and documentation; sales practices; margin, capital and
segregation of customer collateral; and maintaining a chief compliance
officer.\1441\ We expect that the significance of those programmatic
costs will outstrip the more discrete and entity-specific assessment
costs (discussed in more detail below) that individual entities will
incur in determining whether they fall within the dealer and major
participant definitions.
---------------------------------------------------------------------------

    \1441\ For example, dealers and major participants will be
subject to business conduct requirements of section 15F of the
Exchange Act, and thus will be required, among other things, to
determine that their counterparty meets certain eligibility
standards before entering into security-based swaps with them and to
disclose information about material risks and characteristics,
material incentives, conflicts of interest, the daily mark, and
clearing rights. See Securities Exchange Act Release No. 64766 (June
29, 2011), 76 FR 42396, 42406, 42410 (July 18, 2011). Also, for
example, in connection with registration requirements we expect
security-based swap dealers and major security-based swap
participants to incur costs in connection with completing and filing
forms, providing related certifications, addressing additional
requirements in connection with associated persons, as well as
certain additional costs. See Securities Exchange Act Release No.
65543 (Oct. 12, 2011), 76 FR 65784, 65813-18 (Oct. 24, 2011). The
costs associated with these and other substantive rules applicable
to dealers and major participants are being addressed in more detail
in connection with the applicable rulemakings.
---------------------------------------------------------------------------

    The programmatic costs linked to compliance by regulated entities
with specific requirements are not the only overall costs associated
with the regulation of dealers and major participants. Other potential
costs associated with the establishment of a new regulatory structure
over dealers and major participants, such as costs related to the
potential reduction of competition in the market, the deterrence of new
entrants, or reductions in capital formation, are discussed more fully
below.\1442\
---------------------------------------------------------------------------

    \1442\ See part VIII.A.4, infra.
---------------------------------------------------------------------------

b. Programmatic Benefits
    The regulation of dealers and major participants also will provide
a number of programmatic benefits to the security-based swap market and
to market participants. As discussed above,\1443\ registered security-
based swap dealers and major participants will be subject to a number
of entity-level and transaction-level requirements that we expect to
produce a broad array of benefits consistent with the purposes of Title
VII.\1444\
---------------------------------------------------------------------------

    \1443\ See part II.D.3.a, supra.
    \1444\ In application, the programmatic requirements applicable
to security-based swap dealers may differ from the programmatic
requirements applicable to major security-based swap participants.
For example, the proposed business conduct rules applicable to
dealers include ``know your customer,'' suitability and ``pay to
play'' requirements that would not also apply to major participants.
See Exchange Act Release No. 64766 (June 29, 2011), 76 FR 42396,
42399-401 (July 18, 2011).
---------------------------------------------------------------------------

    For example, section 15F(e) of the Exchange Act and related rules
impose capital and margin requirements on dealers and major
participants,\1445\ which will reduce the financial risks of these
institutions and contribute to the stability of the security-based swap
market in particular and the U.S. financial system more generally.
Section 3E of the Exchange Act, among other things, requires security-
based swap dealers that collect margin from counterparties to cleared
security-based swap transactions to maintain that collateral in
segregated accounts, as well as providing counterparties to uncleared
security-based swap transactions with security-based swap dealers and
major

security-based swap participants with the right to require the
segregation of assets held as collateral with an independent third-
party custodian. These protections provide market participants who
enter into transactions with these entities confidence that their
collateral accounts will remain separate from the dealer or major
participant's assets in the event of bankruptcy.\1446\ Title VII also
requires registered entities to implement risk management policies and
procedures that should allow them to avoid taking on excessive risk and
to better deal with market fluctuations that might otherwise endanger
the financial health of the entity.\1447\
---------------------------------------------------------------------------

    \1445\ See Exchange Act section 15F(e).
    \1446\ See Exchange Act section 3E.
    \1447\ See Exchange Act section 15F(j)(2).
---------------------------------------------------------------------------

    Title VII further imposes a range of business conduct requirements
upon these registered entities, which should deter fraudulent or
deceptive conduct and increase information transparency for customers
and counterparties seeking to access the security-based swap market.
For example, section 15F(h)(3)(B) of the Exchange Act and related rules
establish certain disclosure requirements for dealers and major
participants,\1448\ while section 15F(h)(3)(C) of the Act and related
rules require that communications by these entities meet certain
standards of fairness and balance.\1449\ Section 15F(j)(5) of the Act
and related rules introduce requirements intended to address potential
conflicts of interest that may arise in transactions between a dealer
or major participant and its counterparty.\1450\ Title VII also
establishes higher levels of protection for special entities entering
into transactions with dealers or major participants.\1451\ As we
discuss in more detail in our analysis of the competitive effects of
these rules, these protections, and the related increase in
transparency in dealings with registered entities may be expected to
improve the competitiveness and efficiency of the market.
---------------------------------------------------------------------------

    \1448\ See Exchange Act section 15F(h)(3)(B).
    \1449\ See Exchange Act section 15F(h)(3)(C).
    \1450\ See Exchange Act section 15F(j)(5).
    \1451\ See Exchange Act sections 15F(h)(2), (h)(4), (h)(5).
---------------------------------------------------------------------------

    Finally, Title VII also imposes requirements that are designed to
promote effective market operation and transparency. Sections 15F(f),
(g), and (j)(3) of the Exchange Act and related rules impose certain
reporting, recordkeeping, and regulatory disclosure requirements upon
registered entities, which should enhance the volume and quality of
information available in the market and facilitate effective oversight
by the Commission.\1452\ Section 15F(i) establishes regulatory
standards related to the confirmation, processing, netting,
documentation and valuation of security-based swaps, which should
enhance the efficiency of the procedures surrounding the execution of
security-based swap transactions.\1453\
---------------------------------------------------------------------------

    \1452\ See Exchange Act section 15F(f) (reporting and
recordkeeping requirements); Exchange Act section 15F(g) (daily
trading records requirements); and Exchange Act section 15F(j)(3)
(requirements related to the disclosure of information to
regulators).
    \1453\ See Exchange Act section 15F(i).
---------------------------------------------------------------------------

    We expect that the regulation of security-based swap dealers and
major participants through these provisions will advance the
transparency, risk reduction and counterparty protection purposes of
Title VII.\1454\ While these benefits will be significant, they will
not be entirely measurable, as it is not possible to quantify the
benefits of mitigating or avoiding a future financial crisis, or the
benefits of avoiding an unsuitable security-based swap
transaction.\1455\ Those benefits, moreover, can be expected to
manifest themselves over the long-term and be distributed over the
market as a whole.
---------------------------------------------------------------------------

    \1454\ Prior to the enactment of the Dodd-Frank Act, a Treasury
Department blueprint for financial reform articulated benefits of
comprehensive regulation of derivatives: ``OTC derivatives markets,
including CDS markets, should be subject to comprehensive regulation
that addresses relevant public policy objectives: (1) preventing
activities in those markets from posing risk to the financial
system; (2) promoting the efficiency and transparency of those
markets; (3) preventing market manipulation, fraud, and other market
abuses; and (4) ensuring that OTC derivatives are not marketed
inappropriately to unsophisticated parties.'' Department of the
Treasury, Financial Regulatory Reform--A New Foundation 46-47
(2009).
    \1455\ See note 421, supra. The significance of these potential
benefits is suggested by the 2008 financial crisis. Better Markets
cited estimates that the worldwide cost of the 2008 financial crisis
in terms of lost output was between $60 trillion and $200 trillion,
depending primarily on the long-term persistence of the effects. See
letter from Better Markets. We recognize, however, that this
estimate addresses the aggregate cost of the financial crisis, and
that Title VII is directed to only one aspect of the factors that
contributed to the crisis.
---------------------------------------------------------------------------

c. The Relation Between These Rules and the Programmatic Costs and
Benefits
    In adopting these final rules, we recognize that: (a) The choices
reflected by these rules will affect how many persons and which persons
ultimately will be deemed to be dealers or major participants; and (b)
those results, combined with the substantive requirements that are to
be adopted in connection with the dealer and major participant
regulatory regime, ultimately will determine the programmatic costs and
benefits that will be associated with the substantive regulation of
dealers and major participants.
    This is not to say that there would be a one-to-one correlation
between the regulation (or non-regulation) of any particular entity as
a dealer or major participant and the additional (or reduced)
programmatic costs and benefits that would be associated with the
regulation (or non-regulation) of that entity. Some of the costs of
regulating a particular person as a dealer or major participant, such
as costs of registration, may largely be fixed. At the same time, other
costs associated with regulating that person as a dealer or major
participant (e.g., costs associated with margin and capital
requirements) may be variable, reflecting the level of the person's
security-based swap activity. Similarly, the regulatory benefits that
would arise from deeming that person to be a dealer or major
participant (e.g., benefits associated with increased transparency and
efficiency, and reduced risks faced by customers and counterparties),
although not quantifiable, may be expected to be variable in a way that
reflects the person's security-based swap activity. In addition, it is
reasonable to believe that the implementation of Title VII itself will
change the security-based swap market, and, with the full
implementation of Title VII--which in part is conditioned on these
definitions--more information will be available for this
analysis.\1456\
---------------------------------------------------------------------------

    \1456\ The lack of market data is particularly significant in
the context of total return swaps on equity and debt. We do not have
the same amount of information regarding those products as we have
in connection with the present market for single-name credit default
swaps.
---------------------------------------------------------------------------

    Given these limitations on our ability to conduct a quantitative
assessment of the programmatic costs and benefits associated with these
definitional terms, we have considered these costs and benefits
primarily in qualitative terms. In that framework it is possible to
identify a subset of such entities that, because of the volume of their
dealing activity or the size of their security-based swap exposure,
appear to be the types of entities for which the other statutory
requirements of Title VII were created. We have therefore sought to
adopt definitions that would capture these entities, as the statute
requires us to do, without imposing the costs of Title VII on those
entities for which regulation currently may not be justified in light
of those purposes. We believe that this approach will maximize the
benefits provided by Title VII while minimizing costs to the extent

consistent with the purposes of the statute.
    Moreover, as discussed above, the SEC has directed the staff to
report to the Commission on all aspects of the dealer and major
participant definitions no later than three years following the later
of: (i) the last compliance date for the registration and regulatory
requirements for security-based swap dealers and major security-based
swap participants under Section 15F of the Exchange Act; and (ii) the
first date on which compliance with the trade-by-trade reporting rules
for credit-related and equity-related security-based swaps to a
registered security-based swap data repository is required. This report
will provide the SEC and market participants with more information
about the security-based swap market following the implementation of
Title VII--including information regarding the business of dealers and
major participants, the characteristics of positions they and other
market participants hold, the structure of the market, and how Title
VII has affected those aspects of the market. This report, which will
take into account the additional data from our observations of the
security-based swap market and the functioning of the associated
regulatory requirements, is intended to help the SEC assess whether to
make changes to the scope of the dealer and major participant
definitions (as well as to assess future actions related to the
extended compliance period in connection to the de minimis exception to
the security-based swap dealer definition).
d. Analysis of the Effect of Specific Rules on Programmatic Costs and
Benefits
    We have sought to establish definitions that capture the types of
entities whose security-based swap activity or whose security-based
swap positions warrant regulation under Title VII as dealers or major
participants, and to exclude the types of entities whose activity or
positions may not warrant such regulation. The relationship between a
given rule and the scope of the persons that ultimately will fall
within the dealer or major participant definitions--along with the
related costs and benefits--manifests itself in different ways
depending on the rule at issue. Some of these rules may be expected to
have a close link to the overall programmatic costs and benefits
associated with dealer and major participant regulation because they
play a significant role in determining the overall scope of the
definitions (for example, because they are relevant to the status of
relatively more entities). Other rules may be expected to affect the
status of relatively fewer entities and thus have a smaller effect on
those programmatic costs and benefits.
    We anticipate that the report that the SEC staff will make to the
Commission following the full implementation of Title VII with regard
to these definitions will help us more fully evaluate the programmatic
impact of all of these rules, both in terms of the number of potential
major participants and dealers that would result from the definition we
are adopting as well as potential alternatives, and in terms of the
associated programmatic costs and benefits.
i. Core Rules That Implicate Programmatic Costs and Benefits
    The core definitional terms with respect to establishing the scope
of the dealer and major participant definitions are those relating to:
(i) the core dealer definition, (ii) the dealer de minimis exception,
and (iii) the definitions of ``substantial position'' and ``substantial
counterparty exposure'' within the major participant definition.

A. Dealer Definition

    Exchange Act rule 3a71-1 defines ``security-based swap dealer'' and
thus plays a central role in determining the scope of the Title VII
regulatory regime going forward. Based on the available data regarding
activity in the market for single-name credit default swaps, including
the application of various criteria that may be indicative of dealing
activity in that market, and taking into account the availability of
the de minimis exception to the dealer definition, we estimate that 50
or fewer entities ultimately may have to register with the SEC as
security-based swap dealers.\1457\ This is consistent with the estimate
that accompanied the proposal.\1458\
---------------------------------------------------------------------------

    \1457\ This estimate--which potentially overstates the number of
potential dealers--is consistent with the data considered in the CDS
Data Analysis. That analysis implied a range of alternative
estimates--from 16 possible dealers to 93 possible dealers--based on
currently available data and reflecting a $3 billion de minimis
level. Compare CDS Data Analysis at table 2a (identifying 16
potential dealers above the $3 billion level based on the criterion
of having 20 or more unique counterparties) with CDS Data Analysis
at table 2c (identifying 93 potential dealers above that level based
on the criterion of having 10 or more unique counterparties).
However, most of the criteria applied by the CDS Data Analysis as
potentially indicative of dealer activity suggested estimates of
fewer than 50 possible dealers after accounting for the $3 billion
de minimis level. See id. at table 2b (identifying 32 possible
dealers based on the criterion of having 15 or more unique
counterparties); id. at table 3 (identifying 16, 19, or 25 possible
dealers based on the criterion of having a certain number of
counterparties not identified as dealers by ISDA); id. at table 4
(identifying 32 possible dealers based on the criterion of having a
``flat notional book''); id. at table 5 (identifying 33 possible
dealers based on the criterion of having ``flat transaction
volume''); id. at table 7 (identifying 40 possible dealers that meet
two or more of the other criteria cited in the analysis); id. at
table 8 (identifying 27 possible dealers that meet three or more of
the other criteria cited in the analysis). Only two criteria
suggested estimates in excess of 50 possible dealers above the $3
billion level. See id. at table 2c (identifying 93 possible dealers
based on the criterion of having 10 or more unique counterparties,
which may also be explained by the fact that non-dealers may
maintain trading relations with multiple dealers); id. at table 6
(identifying 52 possible dealers based on the criterion of posting
initial margin with low frequency, which may also be explained by
underreporting of margin due to the fact that such reporting was
voluntary with respect to the data underlying the CDS Data
Analysis).
    While recognizing that alternative criteria for identifying
possible dealing activity produced varied results, we believe that
the results largely are consistent with the estimate of 50 or fewer
security-based swap dealer registrants. We further believe that it
is appropriate to place particular weight on one criterion that
identified possible dealing activity based on whether an entity
engaged in security-based swap transactions with three or more
counterparties that themselves were not identified as dealers by
ISDA. That analysis identified 28 entities possibly engaged in
dealing activity (with 25 of those with trailing notional
transactions that exceed the $3 billion de minimis threshold we are
adopting). See CDS Data Analysis at table 3c. We believe that this
metric serves as a useful proxy for the application of the dealer-
trader distinction, given that persons with the business model of
seeking to profit by providing liquidity in general may reasonably
be expected to engage in transactions with persons who are not
themselves recognized as dealers.
    In estimating that 50 or fewer entities ultimately may have to
register as dealers, we are seeking to take a conservative approach
that recognizes both the limitations on the conclusions that may be
drawn from available data and the potential for changes in the
security-based swap market. We recognize that the criteria applied
in the CDS Data Analysis are imperfect in that they do not directly
apply the dealer-trader distinction, and that some alternative
criteria may prove to be superior predictors of actual dealing
activity. We also recognize that the estimate may overstate the
number of possible registered dealers insofar as not all of the
activity of persons identified as potential dealers based on the CDS
Data Analysis necessarily reflects dealing activity, meaning that in
practice a greater number of entities may be able to take advantage
of the de minimis exception, and fewer entities would have to
register as dealers, than estimates implied by that analysis may
suggest. This estimate of 50 potential dealers further seeks to
reflect the potential for growth in the size of the security-based
swap market, as well as growth in the number of registered dealers
as a result of competition promoted by the policies contemplated by
the Dodd-Frank Act, and the possibility that some business groups
that are identified as a single entity for purposes of this data
ultimately may register multiple legal entities as security-based
swap dealers.
    \1458\ The proposal estimated approximately 50 entities would be
required to register as security-based swap dealers, based on
discussions with industry. See Proposing Release, 75 FR at 80209,
n.188. Commenters did not contradict this estimate. To the extent
that the actual number of registrants differs from this estimate, it
is reasonable to assume that the actual number will be lower than
the estimate in the proposal because the de minimis level
established by the final rules for credit default swaps that are
security-based swaps--as described above, by far the overwhelming
majority of the security-based swap market--is higher than the level
that was proposed (i.e., $3 billion vs. $100 million).

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

    Alternative approaches to identifying dealer activity, including
those suggested by commenters, may have led to a lower or higher number
of potential dealers out of the over 1,000 total participants in the
security-based swap market. For example, commenters variously
suggested, among other approaches, that the dealer definition should be
interpreted to be coextensive with the concept of market making
activity, that dealer status should be limited to persons available to
take either side of the market at any time, or that dealer status
should be limited to transactions arising from a ``customer''
relationship.\1459\ Following those alternative approaches potentially
would reduce the ultimate number of persons required to register as
dealers.
---------------------------------------------------------------------------

    \1459\ See part II.A.2, supra.
---------------------------------------------------------------------------

    In adopting the final rules and providing interpretive guidance
that adapts our traditional dealer-trader analysis for the security-
based swap market, we have sought to capture those entities whose
security-based swap activity is warranted due to the nature of their
interactions with counterparties, or is warranted to promote market
stability and transparency. In this respect, we have sought to limit
the costs imposed by regulation under Title VII to those entities whose
regulation would serve the transparency, customer protection, and
market stability purposes of the statute while not imposing those costs
on entities whose regulation may not produce sufficient benefit in
terms of those purposes. The core dealer analysis that we have adopted
here focuses on activity that characterizes dealers, as the statutory
text requires, and does so while drawing on a well-established approach
used in an analogous securities dealer context by a wide range of
financial intermediaries.\1460\
---------------------------------------------------------------------------

    \1460\ See part II.A.5, supra (discussing the application of the
dealer-trader distinction to the security-based swap market).
---------------------------------------------------------------------------

B. De Minimis Exception to the Dealer Definition

    Exchange Act rule 3a71-2 implements the de minimis exception to the
dealer definition. This rule will directly affect the scope of the
dealer definition by excepting certain entities that otherwise would be
encompassed by the dealer definition but whose security-based swap
dealing activities fall below a specified notional threshold. As above,
we believe that the application of the final rule implementing the de
minimis exception, in combination with application of the dealer-trader
distinction, reasonably may be expected to result in 50 or fewer
entities ultimately registering with the SEC as security-based swap
dealers.\1461\
---------------------------------------------------------------------------

    \1461\ See note 1457, supra.
---------------------------------------------------------------------------

    As discussed above, the final rule implementing the de minimis
exception reflects our attempt to focus the application of dealer
regulation onto those entities for which that regulation would be
appropriate, taking into account the comparative costs and benefits of
dealer regulation, and the high degree of concentration of dealing
activity in the security-based swap market.\1462\ The final rule
particularly provides that a dealer may take advantage of the exception
if the notional amount of its dealing activity involving security-based
swaps that are credit default swaps over the trailing 12 months is no
more than $3 billion. For other types of swaps, a dealer may take
advantage of the exception if the notional amount of its dealing
activity is no more than $150 million. The threshold for dealing
activity with counterparties that are ``special entities,'' regardless
of the type of security-based swap, is $25 million. The final rule also
eliminates proposed tests based on the number of an entity's dealing
counterparties and on the number of its dealing security-based swaps.
This approach also mitigates concerns raised by some commenters about
the exception being overly narrow.\1463\
---------------------------------------------------------------------------

    \1462\ See parts II.D, supra. Regardless of the criterion used
for identifying entities engaged in dealing activity, analysis of
2011 transaction data for single-name credit default swaps indicates
that possible dealers with $3 billion or more in trailing notional
activity account for over 98 percent of all the trailing notional
activity by such entities. See CDS Data Analysis at 8-17.
    \1463\ See part II.D.2, supra. Conversely, some commenters
suggested lower thresholds than those provided in the final rule, an
approach that reasonably would be expected to lead more entities to
have to register as security-based swap dealers. We did not adopt
these lower thresholds because we determined that, given our
understanding of the current structure of the market, it was
unnecessary to do so to achieve the purposes of Title VII. Under any
of the metrics used in the CDS Data Analysis (with the exception of
the metrics relying on the posting of margin, which are, for reasons
provided in the analysis, particularly unreliable), for example,
retaining the proposed de minimis threshold of $100 million would
have captured at most an additional 0.75 percent of transaction
activity engaged in by entities captured by the respective analysis.
See CDS Data Analysis at 8-17.
    In adopting this rule we also considered alternative approaches
and thresholds suggested by some commenters that potentially may
lead fewer entities to have to register as security-based swap
dealers. For example, while some commenters supported the use of an
exposure-based threshold rather than a notional threshold, we
declined to adopt this approach because the use of an exposure
threshold could permit a virtually unlimited amount of dealing
activity within the de minimis exception so long as exposures are
collateralized (or offset, as generally occurs with dealing
activity), a result inconsistent with the purposes of Title VII.
---------------------------------------------------------------------------

    We have concluded that a $3 billion threshold for security-based
swaps that are credit default swaps would appropriately apply dealer
regulatory requirements to entities that comprise the vast majority of
domestic dealing activities in these products, while not imposing the
fixed costs of dealer regulation upon those entities responsible for
only a small portion of total dealing activity, and avoiding the threat
of leaving an excessive amount of dealing activity outside the ambit of
dealer regulation.\1464\ We believe that this approach strikes a
balance that appropriately maximizes the benefits of dealer regulation
while avoiding the application of the fixed costs of dealer regulation
onto those entities for which dealer regulation may not significantly
contribute to those benefits and avoiding the threat of allowing an
excessive volume of unregulated dealing activity.\1465\
---------------------------------------------------------------------------

    \1464\ As noted above, a sufficiently high de minimis threshold
could allow a significant amount of unregulated security-based swap
dealing activity to develop among entities whose dealing activity
does not exceed the de minimis threshold. See part II.D.5.b, supra.
    \1465\ As noted above, an extended compliance period will be
available to entities that engage in $8 billion or less in annual
notional dealing activity in security-based swaps that are credit
default swaps (or $400 million in dealing activity in other types of
security-based swaps), to help facilitate the orderly implementation
of Title VII and to afford the SEC additional time to study the
security-based swap market as it evolves in the new regulatory
framework. See part II.D.5.c.ii, supra.
---------------------------------------------------------------------------

    Similar considerations influenced our determination that a $3
billion de minimis threshold would be inappropriate for persons engaged
in dealing activity involving other types of security-based swaps,
given the comparatively smaller size of that market.\1466\ We instead
have set the threshold at a level that reflects the relative volume in
the security-based swap market of security-based swaps that are not
credit default swaps.\1467\
---------------------------------------------------------------------------

    \1466\ See part II.D.5.d, supra.
    \1467\ See id. (discussing rationale for use of $150 million
threshold and $400 million phase-in level in connection with those
types of security-based swaps).
---------------------------------------------------------------------------

    The final rule implementing the de minimis exception also sets
forth a lower notional threshold for dealing activities involving
``special entities,'' consistent with the special protections that
Title VII affords those entities. While we recognize that this lower
threshold may deter certain entities that are not registered as dealers
from

entering into security-based swap transactions with special entities,
and hence may have the effect of reducing the availability of security-
based swaps to those entities or increasing their costs,\1468\ we
believe that this lower threshold is appropriate to avoid undermining
those separate Title VII protections.\1469\
---------------------------------------------------------------------------

    \1468\ We expect any such effect will likely be minimal. An
analysis of 2011 transaction data regarding single-name credit
default swap transactions involving special entities shows that 16
counterparties account for all transactions with special entities.
Although all but one of these entities engaged in more than $25
million in transactions with such entities in 2011, all of these
entities engaged in total single-name credit default swap activity
well in excess of the $3 billion de minimis threshold that applies
to dealers generally. See CDS Data Analysis, Table 9 and note 8.
Consequently, it is possible that all 16 entities would have been
required to register as dealers under the standard de minimis
threshold of $3 billion, regardless of the lower de minimis
threshold for special entities.
    \1469\ See note 179, supra (discussing business conduct
requirements applicable to dealing activities involving special
entities).
---------------------------------------------------------------------------

    The final rule implementing the de minimis exception further
provides that security-based swap activities of affiliates under common
control with an entity should be considered when determining whether
the entity can avail itself of the de minimis exception. That is
intended to avoid evasion of the dealer registration requirement; thus,
while a contrary approach might be expected to reduce the number of
registered dealers, such an approach would not be consistent with the
purposes of Title VII.\1470\
---------------------------------------------------------------------------

    \1470\ See note 437, supra (discussing use of common control
standard in this anti-evasion context, rather than the majority
ownership standard used in connection with the inter-affiliate
exclusions from the dealer and major participant definitions).
---------------------------------------------------------------------------

C. ``Substantial Position'' and ``Substantial Counterparty Exposure''
Definitions
    Exchange Act rules 3a67-3 and 3a67-5 define ``substantial
position'' and ``substantial counterparty exposure,'' which constitute
key terms within the major participant definition. The rules defining
these thresholds--including the use of current exposure and potential
future exposure tests, the specific features of those tests, and the
thresholds associated with those tests\1471\--can be expected to
directly influence the overall number of persons who may fall with the
major participant definition.
---------------------------------------------------------------------------

    \1471\ As detailed above in part IV.B.3, an entity will
generally be required to register as a major security-based swap
participant if its current security-based swap exposure exceeds $1
billion in a single major category of security-based swaps or to a
single counterparty or if its current security-based swap exposure
plus its potential future exposure exceeds $2 billion in a single
major category of security-based swaps or to a single counterparty.
The current exposure test looks to an entity's current
uncollateralized exposure posed by its security-based swap positions
in a given category; the potential future exposure test looks to the
effective notional exposure represented by an entity's security-
based swap positions, with certain adjustments for cleared or
margined positions and netting.
---------------------------------------------------------------------------

    These tests seek to capture persons whose security-based swap
positions pose sufficient risk to counterparties and the markets
generally that regulation as a major participant is warranted.\1472\
Based on available data regarding the single-name credit default swap
market--which we believe will comprise the majority of security-based
swaps--we estimate that the number of major security-based swap
participants likely will be fewer than five and, in actuality, may be
zero. As discussed above, an entity that posts daily variation margin
in connection with those positions generally would need to have
security-based swap positions approaching $100 billion to reach the
levels of potential future exposure required to meet the substantial
position threshold, even before accounting for the impact of netting,
while an entity that clears its security-based swaps generally would
need to have positions approaching $200 billion.\1473\ The available
data shows that as of December 2011 a single entity had aggregate gross
notional positions (i.e., aggregate buy and sell notional positions) in
single-name credit default swaps exceeding $100 billion, and three
others had aggregate gross notional positions between $50 and $100
billion.\1474\ However, as discussed above, the purchase of credit
protection is weighed less heavily than the sale of credit protection
for purposes of the analysis,\1475\ meaning that an entity's positions
reflecting single-name credit protection sold to its counterparties may
be expected to be more of a key determinant of the entity's potential
future exposure level under the rules we are adopting. The data shows
that no entities have more than $100 billion in positions arising from
selling single-name credit protection and that only two have between
$50 and $100 billion in positions arising from such transactions.\1476\
---------------------------------------------------------------------------

    \1472\ See parts IV.C.3 and IV.E.3, supra.
    \1473\ See note 914, supra. Although it is possible that a
notional position of $20 billion could cause an entity to be a major
participant in the absence of central clearing or mark-to-market
margining (and assuming that there is no risk reduction associated
with netting or with certain positions that pose lower credit risk),
we expect that those entities (such as hedge funds) that may be
expected to have large positions would, as a matter of course, post
mark-to-market margin in connection with positions that are not
cleared. See Proposing Release, 75 FR 80207-08 n.181 (stating our
understanding that banks, securities firms, and hedge funds
typically collateralize most or all of their mark-to-market exposure
to U.S. banks as a matter of practice). Accordingly, we believe that
$100 billion provides a reasonable focus for the analysis.
    \1474\ See CDS Data Analysis at table 10.
    \1475\ See part IV.B.3.c.iii, supra.
    \1476\ See id. Although this data describes aggregate notional
positions only for single-name credit default swaps and does not
include analysis of positions in other types of security-based
swaps, as noted above, credit default swaps appear to account for
approximately 95 percent of the security-based swap market. That
fact reduces the likelihood that positions involving security-based
swaps that are not credit-related would cause a person to be a major
security-based swap participant, or lead any entity to find it
necessary to perform the major participant analysis in connection
with those instruments.
---------------------------------------------------------------------------

    While a ``substantial position'' or ``substantial counterparty
exposure'' also can be established by a sufficiently high amount of
current uncollateralized exposure, the available data does not provide
information about individual entities' uncollateralized exposure in
connection with security-based swap positions. We note, however, our
understanding that certain of the financial entities that may have
large security-based swap positions, such as hedge funds, tend to
collateralize their security-based swap exposures as a matter of
course, which would reduce the potential impact of this aspect of the
test.
    As noted above, commenters suggested both higher and lower
thresholds, as well as different discounts or risk multipliers for
certain positions.\1477\ If the final rules defining ``substantial
position'' and ``substantial counterparty exposure'' incorporated
higher major participant thresholds, potentially fewer entities may be
major participants. Conversely, lower thresholds may have led to a
higher number of major participants, with the upper bound being
represented by the over 1,000 non-dealer entities that participate in
the security-based swap market.\1478\
---------------------------------------------------------------------------

    \1477\ See part IV.B.2, supra.
    \1478\ See CDS Analysis at tables 10 through 12.
---------------------------------------------------------------------------

    By potentially capturing more or fewer major participants, such
alternatives would have correspondingly increased or decreased the
programmatic costs and benefits associated with Title VII regulation of
major participants. As discussed above, however, the tests incorporated
into the final rules, and the thresholds associated with those tests,
are in our view tailored to capture only those entities that pose the
risks that major participant regulation in Title VII seeks to address;
in other words, these thresholds and related calculations

incorporate the risk criteria embedded in the major participant
definition.\1479\ For example, we have declined to exclude centrally
cleared positions from the potential future exposure test, instead
permitting entities to discount those positions for purposes of the
analysis, because central clearing cannot reasonably be expected to
fully eliminate all counterparty risk that may affect the broader
markets. Based on this fact, we conclude that it would be
inappropriate, given the purposes of Title VII, to exclude an entity
from the major participant definition simply because all of its
security-based swap positions arise from cleared transactions.\1480\
Similar considerations informed our approach to other aspects of the
substantial position and substantial counterparty position tests, as
discussed more fully above.\1481\
---------------------------------------------------------------------------

    \1479\ See part IV.B.3, supra (discussing the decisions made
regarding the substantial position definition and the reasoning
behind the adopted approach). For example, we have concluded that
the proposed thresholds are set prudently in a manner that takes
into account the financial system's ability to absorb losses of a
particular size, the need for major participant regulation not to
encompass entities only after they pose significant risks to the
market, and the need to account for the possibility that multiple
market participants may fail close in time. In addition, as
discussed above, we believe that this threshold is tailored to
address the types of events associated with the failure of AIG FP.
See part IV.B.3.d, supra.
    \1480\ Central clearing helps to mitigate counterparty credit
risk by improving risk management and, among other things,
mutualizing the risk of counterparty failure. If multiple members of
a central counterparty fail beyond the level to which such risk is
managed, however, the central counterparty would also be at risk of
failure. Cf. Basel Committee on Banking Supervision, Consultative
Document, ``Capitalisation of bank exposures to central
counterparties,'' Nov. 25, 2011 (available at: http://www.bis.org/publ/bcbs206.pdf) (proposing that the capital charge for trade
exposures to a qualifying central counterparty should carry a low
risk weight, reflecting the relatively low risk of default of the
qualifying central counterparty).
    \1481\ See part IV.B.3, supra.
---------------------------------------------------------------------------

ii. Rules That May Be Expected To Have a Lesser Effect on Programmatic
Costs and Benefits
    Several of the final rules may be expected to have relatively
smaller effects on the scope of the major participant and dealer
definitions because they are likely to affect relatively fewer
entities. By extension, they will also have a smaller effect on the
programmatic costs and benefits arising from these definitions.

A. Limited Purpose Dealer and Major Participant Designations

    Exchange Act rules 3a67-1 and 3a71-1 retain the presumption that a
person that is encompassed within the major participant or dealer
definitions will be deemed to be a dealer or major participant with
respect to all of its security-based swap activities or positions,
unless the SEC exercises its authority to limit the person's
designation as a dealer to specified categories of swaps or security-
based swaps, or to specified activities. This presumption may affect
programmatic costs in at least two ways.
    First, by not providing for registration as a limited purpose major
participant or dealer as a matter of course, the final rules may be
expected to increase the costs associated with the registration of
those entities that seek designation as dealers or major participants
or dealers. Aside from the costs of registration described in the SEC's
proposal related to the registration of dealers and major
participants,\1482\ we expect that entities seeking to register as a
limited purpose major participant or dealer would incur some additional
marginal costs associated with making applications for limited
designation.\1483\
---------------------------------------------------------------------------

    \1482\ See ``Registration of Security-Based Swap Dealers and
Major Security-Based Swap Participants,'' Exchange Act Rel. No. 34-
65543 (``Registration Proposing Release''), 76 FR 65784, 65814-65818
(describing various costs associated with registration, including
$11,800 per entity to complete and file form SBSE and between
approximately $94,000 and $610,000 per entity to certify to the
capabilities of the entity seeking registration).
    \1483\ These costs may include the costs of identifying how the
entity would be able, as a limited designation entity, to comply
with the various entity-level requirements of Title VII.
---------------------------------------------------------------------------

    In addition, the presumption against limited purpose designation
may be expected to reduce the number of limited purpose major
participants and dealers below the number that would otherwise register
as limited purpose entities absent the presumption. In concept, broader
availability of limited purpose registration of major participants or
dealers may be expected to reduce the programmatic costs associated
with regulation under Title VII, without necessarily reducing certain
programmatic benefits if appropriately crafted. In particular, any
programmatic effects of an appropriately scoped limited designation
likely would affect only the transaction-level requirements applicable
to dealers and major participants (e.g., certain business conduct
standards and requirements related to trading records, documentation
and confirmations), potentially reducing costs and benefits that would
otherwise arise from such requirements with respect to transactions
that occur outside the limited designation. At the same time, certain
of the entity-level regulatory requirements applicable to dealers and
major participants as a whole (such as requirements related to capital)
would continue to apply in the context of limited designation, ensuring
that a limited purpose designation would not undermine the counterparty
protection and systemic risk concerns of Title VII.
    Notwithstanding these effects, we believe that the presumption
against limited purpose designations is appropriate. This conclusion
reflects the statutory language, the difficulty of separating a
dealer's activities from its non-dealing activities (or a major
participant's security-based swap positions taken under its limited
purpose designation from other of its security-based swap positions)
for compliance purposes, and the challenges of applying dealer or major
participant regulatory requirements to only a portion of the entity's
security-based swap business. Instead, we will consider limited purpose
applications on an individual basis through analysis of the unique
circumstances of each applicant.\1484\
---------------------------------------------------------------------------

    \1484\ We will consider applications for limited purpose
designation in the context of the registration requirements for
major participants and dealers. In that context, we could consider
applications on a case-by-case basis, pursuant to requests by
specific major participants or dealers. This could help to ensure
that any person that is designated as a limited purpose major
participant or dealer is able to comply with the regulatory
requirements applicable to major participants or dealers.
Accordingly, we intend to further consider issues regarding limited
designations, including associated costs, in a release relating to
the specific registration requirements (for example, the form used
for registration) for major participants and dealers. Furthermore,
as noted above, the SEC is directing the staff to prepare a report
on all aspects of the dealer and major participant definitions. Upon
completion of this report, the SEC may further assess whether
changes to the presumption against limited designation are warranted
in light of the then-current state of the security-based swap market
and the types of business in which security-based swap dealers are
engaged.
---------------------------------------------------------------------------

    We note that the available data does not indicate how many, or
which, entities may have business models that conceivably could make
limited purposed designations appropriate (e.g., large positions in one
major category of security-based swaps accompanied by minor positions
in the other).\1485\
---------------------------------------------------------------------------

    \1485\ The study that will be conducted in connection with the
dealer and major participant definitions may also provide relevant
information regarding limited designations of dealers and major
participants.
---------------------------------------------------------------------------

B. Inter-Affiliate Exclusions From Dealer and Major Participant
Definitions

    Exchange Act rules 3a67-3 and 3a71-1 respectively exclude inter-
affiliate security-based swaps from the calculation of substantial
position and substantial counterparty position thresholds under the
major participant

definition, and from the de minimis calculation under the dealer
definition. The inter-affiliate exclusion from the major participant
and dealer definitions has the potential to affect the scope of these
definitions for those entities that engage in inter-affiliate
transactions by leading some entities not to meet the major participant
or dealer de minimis thresholds when they otherwise would have met
those thresholds (or by allowing certain centralized hedging facilities
to look only at their market-facing activities in conducting the
dealer-trader analysis). The exclusion or inclusion of certain inter-
affiliate transactions thus may have some impact on the programmatic
costs and benefits associated with dealer and major participant
regulation.
    We are adopting a majority-ownership standard for determining
whether transactions between affiliates can be excluded from these
threshold calculations because such transactions between entities whose
economic interests are aligned to a degree represented by majority
ownership do not appear to pose the kinds of counterparty and market
risks that Title VII addresses.\1486\ Some commenters suggested lower
levels of control (such as common control) that may be expected to lead
to fewer entities being registered as dealers or major participants,
with associated impacts on programmatic costs and benefits. In our
view, however, such alternative standards would not be consistent with
the scope of the interactions to which dealer regulation is intended to
apply, or with an alignment of economic interests consistent with an
exclusion from the major participant definitions.
---------------------------------------------------------------------------

    \1486\ See parts II.C.2.b and IV.G.2, supra (discussing nature
of inter-affiliate security-based swap transactions).
---------------------------------------------------------------------------

    We also note that the data upon which the staff assessment of
credit default swap transactions and positions is based excludes
certain inter-affiliate credit default swap transactions. As a result,
estimates of market concentration and the distribution of dealing
activity or credit default swap positions derived from this data should
reflect to some extent the effect of the inter-affiliate exclusions we
are adopting in this rule.

C. Commercial Risk Hedging Exclusion

    Exchange Act rule 3a67-4 defines ``hedging or mitigating commercial
risk'' as that term is used in the major participant definition. The
scope of this definition has the potential to determine whether certain
market participants will be major participants by virtue of the first
statutory major participant test, and will therefore affect the scope
of the programmatic costs and benefits associated with major
participant regulation. In application, this effect may be limited in
light of the fact that we estimate that, as discussed above, only five
or fewer entities--perhaps as few as zero--may have to register as
major security-based swap participants.
    The final rule adopts an ``economically appropriate'' standard for
determining whether a security-based swap position hedges or mitigates
commercial risk, and sets forth exclusions for security-based swap
positions that have a speculative or trading purpose. As we discuss
above, we carefully considered the alternative approaches suggested by
some commenters, including the suggestion that the definition should
encompass positions that hedge speculative or trading positions and the
suggestion that the definition should incorporate a ``congruence''
standard. We concluded, however, that these approaches are inconsistent
with the focus of the statutory text, which is on ``commercial risk.''
\1487\ We also concluded that broadening the exclusion as some
commenters suggested could largely exclude security-based swap
positions from the first major participant test. This would produce a
result that we believe to be contrary to the purposes of that part of
the statutory definition, which envisions that entities might be
required to register as major participants by virtue of their security-
based swap positions.
---------------------------------------------------------------------------

    \1487\ See parts IV.C.5.a and IV.C.5.b, supra (discussing
rationale for excluding hedges of speculative and trading positions
from the definition).
---------------------------------------------------------------------------

D. ``Financial Entity'' Definition

    Exchange Act rule 3a67-6 defines ``financial entity'' for purposes
of the third test of the major participant definition, which applies to
certain highly leveraged non-bank financial entities and does not
prevent them from excluding commercial risk hedging positions when
conducting the substantial position analysis (in contrast to the first
test within the major participant definition, which permits exclusion
of those hedging positions).
    Although the scope of the financial entity definition has the
potential to affect the number of persons who are captured by the third
test of the statutory major participant definition (and thus, by
extension, the programmatic costs and benefits associated with major
participant regulation), we believe that as a practical matter such an
effect would be minimal. This is based on our view that persons that
have security-based swap positions large enough and risky enough to
potentially lead to major participant status to be financial in nature
and thus would likely fall within any reasonable interpretation of the
term ``financial entity,'' \1488\ thus making such entities potentially
subject to the third major participant test (to the extent that such
entities are subject to bank capital requirements).
---------------------------------------------------------------------------

    \1488\ See Federal Reserve Bank of New York staff reports, ``An
Analysis of CDS Transactions: Implications for Public Reporting''
(2011) at table 3 (``NY Fed analysis'') (available at http://www.newyorkfed.org/research/staff_reports/sr517.pdf) (discussing
credit default swap trade frequency by market type, and indicating
that most activity is done by entities of a financial nature).
---------------------------------------------------------------------------

E. ``Highly Leveraged'' Definition

    Exchange Act rule 3a67-7 defines ``highly leveraged'' for purposes
of the third prong of the major participant definition, which applies
to certain non-banks as described above. In adopting the final rule, we
have considered alternative approaches suggested by commenters. For
example, a number of commenters favored the use of a 15 to 1 leverage
ratio, which may be expected to reduce the number of persons who are
deemed to be ``highly leveraged'' and thus subject to the third test.
Conversely, some commenters favored a ratio that is lower than the one
found in the final rule, which may be expected to increase the number
of entities deemed to be highly leveraged.\1489\
---------------------------------------------------------------------------

    \1489\ See part IV.F.2.b, supra.
---------------------------------------------------------------------------

    The final rule defines ``highly leveraged'' as a leverage ratio of
12 to 1 or higher. In our view, this ratio reasonably sets forth
objective criteria for identifying entities that pose a heightened risk
of being unable to meet their obligations through their use of
leverage. This 12 to 1 ratio reflects a number of factors, including
the use of a 12 to 1 ratio in connection with certain broker-dealer
capital rules, as well as reasons to distinguish the use of a 15 to 1
ratio in Title I of the Dodd-Frank Act.\1490\
---------------------------------------------------------------------------

    \1490\ See part IV.F.3.b, supra (discussing the rationale for
using a 12 to 1 ratio for purposes of defining the term ``highly
leveraged'' in the context of the major participant definitions).
---------------------------------------------------------------------------

    As with the financial entity definition in rule 3a67-6, as a
practical matter we do not believe that expanding or narrowing the
leverage ratio within any reasonable definition of ``highly leveraged''
for purposes of the third major participant test will have a
significant impact on the programmatic costs and benefits of major
participant regulation. In part, this is because we believe that in
many circumstances the

sales of credit protection cannot reasonably be interpreted to
constitute the hedging of commercial risk,\1491\ meaning that such
positions in any event may be expected to be considered as part of the
analysis of the first major participant test. The programmatic impact
of this definition further is mitigated by the fact that we believe
that there will be relatively few entities whose security-based swap
positions would cause them to be major participants.
---------------------------------------------------------------------------

    \1491\ See note 1019, supra.
---------------------------------------------------------------------------

F. ``Major'' Categories of Security-Based Swaps

    Exchange Act rule 3a67-2 defines ``major'' categories of security-
based swaps, a term that plays a role in the two statutory major
participant tests that turn upon the presence of a substantial position
in a ``major'' category of security-based swaps. The final rule retains
the proposal's division of those instruments into debt-based and other
categories. As discussed above, these major categories are broadly
consistent with market usage and statistics, and we believe that it is
reasonable for entities undertaking this analysis to use these
categories in calculating whether they have a substantial
position.\1492\
---------------------------------------------------------------------------

    \1492\ See part IV.A.3 (discussing rationale for final ``major''
categories).
---------------------------------------------------------------------------

    In theory, it is possible that the categorization of security-based
swaps for these purposes could result in a particular entity exceeding
the applicable thresholds in a major category, causing it to be a major
security-based swap participant and triggering the Title VII
registration and regulatory requirements.\1493\ The relationship
between the major security-based swap categories as we have defined
them in this rule and the programmatic costs and benefits associated
with major participant regulation will depend largely on how the
security-based swap positions of entities with security-based swap
exposures approaching these thresholds are distributed between these
categories.
---------------------------------------------------------------------------

    \1493\ In other words, the dividing line that the rule sets
between the major category of debt-based security-based swaps and
the major category for other security-based swaps (or other dividing
lines based on different or additional major categories) could
determine whether an entity's security-based swap positions exceed
or fall below the major participant thresholds for a particular
major category, and hence whether the entity will be deemed to be a
major participant.
---------------------------------------------------------------------------

    The available data suggests that the debt-based major category
(i.e., credit default swaps) accounts for the vast majority of
security-based swap positions.\1494\ Absent an approach that breaks
single-name credit default swaps in to multiple ``major'' categories--
which itself would not appear to be justified based on current
information--this suggests that this categorization as a practical
matter will not have a significant effect on the programmatic costs and
benefits of major participant regulation.\1495\
---------------------------------------------------------------------------

    \1494\ See note 476, supra.
    \1495\ For example, an alternative approach might divide narrow-
based index CDS and single-name CDS into separate major categories.
We believe, however, that single-name CDS account for the large
majority of debt-based security-based swaps, see id., suggesting
that most entities' status as major participants would turn on their
single-name CDS exposures under any reasonable approach to defining
major categories and that the subtraction of narrow-based index CDS
exposures in the calculation of substantial exposure would, given
their relatively small market volume, have little effect on whether
most entities meet the substantial exposure threshold. Thus, we
believe that the decision to classify all debt-based security-based
swaps in a single category will likely have minimal effect, if any,
on any entity's status as a major participant, as compared to
dividing debt-based security-based swaps into two categories.
---------------------------------------------------------------------------

G. Registration Period

    Exchange Act rules 3a67-8 and 3a71-2 establish periods for
registration as a dealer and major participant, as well as periods for
revaluating or terminating one's status as a registered entity. As
such, these provisions may affect the length of time that particular
entities may be deemed to be major participants or dealers, and hence
subject to the requirements applicable to those entities. However, any
effect of delaying or accelerating dealer or major participant status
on the programmatic costs and benefits associated with major
participant or dealer status likely will be negligible compared to the
overall programmatic costs and benefits associated with major
participant or dealer regulation.

H. Calculation Safe Harbor

    Exchange Act rule 3a67-9 establishes a calculation safe harbor for
the major participant threshold tests. We do not believe that this safe
harbor changes the scope of the major participant definition, as it
should not exclude from the major participant definition any entity
that would otherwise fall within the definition if that entity
performed the substantial position calculations.\1496\ Accordingly, we
do not believe that the safe harbor would have a material effect on the