programmatic costs and benefits associated with major participant
regulation.
---------------------------------------------------------------------------

    \1496\ See part IV.M.2, supra.
---------------------------------------------------------------------------

I. Interpretation Related to Guarantees

    In adopting these final rules, we also have finalized an
interpretation regarding when a person will have security-based swap
positions attributed to it by virtue of having guaranteed the positions
of another party. In general, we have clarified that an entity's
security-based swap positions need not be attributed to its parent
unless the counterparty has recourse to the parent. We also clarified
that, even in the presence of a guarantee, positions of certain
regulated entities--including swap dealers, security-based swap
dealers, major participants, broker-dealers, FCMs and certain entities
subject to U.S. bank capital requirements--will not be attributed to
the guarantor.\1497\
---------------------------------------------------------------------------

    \1497\ See part IV.H.3, supra.
---------------------------------------------------------------------------

    We recognize that attributing security-based swap positions to the
entity guaranteeing another entity's security-based swap transactions
may increase the number of major participants. At the same time,
excluding certain regulated entities from the attribution requirement
even in the presence of a guarantee may help prevent a guarantor, such
as a holding company, from being deemed to be a major participant when
the risks associated with those positions already are subject to
regulation.
    We do not currently possess data relating to the existence of
guarantees of the security-based swap positions of other parties and
thus cannot reasonably estimate the number of additional entities that
may be brought within the ambit of major participant regulation by
virtue of this interpretation. However, we note that, to the extent
that guarantees of another entity's security-based swap positions
creates the level of exposure--and corresponding risk to the market and
to counterparties--that warrants regulation under Title VII, it would
appear inconsistent with the purposes of the statute not to subject
that entity to major participant regulation.

J. Other Interpretations

    Finally, in this release we also have provided a number of
additional interpretations and discussions in connection with the
dealer and major participant definitions. These include, among others:
the rejection of requests for entity-specific exclusions from the
dealer and major participant definitions; \1498\ interpretations
regarding the application of the ERISA exclusion from the first major

participant test,\1499\ and interpretations regarding the application
of the major participant analysis to managed accounts.\1500\ In theory,
each of these interpretations potentially has a programmatic
impact.\1501\ For the reasons discussed above, we believe that these
interpretations reflect reasonable choices.
---------------------------------------------------------------------------

    \1498\ See parts II.A.6 and IV.J, supra (stating that such
exclusions from the dealer definition would have no basis in the
statutory text and would be inconsistent with the activity focus of
the dealer definition, and not providing entity exclusions from the
major participant definition because entities that meet the
thresholds of the rules may pose high risk to the U.S. financial
system regardless of how they are organized).
    \1499\ See part IV.D, supra (interpreting the provision to
exclude security-based swap positions entered into for the primary
purpose of hedging or mitigating risks associated with operation of
the plan, consistent with the statutory language that does not limit
the hedging exclusion for ERISA plans to commercial risk; also
clarifying that such positions may be eligible for exclusion even if
they are held by a non-plan entity that holds plan assets).
    \1500\ See part IV.I, supra (clarifying that the position will
be attributed to the client account rather than to the investment
advisers or asset managers and that a beneficial owner should be
required to treat the positions of such an account as its own only
if the security-based swap counterparty has recourse to the
beneficial owner).
    \1501\ For example, attributing security-based swap positions to
investment advisors would have increased the likelihood of advisers
being deemed to be major participants. Our interpretations do not
take that approach, however, as we believe that it would be
inconsistent with the focus of the statutory definition.
---------------------------------------------------------------------------

3. Analysis of Assessment Costs
    Certain persons engaged in security-based swap activity are likely
to incur costs in connection with evaluating whether they fall within
the dealer or major participant definitions.\1502\ As detailed below,
we have considered these assessment costs in adopting definitional
rules and interpretations that seek to capture entities whose security-
based swap activity or whose security-based swap positions warrant
regulation under Title VII as dealers or major participants, while
excluding entities whose activity or positions do not warrant such
regulation.
---------------------------------------------------------------------------

    \1502\ These costs are distinguishable from the costs associated
with registration as a dealer or major participant (which for
purposes of this analysis we treat programmatic costs) and the other
programmatic costs discussed above.
---------------------------------------------------------------------------

a. Assessment Costs Associated With the ``Security-Based Swap Dealer''
Definition
i. Core Dealer Analysis and De Minimis Exception

A. Overview

    Exchange Act rule 3a71-1 in part restates the statutory definition
of ``security-based swap dealer'' to consolidate the definition and
related interpretations for market participants' ease of reference. In
conjunction with these final rules the SEC has set forth
interpretations to provide additional guidance to implement the
statutory approach of capturing persons that engage in certain
security-based swap activities while excluding persons that do not
engage in those activities as part of a ``regular business.'' \1503\ We
believe that this guidance--including its reliance on the distinction
between dealing activity and non-dealing activity such as hedging or
trading--will allow a number of market participants to readily conclude
that their security-based swap activities will not cause them to be
security-based swap dealers. In adopting this approach, we have
considered alternative views, expressed by some commenters, that would
have had the effect of narrowing the statutory definition's
scope.\1504\
---------------------------------------------------------------------------

    \1503\ See part II.A.5, supra.
    \1504\ These include suggestions that: the dealer definition
should be interpreted to be coextensive with the concept of market
making activity; the dealer definition requires that a person be
available to take either side of the market at any time; the dealer
definition should not extend to persons solely engaged in security-
based swap activity on swap execution facilities; the dealer
definition should exclude persons whose security-based swap dealing
activity is relatively small compared to its other activities; and
dealing activity requires the presence of a ``customer''
relationship. See id. (discussing interpretive approach to
``security-based swap dealer'' definition). Conversely, a few
commenters suggested rejection of the dealer-trader distinction, and
implied that the dealer definition should be applied more broadly.
See id.
    These also include suggestions that the dealer analysis
incorporate particular per se exclusions. Although we recognize that
such approaches may be simpler for market participants to implement,
we nonetheless do not believe that such per se exclusions would be
consistent with the statutory definition, which identifies dealers
based on their security-based swap activities. See part II.A.6,
supra (discussing reasons not to include per se exclusions from the
dealer definitions).
---------------------------------------------------------------------------

    Exchange Act rule 3a71-2 specifies when a person that otherwise
would be a security-based swap dealer can take advantage of the de
minimis exception. In adopting the rule's tests and thresholds--
including the use of a $3 billion notional threshold in connection with
dealing activity involving credit default swaps that are security-based
swaps, a $150 million notional threshold in connection with other types
of security-based swaps, higher phase-in levels in connection with
those thresholds, and a separate $25 million threshold in connection
with dealing activity involving ``special entities''--we have
considered a range of alternative approaches and thresholds suggested
by commenters.\1505\
---------------------------------------------------------------------------

    \1505\ See parts II.D.3 and II.D.5, supra.
---------------------------------------------------------------------------

    In application, the assessment costs associated with the core
dealer test and de minimis exception are linked.

B. Assessment Costs Associated With the Final Rules and Interpretations

    We recognize that certain participants in the security-based swap
market may incur costs in connection with the facts-and-circumstances
analysis of whether they are security-based swap dealers as defined in
the statute and in the final rules, particularly with regard to the
application of the dealer-trader distinction and the de minimis
exception.
    As noted above, analysis of market data indicates that the
overwhelming number of participants in the single-name credit default
swap market in 2011 had total activities (dealing or non-dealing) of
significantly less than $3 billion notional amount over the prior 12
months.\1506\ In general--aside from potential dealing activity
involving other types of security-based swaps and dealing activity
involving ``special entities''--such persons likely would not be deemed
to be security-based swap dealers regardless of whether their current
level of security-based swap activities constitutes dealing (apart from
those entities that increase their dealing activity following the
implementation of Title VII).
---------------------------------------------------------------------------

    \1506\ Of 1,084 entities with single-name credit default swap
transaction activity over the 12 months ending in December 2011, 961
entities, or 88.7 percent, engaged in less than $3 billion notional
in such activity. These 961 entities were responsible for
approximately 3.2 percent of the notional value of all single-name
credit default swap transactions during that period. See CDS Data
Analysis, table 1.
---------------------------------------------------------------------------

    On the other hand, some market participants whose security-based
swap activities exceed, or are not materially below, the $3 billion de
minimis threshold may be expected to incur costs in connection with the
dealer analysis. Those entities reasonably may conclude that they need
to incur costs to analyze their security-based swap activities to
determine whether those activities are non-dealing in nature (e.g.,
hedging or trading), or whether those activities instead are dealing in
nature (e.g., part of a business purpose of providing liquidity in
connection with security-based swaps), consistent with the statute and
the rules and guidance provided in this release.\1507\
---------------------------------------------------------------------------

    \1507\ The use of the $8 billion phase-in level in connection
with these activities may also be expected to temporarily mitigate
such costs.
---------------------------------------------------------------------------

    There are over 1,000 entities (U.S. and non-U.S.) that from time to
time may engage in single-name credit default swap transactions.\1508\
Of this number,

however, only 123 entities engaged in more than $3 billion in single-
name credit default swap transactions over the previous 12 months. For
purposes of analyzing the assessment costs of this rule, we have
assumed that all of these entities would perform the dealer
analysis.\1509\ We also recognize that some entities whose activities
fall below the de minimis threshold may opt to engage in this analysis
out of an abundance of caution or to meet internal compliance
requirements, and for purposes of this analysis have assumed that the
43 entities whose activity during the trailing 12 month period fell
between $2 and $3 billion also would engage in the dealer analysis,
leading to a total of 166.\1510\
---------------------------------------------------------------------------

    \1508\ See CDS Data Analysis, table 1. The Federal Reserve Bank
of New York has published data that is consistent with this
analysis. See NY Fed analysis at 10 (noting that for a three month
period spanning from May through July of 2010, there were 933 unique
market participants in the credit default swap market).
     As noted above, see note 148, supra, in relying on the
available data we are not indicating our views as to the application
of Title VII to non-U.S. persons. Issues regarding the
extraterritorial application of Title VII instead will be addressed
in a separate release.
    \1509\ See CDS Data Analysis, table 1. This approach potentially
overstates the number of entities that would need to engage in the
analysis. Of entities with more than $3 billion in activity over the
trailing 12 month period, some number can be expected to determine,
given the nature of their business, that they are (or are not)
dealers under the definition without having to engage in this
analysis. For example, the NY Fed analysis discussed above found
that so-called G14 dealers were responsible for roughly 78 percent
of CDS transactions as buyer and 85 percent of CDS transactions as
sellers, and that so-called ``other dealers'' were responsible for
approximately an additional seven percent of CDS transactions as
sellers and six percent as buyers. See NY Fed analysis at 9, table
3. Many of these entities would likely determine that performing
this analysis was unnecessary.
    \1510\ For the reasons stated above, we also believe that this
number potentially overstates the number of entities with less than
$3 billion in activity over the trailing 12 month period that would
be likely to engage in this analysis. Because it appears that all
entities engaged in security-based swap transactions with special
entities engaged in more than $8 billion in security-based swap
transactions in 2011, see CDS Data Analysis at 21 n.8, we do not
expect that the de minimis threshold for dealing activity involving
special entities to cause market participants to incur costs
independent of those associated with the general de minimis
threshold.
---------------------------------------------------------------------------

    This estimate of 166 entities, although derived from data about
total (dealing and non-dealing) transactions,\1511\ illustrates a
potential upper bound for the total costs arising from security-based
swap dealer determinations, to the extent that all market participants
whose security-based swap activity approaches or exceeds the $3 billion
de minimis threshold identify a need to retain outside counsel to
analyze their status under the security-based swap dealer definition.
In that context, this estimate suggests that the costs of analysis may
approach $4.2 million.\1512\
---------------------------------------------------------------------------

    \1511\ The CDS Data Analysis uses criteria that screen for
likely characteristics of entities engaged in dealing activity. See
CDS Data Analysis at 2. However, the available data does not permit
identification of which of these entities' transactions arise from
dealing activity and which arise from non-dealing activity (such as
proprietary trading or hedging). It is therefore likely that the
notional amounts provided in each table of the data analysis include
both dealing and non-dealing activity. For purposes of the economic
analysis of our rules further defining ``security-based swap
dealer,'' we have assumed that the entire notional amount for each
entity appearing in Tables 2-9 represents dealing activity. Although
this potentially results in an overestimate of dealing activity for
these entities--and thus in an overestimate of the costs associated
with conducting the dealer analysis--we believe that this represents
a conservative approach to evaluating the assessment costs of these
rules.
    \1512\ This total is based on the assumption that 166 market
participants would seek outside legal counsel to determine their
status under the security-based swap dealer definition, with such
analysis costing an average of $25,000 per entity.
    The average cost incurred by such entities in connection with
outside counsel is based on staff experience in undertaking legal
analysis of status under federal securities laws, and assumes that
the legal analysis for a complex entity on average may cost $30,000,
and that the legal analysis for a less complex entity on average may
cost $20,000. The use of inside counsel in lieu of outside counsel
would reduce this upper bound.
    We recognize that the complexity of market participants may vary
greatly, and that we do not have insight into market participants
such that we could reasonably determine how many entities may be
considered more or less complex for these purposes. Thus, based on
our understanding of the market we believe that an average of the
costs associated with more complex and less complex entities
equaling $25,000 would reasonably approximate the average costs for
entities across the credit default swap market, assuming that all
such participants perceive a need to retain outside counsel for
purposes of the analysis.
---------------------------------------------------------------------------

    In accounting for the de minimis exception in estimating these
costs, we note our expectation that market participants generally would
be aware of the notional amount of their activity involving security-
based swaps as a matter of good business practice. Consequently, we
would not expect market participants to incur costs in determining the
availability of the de minimis exception significantly in excess of the
costs associated with the general dealer determination.\1513\
---------------------------------------------------------------------------

    \1513\ We note that different cost estimates have been used for
purposes of the ``swap dealer'' definition under the CEA. We do not
believe that the estimate of the number of persons who would have to
engage in a dealer analysis under the CEA would be germane to the
analysis of the costs associated with the Exchange Act's ``security-
based swap dealer'' definition, given the wide range of markets that
are exclusive to the ``swap'' definition. We also do not believe
that the basis that underpins the CFTC's estimate of the cost of
performing the dealer analysis under the definition of swap as set
forth in the CEA would be relevant to the Exchange Act definition.
In part, this is because we believe that the entities whose
security-based swap activities may cause them to be dealers likely
would have businesses that are financial in nature. We thus expect
that those entities would be particularly sensitive to the link
between the business purpose of their activities and the dealer
definition. In many cases those entities also should be familiar
with the use of the dealer-trader distinction in connection with
their activities involving other types of securities.
    We also note that different cost estimates have been used for
purposes of the de minimis exception under the CEA. We expect,
however, that entities whose security-based swap activities may
cause them to be dealers likely would have businesses that are
financial in nature. We thus expect that those entities would: (a)
be well placed to distinguish their security-based swap dealing
activities from their non-dealing activities under the dealer-trader
distinction; and (b) would be familiar with the notional amount of
their security-based swap activities over the prior year.
---------------------------------------------------------------------------

    We recognize that additional market participants may be expected to
incur these types of assessment costs to the extent that they engage in
activity involving other types of security-based swaps in an amount
close to, or in excess of, $150 million annually. Because the market
for these other types of security-based swaps appears to be highly
concentrated (like the single-name credit default swap market) and to
involve many of the same entities,\1514\ we expect the number of
entities that will incur assessment costs solely by virtue of this
lower threshold also to be small.
---------------------------------------------------------------------------

    \1514\ See, e.g., OCC Quarterly Report at tables 1 and 10
(listing notional credit and equity derivatives for largest U.S.
banks and trust companies). See also note 429, supra.
---------------------------------------------------------------------------

    In addition, we recognize that some market participants potentially
may incur these types of assessment costs to the extent they engage in
security-based swap activities in an amount close to, or in excess of,
$25 million annually.\1515\
---------------------------------------------------------------------------

    \1515\ We believe that any such costs would be modest, in light
of data indicating that persons who are counterparties to special
entities in the single-name credit default swap market may otherwise
have to register as dealers notwithstanding the lower threshold
connected with special entities. See note 1510, supra.
---------------------------------------------------------------------------

    For the reasons discussed above we believe that the approach we are
adopting in the final rules is necessary and appropriate given the
goals of Title VII and the statute's express requirement that we
implement a de minimis exception to the dealer definition.
ii. Additional Issues Related to the Dealer Analysis

A. Limited Designation of Dealers

    Exchange Act rule 3a71-1(c) implements the portion of the
``security-based swap dealer'' definition that provides for limited
purpose registration of dealers. The rule provides for a presumption
that a person that acts as a security-based swap dealer is a dealer
with regard to all of its security-based swaps or security-based swap
activities, unless the SEC limits its designation. While we recognize
that permitting persons to more broadly take advantage of limited
dealer designations potentially would lower the cumulative costs that
individual dealers otherwise would incur to determine whether to

seek a limited designation,\1516\ after careful consideration of
commenter concerns we have determined that it is appropriate to adopt a
presumption against limited designation.\1517\
---------------------------------------------------------------------------

    \1516\ A default presumption in favor of the availability of
limited designations may be expected to reduce the costs associated
with an entity determining whether it qualifies for such relief,
such as the costs of hiring outside legal counsel to undertake this
analysis to determine that they could take advantage a limited
designation relief.
    \1517\ In this regard we note the relative lack of data about
the types of security-based swap positions held by particular
entities that will fall within the dealer definition. Our decision
takes into account the difficulty of separating a dealer's
activities from its non-dealing activities for compliance purposes,
and the challenges of applying dealer requirements to only a portion
of the entity's security-based swap activities. In reaching our
decision, we have especially been influenced by the statutory
definition's discretionary language in connection with the potential
for limited designations, and by the need for persons subject to
limited designations to be able to comply with the statutory and
regulatory requirements applicable to major participants. See part
II.E.3, supra (discussing limited designation principles applicable
to dealers).
    We note that the discussion of limited designation of ``swap
dealers'' under the CEA generally seeks to quantify the costs
associated with applications for limited designations. However, we
believe that the costs of applying for a limited designation are
dependent upon the application process for this type of registration
category. As noted previously, the SEC expects to address the
limited designation application process for security-based swap
dealers in separate rulemakings. See id. As such, we believe that
the costs associated with security-based swap dealer limited
designation applications under the Exchange Act are more
appropriately addressed in the context of those separate
rulemakings.
---------------------------------------------------------------------------

    Certain persons who satisfy the dealer definition may incur costs
in determining whether to seek a limited designation. We believe that
such costs would affect no more than the 166 entities that potentially
may be expected to engage in the dealer analysis,\1518\ and expect
these costs to be included in the estimated costs of seeking outside
legal counsel described above.
---------------------------------------------------------------------------

    \1518\ As discussed above, see note 1457, supra, we have
estimated that 50 or fewer entities ultimately may have to register
as security-based swap dealers.
---------------------------------------------------------------------------

B. Exclusion of Inter-Affiliate Security-Based Swaps

    Exchange Act rule 3a71-1 also provides that security-based swaps
between majority-owned affiliates will be excluded for purposes of the
dealer analysis. After consideration of commenter views, we are
adopting this standard, rather than potential alternatives such as a
common control test, because we believe that it is appropriate, in
light of the goals of Title VII, that the dealer definition not capture
entities by virtue of security-based swap transactions with affiliated
entities that have a sufficient alignment of economic interests to
avoid raising systemic risk, customer protection, and other concerns
that dealer regulation is intended to address.\1519\ Moreover, we note
that a majority-ownership test should, given its objective nature,
impose fewer assessment costs on market participants than a more
subjective common control test.
---------------------------------------------------------------------------

    \1519\ See part II.C.2, supra.
---------------------------------------------------------------------------

    Some market entities may need to incur costs in connection with
determining whether particular security-based swap positions may be
excluded from the dealer analysis by virtue of the inter-affiliate
exclusion. Such costs potentially could be incurred by any of the
approximately 166 entities that we believe may engage in the dealer
analysis. The costs specifically associated with that assessment may
vary depending on factors including the extent to which those entities
engage in inter-affiliate security-based swaps, but we expect these
costs to be included in the estimated costs of seeking outside legal
counsel described above.

C. Timing Issues Connected to the De Minimis Exception

    In response to commenter concerns, Exchange Act rule 3a71-2
specifies that an entity that no longer may rely on the de minimis
exception, because its dealing activity has exceeded the exception's
thresholds, has two months to submit a completed application to
register as a dealer.\1520\ The final rule also specifies that a person
who has been registered as a dealer for at least 12 months may withdraw
from registration while continuing to engage in a limited amount of
dealing activity under the exception.
---------------------------------------------------------------------------

    \1520\ See part II.D.6, supra (discussing rational for final
rule addressing registration period for entities that exceed the de
minimis threshold).
---------------------------------------------------------------------------

    In adopting these rules we have carefully considered alternatives
that would lead to slower entry and faster exit from dealer status, and
we recognize that providing particular entities with additional time to
register as a dealer may have the potential to reduce the costs
associated with the registration process.\1521\ We believe, however,
that a two-month period for registration should provide entities with
sufficient time to register without incurring additional expenses--both
for large firms with security-based swap businesses well above the $3
billion threshold, and for mid-sized firms that fluctuate near the $3
billion threshold amount. We also conclude that this approach will
appropriately help to avoid applying dealer requirements to entities
that no longer meet the dealer criteria, and will avoid the prospect of
persons moving in and out of dealer status overly frequently.
---------------------------------------------------------------------------

    \1521\ For example, a shorter period for registration might be
expected to cause some entities to incur over-time costs arising
from the need to complete the registration process within a short
time frame, whereas a longer time period could have enabled such an
entity to avoid those costs.
---------------------------------------------------------------------------

b. Assessment Costs Associated With the ``Major Security-Based Swap
Participant'' Definition
i. ``Substantial Position'' and ``Substantial Counterparty Exposure''
Definitions

A. Overview of ``Substantial Position'' and ``Substantial Counterparty
Exposure'' Definitions

    Exchange Act rule 3a67-3 defines the term ``substantial position''
for purposes of the first and third tests of the statutory major
participant definition (which address whether a person has a
``substantial position'' in a major category of security-based swaps).
The final rule sets forth two tests for identifying the presence of a
substantial position--one test based on a $1 billion daily average
measure of uncollateralized mark-to-market exposure, and one based on a
$2 billion daily average measure of combined uncollateralized mark-to-
market exposure and potential future exposure. Both of those daily
measures would be calculated and averaged over a calendar quarter. In
developing the ``substantial position'' tests and their associated
thresholds, we have sought to capture those entities whose security-
based swap positions have the potential to pose significant risks to
financial markets, while not capturing other entities for which major
participant regulation and its associated costs would be
unwarranted.\1522\
---------------------------------------------------------------------------

    \1522\ See part IV.B.3, supra (discussing basis for the
substantial position analysis we are adopting).
---------------------------------------------------------------------------

    Exchange Act rule 3a67-5 defines ``substantial counterparty
exposure that could have serious adverse effects on the financial
stability of the United States banking system or financial markets,'' a
phrase that comprises part of the second test of the ``major security-
based swap participant'' definition. The analysis set forth in this
rule parallels the ``substantial position'' analysis, but: (i) Contains
higher thresholds; (ii) examines an entity's security-based swap
positions as a whole (rather than focusing on a particular ``major''
category); and (iii) would not exclude certain hedging positions.\1523\
---------------------------------------------------------------------------

    \1523\ See part IV.E.3, supra (discussing basis for the
substantial counterparty exposure analysis we are adopting).
---------------------------------------------------------------------------

    In adopting these definitions, we carefully considered alternative

approaches suggested by commenters, including suggestions that the
thresholds should be raised or lowered, and that certain positions
should be excluded from the potential future exposure test, or that the
test should discount certain positions differently.\1524\ We have
retained the tests largely as proposed, however, as we believe that the
tests appropriately address the risk criteria embedded in the major
participant definition.\1525\ We also believe that the tests minimize
the assessment costs to these entities in a manner consistent with the
statutory definition. For example, the decision to base the potential
future exposure analysis on tests used by bank regulators for purposes
of setting prudential capital reflects our view that it would be
appropriate to implement the analysis by building upon an existing
regulatory approach that is less subjective--and thus less costly--for
market participants to utilize (as compared to, for example, a VaR
approach \1526\) and would lead to reproducible results, rather than
seeking to develop a brand new approach.\1527\
---------------------------------------------------------------------------

    \1524\ See parts IV.B.2 and IV.E.2, supra.
    \1525\ See part IV.B.3, supra (discussing the decisions made
regarding the substantial position definition and the reasoning
behind the adopted approach). For example, we have concluded that
the proposed thresholds are set prudently in a manner that takes
into account the financial system's ability to absorb losses of a
particular size, the need for major participant regulation not to
encompass entities only after they pose significant risks to the
market, and the need to account for the possibility that multiple
market participants may fail close in time. In addition, as
discussed above, we believe that this threshold is tailored to
address the types of events associated with the failure of AIG FP.
See part IV.B.3.d, supra.
    As discussed above, for an entity with no current
uncollateralized exposure--and before accounting for netting--it
would take a $100 billion notional portfolio of marked-to-market
security-based swaps that reflect written protection on credit to
meet the $2 billion potential future exposure threshold for
security-based credit derivatives, and it would take a $200 billion
notional portfolio of cleared positions to meet that threshold. Even
in the absence of clearing or daily mark-to-market margining, it
would take a minimum $20 billion notional portfolio of written
protection on credit (reflecting the 0.10 multiplier in the risk
adjustment tables) to meet the $2 billion potential future exposure
threshold. Accounting for netting (which can reduce potential future
exposure measures by up to 60 percent) could materially increase
that required amount. See note 914, supra.
    \1526\ For example, because value-at-risk measures typically
account only for market risk and not for other types of risk, an
approach based on such measures would likely require separate
calculations for these other risks, as well as calculations to
account for possible losses in the event of a severe market
downturn; such an approach would also require the selection of
appropriate parameters for the test. See Concept Release: Net
Capital, Exchange Act Rel. No. 39456, at 13-19 (comparing value-at-
risk and haircut approaches to net capital calculations).
    \1527\ See part IV.B.3.c, supra.
---------------------------------------------------------------------------

B. Assessment Costs Associated With the Final Rules Defining
``Substantial Position'' and ``Substantial Counterparty Exposure''

    Certain market participants may be expected to incur costs in
connection with the determination of whether they have a ``substantial
position'' in security-based swaps or pose ``substantial counterparty
exposure'' in connection with security-based swaps.
    Based on a review of notional positions maintained in 2011 by
entities with single-name credit default swap positions, we estimate
that approximately 12 entities have security-based swap positions of
such an amount that, as a matter of prudence, they may reasonably find
it necessary to engage in the requisite calculations, particularly
given the additional availability of the calculation safe harbor.\1528\
In our view, the data indicates that other than approximately 12
entities, the non-dealer market participants in the security-based swap
market use these products in such limited amounts that they reasonably
would conclude that they do not need to undertake the calculations used
to determine whether they have a ``substantial position.'' \1529\
---------------------------------------------------------------------------

    \1528\ In the Proposing Release, we stated that based on our
understanding of the market, we concluded that only 10 entities had
security-based swap positions of a size to necessitate performing
the calculations to determine whether they meet those thresholds.
See Proposing Release, 75 FR at 80207-08. Some commenters challenged
the assumption that only approximately 10 entities would engage in
the requisite calculations. Those commenters took the view that
certain entities with smaller security-based swap positions would
perceive a need to conduct the relevant calculations on a daily
basis even if they are not reasonably likely to be major
participants, and, to address that concern, requested a safe harbor
from having to perform the major participant calculations. See
letters from SIFMA AMG I and Vanguard.
    \1529\ As discussed above, an entity that margins its positions
daily generally would need to have security-based swap positions
approaching $100 billion notional to meet the substantial position
threshold, assuming no current uncollateralized exposure, while an
entity that clears those positions generally would need positions
approaching $200 billion notional to meet the threshold. See note
914, supra. We believe that it is reasonable to assume that most
entities that will have security-based swap positions large enough
to potentially cause them to be major participants in practice will
post variation margin in connection with those positions that they
do not clear, making $100 billion the relevant measure. The
available data shows that as of December 2011 a single entity had
aggregate gross notional positions from bought and sold credit
protection exceeding $100 billion, four had aggregate gross notional
single-name credit default swap positions exceeding $50 billion, and
12 had aggregate gross notional single-name credit default swap
positions exceeding $25 billion. See CDS Data Analysis at table 10.
Making allowances for certain entities that may determine, due to
internal policies or other reasons, that they need to conduct this
analysis and cannot rely on the calculation safe harbor we also are
adopting, we believe that it is reasonable to assume that entities
with aggregate gross notional single-name credit default swap
positions exceeding $25 billion may identify a need to perform the
major participant analysis. (In the Proposing Release, we stated
that based on our understanding of the market, we thought that fewer
than ten entities had security-based swap positions of a size to
necessitate performing the calculations to determine whether they
meet those thresholds. See Proposing Release, 75 FR at 80207-08.)
    We believe, moreover, that the estimate that 12 entities will
perceive a need to perform this analysis in practice may overstate
the number of entities that reasonably will find it necessary to
perform the major participant analysis, given that only four
entities had $25 billion or more of aggregate gross notional single-
name credit default swap positions arising from the selling of
credit protection. See id. As discussed above, moreover, we believe
that fewer than five entities ultimately may be required to register
as major security-based swap participants. See part VIII.A.2.d.i.C,
supra.
     Finally, we note that this estimate may also overstate the size
of positions held by individual legal entities, thus further
overstating the number of legal entities that have security-based
swap positions of such a size as to potentially trigger major
participant status. This is because the data in the analysis at
times aggregates multiple affiliated accounts--which may reflect the
legal entities that are counterparties to the security-based swap--
at the parent level. While such aggregation is appropriate for these
purposes given that parents may be deemed to be major participants
by virtue of security-based swap positions that they guarantee, the
aggregation in fact may tend to overstate the extent to which a
legal entity bears credit risk in connection with security-based
swaps.
     To the extent that an entity's security-based swap transactions
are not cleared or associated with the posting of variation margin,
security-based swap positions of $20 billion may lead to sufficient
potential future exposure to cause the entity to be a major
participant. As we have noted, we believe that few if any entities
with significant security-based swap positions will have a
significant number of such transactions. Even then, the data
indicates that only a total of 32 entities have notional credit
default swap positions in excess of $10 billion. See CDS Data
Analysis at table 10 (showing that 32 entities have aggregate gross
single-name credit default swap positions of $10 billion or
greater).
---------------------------------------------------------------------------

    Although some commenters noted concerns about the complexity of the
major participant calculation,\1530\ commenters did not appear to
directly question the Proposing Release's per-entity cost
estimates.\1531\ After further

consideration, however, we are modifying that estimate, in that we
believe that the annual per-entity costs associated with the assessment
will amount to $15,268, and the annual one-time per-entity costs
associated with the assessment will amount to approximately
$13,692.\1532\ The total industry-wide assessment costs associated with
the major participant definition, given our expectation that 12
entities will need to engage in this analysis, is $183,216 for annual
costs and $164,304 for annual one-time costs.\1533\
---------------------------------------------------------------------------

    \1530\ E.g., letter from WGCEF II (addressing technical
complexity of the proposed major participant calculations).
    \1531\ Based on industry discussions, in the Proposing Release
we estimated that those 10 entities would incur one-time programming
costs of approximately $13,444 per entity, or $134,440 in total, and
that these entities would incur annual ongoing costs of $7,260 per
entity, or $72,600 in total. See Proposing Release, 75 FR at 80207-
08, nn.183-86 and accompanying text (providing a summary of the
methodology used to estimate these costs). The hourly cost figures
in the Proposing Release for the positions of Compliance Attorney,
Compliance Manager, Programmer Analyst, and Senior Internal Auditor
were based on data from SIFMA's Management & Professional Earnings
in the Securities Industry 2009. For purposes of the cost estimates
in this release, we have updated these figures with more recent data
as follows: the figure for a Compliance Attorney is $322/hour, the
figure for a Compliance Manager is $279/hour, the figure for a
Programmer Analyst is $196/hour, and the figure for a Senior
Internal Auditor is $198/hour, each from SIFMA's Management &
Professional Earnings in the Securities Industry 2011, modified by
SEC staff to account for an 1800-hour work-year and multiplied by
5.35 to account for bonuses, firm size, employee benefits, and
overhead. We have also updated the Proposing Release's $450/hour
figure for a Chief Financial Officer, which was based on data from
2010. Using the consumer price index to make an inflation adjustment
to this figure, we have multiplied the 2010 estimate by 1.03 and
arrived at a figure of $464/hour for a Chief Financial Officer in
2011. Incorporating these new cost figures, the updated one-time
programming costs based upon our assumptions regarding the number of
hours required in the proposing release would be $13,692 per entity,
or $136,920 in total, and the annual ongoing costs would be $7,428
per entity, or $74,280 in total.
    \1532\ This revision in part is based on the addition of an
ongoing cost of a Programmer Analyst who we estimate would spend an
additional 40 hours annually on software maintenance attributable to
the modifications made to an automated system to undertake these
tests. We further estimate that the hourly wage of a Programmer
Analyst would be approximately $196. The $196/hour figure for a
Programmer Analyst is from SIFMA's Management & Professional
Earnings in the Securities Industry 2011, modified by SEC staff to
account for an 1800-hour work-year and multiplied by 5.35 to account
for bonuses, firm size, employee benefits, and overhead. Based on
these assumptions, we estimate these additional costs as $7,840 per
year per entity and $94,080 per year for all entities as follows:
(Programmer Analyst at $196 per hour for 40 hours) x (12 entities) =
$94,080.
    \1533\ These adjustments do not materially change the estimated
costs associated with performing these calculations.
    To the extent that additional entities perceive a need to
perform the major participant calculations provided by the rules,
notwithstanding a relatively low position in security-based swaps,
these costs would differ. For example, if we assume that 32 entities
will perceive the need to conduct the major participant analysis,
see note 1529, supra, initial legal costs will total approximately
$960,000 (based on the per-entity cost estimate of $30,000); one-
time industry-wide costs would total approximately $440,000 (based
on the per-entity cost estimate of $13,692); and annual industry-
wide costs would total approximately $490,000 (based on the per-
entity cost estimate of $15,268 addressed below).
    At the extreme, available data indicates that 1,188 participants
have single-name credit default swap positions in the security-based
swap market (excluding ISDA-recognized dealers and ICE Trust). See
CDS Data Analysis at table 10, To the extent that none of these
1,188 entities avail themselves of the calculation safe harbor we
are adopting, and that all of them engage in the full major
participant analysis, then there potentially will be initial legal
costs of approximately $35.6 million (based on the per-entity cost
estimate of $30,000), one-time industry-wide costs of approximately
$16.3 million (based on the per-entity cost estimate of $13,692),
and annual industry-wide costs of approximately $18.1 million (based
on the per-entity cost estimate of $15,268 addressed below).
     In practice, however, we think that the estimates for 12
entities more fairly assesses the relevant costs for the reasons
discussed above. See note 1529, supra. In our view, a large number
of participants in the market have notional security-based swap
positions low enough to permit them to conclude that they do not
have to engage in the relevant calculations. See id.
---------------------------------------------------------------------------

    We believe that these estimates also address the assessment costs
under the ``substantial counterparty exposure'' test. Because credit
default swaps may be expected to constitute the bulk of the likely
security-based swap market, it is possible that participants in the
market may be more likely to have a ``substantial position'' in debt-
related security-based swaps than they would be to meet this second
test. Nonetheless, we conservatively estimate that the same
approximately 12 entities would engage in the ``substantial
counterparty exposure'' calculation as would undertake the
``substantial position'' calculation.\1534\ Given the link between this
rule and the ``substantial position'' calculations, however, we do not
anticipate that the ``substantial counterparty exposure'' test would
create incremental costs additional to those associated with the
definition of ``substantial position.'' \1535\ We thus believe that the
estimate of assessment costs in connection with the ``substantial
position'' analysis (consisting of one-time programming costs of
approximately $13,692 per entity, and annual costs of $15,268 per
entity) also adequately addresses the costs of assessment under this
statutory test.\1536\
---------------------------------------------------------------------------

    \1534\ See part VIII.A.3.b.i.A, supra. These costs would differ
if additional entities perceive a need to perform the major
participant calculations provided by the rules, notwithstanding a
relatively low position in security-based swaps. Commenters have
taken the view that more than 10 entities may identify a need to
perform the requisite calculations. As already noted, based on the
analysis of 2011 transaction data, we have revised this estimate
upward to 12 entities, though we believe that the actual number is
likely to be smaller. In any event, these concerns should be
addressed by the calculation safe harbor that we are adopting as
part of these final rules.
    \1535\ See Proposing Release, 75 FR at 80209.
    \1536\ We note that higher cost estimates have been used for
purposes of the ``major swap participant'' definition under the CEA.
We expect, however, that the entities that may have security-based
swap positions of a size that could lead them to be major
participants likely would have businesses that are financial in
nature (rather than being non-financial entities that use security-
based swaps as part of their commercial activities). As such, we
would expect those entities to generally be cognizant of, or in a
good position to obtain information about: their uncollateralized
exposure with counterparties (to the extent that those financial
entities have any material amount of uncollateralized exposure); the
total notional amount of their security-based swap positions; the
notional amount of those positions that are subject to central
clearing or daily mark-to-market margining; and the extent to which
those positions are in-the-money or out-of-the-money (for purposes
of calculating the netting discount to the potential future exposure
calculation). We also expect that security-based swaps will be used
less frequently for hedging purposes than swaps. See, e.g.,
Bernadette A. Minton, Ren[eacute] Stulz & Rohan Williamson, ``How
Much Do Banks Use Credit Derivatives to Hedge Loans?,'' 35 J. Fin.
Serv. Res. 1 (2008) (noting that the ``net notional amount of credit
derivatives used for hedging of loans in 2005 represents less than
2% of the total notional amount of credit derivatives held by
banks''). Accordingly, there is reason to believe that the costs of
calculation associated with the ``major security-based swap
participant'' assessment will be lower than the costs associated
with the ``major swap participant'' assessment.
---------------------------------------------------------------------------

    At the same time, upon further consideration we believe these rules
also may impose certain interpretive costs, including those related to
obtaining legal counsel, on market participants. Given the size and
complexity of the entities that may find it necessary to analyze their
status under the major participant definition, we believe that it is
reasonable to conclude that at least some entities with security-based
swap positions that approach the major participant thresholds are
likely to seek legal counsel for interpretation of various aspects of
the rules pertaining to the major participant definition. The costs
associated with obtaining such legal services would vary depending on
the relevant facts and circumstances, including the size and complexity
of the person's security-based swap positions, and the extent to which
these interpretations may be germane to whether the entity ultimately
is deemed to be a major participant. We believe, however, that $30,000
represents a reasonable estimate of the upper end of the range of the
costs of obtaining the services of outside counsel in undertaking the
legal analysis of the entity's status as a major participant.\1537\

Based on the conclusion that no more than 12 entities have security-
based swap positions that they would face enough of a possibility of
being a major participant that they would need to engage in such
analysis,\1538\ we estimate that the total legal costs associated with
evaluating the various elements of this definition may approach
$360,000.\1539\
---------------------------------------------------------------------------

    \1537\ The average cost incurred by such entities in connection
with outside counsel is based on staff experience in undertaking
legal analysis of status under federal securities laws. The staff
believes that costs associated with obtaining outside legal counsel
relating to such determinations range from $20,000 to $30,000
depending on the complexity of the entity. We believe that an entity
that maintains security-based swap exposures of the size that would
necessitate undergoing this analysis will generally be large,
complex financial organizations. We also recognize that, while the
major participant test may be more objective and quantitative than
the dealer test (and therefore require a less involved legal
analysis), the test is novel (unlike the core dealer test, which
draws on the dealer-trader distinction familiar to many market
participants) and, as such, may cause entities to incur additional
costs in interpreting and applying the test. Together, these factors
lead us to estimate that entities undertaking this analysis will
incur legal costs at the upper end of our estimated range. The use
of inside counsel in lieu of outside counsel would reduce this upper
bound.
     The legal costs associated with the major participant analysis
may include, among other things, legal advice with respect to
whether an affiliate with which the entity enters into security-
based swap transactions qualifies as an ``affiliate'' under rule
3a67-3, whether particular transactions fall within the definition
of security-based swap, whether certain types of security-based swap
transactions fall within the debt-based security-based swap or other
security-based swap category, whether the entity falls within the
definition of ``financial entity,'' and whether certain types of
security-based swap transactions qualify for the hedging exclusion
under the substantial exposure tests. We recognize that the
complexity of the analysis required for any of these issues may vary
considerably across entities, depending on each entity's individual
business model.
     The major participant test is based on daily average exposures
over the course of the previous quarter, and, as discussed further
below, some number of entities may decide to establish a system that
will monitor their exposure on an ongoing basis. To the extent that
the entity does so, we expect that any initial legal analysis should
permit the entity to make determinations about these calculations on
an ongoing basis. As such, we assume that any additional costs
associated with outside counsel with respect to ongoing monitoring
of positions would be negligible.
    \1538\ See note 1529, supra.
    \1539\ If 32 entities were to perform this analysis, as
discussed above, the market-wide legal costs associated with the
analysis would total $960,000.
---------------------------------------------------------------------------

ii. Calculation Safe Harbor
    We also are adopting Exchange Act rule 3a67-9, which provides a
safe harbor from the definition of ``major security-based swap
participant'' for market participants whose security-based swap
positions fall below certain thresholds. This safe harbor responds to
concerns raised by commenters that--based on internal compliance
policies and procedures, out of an abundance of caution, or for other
reasons--certain entities may feel compelled to perform the full major
participant calculations even if their security-based swap positions
did not rise to a level near the thresholds in the ``substantial
position'' or ``substantial counterparty exposure'' definitions.\1540\
---------------------------------------------------------------------------

    \1540\ In particular, some commenters challenged the assumption
in the Proposing Release that only approximately 10 entities had
security-based swap positions large enough to lead them to engage in
the major participant calculations. Those commenters took the view
that certain entities with smaller security-based swap positions
would perceive a need to conduct the relevant calculations on a
daily basis even if they are not reasonably likely to be major
participants, and, to address that concern, requested a safe harbor
from having to perform the major participant calculations. See
letters from SIFMA AMG I and Vanguard.
---------------------------------------------------------------------------

    The safe harbor makes use of three alternative tests. The first of
these is based on the maximum possible uncollateralized exposure under
the applicable credit support arrangements, and on the notional amount
of a participant's security-based swap positions. The two other
alternatives entail monthly calculations, with the second alternative
using calculations based on the maximum possible uncollateralized
exposure under the applicable credit support arrangements and monthly
adaptations of the substantial position and substantial counterparty
exposure calculations, and the third alternative using calculations
based on uncollateralized exposure and a modified version of the
potential future exposure calculation.
    Although the provisions of the safe harbor we are adopting do not
mirror the safe harbors suggested by commenters,\1541\ the inclusion of
this safe harbor should help address commenter concerns regarding
entities with small positions that would nonetheless feel compelled
(due to their own internal compliance programs, or otherwise) to
undertake the major participant calculations. While recognizing that
more liberal standards for this safe harbor \1542\ could further
mitigate costs of assessing major participant status, the safe harbor
may be expected to help some entities avoid the costs associated with
assessing if they are major participants.
---------------------------------------------------------------------------

    \1541\ See part IV.M, supra (discussing rationale for safe
harbor).
    \1542\ See part IV.M.2, supra (discussing rationale for final
rule implementing safe harbor).
---------------------------------------------------------------------------

    It is not clear how many firms may ultimately seek to rely on the
calculation safe harbor.\1543\ Participants in the security-based swap
market vary greatly in the size of their positions, and may be expected
to vary greatly in the complexity of their operations, and in the
requirements of their internal compliance and risk management policies.
As a result, it is possible that some firms with relatively small
positions may choose to undertake the safe harbor analysis while
significantly larger firms may determine that such analysis is
unnecessary.
---------------------------------------------------------------------------

    \1543\ As noted previously in part VIII.A.3.b.i.B, supra, we
expect that approximately 12 entities may have security-based swap
positions in an amount such that it may be reasonably necessary for
them to undertake the major participant calculations. To the extent,
however, that entities with smaller positions nonetheless identify a
reason to perform a major participant analysis, the safe harbor
would permit those entities to conclude that they are not major
participants without the need to engage in the full set of
calculations otherwise anticipated by the rules.
---------------------------------------------------------------------------

    The first of the three alternatives within the safe harbor would be
based on the maximum possible uncollateralized exposure under the
applicable credit support arrangements, and on the notional amount of a
participant's security-based swap positions. We believe that as a
matter of good business practice large participants in the security-
based swap market already would be aware of that information, making
the test relatively simple to implement. We also note that available
data indicates that 1,073 of the 1,188 entities with single-name credit
default swap positions (other than ISDA-recognized dealers and ICE
Trust), have notional positions less than $2 billion, potentially
making the first test of the safe harbor available to them.\1544\
---------------------------------------------------------------------------

    \1544\ See CDS Data Analysis at table 10.
---------------------------------------------------------------------------

    The other alternatives within the safe harbor would also entail
monthly calculations, with such calculations for the second alternative
based on the maximum possible uncollateralized exposure under the
applicable credit support arrangements and monthly adaptations of the
substantial position and substantial counterparty exposure
calculations, while the monthly calculation for the third alternative
is based on uncollateralized exposure and a modified version of the
potential future exposure calculation. Both of these would entail
additional analysis beyond current industry practices, causing entities
to incur higher costs than the first alternative, but no more than
would be required to complete the full major participant test.\1545\
---------------------------------------------------------------------------

    \1545\ We expect that the outer bounds of the assessment costs
associated with this safe harbor will be no higher than the one-time
costs associated with conducting the major participant analysis,
given that, to the extent that an entity determines that performing
the safe harbor analysis is more expensive, it would likely choose
to perform the less-costly major participant analysis. As such, the
upper bound of costs associated with the safe harbor is not likely
to exceed our estimates of the costs associated with the full major
participant analysis, and should in fact be considerably lower.
    We estimate that one-time costs associated with establishing a
system to identify and monitor security-based swap positions, as may
be necessary to perform the monthly assessments anticipated by two
of the three alternative tests that comprise the safe harbor, would
be similar to the one-time costs associated with the major
participant analysis, and that, therefore, up to 1,188 entities may
incur one-time industry-wide costs of approximately $16.3 million.
See note 1533 and accompanying text, supra. The annual costs
associated with monthly assessment would be expected to be less than
the costs of daily assessment, and $9.1 million--approximately half
of the estimated $18.1 million estimated annual costs if all 1,188
entities found it necessary to perform the daily assessment required
by the substantial position test (see id.)--may be a reasonable
estimate of that amount, given the relative simplicity of the test
and the less frequent assessments that it requires. In practice,
however, we believe that the costs associated with this safe harbor
will be less because we expect that far fewer entities would
perceive a need to rely on these aspects of the safe harbor,
particular given that, as noted above, approximately 1,073 entities
have aggregate gross notional single-name credit default swap
positions under $2 billion. See note 1544 and accompanying
discussion, supra.
    We note that our analysis of the safe harbor in connection with
the ``major security-based swap participant'' definition differs
from that of the CFTC with regard to the ``major swap participant''
safe harbor. This, in part, reflects the differences between the
markets for swaps and security-based swaps. We also note our
expectation that many of the entities that may opt to avail
themselves of the safe harbor likely would have businesses that are
financial in nature (rather than being non-financial entities that
use security-based swaps as part of their commercial activities). As
such, we would expect those entities to generally be cognizant of,
or in a good position to obtain information about: Their maximum
potential uncollateralized exposure with security-based swap
counterparties; the total notional amount of their security-based
swap positions; the notional amount of those positions that are
subject to central clearing or daily mark-to-market margining; and
the extent to which those positions are in-the-money or out-of-the-
money (for purposes of calculating the netting discount to the
potential future exposure calculation). Other non-financial entities
seeking to take advantage of the safe harbor may minimize their
costs by utilizing whichever safe harbor option may be expected to
most closely align with the security-based swap information that
readily is available to such entities.

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

iii. Additional Issues Related to the Major Participant Analysis

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

    Exchange Act rule 3a67-2 sets forth two ``major'' categories of
security-based swaps for purposes of the first and third tests of the
major participant definitions--one consisting of debt-based security-
based swaps and the other consisting of other security-based swaps
(including equity swaps). These categories are consistent with our
understanding of the ways in which those products are used, as well as
market statistics and current market infrastructures,\1546\ and we
believe it is appropriate that those market categories be reflected in
the major participant definition.
---------------------------------------------------------------------------

    \1546\ In particular, the major categories of security-based
swaps adopted in these final rules are consistent with how bank
derivatives data is presented by the Office of the Comptroller of
the Currency, as well as with categories used by derivatives market
infrastructure such as The Depository Trust & Clearing Corporation.
See part IV.A.3, supra.
---------------------------------------------------------------------------

    The consistency of the rule with current market practices should
help mitigate any assessment costs incurred by market participants.
Moreover, we do not expect that market participants will be required to
incur costs to determine the major category with respect to a large
majority of their security-based swap positions, given that the vast
majority of security-based swaps likely fall within the debt-based
security-based swap major category. Also, in adopting the final rules
we also have provided additional guidance related to the categorization
of certain types of instruments in response to commenter concerns.
Nonetheless, given the fact-specific nature of any such assessment, we
recognize that some entities may seek the opinion of legal counsel as
to how specific security-based swap transactions should be categorized
for purposes of this rule (such as legal costs associated with having
counsel analyze a particular security-based swap to determine its
status under these rules, to the extent that certain types of security-
based swaps with complex, novel or bespoke structures are not readily
categorized within one of the two identified major categories). We
expect that these costs would be included in the estimated costs of
seeking outside legal counsel in connection with the major participant
analysis, as described above.\1547\
---------------------------------------------------------------------------

    \1547\ Entities may also incur programming and other costs
related to recording the classification of their security-based swap
transactions in systems designed to monitor current exposure and
potential future exposure, but we expect these costs to be one
component of entities' overall system costs relating to its
substantial position calculations, which we discuss in further
detail above. See part VIII.A.3.b.i.B, supra.
---------------------------------------------------------------------------

B. Definition of ``Hedging or Mitigating Commercial Risk''

    Exchange Act rule 3a67-4 defines the term ``hedging or mitigating
commercial risk'' for purposes of the exclusion from the first major
participant test. Among other aspects, this rule makes use of an
``economically appropriate'' standard, and sets forth exclusions for
security-based swap positions that have a speculative or trading
purpose.
    As discussed above, we carefully consider alternative approaches
suggested by some commenters, including the suggestion that the
definition should encompass positions that hedge speculative or trading
positions and the suggestion that the definition should incorporate a
``congruence'' standard.\1548\ We concluded, however, that these
approaches are inconsistent with the focus of the statutory text, which
is on ``commercial risk,'' and in adopting this definition we have
sought to set forth criteria that reasonably distinguish hedging
positions from other positions. We believe that the approach we are
adopting, which seeks to exclude positions that hedge commercial risk
without also excluding other types of positions, is necessary and
appropriate in light of the statute.\1549\
---------------------------------------------------------------------------

    \1548\ See parts IV.C.5.a and IV.C.5.b, supra (discussing
rationale for excluding positions hedging speculative and trading
positions from the definition).
    \1549\ See parts IV.C.3 and IV.C.5, supra.
---------------------------------------------------------------------------

    Some market participants may be expected to incur costs in
connection with determining whether certain security-based swap
positions fall within this hedging exclusion.\1550\ Any such costs of
analyzing the status of particular security-based swaps as a hedge of
commercial risk would reflect the unique character of individual
positions and the business purpose associated with the position. Such
costs may be particularly relevant for security-based swaps of a more
complex nature, or for security-based swaps that introduce some degree
of basis risk in connection with the hedge. Because of the facts-and-
circumstances nature of this analysis,\1551\ we believe that some
entities may seek the opinion of legal counsel as to whether certain
transactions qualify for the commercial hedging exclusion at the time
they conduct their initial analysis, and these costs would likely be
encompassed within the estimated costs of legal services related to the
major participant definition.\1552\
---------------------------------------------------------------------------

    \1550\ We have incorporated provisions into the final rule
designed to provide guidance to market participants as to which
types of security-based swap positions could be expected to fall
within this exclusion. This release also provides further guidance
as to the scope of the exclusion.
    \1551\ The transaction-related costs of making a hedging
determination would apply only to entities with security-based swap
positions that are near to or exceed the substantial position
threshold prior to taking advantage of the hedging exclusion. This
may be expected to mitigate costs associated with making this
determination.
    \1552\ Separately, the proposed rule defining this term would
have included certain documentation and assessment conditions that
commenters stated could lead to significant costs. Commenters
expressed concerns regarding the application of these conditions and
the associated costs. As discussed previously in this release, we
have determined not to include these conditions in the final rule.
See part IV.C.5.d, supra.
---------------------------------------------------------------------------

C. Definitions of ``Financial Entity'' and ``Highly Leveraged''

    Exchange Act rule 3a67-6 defines the term ``financial entity'' for
purposes of the third major participant test. This definition is
largely consistent with the statutory ``financial entity'' definition
used in Title VII's exception from mandatory clearing for commercial
end-users.\1553\ However, in response to commenter concerns, the final
rules exclude centralized hedging facilities from the ``financial
entity'' definition (in a way that itself is consistent with that Title
VII hedging exception).\1554\

Although particular market participants may incur costs in connection
with determining whether they fall within the ``financial entity''
definition, we believe that such costs would be minimal in light of the
objective nature of the definition, and its consistency with the use of
the term elsewhere in Title VII. We also recognize that entities may
seek the opinion of legal counsel as to whether the entity falls within
the scope of this ``financial entity'' definition, but believe that
these costs would likely be encompassed within the estimated costs of
legal services related to the major participant definition.
---------------------------------------------------------------------------

    \1553\ See Exchange Act section 3C(g).
    \1554\ In addition, we considered, but do not incorporate, some
commenters' suggestion that ``financial entity'' be defined more
narrowly, such as by excluding employee benefit plans. See part
IV.F.3.a, supra, (discussing rationale for final rule defining
``financial entity'').
---------------------------------------------------------------------------

    Exchange Act rule 3a67-7 defines the term ``highly leveraged,''
also for purposes of the third statutory major participant test. After
considering commenters' views, the final rule defines that term based
on a 12 to 1 leverage ratio, as discussed in greater detail above. In
adopting this leverage ratio, we also modify the proposed method of
calculating leverage in certain respects,\1555\ but conclude that it
would not be appropriate to provide special methodologies for insurers
to measure leverage.\1556\ It is possible that certain market
participants will incur costs in connection with determining whether
they are ``highly leveraged'' for purposes of the major participant
definitions. In part, we believe that those costs are mitigated by the
fact that the final rules identify ``highly leveraged'' entities based
on a ratio of liabilities to equity, which we expect are simpler for
entities to implement than alternative methods for measuring leverage,
such as risk-adjusted methods.
---------------------------------------------------------------------------

    \1555\ See part IV.F.3.b, supra (addressing leverage ratio
calculation for certain employee benefit plans).
    \1556\ See note 1107, supra (providing special rules related to
the calculation of leverage for certain employee benefit plans).
---------------------------------------------------------------------------

    We recognize that the unavailability of an alternative method of
calculation for insurers may have the effect of increasing certain
insurers' cost of calculating leverage for purposes of determining
whether they fall within the major participant definition, to the
extent that insurers have security-based swap positions that are close
enough to the relevant thresholds that they have to perform the
required calculations.\1557\ We believe, however, that a uniform
approach to defining ``highly leveraged'' is appropriate here given
that the large insurance firms that are most likely to meet the major
participant definition would be expected already to use GAAP in
preparing their financial statements. This should mitigate any
additional costs arising from the absence of an alternative calculation
method for insurers.
---------------------------------------------------------------------------

    \1557\ We note that many large insurers of the type that
maintain security-based swap positions in an amount that would
require them to perform the major participant calculations may be
publicly traded companies, in which case they would already
calculate their financial statements according to GAAP for purposes
of public disclosure, and thus would not incur additional costs due
to our decision not provide special methodologies for insurers to
calculate their leverage. We also expect that the concerns of many
smaller insurers that are not publicly traded and thus may not use
GAAP will be addressed by our inclusion of the safe harbor for major
participant calculations.
    In addition, publicly available information regarding insurer
use of derivatives suggests that the potential costs to insurers
arising from the definition of ``major security-based swap
participant'' may be negligible. As of the end of 2010, U.S.
insurers as a whole had enter into roughly $33.5 billion in notional
amount of credit default swaps (not distinguishing between credit
default swaps that fall within the ``security-based swap''
definition and those that are ``swaps''). See National Association
of Insurance Commissioners, ``Insights into the Insurance Industry's
Derivatives Exposure'' (available at http://www.naic.org/capital_markets_archive/110610.htm) (stating that life insurers had entered
into roughly $27.1 billion of that amount, and that property and
casualty insurers had entered into roughly $6.4 billion of that
amount). Even if those positions were concentrated within single
entity, they would not necessarily lead that entity to exceed the
thresholds that could cause it to be a major participant, see note
914, supra, suggesting that, given the likely distribution of these
positions across a significant number of insurers, few or no
insurers may have exposures that approach the thresholds.
---------------------------------------------------------------------------

D. Limited Designations of Major Participants

    Exchange Act rule 3a67-1 in part implements the portion of the
``major security-based swap participant'' definition that provides for
limited purpose registration of major participants. The rule sets forth
a presumption that a person that acts as a major security-based swap
participant in general will be deemed to be a major participant with
regard to all of its security-based swaps, unless the SEC limits its
designation.
    In adopting this rule we have considered the alternative, suggested
by some commenters, of permitting persons to more broadly take
advantage of limited major participant designations.\1558\ Our decision
to use this presumption takes into account the difficulty of separating
a major participant's positions taken under its limited purpose
designation from other of its positions for purposes of compliance, and
the challenges of applying major participant regulatory requirements to
only a portion of the entity's security-based swap activities. The
presumption further reflects the statutory definition's discretionary
language in connection with the potential for limited designations, and
the need for persons subject to limited designations to be able to
comply with the statutory and regulatory requirements applicable to
major participants.\1559\
---------------------------------------------------------------------------

    \1558\ Such an approach may be expected to lower the cumulative
costs that major participants would incur in determining whether to
seek a limited designation. For example, a default presumption in
favor of the availability of limited designations may be expected to
reduce the costs that certain entities would incur to determine that
they could take advantage of limited designation relief, and thus
reduce the costs associated with an entity determining whether it
qualifies for such relief, such as the costs of hiring outside legal
counsel to undertake this analysis to determine that they could take
advantage a limited designation relief. A default presumption in
favor of limited designations also would be expected to reduce costs
in connection with the registration process for entities seeking
limited designation status, as discussed above. See part
VIII.A.2.d.ii.A, supra.
    \1559\ See part IV.N.3, supra (discussing limited designation
principles applicable to major participants). We note that the
discussion of limited designation of ``swap dealers'' under the CEA
generally seeks to quantify the costs associated with applications
for limited designations. However, we believe that the costs of
applying for a limited designation are dependent upon the
application process for this type of registration category. As noted
previously, the SEC expects to address the limited designation
application process for major security-based swap participants in
separate rulemakings. See id. As such, we believe that the costs
associated with major security-based swap participant limited
designation applications under the Exchange Act are more
appropriately addressed in the context of that separate rulemaking.
---------------------------------------------------------------------------

    Certain persons who satisfy the major participant definition may
incur costs in determining whether to seek a limited designation.
Consistent with the discussion above, in general we believe that such
costs would affect no more than 12 entities.\1560\ These costs could,
however, vary significantly depending on the structure or other
characteristics of an entity's business.
---------------------------------------------------------------------------

    \1560\ See note 1529, supra.
---------------------------------------------------------------------------

E. Exclusion of Inter-Affiliate Security-Based Swaps

    Exchange Act rule 3a67-3 provides that security-based swap
transactions between majority-owned affiliates will be excluded for
purposes of the substantial position test.\1561\ We have concluded that
majority ownership represents an alignment of interests appropriate to
justify an inter-affiliate exclusion.\1562\ Moreover, we note that a
majority-ownership test should, given its objective nature, impose
fewer assessment costs on market participants than a more subjective
common control test.
---------------------------------------------------------------------------

    \1561\ This exclusion also applies to the ``substantial
counterparty exposure'' analysis.
    \1562\ See part IV.G.2, supra (discussing rationale for the
approach we are adopting, and considering alternative approaches).
---------------------------------------------------------------------------

    Some market entities may incur costs in connection with determining
whether

particular security-based swap positions may be excluded from the major
participant analysis by virtue of the inter-affiliate exclusion. It is
possible that such costs could be incurred by any of the approximately
12 entities that we believe reasonably may have to engage in the major
participant calculations.\1563\ We believe that any costs arising out
of such an analysis would be encompassed within the $30,000 estimated
for legal services related to the major participant definition as a
whole.
---------------------------------------------------------------------------

    \1563\ The data underlying this assessment already excludes
certain inter-affiliate credit default swaps.
---------------------------------------------------------------------------

F. Timing Requirements, Reevaluation Period and Termination of Status

    Exchange Act rule 3a67-8 specifies the time at which an entity that
satisfies the major participant tests would be deemed to be a ``major
security-based swap participant,'' and also addresses the time at which
an entity's status as a major security-based swap participant would be
terminated. In adopting this rule we have considered alternatives that
would lead to slower entry and faster exit from major participant
status, and we believe that the approach that we are adopting provides
a reasonable amount of time for registration based on the proposed
registration process, will appropriately help to avoid applying major
participant requirements to entities that meet the major participant
criteria for only a short time due to unusual activity, and will avoid
the prospect of persons moving in and out of major participant status
overly frequently.\1564\
---------------------------------------------------------------------------

    \1564\ See part IV.L.3, supra (discussing rationale for the
final rules addressing timing, reevaluation and termination).
---------------------------------------------------------------------------

    Persons falling within the major participant definitions will incur
costs in connection with the registration process,\1565\ and it is
possible that alternative timing approaches could allow such persons to
register at a more deliberate pace, potentially reducing the associated
costs.\1566\ Such cost differences may affect the up-to-twelve entities
that we believe reasonably may have to engage in the major participant
calculations. Moreover, altering the timing requirements may not
significantly decrease costs associated with registration because in
all cases we would expect the same preparatory actions to be taken, and
we believe that the final rules provide sufficient time for entities to
perform the activities necessary for compliance.\1567\
---------------------------------------------------------------------------

    \1565\ Registration Proposing Release, 76 FR at 65814-65818.
    \1566\ For example, it is possible that an entity may perceive
the steps associated with the registration process as requiring it
to take additional steps to complete the registration process within
the time frame we are adopting, whereas a longer time period could
have enabled such an entity to avoid those costs.
    \1567\ Specific costs associated with the registration process
will be addressed by the SEC in final rules related to the
registration of major security-based swap participants that have not
yet been adopted. However, we expect any additional costs arising
from the timing provisions of this rule to be insignificant.
---------------------------------------------------------------------------

4. Consideration of Burden on Competition, and Promotion of Efficiency,
Competition, and Capital Formation
    Section 3(f) of the Exchange Act requires the SEC, whenever it
engages in rulemaking and is required to consider or determine whether
an action is necessary or appropriate in the public interest, to
consider, in addition to the protection of investors, whether the
action would promote efficiency, competition, and capital
formation.\1568\ In addition, section 23(a)(2) of the Exchange Act
\1569\ requires the SEC, when adopting rules under the Exchange Act, to
consider the impact such rules would have on competition. Section
23(a)(2) of the Exchange Act also prohibits the SEC from adopting any
rule that would impose a burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \1568\ 15 U.S.C. 78c(f).
    \1569\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We are adopting these rules and interpretive guidance pursuant to
authority under section 712(d) of the Dodd-Frank Act, which requires
the Commissions to further define several terms, including ``security-
based swap dealer'' and ``major security-based swap participant.''
\1570\ In the Proposing Release, we stated that we preliminarily
believed that the proposed Exchange Act rules would not result in any
burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act, that they would not
significantly affect capital formation, and that they would improve
efficiency. We requested comment on each of these issues, and certain
commenters raised concerns that overbroad definitions would lead to
undue competitive impacts.\1571\
---------------------------------------------------------------------------

    \1570\ The SEC is also acting pursuant to its rulemaking
authority provided by Exchange Act sections 3 and 23(a).
    \1571\ See, e.g., letters from Representatives Bachus and Lucas
(``Casting an overly-broad net in defining these terms could force
some smaller participants to leave the marketplace as a result of
increased costs, or eliminate certain types of contracts used for
hedging.''), SIFMA--Regional Dealers (stating that the proposed de
minimis exception ``is unnecessarily narrow, will discourage smaller
dealers from competing in the market and will limit the availability
of efficient and cost-effective intermediation services to small-
and medium-sized organizations'') and Midsize Banks (stating that a
reduction in small dealers due to an overly narrow de minimis
exception would ``curtail economic development going forward and
would leave end-users less options for hedging risks with community
and smaller regional dealers'').
---------------------------------------------------------------------------

    In adopting these final rules, we recognize that the most
significant impact of the dealer and major participant definitions will
derive from those definitions' role in implementing Title VII,
particularly given the significant impacts that Title VII will have on
the security-based swap market. Many of these impacts may be expected
to be positive, because Title VII imposes, among other measures,
requirements that may be expected to promote safety and soundness,
transparency, and competition within the security-based swap market. We
recognize, however, that regulation also can pose costs that have
negative impacts on the markets.
    In adopting these definitional rules and interpretations, moreover,
we have sought to fairly reflect the statutory definitions and their
underlying intent. Given the link between these definitional rules and
interpretations and the Title VII framework, the scope of the
definitions will affect the ultimate regulatory benefits and costs that
will accompany the full implementation of Title VII. Definitions that
capture more entities will tend to promote the Title VII benefits, but
will also risk increasing the accompanying costs. Definitions that
capture fewer entities may be expected to lead to the converse result.
a. Competitive Impacts
    As noted above, the SEC is required to consider the effect of these
rules and interpretations on competition. The SEC also is prohibited
from adopting any rule that would impose a burden on competition that
is not necessary or appropriate in furtherance of the purposes of the
Exchange Act. Because these definitional rules and interpretations will
help determine which entities within the market are subject to the
Title VII requirements that govern dealers and major participants, they
may also affect competition within the security-based swap market.
    In enacting Title VII, Congress set forth a regulatory framework
for OTC derivatives; security-based swaps represent one segment of the
overall OTC derivatives market. Within the security-based swap market,
dealers compete for business from counterparties, while non-dealers
that participate in the market use security-based swaps for purposes
that can

include speculation and hedging. To date, security-based swaps
primarily have traded in the over-the-counter market, and have not been
subject to comprehensive regulation in the U.S. We understand that
entities engaged in dealing activity within this market facilitate the
vast majority of security-based swap transactions.\1572\ Dealing
activity within the market also is highly concentrated.\1573\ This
concentration in large part appears to reflect the fact that larger
entities possess competitive advantages in engaging in over-the-counter
security-based swap dealing activities, particularly with regard to
having sufficient financial resources to provide potential
counterparties with adequate assurances of financial performance.\1574\
As such, it is reasonable to conclude that there are high barriers to
entry in connection with security-based swap dealing activity.\1575\
---------------------------------------------------------------------------

    \1572\ Data from the credit default swap trade information
warehouse operated by DTCC indicates that as of the week ending
October 7, 2011, single-name credit default swaps involving two
counterparties that are not dealers (as identified by DTCC)
constitutes roughly 0.2 percent of the notional amount of all open
positions involving single-name credit default swaps (amounting to
$24.6 billion gross notional out of a total of $15.2 trillion gross
notional). Conversely, single-name credit default swaps involving
two dealers (as identified by DTCC) constitute roughly 74.2 percent
of the total notional amount (amounting to $11.3 trillion gross
notional out of the $15.2 trillion total). See http://www.dtcc.com/products/derivserv/data/index.php (as of October 7, 2011). We have
no reason to believe that the market for other types of security-
based swaps exhibits different amounts of concentration with regard
to dealer activity.
    \1573\ As discussed above in the context of the de minimis
exception to the security-based swap dealer definition, analysis of
available data shows that, under any metric used to screen for
dealers in our CDS Data Analysis, over 90 percent of activity in
single-name credit default swaps among entities identified as
dealers is attributable to the fourteen or fifteen largest of those
entities. We have no reason to believe that the concentration of
dealing activity involving other types of security-based swaps
significantly differs from the concentration of dealers in the
single-name credit default swap market.
    \1574\ See Pirrong, note 487, supra, at 17-18 (noting that
counterparties seek to reduce risk of default by engaging in credit
derivative transactions with well capitalized firms).
    \1575\ See id., at 18-19 (noting lack of success among new
entrants into derivatives dealing market due to perception that AAA
rating for subsidiary is less desirable than a slightly lower rating
for a larger entity, and suggesting that there are ``economies of
scale in bearing default risk'' that may induce ``substantial
concentration in dealer activities'').
---------------------------------------------------------------------------

    At the same time, commenters have noted that some entities engage
in smaller volumes of security-based swap dealing activity. Some small
and mid-size banks, for example, routinely provide such services
involving relatively small notional amounts to their customers.\1576\
Although these relatively smaller dealers in general may not compete
directly with the largest dealers (because they service a different
segment of the market), they may be expected to play a role in helping
certain types of customers (such as customers with a relatively smaller
need for security-based swaps) enter into security-based swaps, thus
promoting the availability of these products.
---------------------------------------------------------------------------

    \1576\ See letter from FSR I.
---------------------------------------------------------------------------

    Fundamentally, in considering the competitive impacts associated
with Title VII regulation of dealers and major participants--and hence
the competitive impacts associated with the dealer and major
participant definitions--we recognize that one consequence of the
current concentrated market structure \1577\ is the potential for risk
spillovers and systemic risk, which can occur when the financial sector
as a whole (or certain key segments) becomes undercapitalized. Risk
spillovers emerge when losses and financial distress at one firm lead
to losses and financial distress for the financial sector as a whole,
either through direct counterparty relationships or the deterioration
of asset values. As financial distress spreads, the aggregate financial
system may become undercapitalized, hindering its ability to provide
financial intermediation services. If firms do not internalize this
aggregate cost, the financial system may end up holding more risk than
its aggregate capital can manage.
---------------------------------------------------------------------------

    \1577\ See, e.g., notes 478 and 485, supra, and accompanying
text.
---------------------------------------------------------------------------

    In enacting Title VII, Congress set forth a framework that will
impose new costs and regulatory burdens, including capital, margin, and
registration requirements, on persons who act as security-based swap
dealers, and on persons whose security-based swap positions are large
enough to cause them to be major security-based swap participants.
While the substantive rules associated with capital, margin, and
registration requirements have yet to be finalized, we have sought to
set the dealer and major participant definitions in such a way as to
impose the substantive rules on those entities most likely to
contribute to an aggregate capital shortfall without imposing
unnecessary burdens on those who do not pose similar risks to the
market.\1578\ It is reasonable to expect that it is the largest
security-based swap entities that are more likely to contribute to an
aggregate capital shortfall than smaller participants, as more risk is
likely to be concentrated within these entities.\1579\
---------------------------------------------------------------------------

    \1578\ We expect that implementation of Title VII will provide
both the SEC and market participants with more information about the
business of dealers and major participants, the characteristics of
positions they and other market participants hold, the structure of
the market, and how each of these have changed under the Title VII
framework. For that reason the SEC has directed the staff to report
to the Commission on all aspects of the dealer and major participant
definitions. See part V, supra.
    \1579\ See Acharya, Pedersen, Philippon, and Richardson,
Measuring Systemic Risk (May 2010) (available at http://vlab.stern.nyu.edu/public/static/SR-v3.pdf) (working paper that
derives an empirical measure of a financial entity's expected
contribution to an aggregate capital shortfall that scales with the
size of the institution, and that shows using historical data that
their measure predicted the risks that emerged during the recent
financial crisis).
---------------------------------------------------------------------------

    As discussed above, persons who fall within the statutory
definitions of security-based swap dealer and major security-based swap
participant will incur a range of one-time costs and ongoing costs by
virtue of that status.\1580\ Also, as discussed above, market
participants may incur costs in connection with determining whether
their security-based swap activities or positions will cause them to be
dealers or major participants.\1581\ To the extent the costs associated
with these statutorily mandated requirements are relatively fixed or
large enough, they may negatively affect competition within the market.
This may, for example, lead smaller dealers or entities for whom
dealing is not a core business to exit the market, which could cause
smaller customers to have less access to the market or to incur higher
costs in accessing the market. Such costs might also deter the entry of
new firms into the market. If sufficiently high, these costs of
compliance may increase concentration among dealers. We also recognize
that some market participants may be expected to incur costs in
connection with determining their status as a dealer or major
participant, but such costs can be expected to be significantly less
than the costs associated with the various rules applicable to dealers
or major participants.
---------------------------------------------------------------------------

    \1580\ As discussed above, for example, security-based swap
dealers and major security-based swap participants will have to meet
minimum capital and margin requirements, maintain specified business
and transaction records and adhere to certain standards of business
conduct, along with other obligations. See, e.g., notes 178 to 180,
supra.
    \1581\ See part VIII.A.3, supra.
---------------------------------------------------------------------------

    Conversely, certain aspects of Title VII may enhance competition in
the market. For example, the business conduct and other requirements of
Title VII may enhance the availability of information to market
participants. Measures designed to equalize access to information
through disclosure requirements should promote participation, which may
intensify price competition among dealers, and thus

may increase participation in the security-based swap market. Other
aspects of Title VII, such as rules promoting access of dealers to
central clearing facilities, also may be expected to enhance
competition in the market.
i. Security-Based Swap Dealer Definition
    Persons who are deemed to be dealers may be expected to incur costs
in connection with the substantive rules applicable to dealers, and to
incur comparatively smaller costs in connection with determining
whether they fall within the dealer definition. We cannot rule out the
possibility that the prospects of these aggregate costs might deter new
entrants from engaging in security-based swap activity that potentially
could lead them to be dealers.\1582\ We also cannot rule out the
possibility that the imposition of those costs could lead some persons
who currently engage in dealing activity involving security-based swaps
to lessen or cease that activity. Those effects--if they were to
occur--would be expected to reduce competition in the market.
Conversely, the application of the Title VII requirements applicable to
dealers, such as, for example, the business conduct requirements
related to disclosures to counterparties, may be expected to enhance
the availability of information to market participants. The resulting
reduction in information asymmetries may be expected to promote
participation, and therefore competition, in the market. Accordingly,
the scope of the rules and interpretations defining security-based swap
dealer, including the scope of the de minimis exception to the dealer
definition, can be expected to affect competition in the market in a
variety of ways.\1583\
---------------------------------------------------------------------------

    \1582\ We do think it unlikely that the costs associated with
determining an entity's status, considered on their own, would have
any measurable effect on competition. As noted above, we estimate
that the cost of making this determination to be $30,000 at most,
and likely significantly less for most entities. See note 1537,
supra. In other words, the costs would amount to, at most, 0.1
percent of the de minimis threshold, and it is likely that few firms
would feel compelled to conduct this analysis until their dealing
volume approached the de minimis threshold.
    \1583\ At the same time, it is possible that these additional
costs associated with dealer regulation will be comparatively small
compared to the existing barriers to entry in the market
(particularly the need for resources to provide counterparties with
sufficient assurance of performance). Cf. Pirrong, note 487, supra,
at 18-19 (noting that firms with smaller balance sheets, relative to
largest dealers, ``have largely failed to make major inroads as
derivatives dealers despite concerted efforts to do so''). It thus
is possible the incremental costs associated with dealer regulation
may not be of the magnitude to cause persons who currently engage in
security-based swap dealing activity to exit the market.
---------------------------------------------------------------------------

    As discussed above, in rule 3a71-1 we have codified the statutory
definition of security-based swap dealer and provided guidance to
interpret the contours of this definition in the context of the dealer-
trader distinction. After considering commenters' views, we believe
that this guidance interprets the statute to give effect to the four
dealer tests and the ``regular business'' exclusion in a way that
reflects the features of the security-based swap market. This use of
the dealer-trader distinction--which parallels the analysis that
securities market participants currently use in the context of the
Exchange Act's ``dealer'' definition--also should help reduce the
potential competitive effects associated with the costs that market
participants incur to analyze their possible status as a dealer by
imposing fewer costs than a more novel approach.\1584\
---------------------------------------------------------------------------

    \1584\ As noted above, we have declined to adopt per se
exclusions or overly simple tests, even though they might impose
fewer assessment costs on market participants conducting the dealer
analysis because we do not believe that such exclusions or tests
would capture the full range of entities that should be regulated as
dealers under Title VII. Moreover, the nature of the tests being
adopted are straightforward to implement and rely on information
that already should be readily available to market participants.
---------------------------------------------------------------------------

    Moreover, as discussed above, in rule 3a71-2 we have adopted a de
minimis test and thresholds that will impose the costs associated with
dealer regulation upon entities that engage in the bulk of dealing
activity in the market, without imposing those costs upon persons who
account for a small portion of dealing activity (and for which dealer
regulation may be accompanied by comparatively modest benefits). We
believe this will mitigate some of the potential competitive burdens
associated with dealer status that could fall on entities engaged in a
smaller amount of dealing activity, without leaving an undue amount of
dealing activity outside of the ambit of dealer regulation. As
discussed in detail above, we believe we have set the threshold in a
way that appropriately considers this risk along with the benefits
afforded to smaller entities by a higher threshold. Furthermore, after
considering commenters' views, we believe that this approach strikes a
balance that appropriately will implement the transparency, risk, and
customer and counterparty protection goals of Title VII. This approach,
including the general use of a $3 billion threshold, also can
facilitate the initial entrance of dealers into the market, and permit
persons to engage in limited dealing activity that helps smaller
entities participate in the market. While we recognize that the lower
threshold associated with dealing activity involving ``special
entities'' has the potential to reduce competition to provide dealing
services to those entities, we believe that this lower threshold is
appropriate to preserve the protections that Title VII affords to those
entities.
    In rule 3a71-1, we also have set forth a presumption that a person
that acts as a dealer in the security-based swap market will be a
dealer with regard to all of its security-based swaps. We recognize
that this presumption may have competitive impacts: on the one hand, by
imposing regulatory costs on a wider range of activities, certain
entities concentrated in discrete security-based swap segments may face
higher costs than they might without the presumption; on the other
hand, the presumption suggests a single, uniform baseline for
competition across dealers. While these impacts may bear out in a
number of ways, we believe that the presumption is appropriate in light
of the statutory language and the need to help ensure that security-
based swap dealers comply with all applicable legal requirements.
    In rule 3a71-1, we also have provided an exclusion from dealer
status in connection with security-based swaps involving majority-owned
affiliated counterparties. To the extent that the scope of this
exclusion may have competitive impacts--such as in connection with
dealing activity involving affiliates that are not majority-owned, and
that hence cannot take advantage of the exclusion--we believe that the
exclusion appropriately applies the Title VII dealer requirements in a
way that reflects the economic reality of swaps among affiliates, which
generally does not raise the customer protection or market risk
concerns addressed by Title VII.
    In sum, to the extent that the application of Title VII dealer
requirements to certain persons were to pose a net burden on
competition in the security-based swap market, we believe those effects
would be a necessary or appropriate consequence of implementing the
statutory definitions consistent with the purposes of the Title VII
amendments to the Exchange Act.
ii. Major Security-Based Swap Participant Definition
    As we discuss above, we have estimated that entities approaching
the level of exposure required to be a major participant may incur
certain costs in connection with analyzing their

status.\1585\ Given the size of the exposures and notional amounts
required to trigger the major participant test (e.g., $1 billion in
daily average current uncollateralized exposure in a major category),
we do not believe that these costs of assessment would materially
impact the competitive role played in the security-based swap market by
persons who have positions large enough that they potentially may be
major participants.
---------------------------------------------------------------------------

    \1585\ See text accompanying note 1532, supra (estimating
assessment costs as roughly $44,000 in the first year, and $15,268
in subsequent years).
---------------------------------------------------------------------------

    We expect that the programmatic costs associated with the rules
applicable to major participants will be more significant. Presumably,
a market participant will weigh the costs of complying with the rules
against the benefit it expects from maintaining security-based swap
positions of a magnitude that would require registration as a major
participant, in deciding whether to continue to maintain such
positions. We cannot rule out the possibility that the prospect of
those costs could deter persons from maintaining security-based swap
positions of such a magnitude, and that this may reduce competition in
the market.\1586\
---------------------------------------------------------------------------

    \1586\ The extent of such possible deterrence is mitigated by
the fact that major participant status is a prospect only for those
persons with very large security-based swap positions.
---------------------------------------------------------------------------

    As discussed above, Exchange Act rules 3a67-1 through 3a67-9 and
the accompanying interpretations reflect choices that we believe are
reasonably designed to satisfy the risk criteria set forth in the major
participant definition.\1587\ In reaching these conclusions we
considered commenters' views on a variety of issues, including
suggested alternative approaches that would lessen the likelihood of
particular entities being deemed to be major participants (e.g.,
alternative tests, higher thresholds, a broader hedging exclusion, and
a higher leverage test). We believe that the choices reflected in the
final rules and interpretations are necessary or appropriate in
furtherance of the purposes of the Exchange Act and reasonably reflect
the criteria set forth by the statutory definition.
---------------------------------------------------------------------------

    \1587\ See part VIII.A.2, supra.
---------------------------------------------------------------------------

b. Efficiency and Capital Formation
    As noted above, in adopting these final rules and interpretations
we also are required to consider whether these actions would promote
efficiency and capital formation.
    In significant part, the effect of these rules on efficiency and
capital formation are linked to the effect of these rules on
competition. For example, markets that are competitive, with fair and
transparent pricing and equal access to security-based swaps, may be
expected to promote the efficient allocation of capital. Similarly,
definitional rules that promote, or do not unduly restrict, competition
can be accompanied by regulatory benefits that minimize the risk of
market failure and thus promote efficiency within the market. Such
competitive markets would increase the efficiency by which market
participants could transact in security-based swaps for speculative,
trading, hedging and other purposes.
    Definitional rules and interpretations of an appropriate scope also
can be expected to promote capital formation by facilitating the
appropriate use of security-based swaps for hedging purposes, and thus
by contributing to liquidity and reducing costs in connection with the
issuance of equity and debt securities. In the context of credit
default swaps based on loans, moreover, definitional rules and
interpretations of an appropriate scope can be expected to promote
capital formation by facilitating loans to businesses that may not
otherwise be made absent such a swap. Since credit risk is correlated,
lenders may find it desirable to hedge credit risks on their loan
portfolios by purchasing protection through single-name or index credit
default swaps. Even though there is basis risk in this type of trade,
it should be particularly effective at reducing exposure to systemic
credit events. More generally, security-based swaps can be expected to
promote risk transfer to persons better positioned and more willing to
bear certain risks (e.g., the transfer of risks from hedgers to
speculators).
    Conversely, definitional rules that are accompanied by too many
competitive burdens pose the risk of imposing excessive costs of
regulation that could deter the efficient allocation of capital to
security-based swaps. Such rules also may be expected to reduce the
capital formation benefits that otherwise would be associated with
security-based swaps. Definitional rules of an inappropriate scope
further may reduce the availability of security-based swaps and thus
direct market participants not to seek to address certain business
needs, or to use less effective financial instruments to meet their
business needs. For example, major participant thresholds that broadly
capture much of the security-based swap market would discourage certain
entities from participating in the market, particularly if the
regulatory costs for major participants are high. This could make it
difficult for hedgers to find a counterparty, which would make it more
expensive to hedge risks and hinder efficient risk-sharing in the
broader economy. In addition, definitional rules that pose the risk of
creating a market that contains an undue amount of unregulated dealing
activity--as may be the result of a de minimis threshold that is too
high--would lead to disparate treatment of dealers and could undermine
the benefits of Title VII.
    The rules and interpretations that we are adopting in connection
with the dealer and major participant definitions are designed to apply
the statutory definitions in a way that reasonably effects the goals of
Title VII. For example, the rule implementing the de minimis exception
to the dealer definition is designed to focus the application of the
dealer definition in a way that implements the benefits associated with
the regulation of security-based swap dealers under Title VII, without
imposing the costs associated with those regulations on those entities
responsible for only a small portion of total dealing activity. In
addition, the rules and interpretations in connection with the major
participant definition are geared to focus major participant regulation
on entities whose security-based swap positions pose a particularly
high degree of credit risk to the market, without applying those
regulations on persons who pose a lesser degree of risk.
    In conclusion, we believe that the rules and interpretations may be
expected to promote efficiency in the allocation of capital to
security-based swaps, and to promote the capital formation benefits of
security-based swaps, by helping to focus the costs and burdens of the
regulation of dealers and major participants under Title VII upon those
persons for whom the imposition of those costs are most appropriate
given their overall activity and positions in the security-based swap
market. The rules and interpretations similarly may be expected to
apply certain Title VII requirements (e.g., counterparty disclosure
requirements that can be expected to reduce information asymmetries) to
those entities that engage in activities or maintain positions in the
security-based swap market such that their compliance with these
requirements may promote the efficiency and capital allocation benefits
associated with such regulation.

B. Paperwork Reduction Act Analysis

    The Proposing Release addressed a potential new ``collection of
information'' requirement, within the

meaning of the Paperwork Reduction Act of 1995,\1588\ because the
proposed definition of the term ``hedging or mitigating commercial
risk'' included documentation and assessment conditions.
---------------------------------------------------------------------------

    \1588\ 44 U.S.C. 3501.
---------------------------------------------------------------------------

    As discussed above, final rule defining ``hedging or mitigating
commercial risk'' does not contain those proposed documentation and
assessment conditions. Accordingly, the Paperwork Reduction Act does
not apply to these definitions.\1589\
---------------------------------------------------------------------------

    \1589\ Consistent with the discussion above, we recognize that
the substantive rules applicable to dealers and major participants
may contain collections of information, and that these definitions
will affect which entities are subject to those collections of
information. We believe that these Paperwork Reduction Act issues
are more appropriately addressed in connection with the substantive
rules applicable to dealers and major participants.
---------------------------------------------------------------------------

C. Regulatory Flexibility Act Certification

    The Regulatory Flexibility Act (``RFA'') \1590\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. Section 603(a) \1591\ of the Administrative
Procedure Act,\1592\ as amended by the RFA, generally requires the SEC
to undertake a regulatory flexibility analysis of all proposed rules,
or proposed rule amendments, to determine the impact of such rulemaking
on ``small entities.'' \1593\ Section 605(b) of the RFA provides that
this requirement shall not apply to any proposed rule or proposed rule
amendment, which if adopted, would not have a significant economic
impact on a substantial number of small entities.\1594\
---------------------------------------------------------------------------

    \1590\ 5 U.S.C. 601 et seq.
    \1591\ 5 U.S.C. 603(a).
    \1592\ 5 U.S.C. 551 et seq.
    \1593\ Although Section 601(b) of the RFA defines the term
``small entity,'' the statute permits the Commissions to formulate
their own definitions. The SEC has adopted definitions for the term
small entity for the purposes of SEC rulemaking in accordance with
the RFA. Those definitions, as relevant to this proposed rulemaking,
are set forth in Rule 0-10, 17 CFR 240.0-10. See Securities Exchange
Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982)
(File No. AS-305).
    \1594\ See 5 U.S.C. 605(b).
---------------------------------------------------------------------------

    For purposes of SEC rulemaking in connection with the RFA, a small
entity includes: (i) When used with reference to an ``issuer'' or a
``person,'' other than an investment company, an ``issuer'' or
``person'' that, on the last day of its most recent fiscal year, had
total assets of $5 million or less,\1595\ or (ii) a broker-dealer with
total capital (net worth plus subordinated liabilities) of less than
$500,000 on the date in the prior fiscal year as of which its audited
financial statements were prepared pursuant to Rule 17a-5(d) under the
Exchange Act,\1596\ or, if not required to file such statements, a
broker-dealer with total capital (net worth plus subordinated
liabilities) of less than $500,000 on the last day of the preceding
fiscal year (or in the time that it has been in business, if shorter);
and is not affiliated with any person (other than a natural person)
that is not a small business or small organization.\1597\ Under the
standards adopted by the Small Business Administration, small entities
in the finance and insurance industry include the following: (i) For
entities engaged in credit intermediation and related activities,
entities with $175 million or less in assets; \1598\ (ii) for entities
engaged in non-depository credit intermediation and certain other
activities, entities with $7 million or less in annual receipts; \1599\
(iii) for entities engaged in financial investments and related
activities, entities with $7 million or less in annual receipts; \1600\
(iv) for insurance carriers and entities engaged in related activities,
entities with $7 million or less in annual receipts; \1601\ and (v) for
funds, trusts, and other financial vehicles, entities with $7 million
or less in annual receipts.\1602\
---------------------------------------------------------------------------

    \1595\ See 17 CFR 240.0-10(a).
    \1596\ See 17 CFR 240.17a-5(d).
    \1597\ See 17 CFR 240.0-10(c).
    \1598\ See 13 CFR 121.201 (Subsector 522).
    \1599\ See id. at Subsector 522.
    \1600\ See id. at Subsector 523.
    \1601\ See id. at Subsector 524.
    \1602\ See id. at Subsector 525.
---------------------------------------------------------------------------

    The Proposing Release stated that based on feedback from industry
participants about the security-based swap markets, the SEC
preliminarily believes that any entities that would qualify as
security-based swap dealers and major security-based swap market
participants would exceed the thresholds defining ``small entities,''
and that the SEC believes it is unlikely that the proposed rules would
have a significant economic impact on any small entity. As a result,
the SEC certified that the proposed rules would not have a significant
economic impact on a substantial number of small entities for purposes
of the RFA, and requested written comments regarding this
certification.\1603\
---------------------------------------------------------------------------

    \1603\ See Proposing Release, 75 FR at 80211.
---------------------------------------------------------------------------

    While we received comment letters that addressed cost issues in
connection with the proposed rules, we did not receive any comments
that specifically addressed whether the rules defining ``security-based
swap dealer'' or ``major security-based swap participant'' would have a
significant economic impact on small entities.
    The SEC continues to believe that the types of entities that would
engage in more than a de minimis amount of dealing activity involving
security-based swaps--which generally would be major banks--would not
be ``small entities'' for purposes of the RFA. Similarly, the SEC
continues to believe that the types of entities that may have security-
based swap positions above the level required to be a ``major security-
based swap participant'' would not be a ``small entity'' for purposes
of the RFA. Accordingly, the SEC certifies that the final rules
defining ``security-based swap dealer'' or ``major security-based swap
participant'' would not have a significant economic impact on a
substantial number of small entities for purposes of the RFA.

Statutory Basis and Text of the Amendments

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.

Commodity Futures Trading Commission

    For the reasons stated in the preamble, the CFTC is adopting the
following amendments to 17 CFR part 1.

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0
1. The authority citation for part 1 is revised to read as follows:

    Authority:  7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c,