example to include all nonfinancial energy commodities. The
parenthetical example was not intended to be limited to agreements to
purchase home heating fuel.
---------------------------------------------------------------------------

    \453\ See CDEU Letter; FCC Letter; FERC Letter; FHLB Letter;
ISDA Letter; Just Energy Letter; PMAA/NEFI Letter; and SEIA Letter.
    \454\ See Just Energy Letter.
---------------------------------------------------------------------------

    One commenter suggested that the Commissions should include as an

additional example residential fuel storage contracts.\455\ The
Commissions agree that these arrangements should not be considered
swaps or security-based swaps, provided that they are residential fuel
storage contracts where the consumer takes delivery of and consumes the
fuel, and the counterparty is a merchant (or agent of a merchant) that
delivers in the service area where the consumer's residence is located.
Although the consumer may not immediately consume the fuel contracted
for, because it will ultimately consume the fuel for personal, family,
or household purposes, such a transaction is a type of customary
consumer transaction excluded from the swap and security-based swap
definitions.
---------------------------------------------------------------------------

    \455\ See PMAA/NEFI Letter.
---------------------------------------------------------------------------

    Three commenters requested clarification that commercial loans and
mortgages would fall within the interpretation regardless of whether
entered into by a bank or non-bank.\456\ Two of these commenters were
concerned that the specific example was limited to commercial loans and
mortgages entered into by non-banks and did not address commercial
loans and mortgages entered into by financial institutions that are
banks but whose loans and mortgages do not qualify as identified
banking products.\457\ The Commissions are revising the example to
clarify that it includes fixed or variable interest rate commercial
loans or mortgages entered into by both banks and non-banks, including
such loans and mortgages entered into by the Farm Credit System
institutions and Federal Home Loan Banks. The Commissions understand
that the CEA does not apply to, and the CFTC may not exercise
regulatory authority over, and the definitions of the terms ``security-
based swap'' and ``security-based swap agreement'' do not include, any
fixed or variable interest rate commercial loan or mortgage entered
into by a bank that is an identified banking product.\458\ However,
loans and mortgages provided by certain banks may not qualify as
identified banking products because those banks do not satisfy the
definition of ``bank'' for purposes of the ``identified banking
products'' definition.\459\ According to commenters,\460\ while this
definition of ``bank'' includes insured depository institutions,
certain foreign banks, credit unions, institutions regulated by the
Federal Reserve and trust companies, it does not include certain other
financial institutions that provide commercial loans or mortgages, such
as government-sponsored enterprises (including the Federal Home Loan
Banks) and certain cooperatives (including the Farm Credit System
institutions).
---------------------------------------------------------------------------

    \456\ See CDEU Letter; FCC Letter; and FHLB Letter.
    \457\ See FCC Letter and FHLB Letter.
    \458\ See infra note 488, regarding identified banking products.
    \459\ See 7 U.S.C. 27(a). See also FCC Letter and FHLB Letter.
    \460\ See supra note 457.
---------------------------------------------------------------------------

    Three commenters suggested that the Commissions should include as
additional examples commercial rate lock agreements and commercial
loans with interest rate caps, floors, or options.\461\ The Commissions
agree that these arrangements should not be considered swaps or
security-based swaps, provided that the interest rate locks, caps, or
floors, or interest rate options are embedded in the commercial loans
or mortgages and not entered into separately from the commercial loans
and mortgages, and are including these arrangements as examples in the
interpretation. However, the Commissions are limiting the
interpretation to embedded interest rate locks, caps, or floors, and
interest rate options because interest rate locks, caps, or floors, or
interest rate options that are entered into separately from the
commercial loans and mortgages fall within the swap definition.\462\ In
order to further distinguish these arrangements from swaps and
security-based swaps, the interpretation provides the following: (i)
The embedded interest rate lock, cap, or floor must be included for the
sole purpose of providing a lock, cap, or floor on the interest rate on
such loan or mortgage and may not include additional provisions that
would provide exposure to enhanced or inverse performance, or other
risks unrelated to the interest rate risk being addressed, and (ii) the
embedded interest rate option may not include additional provisions
that would provide exposure to leverage, inverse performance, or other
risks unrelated to the primary reason the embedded interest rate option
is included in the commercial loan or mortgage.
---------------------------------------------------------------------------

    \461\ See CDEU Letter; FCC Letter; and FHLB Letter. These
commenters indicated that such arrangements are similar to the
arrangements included in the list of examples of consumer
arrangements that the Commissions would not consider to be swaps or
security-based swaps.
    \462\ See section 1a(47)(A)(i) of the CEA, 7 U.S.C.
1a(47)(A)(i). Similarly, with respect to consumer agreements,
contracts and transactions providing for an interest rate cap or an
interest rate lock on a consumer loan or mortgage, the Commissions
are limiting this example to interest rate caps and interest rate
locks entered into in connection with the consumer loan or mortgage
and prior to closing on the loan or mortgage. For this purpose, both
because obtaining a consumer loan or mortgage can involve a great
deal of documentation, which can be entered into at different times
during the process, and because consumers may have some flexibility
as to their deadline for deciding when to include or exclude an
interest rate cap or lock in their consumer loans or mortgages, the
Commissions will consider an interest rate cap or lock to be entered
into in connection with a consumer loan or mortgage if it is
included in the final terms of the loan at closing.
---------------------------------------------------------------------------

    Four commenters suggested additional examples of commercial
arrangements that relate to nonfinancial energy commodities.\463\ These
arrangements are more appropriately addressed in the context of the
forward contract exclusion for nonfinancial commodities \464\ or the
trade option exemption.\465\
---------------------------------------------------------------------------

    \463\ See BGA Letter (commercial physical transactions in the
natural gas and electric power markets should also fall under the
category of exemptions from the swap definition); FERC Letter
(commercial transactions executed or traded on RTOs/ISOs should be
included in the interpretation); Just Energy Letter (commercial
arrangements to purchase products or services at a fixed price or a
capped or collared price, at a future date or over a certain time
period); and PMAA/NEFI Letter (petroleum fuel and gas storage
contracts between bona fide commercial market participants or
entities other than financial entities).
    \464\ See supra part II.B.2. The Commissions note that they
provided the interpretation regarding consumer arrangements because
the CFTC in the past has not interpreted the forward contract
exclusion for nonfinancial commodities to apply to consumer
arrangements. See supra note 434.
    \465\ See supra note 317 and accompanying text.
---------------------------------------------------------------------------

    One commenter supported the representative characteristics and
factors the Commissions set forth to distinguish consumer and
commercial arrangements from swaps and security-based swaps.\466\ Two
commenters were concerned with certain of these characteristics and
factors because these commenters believed that such characteristics and
factors are common in a wide variety of consumer and commercial
arrangements.\467\ Both commenters suggested that the Commissions
remove ``for other than speculative, hedging or investment purposes''
from the interpretation because many of the types of transactions
listed as examples may be undertaken for speculative, hedging or
investment purposes and because all commercial merchandising
transactions are ``risk-shifting'' of commercial obligations and risks,
and ``hedge'' the enterprise's commercial risks.\468\ The Commissions
are not revising the interpretation to remove or otherwise modify this
representative characteristic and factor. The Commissions believe that
commercial arrangements undertaken for speculative, hedging or
investment purposes may be a swap or a security-based swap depending on
the particular facts and circumstances of the arrangement.
---------------------------------------------------------------------------

    \466\ See FCC Letter.
    \467\ See ETA Letter and ISDA Letter.
    \468\ Id.

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

    One of these commenters also suggested the Commissions remove ``do
not contain payment obligations that are severable'' from the
interpretation because assignment of rights and delegation of
obligations are common in a wide variety of consumer and commercial
transactions.\469\ The Commissions are not revising the interpretation
to remove or otherwise modify this representative characteristic and
factor. The Commissions believe that the severability of payment
obligations could be indicative of a consumer or commercial arrangement
that may be a swap or a security-based swap depending on the particular
facts and circumstances of the arrangement because the severability of
payment obligations could be indicative of an instrument that is merely
an exchange of payments, such as is the case with swaps and security-
based swaps.
---------------------------------------------------------------------------

    \469\ See ISDA Letter.
---------------------------------------------------------------------------

    One of these commenters also suggested that the Commissions remove
``not traded on an organized market or over the counter'' from the
interpretation because many of the types of contracts listed as
examples are assignable and frequently assigned or traded.\470\ The
other commenter did not suggest removing this factor, but requested
that the factor be modified to provide that the arrangement is not
traded on a ``registered entity'' in order not to include transactions
on organized wholesale electricity markets.\471\ The Commissions are
not revising the interpretation to remove or otherwise modify this
representative characteristic and factor. The Commissions believe that
the trading of an instrument on an organized market or over the counter
could be indicative of a consumer or commercial arrangement that may be
a swap or a security-based swap depending on the particular facts and
circumstances of the arrangement. However, as noted above, the
Commissions are clarifying that merely because an arrangement is
assignable does not mean that it is ``traded'' or that the arrangement
is a swap or security-based swap. An assignment of a contractual
obligation must be analyzed to assure that the result is not to sever
the payment obligations.
---------------------------------------------------------------------------

    \470\ Id.
    \471\ See ETA Letter.
---------------------------------------------------------------------------

    Further, as noted above, the representative characteristics and
factors are not intended to be a bright-line test for determining
whether a particular consumer or commercial arrangement is a swap or
security-based swap. These representative characteristics and factors
taken together are indicators that a consumer or commercial arrangement
is not a swap or security-based swap. These representative
characteristics and factors also do not imply or presume that a
consumer or commercial arrangement that does not meet all of these
characteristics and factors is a swap or security-based swap. As noted
above, if a particular arrangement does not meet all of these
characteristics and factors, the parties will need to evaluate the
arrangement based on the particular facts and circumstances. Moreover,
as noted above, if there is a type of consumer or commercial
arrangement that does not meet all of these characteristics and
factors, a party to the arrangement can seek an interpretation from the
Commissions as to whether the arrangement is outside the scope of the
swap and security-based swap definitions.
Residential Exchange Program
    One commenter requested that the CFTC further define the term
``swap'' to exclude consumer benefits under the Pacific Northwest
Electric Power Planning and Conservation Act of 1980 (``Northwest Power
Act'') \472\ and transactions under the ``Residential Exchange
Program'' (``REP'').\473\ According to this commenter, the REP was
established by Congress ``[t]o extend the benefits of low cost Federal
System hydro power to residential and small farm electric power
consumers throughout the Pacific Northwest Region.'' \474\ Based on the
commenter's description, REP transactions do not appear to be among the
types of transactions historically considered swaps or security-based
swaps. Although the REP transactions described by the commenter share
some features with spread options (e.g., they settle in cash based on
the difference between two price sources),\475\ in both swaps and
security-based swaps, each party assumes market risk.\476\ By contrast,
neither party assumes or hedges risk in an REP transaction.\477\
Instead, the Commissions view an REP transaction essentially as a
subsidy provided to residential and small farm utility customers.\478\
Accordingly, the Commissions do not consider the REP transactions
described by the commenter to be swaps or security-based swaps.
---------------------------------------------------------------------------

    \472\ 16 U.S.C. Chapter 12H.
    \473\ Letter from Virginia K. Schaeffer, Attorney, Office of
General Counsel, Bonneville Power Administration, Jul. 22, 2011
(``BPA Letter''). This commenter refers to the implementation of
Section 5(c) of the Northwest Power Act, 16 U.S.C. 839c(c), as the
``Residential Exchange Program.'' See Id.
    \474\ See BPA Letter. This commenter explained that, under the
REP: ``A Pacific Northwest electric utility has a right to * * *
sell power to Bonneville at the utility's average system cost (ASC)
of providing that power * * * Bonneville[] is required to purchase
that power at the utility's ASC, and then sell an equivalent amount
of power back to the utility at Bonneville's rates[,] which are
based in substantial part on low cost Federal hydro power. As
required by the Residential Exchange Statute, the amount of such
power ``exchanged'' is based on the related utility's residential
and small farm customer's power needs (also known as ``loads'') in
the Pacific Northwest Region. Under this ``exchange,'' no actual
power is transferred to or from Bonneville. Instead, consistent with
Congressional intent, the exchange transaction is implemented as an
accounting device that avoids the costs and burdens associated with
a physical exchange of power and that results in the payment of
funds by Bonneville to the REP exchanging utilities. Reduced to the
essentials, the Residential Exchange Statute as implemented in * * *
REP contracts results in Bonneville making cash payments for the
positive difference between the utility's ASC and Bonneville's lower
rate multiplied by the qualifying residential and small farm loads.
And, as required under the Residential Exchange Statute, the entire
monetary benefit Bonneville provides to the REP exchanging utilities
is in turn passed through to the residential and small farm power
consumers of that utility.'' Id.
    \475\ A spread option is ``an option in which the payout is
based on the difference in performance between two assets.''
Superderivatives, ``Spread option in EQ'' definition, available at
http://www.sdgm.com/Support/Glossary.aspx?letter=S. See also S.J.
Denga and S.S. Oren, Electricity derivatives and risk management,
Science Direct at 945 (2006), available at http://
www.ieor.berkeley.edu/~oren/pubs/Deng%20and%20Oren-86.pdf (defining
a spark spread options as ``cross-commodity options paying out the
difference between the price of electricity sold by generators and
the price of the fuels used to generate it''); Chicago Mercantile
Exchange, Soybean-Corn Price Ratio Options Fact Card (describing its
soybean-corn price ratio option contract as ``an option on the ratio
between the price of the referencing Soybean futures contract and
the price of the referencing Corn futures contract * * *''),
available at http://www.cmegroup.com/trading/agricultural/files/AC-440-Soybean-CornRatioOptionsFC.pdf.
    \476\ Even a hedging party assumes the risk that the market can
move against its hedging position, causing the hedge to reduce the
profit it otherwise would have made on an unhedged position.
    \477\ The fact that the Commissions are relying in part on this
aspect of REP transactions to interpret such transactions to be
neither swaps nor security-based swaps does not mean that market
participants should conclude, in other contexts, that a lack of
market risk removes an agreement, contract, or transaction from the
swap and security-based swap definitions. The Commissions'
conclusion as to REP transactions is based on the unique facts and
circumstances presented by the commenter.
    \478\ See, e.g., Paul M. Murphy, Northwest Public Power
Association, Background and Summary of the Residential Exchange
Program Settlement Agreement, March 16, 2011, available at http://www.nwppa.org/cwt/external/wcpages/wcmedia/documents/background_and_summary_of_rep_settlement_agreement.pdf (characterizing the
REP as ``require[ing] BPA to subsidize the residential and small
farm consumers of the higher cost utilities in the Pacific
Northwest'').
---------------------------------------------------------------------------

Loan Participations
    The Commissions provided an interpretation in the Proposing Release
regarding the treatment of loan participations.\479\ The Commissions
are

restating the interpretation set out in the Proposing Release with
certain modifications in response to commenters.\480\
---------------------------------------------------------------------------

    \479\ See Proposing Release at 29834.
    \480\ See infra note 504 and accompanying text.
---------------------------------------------------------------------------

    Loan participations arise when a lender transfers or offers a
participation in the economic risks and benefits of all or a portion of
a loan or commitment it has entered into with a borrower to another
party as an alternative or precursor to assigning to such person the
loan or commitment or an interest in the loan or commitment.\481\ The
Commissions understand that two types of loan participations exist in
the market today,\482\ LSTA-style participations\483\ and LMA-style
participations.\484\ LSTA-style participations transfer a beneficial
ownership interest in the underlying loan or commitment to the
participant.\485\ LMA-style participations do not transfer a beneficial
ownership interest in the underlying loan or commitment to the
participant, but rather create a debtor-creditor relationship between
the grantor and the participant under which a future beneficial
ownership interest is conveyed.\486\
---------------------------------------------------------------------------

    \481\ See Loan Market Association, ``Guide to Syndicated
Loans,'' section 6.2.4 (``A [loan] participation * * * is made
between the existing lender and the participant. This creates new
contractual rights between the existing lender and the participant
which mirror existing contractual rights between the existing lender
and the borrower. However this is not an assignment of those
existing rights and the existing lender remains in a direct
contractual relationship with the borrower.''), available at http://www.lma.eu.com/uploads/files/Introductory_Guides/Guide_to_Par_Syndicated_Loans.pdf.
    \482\ See Letter from R. Bram Smith, Executive Director, The
Loan Syndications and Trading Association, Jan. 25, 2011 (``January
LSTA Letter''); Letter from Elliot Ganz, General Counsel, The Loan
Syndications and Trading Association, Mar. 1, 2011 (``March LSTA
Letter''); and Letter from Clare Dawson, Managing Director, The Loan
Market Association, Feb. 23, 2011. The Commissions understand that
neither type of loan participation is a ``synthetic'' transaction.
See March LSTA Letter. Both types of loan participations are merely
transfers of cash loan positions and the ratio of underlying loan to
participation is always one to one. Id.
    \483\ The LSTA is The Loan Syndications and Trading Association.
    \484\ The LMA is The Loan Market Association.
    \485\ See Letter from Clare Dawson, Managing Director, The LMA,
Jul. 22, 2011 (``July LMA Letter'').
    \486\ See Id. The participant may exercise an ``elevation''
right and request that the grantor use commercially reasonable
efforts to cause the participant to become the legal owner, by
assignment, of the underlying loan or commitment. Id.
---------------------------------------------------------------------------

    Depending on the facts and circumstances, a loan participation may
be a security under the Federal securities laws and, as such, the loan
participation would be excluded from the swap definition as the
purchase and sale of a security on a fixed or contingent basis.\487\ In
addition, depending on the facts and circumstances, a loan
participation may be an identified banking product and, as such, would
be excluded from CFTC jurisdiction and from the security-based swap and
security-based swap agreement definitions.\488\
---------------------------------------------------------------------------

    \487\ See sections 1a(47)(B)(v) and (vi) of the CEA, 7 U.S.C.
1a(47)(b)(v) and (vi), as amended by section 721(a)(21) of the Dodd-
Frank Act (excluding purchases and sales of a security on a fixed or
contingent basis, respectively from the swap definition).
    \488\ See section 403(a) of the Legal Certainty for Bank
Products Act of 2000, 7 U.S.C. 27a(a), as amended by section
725(g)(2) of the Dodd-Frank Act (providing that, under certain
circumstances, the CEA shall not apply to, and the CFTC shall not
exercise regulatory authority over, identified banking products, and
the definitions of the terms ``security-based swap'' and ``security-
based swap agreement'' shall not include identified banking
products).
---------------------------------------------------------------------------

    The Commissions believe it is important to provide further guidance
as to the other circumstances in which certain loan participations
would not fall within the swap and security-based swap definitions.
Consistent with the proposal, the Commissions do not interpret the swap
and security-based swap definitions to include loan participations that
reflect an ownership interest in the underlying loan or commitment. The
Commissions believe that for a loan participation to not be considered
a swap or security-based swap, the loan participation must represent a
current or future direct or indirect ownership interest in the loan or
commitment that is the subject of the loan participation.
    In evaluating whether the loan participation represents such an
ownership interest, the Commissions believe the following
characteristics should be present:
     The grantor of the loan participation is a lender under,
or a participant or sub-participant in, the loan or commitment that is
the subject of the loan participation.
     The aggregate participation in the loan or commitment that
is the subject of the loan participation does not exceed the principal
amount of such loan or commitment. Further, the loan participation does
not grant, in the aggregate, to the participant in such loan
participation a greater interest than the grantor holds in the loan or
commitment that is the subject of the loan participation.
     The entire purchase price for the loan participation is
paid in full when acquired and not financed. The Commissions believe a
purchase price would not be paid in full if the grantor of the loan
participation extends financing to the participant or if such
participant levers its purchase, including by posting collateral to
secure a future payment obligation.
     The loan participation provides the participant all of the
economic benefit and risk of the whole or part of the loan or
commitment that is the subject of the loan participation.
    These characteristics, which were identified by commenters,\489\
are intended to distinguish loan participations from swaps and
security-based swaps based on loans. The first characteristic above
addresses the ownership of the underlying loan or commitment. Swaps and
security-based swaps may be created using a synthetic or derivative
structure that does not require ownership of the underlying loan.\490\
The second characteristic above addresses the ratio of the
participation to the underlying loan or commitment. Swaps and security-
based swaps based on loans may involve synthetic exposure to a loan
that is a multiple of the principal amount.\491\ The third
characteristic above addresses leverage in the financing of a loan
participation. Leverage could be indicative of an instrument that is
merely an exchange of payments and not a transfer of the ownership of
the underlying loan or commitment, such as may be the case with a swap
or security-based swap.\492\ The fourth characteristic above addresses
the level of participation in the economic benefits and risks of the
underlying loan or commitment. This characteristic is indicative of
ownership when analyzed with the other characteristics and, as noted
above, swaps and security-based swaps may be created using a synthetic
or derivative structure that does not require ownership of the
underlying loan.
---------------------------------------------------------------------------

    \489\ See infra note 504 and accompanying text. See also infra
notes 490, 491, and 492 and accompanying text.
    \490\ See July LMA Letter.
    \491\ Id.
    \492\ Id.
---------------------------------------------------------------------------

    The Commissions agree with commenters that the loan participation
does not have to be a ``true participation,'' as the Commissions had
stated in their interpretation in the Proposing Release,\493\ in order
for the loan participation to fall outside the swap and security-based
swap definitions.\494\ The Commissions note that the ``true
participation'' analysis is used to determine whether a transaction has
resulted in the underlying assets being legally isolated from a
transferor's creditors for U.S. bankruptcy law

purposes.\495\ This analysis is unrelated to and does not inform
whether a loan participation is a swap or security-based swap. This
analysis also may be subject to varying interpretations.\496\ Further,
the Commissions understand that this analysis could result in certain
loan participations that reflect an ownership interest in the
underlying loan or commitment being included in the swap and security-
based swap definitions, which the Commissions do not intend.\497\
---------------------------------------------------------------------------

    \493\ Proposing Release at 29834.
    \494\ See infra note 503 and accompanying text.
    \495\ Id.
    \496\ Id.
    \497\ Id.
---------------------------------------------------------------------------

    Rather, as noted above, the Commissions believe that the analysis
as to whether a loan participation is outside the swap and security-
based swap definitions should be based on whether the loan
participation reflects an ownership interest in the underlying loan or
commitment. The Commissions understand that the characteristics noted
above are indicative, based on comments received,\498\ of whether a
loan participation represents such an ownership interest. Further, in
response to commenters,\499\ the Commissions are clarifying that the
interpretation applies to loan participations that are entered into
both with respect to outstanding loans and with respect to a lender's
commitments to lend and fund letters of credit (e.g., under a revolving
credit facility).
---------------------------------------------------------------------------

    \498\ See supra note 482. See infra note 501.
    \499\ See infra note 506 and accompanying text.
---------------------------------------------------------------------------

    The Commissions believe that the interpretation will prevent
disruption in the syndicated loan market for loan participations. Loan
participations facilitate a lender's diversification of its portfolio
holdings, provide a key component of the efficient settlement process,
and enhance liquidity in the global syndicated loan market.\500\ The
interpretation will enable this market to continue operating as it did
prior to the enactment of Title VII.
---------------------------------------------------------------------------

    \500\ See January LSTA Letter.
---------------------------------------------------------------------------

Comments
    Commenters supported the interpretation that certain loan
participations should not be included in the swap and security-based
swaps definitions.\501\ Commenters agreed with the proposal that a loan
participation should represent a current and future direct or indirect
ownership interest in the loan or commitment that is the subject of the
loan participation.\502\ However, commenters disagreed with the
proposal that a loan participation should be required to be a ``true
participation'' in order for the loan participation to fall outside the
swap and security-based swap definitions because LMA-style
participations do not represent a beneficial ownership in the
underlying loan or commitment such that they would be considered a true
participation.\503\ Commenters requested that the Commissions remove
this factor and instead recognize additional factors.\504\ The
Commissions agree that a loan participation does not have to be a true
participation in order for the loan participation to fall outside the
swap and security-based swap definitions and are revising the
interpretation as noted above.
---------------------------------------------------------------------------

    \501\ See FCC Letter; Letter from Richard M. Whiting, Executive
Director and General Counsel, Financial Services Roundtable, Jul.
22, 2011 (``FSR Letter''); July LMA Letter; Letter from R. Bram
Smith, Executive Director, The LSTA, Jul. 22, 2011 (``July LSTA
Letter''); MFA Letter; and Letter from Kenneth E. Bentsen, Jr.,
Executive Vice President, Public Policy and Advocacy, SIFMA, Jul.
22, 2011 (``SIFMA Letter'').
    \502\ See FSR Letter; July LMA Letter; July LSTA Letter; MFA
Letter; and SIFMA Letter. Commenters indicated that both LSTA-style
participations and LMA-style participations represent a current or
future direct or indirect ownership interest in the related loan or
commitment. Id.
    \503\ See July LMA Letter; July LSTA Letter; MFA Letter; and
SIFMA Letter. These commenters indicated that neither LMA-style
participations nor certain LSTA-style participations are true
participations. See July LMA Letter; July LSTA Letter; and SIFMA
Letter. Further, according to the July LSTA Letter, ``[l]oan market
participants in the United States will likely interpret the `true
participation' requirement as a requirement that loan participations
must qualify for `true sale' treatment in order to avoid
classification as a `swap.' A `true sale' or `true participation'
analysis is a test aimed at determining whether a transaction has
resulted in the underlying assets being legally isolated from the
transferor's creditors for U.S. bankruptcy law purposes. Its
underlying purpose is to distinguish between a sale and a financing,
not between a sale and a swap.'' If this is the case, certain LSTA-
style participations, which typically are offered in the United
States, could be determined under a ``true sale'' analysis to be a
financing and not a true participation. See July LSTA Letter.
    \504\ See July LMA Letter; July LSTA Letter; MFA Letter; and
SIFMA Letter. Commenters recommended that the Commissions revise the
interpretation by providing that the Commissions do not interpret
the swap and security-based swap definitions to include loan
participations in which (1) the participant is acquiring a current
or future direct or indirect ownership interest in the related loan
or commitment, and (2) the agreement pursuant to which the
participant is acquiring such an interest (i) is a participation
agreement that is, or any similar agreement of a type that has been,
is presently, or in the future becomes, customarily entered into in
the primary or secondary loan markets, (ii) requires the grantor to
represent that it is a lender under, or a participant or sub-
participant in, the loan or commitment, (iii) provides that the
participant is entitled to receive from the grantor all of the
economic benefit of the whole or part of a loan or commitment to the
extent of payments received by the grantor in respect of such loan
or commitment, and (iv) requires that 100% of the purchase price
calculated with respect to the loan or commitment is paid on the
settlement date. See id. The characteristics identified by these
commenters are reflected in the Commission's revised interpretation.
---------------------------------------------------------------------------

    One commenter also indicated that loan participations are entered
into both with respect to outstanding loans and with respect to a
lender's commitments to lend and fund letters of credit (e.g., under a
revolving credit facility).\505\ This commenter requested that the
Commissions revise the proposed interpretation to reflect both
outstanding loans and a lender's commitments.\506\ The Commissions
agree and are revising the interpretation to reflect both outstanding
loans and loan commitments as noted above.
---------------------------------------------------------------------------

    \505\ See July LMA Letter.
    \506\ Id.
---------------------------------------------------------------------------

C. Final Rules and Interpretations Regarding Certain Transactions
Within the Scope of the Definitions of the Terms ``Swap'' and
``Security-Based Swap''

1. In General
    In light of provisions in the Dodd-Frank Act that specifically
address certain foreign exchange products, the Commissions in the
Proposing Release proposed rules to clarify the status of products such
as foreign exchange forwards, foreign exchange swaps, foreign exchange
options, non-deliverable forwards involving foreign exchange
(``NDFs''), and cross-currency swaps. The Commissions also proposed a
rule to clarify the status of forward rate agreements and provided
interpretations regarding: (i) Combinations and permutations of, or
options on, swaps or security-based swaps; and (ii) contracts for
differences (``CFDs'').
    The Commissions are adopting the rules as proposed without
modification and are restating the interpretations provided in the
Proposing Release without modification. In addition, the Commissions
are providing additional interpretations regarding foreign exchange
spot transactions and retail foreign currency options.
    As adopted, rule 1.3(xxx)(2) under the CEA and rule 3a69-2 under
the Exchange Act explicitly define the term ``swap'' to include certain
foreign exchange-related products and forward rate agreements unless
such products are excluded by the statutory exclusions in subparagraph
(B) of the swap definition.\507\ In adopting these rules, the
Commissions do not mean to suggest that the list of agreements,
contracts, and transactions set forth in rule 1.3(xxx)(2) under the CEA
and rule

3a69-2(b) under the Exchange Act is an exclusive list.
---------------------------------------------------------------------------

    \507\ See section 1a(47)(B) of the CEA, 7 U.S.C. 1a(47)(B).
---------------------------------------------------------------------------

2. Foreign Exchange Products
(a) Foreign Exchange Products Subject to the Secretary's Swap
Determination: Foreign Exchange Forwards and Foreign Exchange Swaps
    The CEA, as amended by the Dodd-Frank Act, provides that ``foreign
exchange forwards'' and ``foreign exchange swaps'' shall be considered
swaps under the swap definition unless the Secretary of the Treasury
(``Secretary'') issues a written determination that either foreign
exchange swaps, foreign exchange forwards, or both: (i) Should not be
regulated as swaps; and (ii) are not structured to evade the Dodd-Frank
Act in violation of any rule promulgated by the CFTC pursuant to
section 721(c) of the Dodd-Frank Act.\508\ A foreign exchange forward
is defined in the CEA as ``a transaction that solely involves the
exchange of two different currencies on a specific future date at a
fixed rate agreed upon on the inception of the contract covering the
exchange.'' \509\ A foreign exchange swap, in turn, is defined as ``a
transaction that solely involves an exchange of 2 different currencies
on a specific date at a fixed rate that is agreed upon on the inception
of the contract covering the exchange; and a reverse exchange of the 2
currencies described in subparagraph (A) at a later date and at a fixed
rate that is agreed upon on the inception of the contract covering the
exchange.'' \510\
---------------------------------------------------------------------------

    \508\ See section 1a(47)(E)(i) of the CEA, 7 U.S.C.
1a(47)(E)(i). The Secretary published in the Federal Register a
request for comment as to whether an exemption from the swap
definition for foreign exchange swaps, foreign exchange forwards, or
both, is warranted, and on the application of the statutory factors
that the Secretary must consider in making a determination regarding
whether to exempt these products. See Determinations of Foreign
Exchange Swaps and Forwards, 75 FR 66829 (Oct. 28, 2010).
Subsequently, the Secretary published in the Federal Register a
proposed determination to exempt both foreign exchange swaps and
foreign exchange forwards from the definition of the term ``swap''
in the CEA. See Determination of Foreign Exchange Swaps and Foreign
Exchange Forwards Under the Commodity Exchange Act, Notice of
Proposed Determination, 76 FR 25774 (May 5, 2011) (``Notice of
Proposed Determination''). The comment period on the Secretary's
proposed determination closed on June 6, 2011. A final determination
has not yet been issued.
    \509\ See section 1a(24) of the CEA, 7 U.S.C. 1a(24).
    \510\ See section 1a(25) of the CEA, 7 U.S.C. 1a(25).
---------------------------------------------------------------------------

    Under the Dodd-Frank Act, if foreign exchange forwards or foreign
exchange swaps are no longer considered swaps due to a determination by
the Secretary, nevertheless, certain provisions of the CEA added by the
Dodd-Frank Act would continue to apply to such transactions.\511\
Specifically, those transactions still would be subject to certain
requirements for reporting swaps, and swap dealers and major swap
participants engaging in such transactions still would be subject to
certain business conduct standards.\512\
---------------------------------------------------------------------------

    \511\ The Secretary's determination also does not affect the
CFTC's jurisdiction over retail foreign currency agreements,
contracts, or transactions pursuant to section 2(c)(2) of the CEA, 7
U.S.C. 2(c)(2). See section 1a(47)(F)(ii) of the CEA, 7 U.S.C.
1a(47)(F)(ii).
    \512\ See, e.g., sections 1a(47)(E)(iii) and (iv) of the CEA, 7
U.S.C. 1a(47)(E)(iii) and (iv) (reporting and business conduct
standards, respectively). In addition, a determination by the
Secretary does not exempt any foreign exchange forward or foreign
exchange swap traded on a designated contract market or a swap
execution facility, or cleared by a derivatives clearing
organization, from any applicable antifraud or anti-manipulation
provision under the CEA. See sections 1a(47)(F)(i) and 1b(c) of the
CEA, 7 U.S.C. 1a(47)(F)(i) and 1b(c).
---------------------------------------------------------------------------

    The Commissions are adopting the rules as proposed to explicitly
define by rule the term ``swap'' to include foreign exchange forwards
and foreign exchange swaps (as those terms are defined in the
CEA),\513\ in order to include in one rule the definitions of those
terms and the related regulatory authority with respect to foreign
exchange forwards and foreign exchange swaps.\514\ The final rules
incorporate the provision of the Dodd-Frank Act that foreign exchange
forwards and foreign exchange swaps will no longer be considered swaps
if the Secretary issues the written determination described above to
exempt such products from the swap definition.\515\ The final rules
also reflect the continuing applicability of certain reporting
requirements and business conduct standards in the event that the
Secretary makes such a determination.\516\
---------------------------------------------------------------------------

    \513\ See rules 1.3(xxx)(3)(iii) and (iv) under the CEA and rule
3a69-2(c)(3) and (4) under the Exchange Act.
    \514\ See rules 1.3(xxx)(2)(i)(C) and (D) under the CEA and
rules 3a69-2(b)(1)(iii) and (iv) under the Exchange Act. The rules
further provide that foreign exchange forwards and forward exchange
swaps are not swaps if they fall within one of the exclusions set
forth in subparagraph (B) of the statutory swap definition. See rule
1.3(xxx)(2)(ii) under the CEA and rule 3a69-2(b)(2) under the
Exchange Act.
    \515\ See rule 1.3(xxx)(3) under the CEA and rule 3a69-2(c)
under the Exchange Act.
    \516\ See rule 1.3(xxx)(3)(ii) under the CEA and rule 3a69-
2(c)(2) under the Exchange Act. The exclusion of foreign exchange
forwards and foreign exchange swaps would become effective upon the
Secretary's submission of the determination to exempt to the
appropriate Congressional Committees. See sections 1a(47)(E)(ii) and
1b of the CEA, 7 U.S.C. 1a(46)(E)(ii) and 1b.
---------------------------------------------------------------------------

Comments
    Two commenters recommended that the Commissions defer action on
defining foreign exchange swaps and foreign exchange forwards in their
regulations until the Secretary has made his final determination about
whether to exempt them.\517\ One commenter believed that finalizing the
Commissions' proposal prior to the Secretary's final determination
would be ``premature.'' \518\ The other commenter believed that the
industry will be ``better positioned'' to assess the need to clarify
the scope of the swap definition with respect to foreign exchange
derivatives after the Secretary has made his determination.\519\ The
Commissions understand that, if the final rules are effective before
the Secretary issues a written determination, market participants
entering into foreign exchange forwards and foreign exchange swaps
might incur costs in order to comply with the requirements of the CEA
(as amended by the Dodd-Frank Act) that could be rendered unnecessary
if the Secretary subsequently were to issue a written determination to
exempt.\520\ The Commissions, however, believe the final rules are
necessary because in the event the Secretary issues a written
determination to exempt, certain reporting requirements and business
conduct standards will continue to apply to the exempted instruments,
and the final rules set forth those requirements that will continue to
apply.
---------------------------------------------------------------------------

    \517\ See CME Letter and SIFMA Letter.
    \518\ See CME Letter. This commenter also believes that if the
Secretary exempts foreign exchange swaps and foreign exchange
forwards from the swap definition, it would create an ``awkward''
situation both for the CFTC and market participants, given that
options on such products would be swaps but the products into which
they exercise would not be swaps, and would result in a lack of
clarity and consistency for market participants. Id.
    \519\ See SIFMA Letter.
    \520\ These costs market participants may incur relate to the
upfront and ongoing costs associated with the regulation of Title
VII instruments generally. See infra parts X and XI, for a
discussion of these costs. The Commissions also note that the final
rules will reduce (and may eliminate), the costs of determining
whether foreign exchange swaps and foreign exchange forwards are
subject to Title VII, as well as the costs associated with
determining which provisions of the new Title VII regulatory regime
will apply to these instruments. Id.
---------------------------------------------------------------------------

    Further, the Commissions do not believe that adopting the rules is
premature, as the Secretary may issue a determination at any time, and
the Secretary's authority to do so is independent of the Commissions'
authority to issue these rules to further define the term ``swap.''
\521\ The

Commissions' final rules are consistent with this statutory framework
by specifically providing that, in the event a determination to exempt
is issued, foreign exchange swaps and foreign exchange forwards will
not be considered swaps, and will be subject only to those CEA
requirements that are specified in the statute.\522\ As such, the final
rules accommodate the possibility of (rather than the certainty of) an
exemptive determination made by the Secretary.
---------------------------------------------------------------------------

    \521\ Compare section 712(d)(1) of the CEA (Commissions' joint
rulemaking authority to further define the term ``swap''), with
section 1a(47)(E) and 1b of the CEA (Secretary's authority to
determine to exempt foreign exchange swaps and foreign exchange
forwards from the definition of ``swap.'').
    \522\ See rule 1.3(xxx)(3)(ii) under the CEA and rule 3a69-
2(c)(2) under the Exchange Act. The statutory requirements that
remain applicable, notwithstanding a written determination by the
Secretary to exempt, are that foreign exchange swaps and foreign
exchange forwards shall be reported to either a swap data
repository, or, if there is no swap data repository that would
accept such swaps or forwards, to the CFTC pursuant to section 4r of
the CEA, 7 U.S.C. 6r, within such time period as the CFTC may by
rule or regulation prescribe, and any party to a foreign exchange
swap or forward that is a swap dealer or major swap participant
shall conform to the business conduct standards contained in section
4s(h) of the CEA, 7 U.S.C. 6s(h). Section 1a(47)(E)(iii) and (iv) of
the CEA, 7 U.S.C. 1a(47)(E)(iii) and (iv).
---------------------------------------------------------------------------

    Moreover, commenters provided no support for the assertion that the
situation would be awkward for market participants because options on
foreign exchange forwards and foreign exchange swaps will be swaps,
regardless of whether the Secretary determines to exempt the underlying
transactions from the swap definition. The Commissions note that
Congress drew the distinction in the statute between foreign currency
options and foreign exchange forwards and foreign exchange swaps. The
Commissions conclude that adopting these final rules would not
contribute to a lack of clarity or consistency for market participants,
regardless of any determination the Secretary makes.
(b) Foreign Exchange Products Not Subject to the Secretary's Swap
Determination
    The Commissions are adopting rules as proposed stating that a
determination by the Secretary that foreign exchange forwards or
foreign exchange swaps, or both, should not be regulated as swaps would
not affect certain other products involving foreign currency, such as
foreign currency options, NDFs, currency swaps and cross-currency
swaps.\523\ The rules explicitly define the term ``swap'' to include
such products, irrespective of whether the Secretary makes a
determination to exempt foreign exchange forwards or foreign exchange
swaps from the swap definition.\524\
---------------------------------------------------------------------------

    \523\ See rule 1.3(xxx)(3)(v) under the CEA and rule 3a69-
2(c)(5) under the Exchange Act.
    \524\ See rule 1.3(xxx)(2)(i) under the CEA and rule 3a69-
2(b)(1) under the Exchange Act. The final rules provide, however,
that none of these products are swaps if they fall within one of the
exclusions set forth in subparagraph (B) of the statutory swap
definition. See rule 1.3(xxx)(2)(ii) under the CEA and rule 3a69-
2(b)(2) under the Exchange Act. Also, the rules do not define the
term ``swap'' to include currency swaps because they are already
included in the statutory definition, but the rules clarify that
currency swaps are not subject to the Secretary's determination. See
section 1a(47)(A)(iii)(VII) of the CEA, 7 U.S.C.
1a(47)(A)(iii)(VII); rule 1.3(xxx)(3)(v)(A) under the CEA; and rule
3a69-2(c)(5)(i) under the Exchange Act.
---------------------------------------------------------------------------

(i) Foreign Currency Options \525\
---------------------------------------------------------------------------

    \525\ This discussion is not intended to address, and has no
bearing on, the CFTC's jurisdiction over foreign currency options in
other contexts. See, e.g., CEA sections 2(c)(2)(A)(iii) and
2(c)(2)(B)-(C), 7 U.S.C. 2(c)(2)(A)(iii) and 2(c)(2)(B)-(C) (off-
exchange options in foreign currency offered or entered into with
retail customers).
---------------------------------------------------------------------------

    As discussed above, the statutory swap definition includes options,
and it expressly enumerates foreign currency options. It encompasses
any agreement, contract, or transaction that is a put, call, cap,
floor, collar, or similar option of any kind that is for the purchase
or sale, or based on the value, of 1 or more interest or other rates,
currencies, commodities, securities, instruments of indebtedness,
indices, quantitative measures, or other financial or economic
interests or property of any kind.\526\ Foreign exchange options traded
on a national securities exchange (``NSE''), however, are securities
under the Federal securities laws and not swaps or security-based
swaps.\527\
---------------------------------------------------------------------------

    \526\ See section 1a(47)(A)(i) of the CEA, 7 U.S.C.
1a(47)(A)(i).
    \527\ See section 1a(47)(B)(iv) of the CEA, 7 U.S.C.
1a(47)(B)(iv).
---------------------------------------------------------------------------

    Any determination by the Secretary, discussed above, that foreign
exchange forwards or foreign exchange swaps should not be regulated as
swaps would not impact foreign currency options because a foreign
currency option is neither a foreign exchange swap nor a foreign
exchange forward, as those terms are defined in the CEA. The
Commissions did not receive any comments either on the proposed rule
further defining the term ``swap'' to include foreign currency options
or the proposed rule clarifying that foreign currency options are not
subject to the Secretary's determination to exempt foreign exchange
swaps and foreign exchange forwards.\528\ Consequently, the Commissions
are adopting rules to explicitly define the term ``swap'' to include
foreign currency options (other than foreign currency options traded on
an NSE).\529\ The rules also state that foreign currency options are
not foreign exchange forwards or foreign exchange swaps under the
CEA.\530\
---------------------------------------------------------------------------

    \528\ A comment regarding the CFTC's jurisdiction over retail
foreign currency options is discussed below.
    \529\ See rule 1.3(xxx)(2)(ii) under the CEA and rule 3a69-
2(b)(1) under the Exchange Act. The final rules treat the terms
foreign currency options, currency options, foreign exchange
options, and foreign exchange rate options as synonymous. Moreover,
for purposes of the final rules, foreign currency options include
options to enter into or terminate, or that otherwise operate on, a
foreign exchange swap or foreign exchange forward, or on the terms
thereof. As discussed above, foreign exchange options traded on an
NSE are securities and therefore are excluded from the swap
definition. See supra note 527 and accompanying text.
    \530\ See rule 1.3(xxx)(3)(v) under the CEA and rule 3a69-
2(c)(5) under the Exchange Act.
---------------------------------------------------------------------------

(ii) Non-Deliverable Forward Contracts Involving Foreign Exchange
    As explained by the Commissions in the Proposing Release,\531\ an
NDF generally is similar to a forward foreign exchange contract,\532\
except that at maturity the NDF does not require physical delivery of
currencies; rather, the contract typically is settled in a reserve
currency, such as U.S. dollars. One of the currencies involved in the
transaction, usually an emerging market currency, may be subject to
capital controls or similar restrictions, and is therefore said to be
``nondeliverable.'' \533\ If the spot market exchange rate on the
settlement date is greater (in foreign currency per dollar terms) than
the previously agreed forward exchange rate, the party to the contract
that is long the nondeliverable (e.g. emerging market) currency must
pay its counterparty the difference between the contracted forward
price and the spot market rate, multiplied by the notional amount.\534\
---------------------------------------------------------------------------

    \531\ See Proposing Release at 29836.
    \532\ A deliverable forward foreign exchange contract is an
obligation to buy or sell a specific currency on a future settlement
date at a fixed price set on the trade date. See Laura Lipscomb,
Federal Reserve Bank of New York, ``An Overview of Non-Deliverable
Foreign Exchange Forward Markets,'' 1 (May 2005) (citation omitted)
(``Fed NDF Overview'').
    \533\ See id. at 1-2 (citation omitted).
    \534\ See id. at 2. Being long the emerging market currency
means that the holder of the NDF contract is the ``buyer'' of the
emerging market currency and the ``seller'' of dollars. Conversely,
if the emerging market currency appreciates relative to the
previously agreed forward rate, the holder of the contract that is
short the emerging market currency must pay its counterparty the
difference between the spot market rate and the contracted forward
price, multiplied by the notional amount. See id. at 2, n.4.
---------------------------------------------------------------------------

    NDFs are not expressly enumerated in the swap definition, but as
was stated in the Proposing Release,\535\ they satisfy clause (A)(iii)
of the swap definition because they provide for a future

(executory) payment based on an exchange rate, which is an ``interest
or other rate[ ]'' within the meaning of clause (A)(iii).\536\ Each
party to an NDF transfers to its counterparty the risk of the exchange
rate moving against the counterparty, thus satisfying the requirement
that there be a transfer of financial risk associated with a future
change in rate. This financial risk transfer in the context of an NDF
is not accompanied by a transfer of an ownership interest in any asset
or liability. Thus, an NDF is a swap under clause (A)(iii) of the swap
definition.\537\
---------------------------------------------------------------------------

    \535\ See Proposing Release at 29836.
    \536\ See section 1a(47)(A)(iii) of the CEA, 7 U.S.C.
1a(47)(A)(iii) (providing that a swap is an agreement, contract, or
transaction ``that provides on an executory basis for the exchange,
on a fixed or contingent basis, of 1 or more payments based on the
value or level of 1 or more interest or other rates, currencies,
commodities, securities, instruments of indebtedness, indices,
quantitative measures, or other financial or economic interests or
property of any kind, or any interest therein or based on the value
thereof, and that transfers, as between the parties to the
transaction, in whole or in part, the financial risk associated with
a future change in any such value or level without also conveying a
current or future direct or indirect ownership interest in an asset
(including any enterprise or investment pool) or liability that
incorporates the financial risk so transferred * * * .'').
    \537\ In addition, as was noted in the Proposing Release, at
least some market participants view NDFs as swaps today, and thus
NDFs also may fall within clause (A)(iv) of the swap definition as
``an agreement, contract, or transaction that is, or in the future
becomes, commonly known to the trade as a swap.'' See Proposing
Release at 29836. See also section 1a(47)(A)(iv) of the CEA, 7
U.S.C. 1a(47)(A)(iv). Cf. rule 35.1(b)(1)(i) under the CEA, 17 CFR
35.1(b)(1)(i) (providing that the definition of ``swap agreement''
includes a ``forward foreign exchange agreement,'' without reference
to convertibility or delivery).
---------------------------------------------------------------------------

    Moreover, the Commissions have determined that NDFs do not meet the
definitions of ``foreign exchange forward'' or ``foreign exchange
swap'' set forth in the CEA.\538\ NDFs do not involve an ``exchange''
of two different currencies (an element of the definition of both a
foreign exchange forward and a foreign exchange swap); instead, they
are settled by payment in one currency (usually U.S. dollars).\539\
---------------------------------------------------------------------------

    \538\ In the Notice of Proposed Determination, the Secretary
stated that his authority to issue a determination ``is limited to
foreign exchange swaps and forwards and does not extend to other
foreign exchange derivatives'' and noted that ``NDFs may not be
exempted from the CEA's definition of ``swap'' because they do not
satisfy the statutory definitions of a foreign exchange swap or
forward.'' See Notice of Proposed Determination.
    \539\ Likewise, the Commissions have determined that a foreign
exchange transaction, which initially is styled as or intended to be
a ``foreign exchange forward,'' and which is modified so that the
parties settle in a reference currency (rather than settle through
the exchange of the 2 specified currencies), does not conform with
the definition of ``foreign exchange forward'' in the CEA. See infra
note 626.
---------------------------------------------------------------------------

    Notwithstanding their ``forward'' label, NDFs also do not fall
within the forward contract exclusion of the swap definition because
currency is outside the scope of the forward contract exclusion for
nonfinancial commodities.\540\ Nor have NDFs traditionally been
considered commercial merchandising transactions. Rather, as the
Commissions observed in the Proposing Release,\541\ NDF markets appear
to be driven in large part by speculation \542\ and hedging,\543\ which
features are more characteristic of swap markets than forward markets.
---------------------------------------------------------------------------

    \540\ Currency is an excluded commodity under the CEA. See
section 1a(19)(i) of the CEA, 7 U.S.C. 1a(19)(i). In accordance with
the interpretation regarding nonfinancial commodities, which as
discussed above, see supra part II.B.2(a), are exempt and
agricultural commodities that can be physically delivered, currency
does not qualify as a nonfinancial commodity for purposes of the
forward exclusion from the swap definition.
    \541\ See Proposing Release at 29836.
    \542\ See Fed NDF Overview at 5 (``[E]stimates vary but many
major market participants estimate as much as 60 to 80 percent of
NDF volume is generated by speculative interest, noting growing
participation from international hedge funds.'') and 4 (``[D]ealers
note that much of the volume in Chinese yuan NDFs is generated by
speculative positioning based on expectations for an alteration in
China's current, basically fixed exchange rate.'') (italics in
original).
    \543\ See id. at 4 (noting that ``[much of the] Korean won NDF
volume[,] * * * estimated to be the largest of any currency, * * *
is estimated to originate with international investment portfolio
managers hedging the currency risk associated with their onshore
investments'').
---------------------------------------------------------------------------

Comments
    Commenters who addressed the nature of NDFs believed that NDFs
should not be considered swaps, but rather should be categorized as
foreign exchange forwards. In general, commenters maintained that NDFs
are functionally and economically equivalent to foreign exchange
forwards, and therefore should be treated in the same manner for
regulatory purposes.\544\ In support of this view, commenters made
several arguments, including that both NDFs and foreign exchange
forwards require the same net value to be transferred between
counterparties; the purpose for using them is the same--to cover
foreign currency exchange risk; both are typically short term
transactions; and both may be cleared by CLS Bank.\545\
---------------------------------------------------------------------------

    \544\ See CDEU Letter; Letter from The Committee on Investment
of Employee Benefit Assets, dated Jul. 22, 2011 (``CIEBA Letter'');
Letter from Bruce C. Bennett, Covington & Burling LLP, dated Jul.
22, 2011 (``Covington Letter''); and Letter from Karrie McMillan and
Cecelia Calaby, the Investment Company Institute/American Bar
Association Securities Association, dated Jul. 22, 2011 (``ICI/ABASA
Letter'').
    \545\ See Covington Letter and ICI/ABASA Letter. CLS Bank
operates the largest multi-currency cash settlement system to
eliminate settlement risk in the foreign exchange market.
---------------------------------------------------------------------------

    In addition, commenters believed that not treating NDFs as foreign
exchange forwards or foreign exchange swaps would be contrary to both
domestic and international market practices. As specific examples,
commenters noted that NDFs typically are traded as part of a bank's or
broker's foreign exchange desk; the Federal Reserve Bank of New York
has described an NDF in a 1998 publication as an instrument ``similar
to an outright forward,'' except that there is no physical delivery or
transfer of the local currency; the Bank for International Settlements
(``BIS'') categorizes NDFs in its ``outright forward'' category;
various European regulations do not distinguish between the two
transaction types; standard foreign exchange trading documentation
includes both net- and physically-settled foreign exchange transactions
in general definitions of foreign exchange transactions; and special
rules under the U.S. tax code apply equally to physically settled and
cash settled foreign exchange forwards.\546\
---------------------------------------------------------------------------

    \546\ See Covington Letter and ICI/ABASA Letter.
---------------------------------------------------------------------------

    Commenters also raised potential negative consequences to certain
U.S. market participants if NDFs are not considered to be foreign
exchange forwards. For example, one commenter argued that treating NDFs
as swaps will put U.S. corporations doing business in emerging markets
at a disadvantage relative to U.S. corporations doing business solely
in developed markets.\547\ This commenter stated that NDFs are widely
used by U.S. corporations that do business in emerging markets to hedge
their exposure to the currencies of those markets, and that regulating
NDFs as swaps would significantly increase the cost of hedging those
exposures.\548\
---------------------------------------------------------------------------

    \547\ See Covington Letter.
    \548\ See supra note 520.
---------------------------------------------------------------------------

    With respect to the Commissions' legal conclusion that NDFs are not
foreign exchange forwards, and thus are not subject to the Secretary's
determination, one commenter stated that the Commissions' reading of
the definition of the term ``foreign exchange forward'' as not
including NDFs is ``too restrictive.'' \549\ In this regard, this
commenter believed that the term ``exchange'' should be read to include
``the economic exchange that occurs in net settlement rather than being
narrowly read as the physical `exchange' of two different currencies.''
---------------------------------------------------------------------------

    \549\ See ICI/ABASA Letter.
---------------------------------------------------------------------------

    One commenter, in contrast, agreed with the Commissions'
interpretation that NDFs are not encompassed within the definition of
the term ``foreign

exchange forward.'' \550\ This commenter requested, though, that the
CFTC exempt NDFs from the swap definition, using its exemptive
authority under section 4(c) of the CEA.\551\
---------------------------------------------------------------------------

    \550\ See CIEBA Letter.
    \551\ 7 U.S.C. 6(c).
---------------------------------------------------------------------------

    While commenters raised a number of objections to the Commissions'
proposal to define NDFs as swaps, these objections primarily raise
policy arguments. No commenter has provided a persuasive, alternative
interpretation of the statute's plain language in the definition of the
term ``foreign exchange forward'' to overcome the Commissions'
conclusion that, under the CEA, NDFs are swaps, not foreign exchange
forwards.
    One commenter believed that the Commissions' interpretation of
``exchange of 2 different currencies'' as used in the foreign exchange
forward definition is too restrictive, and that the phrase should be
read broadly to mean an economic exchange of value in addition to
physical exchange; the Commissions believe that this contention is
misplaced.\552\ This commenter essentially asks the Commissions to
interpret the statutory language to mean an exchange of foreign
currencies themselves, as well as an exchange based on the value of
such currencies. However, only the word ``exchange'' appears in the
relevant definitions, reinforcing the conclusion that Congress intended
the definition of ``foreign exchange forward'' to be distinct from
other types of transactions covered by the definition of ``swap'' in
the CEA. Moreover, the language of each definition emphasizes that
these transactions may ``solely'' involve an exchange. The ordinary
meaning of the verb ``exchange'' is to ``barter'' \553\ or ``part with,
give or transfer for an equivalent,'' \554\ i.e., each party is both
giving to and receiving from the other party. This does not occur under
an NDF, in which only a single party makes a payment.
---------------------------------------------------------------------------

    \552\ See ICI/ABASA Letter.
    \553\ See Webster's New World Dictionary (3d College Ed. 1988).
    \554\ See Black's Law Dictionary.
---------------------------------------------------------------------------

    Elsewhere in the CEA, Congress used explicit language that
potentially could provide support for a broader interpretation of the
type advocated by this commenter, but such language is absent from the
definition of the term ``foreign exchange forward.'' For example,
section 2(a)(1)(C)(ii) confers exclusive jurisdiction on the CFTC over
``contracts of sale for future delivery of a group or index of
securities (or any interest therein or based upon the value thereof)
[that meet certain requirements]''. If the phrase ``exchange of 2
different currencies'' had been intended to include economic exchanges
of value, as suggested by this commenter, that phrase would have
included language similar to ``based on the value thereof'' to indicate
that other mechanisms of transferring value may occur in these
particular types of transactions. Instead, as noted above, Congress
limited the scope of each of these particular transactions by using the
words ``solely involves the exchange of 2 different currencies''. The
Commissions conclude that the use of the word ``solely'' provides
further support for the Commissions' interpretation that exchange means
an actual interchange of the 2 different currencies involved in the
transaction.\555\
---------------------------------------------------------------------------

    \555\ This commenter's request that the CFTC exempt NDFs from
the swap definition using its exemptive authority under section 4(c)
of the CEA, 7 U.S.C. 6(c), and that the SEC exercise its exemptive
authority under section 36 of the Exchange Act, 78 U.S.C. 78mm, with
respect to NDFs, is beyond the scope of this rulemaking.
---------------------------------------------------------------------------

(iii) Currency Swaps and Cross-Currency Swaps
    A currency swap \556\ and a cross-currency swap \557\ each
generally can be described as a swap in which the fixed legs or
floating legs based on various interest rates are exchanged in
different currencies. Such swaps can be used to reduce borrowing costs,
to hedge currency exposure, and to create synthetic assets \558\ and
are viewed as an important tool, given that they can be used to hedge
currency and interest rate risk in a single transaction.
---------------------------------------------------------------------------

    \556\ A swap that exchanges a fixed rate against a fixed rate is
known as a currency swap. See Federal Reserve System, ``Trading and
Capital-Markets Activities Manual,'' section 4335.1 (Jan. 2009).
    \557\ Cross-currency swaps with a fixed leg based on one rate
and a floating leg based on another rate, where the two rates are
denominated in different currencies, are generally referred to as
cross-currency coupon swaps, while those with a floating leg based
on one rate and another floating leg based on a different rate are
known as cross-currency basis swaps. Id. Cross-currency swaps also
include annuity swaps and amortizing swaps. In cross-currency
annuity swaps, level cash flows in different currencies are
exchanged with no exchange of principal; annuity swaps are priced
such that the level payment cash flows in each currency have the
same net present value at the inception of the transaction. An
amortizing cross-currency swap is structured with a declining
principal schedule, usually designed to match that of an amortizing
asset or liability. Id.
    See also Derivatives ONE, ``Cross Currency Swap Valuation'' (``A
cross currency swap is swap of an interest rate in one currency for
an interest rate payment in another currency * * * This could be
considered an interest rate swap with a currency component.''),
available at http://www.derivativesone.com/cross-currency-swap-valuation/; Financial Accounting Standards Board, ``Examples
Illustrating Application of FASB Statement No. 138,'' Accounting for
Certain Derivative Instruments and Certain Hedging Activities,
section 2, Example 1, at 3 (``The company designates the cross-
currency swap as a fair value hedge of the changes in the fair value
of the loan due to both interest and exchange rates.''), available
at http://www.fasb.org/derivatives/examples.pdf.
    \558\ BMO Capital Markets, ``Cross Currency Swaps,'' available
at http://www.bmocm.com/products/marketrisk/intrderiv/cross/default.aspx.
---------------------------------------------------------------------------

    Currency swaps and cross-currency swaps are not foreign exchange
swaps as defined in the CEA because, although they may involve an
exchange of foreign currencies, they also require contingent or
variable payments in different currencies. Because the CEA defines a
foreign exchange swap as a swap that ``solely'' involves an initial
exchange of currencies and a reversal thereof at a later date, subject
to certain parameters, currency swaps and cross-currency swaps would
not be foreign exchange swaps. Similarly, currency swaps and cross-
currency swaps are not foreign exchange forwards because foreign
exchange forwards ``solely'' involve an initial exchange of currencies,
subject to certain parameters, while currency swaps and cross-currency
swaps contain additional elements, as discussed above.
    Currency swaps are expressly enumerated in the statutory definition
of the term ``swap.'' \559\ Cross-currency swaps, however, are
not.\560\ Accordingly, based on the foregoing considerations, the
Commissions are adopting rules explicitly defining the term ``swap'' to
include cross-currency swaps.\561\ The rules also state that neither
currency swaps nor cross-currency swaps are foreign exchange forwards
or foreign exchange swaps as those terms are defined in the CEA. The
Commissions did not receive any comments either on the rule further
defining the term ``swap'' to include cross-currency swaps or the rule
clarifying that cross-currency swaps and currency swaps are not subject
to the Secretary's determination to exempt foreign exchange swaps and
foreign exchange forwards.
---------------------------------------------------------------------------

    \559\ See section 1a(47)(A)(iii)(VII) of the CEA, 7 U.S.C.
1a(47)(A)(iii)(VII).
    \560\ Clause (A)(iii) of the swap definition expressly refers to
a cross-currency rate swap. See section 1a(47)(A)(iii)(V) of the
CEA, 7 U.S.C. 1a(47)(A)(iii)(V). Although the swap industry appears
to use the term ``cross-currency swap,'' rather than ``cross-
currency rate swap'' (the term used in section 1a(47)(A)(iii)(V) of
the CEA), the Commissions interpret these terms as synonymous.
    \561\ See rule 1.3(xxx)(2)(i)(A) under the CEA and rule 3a69-
2(b)(1)(i) under the Exchange Act.
---------------------------------------------------------------------------

(c) Interpretation Regarding Foreign Exchange Spot Transactions
    The CEA generally does not confer regulatory jurisdiction on the
CFTC with respect to spot transactions.\562\ In

the context of foreign currency, spot transactions typically settle
within two business days after the trade date (``T+2'').\563\ The
accepted market practice of a two-day settlement for spot foreign
currency transactions has been recognized by the CFTC \564\ and the
courts.\565\
---------------------------------------------------------------------------

    \562\ But see supra note 227.
    \563\ Bank for International Settlements, Triennial Central Bank
Survey, Report on Global Foreign Exchange Market Activity in 2010 at
32 (Dec. 2010) (defining a foreign exchange spot transaction to
provide for cash settlement within 2 business days); Sam Y. Cross,
Federal Reserve Bank of New York, ``All About * * *. The Foreign
Exchange Market in the United States'' at 31-32 (1998).
    \564\ See CFTC Division of Trading and Markets, Report on
Exchange of Futures for Physicals at 124-127 (1987) (noting that
foreign currency spot transactions settle in 2 days).
    \565\ See CFTC v. Frankwell Bullion, Ltd., 99 F.3d 299, 300 (9th
Cir. 1996) (``Spot transactions in foreign currencies call for
settlement within two days.''); CFTC v. Int'l Fin. Servs. (NewYork),
Inc., 323 F. Supp. 2d 482, 495 (S.D.N.Y. 2004) (noting that spot
transactions ordinarily call for settlement within two days); Bank
Brussels Lambert, S.A. v. Intermetals Corp., 779 F.Supp. 741, 742
(S.D.N.Y. 1991) (same). But the Commissions understand that the
settlement cycle for spot transactions exchanging Canadian dollars
for U.S. dollars (or vice versa) is T+1. See Cross, supra 563, at
31.
---------------------------------------------------------------------------

    The Commissions recognize that the new foreign exchange forward
definition in the CEA, which was added by the Dodd-Frank Act and which
applies to an exchange of two different currencies ``on a specific
future date,'' could be read to apply to any foreign exchange
transaction that does not settle on the same day. Such a reading could
render most foreign exchange spot transactions foreign exchange
forwards under the CEA; as a result, such transactions would be subject
to the CEA reporting and business conduct standards requirements
applicable to foreign exchange forwards even if the Secretary
determines to exempt foreign exchange forwards from the definition of
``swap.'' The Commissions do not believe that Congress intended, solely
with respect to foreign exchange transactions, to extend the reach of
the CEA to transactions that historically have been considered spot
transactions. At the same time, however, the Commissions do not want to
enable market participants simply to label as ``spot'' foreign exchange
transactions that regularly settle after the relevant foreign exchange
spot market settlement deadline, or with respect to which the parties
intentionally delay settlement, both of which would be properly
categorized as foreign exchange forwards, or CEA section 2(c)(2)
transactions (discussed separately below), in order to avoid applicable
foreign exchange regulatory requirements.
    Accordingly, the Commissions are providing an interpretation that a
bona fide foreign exchange spot transaction, i.e., a foreign exchange
transaction that is settled on the customary timeline of the relevant
spot market, is not within the definition of the term ``swap.'' In
general, a foreign exchange transaction will be considered a bona fide
spot transaction if it settles via an actual delivery of the relevant
currencies within two business days. In certain circumstances, however,
a foreign exchange transaction with a longer settlement period
concluding with the actual delivery of the relevant currencies may be
considered a bona fide spot transaction depending on the customary
timeline of the relevant market.\566\ In particular, as discussed
below, the Commissions will consider a foreign exchange transaction
that is entered into solely to effect the purchase or sale of a foreign
security to be a bona fide spot transaction where certain conditions
are met.
---------------------------------------------------------------------------

    \566\ In this regard, while the Commissions will look at the
relevant facts and circumstances, they will not expect that an
unintentional settlement failure or delay for operational reasons or
due to a market disruption will undermine the character of a bona
fide spot foreign exchange transaction as such.
---------------------------------------------------------------------------

    The CFTC will consider the following to be a bona fide spot foreign
exchange transaction: An agreement, contract or transaction for the
purchase or sale of an amount of foreign currency equal to the price of
a foreign security with respect to which (i) the security and related
foreign currency transactions are executed contemporaneously in order
to effect delivery by the relevant securities settlement deadline and
(ii) actual delivery of the foreign security and foreign currency
occurs by such deadline (such transaction, a ``Securities Conversion
Transaction'').\567\ For Securities Conversion Transactions, the CFTC
will consider the relevant foreign exchange spot market settlement
deadline to be the same as the securities settlement deadline. As noted
above, while the CFTC will look at the relevant facts and
circumstances, it does not expect that an unintentional settlement
failure or delay for operational reasons or due to a market disruption
will undermine the character of a bona fide spot foreign exchange
transaction as such.
---------------------------------------------------------------------------

    \567\ The interpretation herein with respect to Security
Conversion Transactions is limited to such transactions.
---------------------------------------------------------------------------

    The CFTC also will interpret a Securities Conversion Transaction as
not leveraged, margined or financed within the meaning of section
2(c)(2)(C) of the CEA.\568\ While it is possible to view the fact that
the buyer of a currency in such a transaction does not pay for the
currency until it is delivered as leverage (in that the buyer puts
nothing down until taking delivery, thus achieving 100% leverage) or a
financing arrangement, the CFTC does not interpret it as such for
purposes of CEA section 2(c)(2)(C).\569\ Congress recognized that
settlement of bona fide spot foreign exchange transactions typically
takes two days.\570\ The fact that Congress expressly excluded these
types of bona fide spot foreign exchange transactions does not mean
that Congress intended to subject Security Conversion Transactions to
regulation under the retail foreign exchange regime.\571\ For the
foregoing reasons, the CFTC will interpret a Securities Conversion
Transaction as not leveraged, margined or financed within the meaning
of section 2(c)(2)(C) of the CEA.\572\
---------------------------------------------------------------------------

    \568\ 7 U.S.C. 2(c)(2)(C). Similarly, a Securities Conversion
Transaction is not an option, option on a futures contract or
futures contract and thus would not be subject to CEA section
2(c)(2)(B), 7 U.S.C. 2(c)(2)(B). Of course, optionality as to
settlement would render the transaction an option and is
inconsistent with a ``spot'' characterization.
    \569\ Cf. 12 CFR 220.8(b)(1) under Regulation T (12 CFR Part
220) (generally permits a customer to purchase a security (including
a foreign security) in a cash account, rather than a margin account,
even if the customer has no collateral in the account, if payment
for the security is made within the appropriate payment period).
Similarly, if a foreign exchange buyer in a Securities Conversion
Transaction posts no margin or collateral on the trade date, the
CFTC does not consider that transaction to be ``margined'' within
the meaning of 7 U.S.C. 2(c)(2)(C)(i)(I)(bb).
    \570\ See section 2(c)(2)(C)(i)(II) of the CEA, 7 U.S.C.
2(c)(2)(C) (``[s]ubclause (I) of this clause shall not apply to * *
* a contract of sale that * * * results in delivery within 2
days'').
    \571\ The CFTC notes, for example, that Congress recognized that
settlement in various spot markets in commodities other than foreign
exchange can be longer than two days. See CEA section
2(c)(2)(D)(ii)(III)(aa) (disapplying the DCM-trading requirement for
certain commodity transactions with non-ECPs when the contract
``results in actual delivery within 28 days or such other longer
period as the [CFTC] may determine by rule or regulation based on
the typical commercial practice in cash or spot markets for the
commodity involved'').
    \572\ This interpretation is not intended to address, and has no
bearing on, the CFTC's interpretation of the term ``actual
delivery'' as set forth in section 2(c)(2)(D)(ii)(III)(aa), 7 CFR
2(c)(2)(D)(ii)(III)(aa). See Retail Commodity Transactions under the
Commodity Exchange Act, 76 FR 77670, Dec. 14, 2011.
---------------------------------------------------------------------------

Comments
    One commenter requested clarification regarding the status of
foreign exchange spot transactions.\573\ This commenter recommended
that the Commissions clarify that foreign exchange spot transactions,
which this commenter defined as ``transactions of

one currency into another that settle within a customary settlement
cycle,'' are neither foreign exchange forwards nor swaps.\574\ Another
commenter indicated that the customary settlement cycle for purchases
of most non-U.S. denominated securities is ``T+3'' (in some securities
markets, such as South Africa, the settlement cycle can take up to
seven days), and requires the buyer to pay for the foreign securities
in the relevant foreign currency.\575\ Typically, according to this
commenter, a broker-dealer or bank custodian acting on behalf of the
buyer or seller will enter into a foreign currency transaction to
settle on a T+3 basis (or the relevant settlement period) as well.
Timing the foreign exchange transaction to settle at the same time as
the securities transaction benefits the customer by reducing his or her
exposure to currency risk on the securities transaction between trade
date and settlement date. The Commissions have provided the
interpretation described above regarding the interplay between the
foreign exchange forward definition, the meaning of ``leveraged,
margined or financed'' under section 2(c)(2)(C) of the CEA, and bona
fide foreign exchange spot transactions to address these commenters'
concerns.
---------------------------------------------------------------------------

    \573\ See SIFMA Letter.
    \574\ Id. In this commenter's view, such clarification is
necessary to avoid the statutory foreign exchange forward definition
``unwittingly captur[ing] many typical foreign exchange spot
transactions * * * settl[ing] within a customary settlement cycle,''
which this commenter stated is generally ``T+2'' in the United
States, but can be ``T+3'' in some other countries.
    \575\ See Letter from Phoebe A. Papageorgiou, Senior Counsel,
American Bankers Ass'n and James Kemp, Managing Director, Global
Foreign Exchange Division, dated April 18, 2012 (``ABA/Global FX
Letter''). This commenter requested clarification that the purchase,
sale or exchange of a foreign currency by a bank on behalf of a
retail customer for the sole purpose of effecting a purchase or sale
of a foreign security or in order to clear or settle such purchase
or sale, when the settlement period for such FX transaction is
within the settlement cycle for such foreign security, is excluded
from the retail foreign exchange under the CEA. The CFTC has
provided the clarification regarding the meaning of ``leveraged,
margined or financed'' under section 2(c)(2)(C) of the CEA to
address this commenter's concern.
---------------------------------------------------------------------------

(d) Retail Foreign Currency Options
    The CFTC is providing an interpretation regarding the status of
retail foreign currency options that are described in section
2(c)(2)(B) of the CEA.\576\ As noted above, the Commissions proposed to
include foreign currency options generally within the definition of the
term ``swap,'' subject to the statutory exclusions in subparagraph (B)
of the definition. The statutory exclusions from the swap definition
encompass transactions described in sections 2(c)(2)(C) and (D) of the
CEA, but not those in section 2(c)(2)(B) of the CEA.\577\ Section
2(c)(2)(B) of the CEA applies to futures, options on futures and
options on foreign currency (other than foreign currency options
executed or traded on a national securities exchange), and permits such
transactions to be entered into with counterparties who are not ECPs
\578\ on an off-exchange basis by certain enumerated regulated
entities.\579\ No issue arises with respect to futures or options on
futures in foreign currency that are covered by section 2(c)(2)(B) of
the CEA, because they are expressly excluded from the statutory swap
definition.\580\ Commodity options, including options on foreign
currency, however, are not excluded from the swap definition (other
than foreign currency options executed or traded on a national
securities exchange).
---------------------------------------------------------------------------

    \576\ 7 U.S.C. 2(c)(2)(B).
    \577\ See section 1a(47)(B)(i) of the CEA, 7 U.S.C.
1a(47)(B)(i). Sections 2(c)(2)(B), (C), and (D) of the CEA, 7 U.S.C.
2(c)(2)(B), (C), and (D), govern certain types of off-exchange
transactions in commodities, including foreign currency, in which
one of the parties to the transaction is not an ECP.
    \578\ ECPs are defined in section 1a(18) of the CEA, 7 U.S.C.
1a(18).
    \579\ Section 2(c)(2)(B)(i) of the CEA provides: (i) This Act
applies to, and the Commission shall have jurisdiction over, an
agreement, contract, or transaction in foreign currency that--(I) is
a contract of sale of a commodity for future delivery (or an option
on such a contract) or an option (other than an option executed or
traded on a national securities exchange registered pursuant to
section 6(a) of the Securities Exchange Act of 1934, 15 U.S.C.
78f(a)); and (II) is offered to, or entered into with, a person that
is not an eligible contract participant, unless the counterparty, or
the person offering to be the counterparty, of the person is
[certain regulated counterparties enumerated in the statute.] 7
U.S.C. 2(c)(2)(B)(i). Thus, under section 2(c)(2)(B)(i) of the CEA,
the CEA's exchange-trading requirement generally applies with
respect to futures, options on futures, and options on foreign
currency. See section 4(a) of the CEA, 7 U.S.C. 6(a) (generally
requiring futures contracts to be traded on or subject to the rules
of a DCM); section 4c(b) of the CEA, 7 U.S.C. 6c(b) (prohibiting
trading options subject to the CEA contrary to CFTC rules,
regulations or orders permitting such trading); Part 32 of the
CFTC's rules, 17 CFR Part 32 (generally prohibiting entering into
options subject to the CEA (other than options on futures) other
than on or subject to the rules of a DCM); and CFTC Rule 33.3(a), 17
CFR 33.3(a) (prohibiting entering into options on futures other than
on or subject to the rules of a DCM). However, if the counterparty
to the non-ECP is an enumerated regulated entity identified in
section 2(c)(2)(B)(i)(II) of the CEA, 7 U.S.C. 2(c)(2)(B)(i)(II),
the CEA's exchange-trading requirement does not apply. Accordingly,
an enumerated regulated entity--including a banking institution
regulated by the OCC--can, pursuant to section 2(c)(2)(B) of the
CEA, lawfully enter into a future, an option on a future, or an
option on foreign currency with a non-ECP counterparty on an off-
exchange basis.
    \580\ See section 1a(47)(B)(i) of the CEA, 7 U.S.C.
1a(47)(B)(i).
---------------------------------------------------------------------------

    The CFTC notes that, in further defining the term ``swap'' to
include foreign currency options, the Proposing Release stated that the
proposal was not intended to address, and had no bearing on, the CFTC's
jurisdiction over foreign currency options in other contexts,
specifically citing section 2(c)(2)(B) of the CEA.\581\ Nonetheless,
the CFTC acknowledges the ambiguity in the statute regarding the status
of off-exchange foreign currency options with non-ECPs that are subject
to section 2(c)(2)(B) of the CEA. While foreign currency options are
swaps, they also are subject to section 2(c)(2)(B) of the CEA when
entered into off-exchange with non-ECPs, and there is no statutory
exclusion from the swap definition for section 2(c)(2)(B) transactions.
If foreign currency options were deemed to be swaps, then, pursuant to
section 2(e) of the CEA, as added by the Dodd-Frank Act,\582\ they
could not be entered into by non-ECP counterparties, except on a DCM.
This would render the provisions of section 2(c)(2)(B) of the CEA,
permitting off-exchange foreign currency options with non-ECPs by
enumerated regulated entities, a nullity.
---------------------------------------------------------------------------

    \581\ See Proposing Release at 29835 n.125.
    \582\ 7 U.S.C. 2(e).
---------------------------------------------------------------------------

    The CFTC believes that Congress did not intend the swap definition
to overrule and effectively repeal another provision of the CEA in such
an oblique fashion.\583\ Nor is there anything in the legislative
history of the Dodd-Frank Act to suggest a congressional intent to
prohibit only one type of off-exchange foreign currency transaction
with non-ECPs (out of the three types of off-exchange foreign currency
transactions with non-ECPs that are addressed in CEA section
2(c)(2)(B)). The omission of section 2(c)(2)(B) of the CEA from the
exclusions set forth in the statutory swap definition appears to be a
scrivener's error.\584\ Accordingly, the CFTC is applying the exclusion
from the swap definition to foreign currency options described in CEA
section 2(c)(2)(B).
---------------------------------------------------------------------------

    \583\ The CFTC notes in this regard that repeals by implication
are strongly disfavored by the courts. See, e.g., Village of
Barrington, Ill. v. Surface Transp. Bd., 636 F.3d 650, 662 (D.C.
Cir. 2011) (``Repeals by implication, however, are strongly
disfavored `absent a clearly expressed congressional intention' '')
(quoting Branch v. Smith, 538 U.S. 254, 273, 123 S.Ct. 1429 (2003));
Agri Processor Co., Inc. v. N.L.R.B., 514 F.3d 1, 4 (D.C. Cir. 2008)
(``[a]mendments by implication, like repeals by implication, are not
favored'' and ``will not be found unless an intent to repeal [or
amend] is `clear and manifest.' '') (quoting United States v.
Welden, 377 U.S. 95, 102 n. 12, 84 S.Ct. 1082 (1964) and Rodriguez
v. United States, 480 U.S. 522, 524, 107 S.Ct. 1391 (1987)).
    \584\ See, e.g., Singer and Singer, Sutherland Statutes and
Statutory Construction Sec.  47:38 (7th ed. 2011) (``Words may be
supplied in a statute * * * where omission is due to inadvertence,
mistake, accident, or clerical error'').

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

3. Forward Rate Agreements
    The Commissions are adopting rules as proposed to explicitly define
the term ``swap'' to include forward rate agreements (``FRAs'').\585\
The Commissions did not receive any comments on the proposed rules
regarding the inclusion of FRAs in the swap definition.
---------------------------------------------------------------------------

    \585\ See rules 1.3(xxx)(2)(i)(E) under the CEA and rule 3a69-
2(b)(1)(v) under the Exchange Act.
---------------------------------------------------------------------------

    In general, an FRA is an over-the-counter contract for a single
cash payment, due on the settlement date of a trade, based on a spot
rate (determined pursuant to a method agreed upon by the parties) and a
pre-specified forward rate. The single cash payment is equal to the
product of the present value (discounted from a specified future date
to the settlement date of the trade) of the difference between the
forward rate and the spot rate on the settlement date multiplied by the
notional amount. The notional amount itself is not exchanged.\586\
---------------------------------------------------------------------------

    \586\ See generally ``Trading and Capital-Markets Activities
Manual,'' supra note 556, section 4315.1 (``For example, in a six-
against-nine-month (6x9) FRA, the parties agree to a three-month
rate that is to be netted in six months' time against the prevailing
three-month reference rate, typically LIBOR. At settlement (after
six months), the present value of the net interest rate (the
difference between the spot and the contracted rate) is multiplied
by the notional principal amount to determine the amount of the cash
exchanged between the parties * * * . If the spot rate is higher
than the contracted rate, the seller agrees to pay the buyer the
differences between the prespecified forward rate and the spot rate
prevailing at maturity, multiplied by a notional principal amount.
If the spot rate is lower than the forward rate, the buyer pays the
seller.'').
---------------------------------------------------------------------------

    An FRA provides for the future (executory) payment based on the
transfer of interest rate risk between the parties as opposed to
transferring an ownership interest in any asset or liability.\587\
Thus, the Commissions believe that an FRA satisfies clause (A)(iii) of
the swap definition.\588\
---------------------------------------------------------------------------

    \587\ It appears that at least some in the trade view FRAs as
swaps today. See, e.g., The Globecon Group, Ltd., ``Derivatives
Engineering: A Guide to Structuring, Pricing and Marketing
Derivatives,'' 45 (McGraw-Hill 1995) (``An FRA is simply a one-
period interest-rate swap.''); DerivActiv, Glossary of Financial
Derivatives Terms (``A swap is * * * a strip of FRAs.''), available
at http://www.derivactiv.com/definitions.aspx?search=
forward+rate+agreements. Cf. Don M. Chance, et al., ``Derivatives in
Portfolio Management,'' 29 (AIMR 1998) (``[An FRA] involves one
specific payment and is basically a one-date swap (in the sense that
a swap is a combination of FRAs[,] with some variations).''). Thus,
FRAs also may fall within clause (A)(iv) of the swap definition, as
``an agreement, contract, or transaction that is, or in the future
becomes, commonly known to the trade as a swap.'' See section
1a(47)(a)(iv) of the CEA, 7 U.S.C. 1a(47)(a)(iv).
    \588\ See section 1a(47)(A)(iii) of the CEA, 7 U.S.C.
1a(47)(A)(iii). CFTC regulations have defined FRAs as swap
agreements. See rule 35.1(b)(1)(i) under the CEA, 17 CFR
35.1(b)(1)(i); Exemption for Certain Swap Agreements, 58 FR 5587
(Jan. 22, 1993). The CFTC recently repealed that rule and amended
Part 35 of its rules in light of the enactment of Title VII of the
Dodd-Frank Act. See Agricultural Swaps, 76 FR 49291 (Aug. 10, 2011).
---------------------------------------------------------------------------

    Notwithstanding their ``forward'' label, FRAs do not fall within
the forward contract exclusion from the swap definition. FRAs do not
involve nonfinancial commodities and thus are outside the scope of the
forward contract exclusion. Nor is an FRA a commercial merchandising
transaction, as there is no physical product to be delivered in an
FRA.\589\ Accordingly, the Commissions believe that the forward
contract exclusion from the swap definition for nonfinancial
commodities does not apply to FRAs.\590\
---------------------------------------------------------------------------

    \589\ See Regulation of Hybrid and Related Instruments, 52 FR
47022, 47028 (Dec. 11, 1987) (stating ``[FRAs] do not possess all of
the characteristics of forward contracts heretofore delineated by
the [CFTC]'').
    \590\ The Commissions note that Current European Union law
includes FRAs in the definition of ``financial instruments.'' See
Markets in Financial Instruments Directive (MiFID), ``Directive
2004/39/EC of the European Parliament and of the Council,'' Annex
I(C), 4, 5, 10 (Apr. 21, 2004), available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2004L0039:20070921:EN:PDF 20070921:EN:PDF. European Commission legislation on derivatives,
central clearing, and trade repositories applies to FRAs that are
traded over-the-counter and, thus, would subject such transactions
to mandatory clearing, reporting and other regulatory requirements.
See Regulation of the European Parliament and of the Council on OTC
derivatives, central counterparties and trade repositories, tit. I,
art. 2 (1(3b)), 7509/1/12 REV 1 (Mar. 19, 2012).
---------------------------------------------------------------------------

    Based on the foregoing considerations, the Commissions are adopting
rules to provide greater clarity by explicitly defining the term
``swap'' to include FRAs. As with the foreign exchange-related products
discussed above, the final rules provide that FRAs are not swaps if
they fall within one of the exclusions set forth in subparagraph (B) of
the swap definition.
4. Combinations and Permutations of, or Options on, Swaps and Security-
Based Swaps
    Clause (A)(vi) of the swap definition provides that ``any
combination or permutation of, or option on, any agreement, contract,
or transaction described in any of clauses (i) through (v)'' of the
definition is a swap.\591\ The Commissions provided an interpretation
regarding clause (A)(vi) in the Proposing Release.\592\ The Commissions
received no comments on the interpretation provided in the Proposing
Release regarding combinations and permutations of, or options on,
swaps and security-based swaps and are restating their interpretation
of clause (A)(vi) of the swap definition with one technical correction
and one clarification.
---------------------------------------------------------------------------

    \591\ See section 1a(47)(vi) of the CEA, 7 U.S.C. 1a(47)(vi).
Clause (A)(vi) of the swap definition refers specifically to other
types of swaps in the swap definition. However, because section
3(a)(68) of the Exchange Act defines a security-based swap as a swap
[with some connection to a security], clause (A)(vi) of the swap
definition is relevant to determining whether any combination or
permutation of, or option on, a security-based swap is a security-
based swap.
    \592\ See Proposing Release at 29838.
---------------------------------------------------------------------------

    Clause (A)(vi) means, for example, that an option on a swap or
security-based swap (commonly known as a ``swaption'') would itself be
a swap or security-based swap, respectively. The Commissions also
interpret clause (A)(vi) to mean that a ``forward swap'' would itself
be a swap or security-based swap, respectively.\593\ By listing
examples here, the Commissions do not intend to limit the broad
language of clause (A)(vi) of the swap definition, which is designed to
capture those agreements, contracts and transactions that are not
expressly enumerated in the CEA swap definition but that nevertheless
are swaps.\594\
---------------------------------------------------------------------------

    \593\ Forward swaps are also commonly known as forward start
swaps, or deferred or delayed start swaps. A forward swap can
involve two offsetting swaps that both start immediately, but one of
which ends on the deferred start date of the forward swap itself.
For example, if a counterparty wants to hedge its risk for four
years, starting one year from today, it could enter into a one-year
swap and a five-year swap, which would partially offset to create a
four-year swap, starting one year forward. A forward swap also can
involve a contract to enter into a swap or security-based swap at a
future date or with a deferred start date. A forward swap is not a
nonfinancial commodity forward contract or security forward, both of
which are excluded from the swap definition and discussed elsewhere
in this release.
    \594\ This category could include categories of agreements,
contracts or transactions that do not yet exist as well as more
esoteric swaps that exist but that Congress did not refer to by name
in the statutory swap definition.
---------------------------------------------------------------------------

5. Contracts for Differences
    As the Proposing Release notes, the Commissions have received
inquiries over the years regarding the treatment of CFDs under the CEA
and the Federal securities laws.\595\ A CFD generally is an agreement
to exchange the difference in value of an underlying asset between the
time at which a CFD position is established and the time at which it is
terminated.\596\ If the value increases, the

seller pays the buyer the difference; if the value decreases, the buyer
pays the seller the difference. CFDs can be traded on a number of
products, including treasuries, foreign exchange rates, commodities,
equities, and stock indexes. Equity CFDs closely mimic the purchase of
actual shares. The buyer of an equity CFD receives cash dividends and
participates in stock splits.\597\ In the case of a long position, a
dividend adjustment is credited to the client's account. In the case of
a short position, a dividend adjustment is debited from the client's
account. CFDs generally are traded over-the-counter (though they also
are traded on the Australian Securities Exchange) in a number of
countries outside the United States.
---------------------------------------------------------------------------

    \595\ See Proposing Release at 29838.
    \596\ See Ontario Securities Commission, Staff Notice 91-702,
``Offerings of Contracts for Difference and Foreign Exchange
Contracts to Investors in Ontario,'' at part IV.1 (defining a CFD as
``a derivative product that allows an investor to obtain economic
exposure (for speculative, investment or hedging purposes) to an
underlying asset * * * such as a share, index, market sector,
currency or commodity, without acquiring ownership of the underlying
asset''), available at http://www.osc.gov.on.ca/documents/en/Securities-Category9/sn_20091030_91-702_cdf.pdf (Oct. 30, 2009);
Financial Services Authority, Consultation Paper 7/20, ``Disclosure
of Contracts for Difference--Consultation and draft Handbook text,''
at part 2.2 (defining a CFD on a share as ``a derivative product
that gives the holder an economic exposure, which can be long or
short, to the change in price of a specific share over the life of
the contract''), available at http://www.fsa.gov.uk/pubs/cp/cp07_20.pdf (Nov. 2007).
    \597\ See, e.g., Int'l Swaps and Derivatives Ass'n, ``2002 ISDA
Equity Derivatives Definitions,'' art. 10 (Dividends) and 11
(Adjustments and Modifications Affecting Indices, Shares and
Transactions).
---------------------------------------------------------------------------

    The Commissions provided an interpretation in the Proposing Release
regarding the treatment of CFDs. The Commissions are restating the
interpretation set out in the Proposing Release without modification.
    CFDs, unless otherwise excluded, fall within the scope of the swap
or security-based swap definition, as applicable.\598\ Whether a CFD is
a swap or security-based swap will depend on the underlying product of
that particular CFD transaction. Because CFDs are highly variable and a
CFD can contain a variety of elements that would affect its
characterization, the Commissions believe that market participants will
need to analyze the features of the underlying product of any
particular CFD in order to determine whether it is a swap or a
security-based swap. The Commissions are not adopting rules or
additional interpretations at this time regarding CFDs.
---------------------------------------------------------------------------

    \598\ In some cases, depending on the facts and circumstances,
the SEC may determine that a particular CFD on an equity security,
for example, should be characterized as constituting a purchase or
sale of the underlying equity security and, therefore, be subject to
the requirements of the Federal securities laws applicable to such
purchases or sales.
---------------------------------------------------------------------------

Comments
    Two commenters requested that the Commissions clarify that non-
deliverable forward contracts are not CFDs.\599\ These commenters
requested that the Commissions determine that NDFs involving foreign
exchange are not swaps. Given that the Commissions are defining NDFs as
swaps and that CFDs involving foreign currency also would be swaps,
there is no need to distinguish NDFs involving foreign exchange from
CFDs involving foreign exchange.
---------------------------------------------------------------------------

    \599\ See Covington Letter and ICI/ABASA Letter.
---------------------------------------------------------------------------

D. Certain Interpretive Issues

1. Agreements, Contracts, or Transactions That May Be Called, or
Documented Using Form Contracts Typically Used for, Swaps or Security-
Based Swaps
    The Commissions are restating the interpretation provided in the
Proposing Release regarding agreements, contracts, or transactions that
may be called, or documented using form contracts typically used for,
swaps or security-based swaps with one modification in response to a
commenter.\600\
---------------------------------------------------------------------------

    \600\ See infra note 606.
---------------------------------------------------------------------------

    As was noted in the Proposing Release,\601\ individuals and
companies may generally use the term ``swap'' to refer to certain of
their agreements, contracts, or transactions. For example, they may use
the term ``swap'' to refer to an agreement to exchange real or personal
property between the parties or to refer to an agreement for two
companies that produce fungible products and with delivery obligations
in different locations to perform each other's delivery obligations
instead of their own.\602\ However, the name or label that the parties
use to refer to a particular agreement, contract, or transaction is not
determinative of whether it is a swap or security-based swap.\603\
---------------------------------------------------------------------------

    \601\ See Proposing Release at 29839.
    \602\ For example, a company obligated to deliver its product to
a customer in Los Angeles would instead deliver the product in
Albany to a different company's customer on behalf of that other
company. In return, the company with the obligation to deliver a
product to its customer in Albany would deliver the product instead
in Los Angeles to the customer of the company obligated to deliver
its product to that customer in Los Angeles.
    \603\ See, e.g., Haekel v. Refco, 2000 WL 1460078, at *4 (CFTC
Sept. 29, 2000) (``[T]he labels that parties apply to their
transactions are not necessarily controlling''); Reves v. Ernst &
Young, 494 U.S. 56, 61 (1990) (stating that the purpose of the
securities laws is ``to regulate investments, in whatever form they
are made and by whatever name they are called'') (emphasis in
original).
---------------------------------------------------------------------------

    It is not dispositive that the agreement, contract, or transaction
is documented using an industry standard form agreement that is
typically used for swaps and security-based swaps,\604\ but it may be a
relevant factor.\605\ The key question is whether the agreement,
contract, or transaction falls within the statutory definitions of the
term ``swap'' or ``security-based swap'' (as further defined and
interpreted pursuant to the final rules and interpretations herein)
based on its terms and other characteristics. Even if one effect of an
agreement is to reduce the risk faced by the parties (for example, the
``swap'' of physical delivery obligations described above may reduce
the risk of non-delivery), the agreement would not be a swap or
security-based swap unless it otherwise meets one of those statutory
definitions, as further defined by the Commissions. If the agreement,
contract, or transaction satisfies the swap or security-based swap
definitions, the fact that the parties refer to it by another name
would not take it outside the Dodd-Frank Act regulatory regime.
Conversely, if an agreement, contract, or transaction is not a swap or
security-based swap, as those terms are defined in the CEA and the
Exchange Act and the rules and regulations thereunder, the fact that
the parties refer to it, or document it, as a swap or security-based
swap will not subject that agreement, contract, or transaction to
regulation as a swap or a security-based swap.
---------------------------------------------------------------------------

    \604\ As noted in the Proposing Release, the CFTC consistently
has found that the form of a transaction is not dispositive in
determining its nature, citing Grain Land, supra note 213, at *16
(CFTC Nov. 25, 2003) (holding that contract substance is entitled to
at least as much weight as form); In the Matter of First Nat'l
Monetary Corp., [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH)
] 22,698 at 30,974 (CFTC Aug. 7, 1985) (``When instruments have been
determined to constitute the functional equivalent of futures
contracts neither we nor the courts have hesitated to look behind
whatever self-serving labels the instruments might bear.'');
Stovall, supra note 63 (holding that the CFTC ``will not hesitate to
look behind whatever label the parties may give to the
instrument''). As also noted in the Proposing Release, the form of a
transaction is not dispositive in determining whether an agreement,
contract, or transaction falls within the regulatory regime for
securities. See SEC v. Merch. Capital, LLC, 483 F.3d 747, 755 (11th
Cir. 2007) (``The Supreme Court has repeatedly emphasized that
economic reality is to govern over form and that the definitions of
the various types of securities should not hinge on exact and
literal tests.'') (quoting Williamson v. Tucker, 645 F.2d 404, 418
(5th Cir. 1981)); Robinson v. Glynn, 349 F.3d 166, 170 (4th Cir.
2003) (``What matters more than the form of an investment scheme is
the `economic reality' that it represents. * * *'') (internal
citation omitted); Caiola v. Citibank, N.A., New York, 295 F.3d 312,
325 (2d Cir. 2002) (quoting United Housing Foundation v. Foreman,
421 U.S. 837, 848 (1975) (``In searching for the meaning and scope
of the word `security' * * * the emphasis should be on economic
reality'')). See Proposing Release at 29839 n. 152.
    \605\ The Commissions note, though, that documentation is not
controlling in evaluating whether an agreement, contract or
transaction is a swap, security-based swap, or neither.

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

Comments
    The Commissions requested comment regarding what agreements,
contracts, or transactions that are not swaps or security-based swaps
are documented using industry standard form agreements that are
typically used for swaps and security-based swaps, and asked for
examples thereof and details regarding their documentation, including
why industry standard form agreements typically used for swaps and
security-based swaps are used. One commenter stated its view that
documentation can be a relevant factor in determining whether an
agreement, contract or transaction is a swap or security-based
swap.\606\ The Commissions are persuaded by the commenter and are
modifying the interpretation to clarify that in determining whether an
agreement, contract or transaction is a swap or security-based swap,
documentation may be a relevant (but not dispositive) factor.
---------------------------------------------------------------------------

    \606\ See IECA Letter. This commenter noted that ``[e]ven though
swaps are commonly documented on the ISDA Master Agreements without
annexes, physical transactions under such agreements with power or
natural gas annexes are not swaps because they are physically
settled forward contracts that are exempt under 1a47(B)''). Id.
---------------------------------------------------------------------------

2. Transactions in Regional Transmission Organizations and Independent
System Operators
    The CFTC declines to address the status of transactions in Regional
Transmission Organizations (``RTOs'') and Independent System Operators
(``ISOs''), including financial transmission rights (``FTRs'') and
ancillary services, within this joint definitional rulemaking. As was
noted in the Proposing Release, section 722 of the Dodd-Frank Act
specifically addresses certain instruments and transactions regulated
by FERC that also may be subject to CFTC jurisdiction. Section 722(f)
added CEA section 4(c)(6),\607\ which provides that, if the CFTC
determines that an exemption for FERC-regulated instruments or other
specified electricity transactions would be in accordance with the
public interest, then the CFTC shall exempt such instruments or
transactions from the requirements of the CEA. Given that specific
statutory directive, the treatment of these FERC-regulated instruments
and transactions should be considered under the standards and
procedures specified in section 722 of the Dodd-Frank Act for a public
interest waiver, rather than through this joint rulemaking to further
define the terms ``swap'' and ``security-based swap.'' \608\
---------------------------------------------------------------------------

    \607\ 7 U.S.C. 6(c)(6).
    \608\ The Commissions note that this approach should not be
taken to suggest any finding by the Commissions as to whether or not
FTRs or any other FERC-regulated instruments or transactions are
swaps (or futures contracts).
---------------------------------------------------------------------------

    The CFTC notes that it has been engaged in discussions with a
number of RTOs and ISOs regarding the possibility of a petition seeking
an exemption pursuant to CEA section 4(c)(6) for certain RTO and ISO
transactions. The CFTC also notes that the status of some RTO and ISO
transactions may have been addressed in the interpretation above
regarding embedded options and the forward exclusion from the swap
definition,\609\ and/or indirectly through the CFTC's recent interim
final rulemaking relating to trade options.\610\
---------------------------------------------------------------------------

    \609\ See supra part II.B.2(a).
    \610\ See supra note 317.
---------------------------------------------------------------------------

Comments
    The CFTC received a number of comments discussing transactions in
RTOs and ISOs.\611\ These commenters argued that the CFTC should
further define the term ``swap'' to exclude transactions executed or
traded on RTOs and ISOs.\612\ One commenter argued that the CEA section
4(c)(6) exemptive approach will leave regulatory ambiguity for market
participants, since the CFTC might not grant an exemption, later revoke
an existing exemption, grant a partial or conditional exemption, or
limit an exemption to existing products.\613\ This commenter also noted
that FERC has complete regulatory authority over RTOs and ISOs and
their transactions, and that Congress expected the CFTC and FERC to
avoid duplicative, unnecessary regulation.\614\ Another commenter
argued that the CFTC should exclude RTO and ISO transactions in the
same manner as insurance has been excluded.\615\ A third commenter
stated that RTO and ISO transactions are commercial merchandising
transactions and thus forwards or, alternatively, that defining them as
swaps is inconsistent with the text, goals, and purpose of the Dodd-
Frank Act.\616\
---------------------------------------------------------------------------

    \611\ See COPE Letter; ETA Letter; and FERC Staff Letter.
    \612\ Id.
    \613\ See COPE Letter.
    \614\ Id.
    \615\ See ETA Letter.
    \616\ See FERC Staff Letter.
---------------------------------------------------------------------------

    By contrast, one commenter asserted that FTRs are in substance
swaps and should be regulated as such.\617\
---------------------------------------------------------------------------

    \617\ See Better Markets Letter.
---------------------------------------------------------------------------

    Two commenters supported the CFTC's use of its section 722(f)
authority to exempt FERC-regulated transactions and other transactions
in RTOs or ISOs.\618\ As discussed above, section 722(f) of the Dodd-
Frank Act added new section 4(c)(6) to the CEA specifically addressing
how the CFTC should approach certain instruments and transactions
regulated by FERC that also may be subject to CFTC jurisdiction. The
CFTC continues to believe, as was stated in the Proposing Release, that
such an approach is the more appropriate means of considering issues
relating to the instruments and transactions specified in CEA section
4(c)(6). One commenter's argument that the CEA section 4(c)(6)
exemptive approach will cause regulatory ambiguity is not a convincing
basis on which to forego a process specifically designated by Congress
for the issue at hand.\619\ The CFTC also believes that the ability to
tailor exemptive relief, after notice and public comment, to the
complex issues presented by transactions on RTOs and ISOs, is further
reason to favor such an approach over the more general directive to
further define the terms ``swap'' and ``security-based swap'' that is
the subject of this rulemaking.
---------------------------------------------------------------------------

    \618\ See NEMA Letter and WGCEF Letter.
    \619\ See COPE Letter.
---------------------------------------------------------------------------

    In response to one commenter's contentions that FERC has complete
regulatory authority over RTOs and ISOs and their transactions, and
that Congress expected the CFTC and FERC to avoid duplicative,
unnecessary regulation, the CFTC notes that Congress addressed this
issue not by excluding RTO and ISO transactions from the comprehensive
regime for swap regulation, but rather by enacting the exemptive
process in CEA section 4(c)(6).
    And in response to another commenter's contention that the CFTC
should exclude RTO and ISO transactions in the same manner as insurance
has been excluded, the CFTC notes that Congress provided neither an
exemptive process equivalent to CEA section 4(c)(6) for insurance, nor
an energy market-equivalent to the McCarran-Ferguson Act.\620\
---------------------------------------------------------------------------

    \620\ 15 U.S.C. 1011-1015.
---------------------------------------------------------------------------

    As noted above, FERC staff opines that defining RTO and ISO
transactions as swaps would be inconsistent with the text, goals, and
purpose of the Dodd-Frank Act. The CFTC can consider concerns of the
sort expressed by FERC staff in connection with any petition for a CEA
section 4(c)(6) exemption that

may be submitted to the CFTC.\621\ Interested parties on all sides of
the issue would receive an opportunity to comment on the scope and
other aspects of any proposed exemptive relief at that time.
---------------------------------------------------------------------------

    \621\ CEA section 4(c)(6) requires the CFTC to determine that an
exemption pursuant to such section ``is consistent with the public
interest and the purposes of th[e CEA].'' 7 U.S.C. 6(c)(6).
---------------------------------------------------------------------------

III. The Relationship Between the Swap Definition and the Security-
Based Swap Definition

A. Introduction

    Title VII of the Dodd-Frank Act defines the term ``swap'' under the
CEA,\622\ and also defines the term ``security-based swap'' under the
Exchange Act.\623\ Pursuant to the regulatory framework established in
Title VII, the CFTC has regulatory authority over swaps and the SEC has
regulatory authority over security-based swaps. The Commissions are
further defining the terms ``swap'' and ``security-based swap'' to
clarify whether particular agreements, contracts, or transactions are
swaps or security-based swaps based on characteristics including the
specific terms and conditions of the instrument and the nature of,
among other things, the prices, rates, securities, indexes, or
commodities upon which the instrument is based.
---------------------------------------------------------------------------

    \622\ See section 1a(47) of the CEA, 7 U.S.C. 1a(47).
    \623\ See section 3(a)(68) of the Exchange Act, 15 U.S.C.
78c(a)(68).
---------------------------------------------------------------------------

    Because the discussion below is focused on whether particular
agreements, contracts, or transactions are swaps or security-based
swaps, the Commissions use the term ``Title VII instrument'' in this
release to refer to any agreement, contract, or transaction that is
included in either the definition of the term ``swap'' or the
definition of the term ``security-based swap.'' Thus, the term ``Title
VII instrument'' is synonymous with ``swap or security-based swap.''
\624\
---------------------------------------------------------------------------

    \624\ In some cases, the Title VII instrument may be a mixed
swap. Mixed swaps are discussed further in section IV below.
---------------------------------------------------------------------------

    The determination of whether a Title VII instrument is either a
swap or a security-based swap should be made based on the facts and
circumstances relating to the Title VII instrument prior to execution,
but no later than when the parties offer to enter into the Title VII
instrument.\625\ If the Title VII instrument itself is not amended,
modified, or otherwise adjusted during its term by the parties, its
characterization as a swap or security-based swap will not change
during its duration because of any changes that may occur to the
factors affecting its character as a swap or security-based swap.\626\
---------------------------------------------------------------------------

    \625\ The determination must be made no later than when the
parties offer to enter into the Title VII instrument because persons
are prohibited from offering to sell, offering to buy or purchase,
or selling a security-based swap to any person who is not an ECP
unless a registration statement is in effect as to the security-
based swap. See section 5(e) of the Securities Act. This analysis
also would apply with respect to mixed swaps and security-based swap
agreements. With respect to swaps, the determination also would need
to be made no later than the time that provisions of the CEA and the