[Federal Register Volume 77, Number 139 (Thursday, July 19, 2012)]
[Rules and Regulations]
[Pages 42560-42591]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-17291]



[[Page 42559]]

Vol. 77

Thursday,

No. 139

July 19, 2012

Part II





Commodity Futures Trading Commission





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17 CFR Part 39





End-User Exception to the Clearing Requirement for Swaps; Final Rule

  Federal Register / Vol. 77 , No. 139 / Thursday, July 19, 2012 / 
Rules and Regulations  

[[Page 42560]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 39

RIN 3038-AD10


End-User Exception to the Clearing Requirement for Swaps

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is adopting final regulations to implement certain provisions of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank 
Act). These regulations govern the exception to the clearing 
requirement available to swap counterparties meeting certain conditions 
under the Commodity Exchange Act (CEA), as amended by the Dodd-Frank 
Act.

DATES: Effective September 17, 2012.

FOR FURTHER INFORMATION CONTACT: Erik F. Remmler, Associate Director, 
202-418-7630, [email protected]; or Eileen A. Donovan, Associate 
Director, 202-418-5096, [email protected], Division of Clearing and 
Risk, Commodity Futures Trading Commission, Three Lafayette Centre, 
1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION: 

I. Background

    The CEA, as amended by Title VII of the Dodd-Frank Act, establishes 
a comprehensive new regulatory framework for swaps. The CEA requires a 
swap: (1) To be cleared through a derivatives clearing organization 
(DCO) if the Commission has determined that the swap is required to be 
cleared, unless an exception to the clearing requirement applies; (2) 
to be reported to a swap data repository (SDR) or the Commission; and 
(3) if the swap is subject to a clearing requirement, to be executed on 
a designated contract market (DCM) or swap execution facility (SEF), 
unless no DCM or SEF has made the swap available to trade.
    Section 2(h)(1)(A) of the CEA establishes a clearing requirement 
for swaps, providing that ``it shall be unlawful for any person to 
engage in a swap unless that person submits such swap for clearing to a 
[DCO] that is registered under [the CEA] or a [DCO] that is exempt from 
registration under [the CEA] if the swap is required to be cleared.'' 
\1\ However, Section 2(h)(7)(A) of the CEA provides that the clearing 
requirement of Section 2(h)(1)(A) shall not apply to a swap if one of 
the counterparties to the swap: ``(i) Is not a financial entity; (ii) 
is using swaps to hedge or mitigate commercial risk; and (iii) notifies 
the Commission, in a manner set forth by the Commission, how it 
generally meets its financial obligations associated with entering into 
non-cleared swaps'' (referred to hereinafter as the ``end-user 
exception'').\2\ The Commission is adopting Sec.  39.6 herein to 
implement certain provisions of Section 2(h)(7). Accordingly, any swap 
that is required to be cleared by the Commission pursuant to Section 
2(h)(2) of the CEA must be submitted to a DCO for clearing by the 
parties thereto unless the conditions of Section 2(h)(7)(A) and Sec.  
39.6 are satisfied.
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    \1\ See Section 2(h)(1)(A) of the CEA, 7 U.S.C. 2(h)(1)(A).
    \2\ See Section 2(h)(7)(A) of the CEA, 7 U.S.C. 2(h)(7)(A).
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    Congress promulgated the end-user exception in Section 2h(7) of the 
CEA to permit non-financial companies to continue using non-cleared 
swaps to hedge risks associated with their underlying business, such as 
manufacturing, energy exploration, farming, transportation, or other 
commercial activities. Additionally, Section 2(h)(7)(F) gives the 
Commission the authority to prescribe rules (or interpretations of such 
rules) that may be necessary to prevent abuse of the end-user 
exception, and Section 2(h)(4)(A) requires the Commission to prescribe 
rules as determined by the Commission to be necessary to prevent 
evasions of the clearing requirement.\3\
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    \3\ 7 U.S.C. 2(h)(7)(F) and 7 U.S.C. 2(h)(4)(A).
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    Regulation 39.6 implements Section 2(h)(7) of the CEA by: (1) 
Establishing the criteria for determining whether a swap hedges or 
mitigates commercial risk for purposes of Section 2(h)(7)(A)(ii); (2) 
specifying the information that counterparties must report to satisfy 
the notification requirement of Section 2(h)(7)(A)(iii); and (3) 
establishing an exemption for small financial institutions pursuant to 
Section 2(h)(7)(C)(ii) of the CEA. The rule also requires reporting of 
certain information that the Commission will use to monitor compliance 
with, and prevent abuse or evasion of, the end-user exception.
    On December 23, 2010, the Commission published for public comment a 
notice of proposed rulemaking (NPRM) for Sec.  39.6.\4\ The Commission 
received approximately 2,000 comment letters, approximately 1,650 of 
which were form letters (cited herein as ``Form Letters''), and 
Commission staff participated in approximately 30 ex parte meetings and 
teleconferences concerning the rulemaking.\5\ The Commission considered 
each of these comments in formulating the final regulations, as 
discussed below.\6\
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    \4\ See 75 FR 80747 (Dec. 23, 2010).
    \5\ The comment file for the proposed rulemaking can be found on 
the Commission Web site, www.cftc.gov.
    \6\ The Commission notes that the Securities and Exchange 
Commission has proposed regulations concerning an exception for end-
users from clearing requirements applicable to security-based swaps. 
See 75 FR 79992 (Dec. 21, 2010). The Commission has reviewed the 
SEC's proposal and consulted with SEC staff regarding the SEC's 
proposal and this final rulemaking.
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II. Comments on the Notice of Proposed Rulemaking

A. Scope of the End-User Exception

    As proposed, Sec.  39.6(a) would provide that a counterparty to a 
swap (an ``electing counterparty'') may elect the end-user exception to 
the clearing requirement provided in Section 2(h)(7)(A) of the CEA 
(i.e., the end-user exception) if the electing counterparty: (1) Is not 
a ``financial entity'' as defined in Section 2(h)(7)(C)(i) of the CEA; 
(2) is using the swap to hedge or mitigate commercial risk as defined 
in Sec.  39.6(c); and (3) provides or causes to be provided to a SDR 
or, if no SDR is available, the Commission, the information specified 
in proposed Sec.  39.6(b).
1. General Scope of Regulation 39.6(a)
    The Commission received a number of comments regarding the general 
scope of Sec.  39.6(a). Commodity Markets Council (CMC) and Riverside 
Risk Advisors, LLC (Riverside) recommended that the end-user exception 
should be available to a wide variety of entities. According to CMC, 
many market participants rely on customized over-the-counter swaps 
because they have small volume transactions or there are no 
standardized contracts available to hedge their specific commercial 
risks. Riverside requested that the Commission allow all potential 
counterparties other than swap dealers or major swap participants 
(MSPs) to elect the end-user exception.
    In contrast, Idaho Petroleum Marketers & Convenience Store 
Association (IPM&CSA) stated that the end-user exception should be 
narrowly tailored to businesses that produce, refine, process, market, 
or consume underlying commodities and to counterparties transacting 
with non-financial counterparties. The Form Letters generally agreed 
with the scope of the proposed rule's exception from

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clearing for non-financial companies engaging in commercial hedging and 
expressed concern with broadening the rule to include financial 
institutions or non-commercial hedges.\7\
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    \7\ The Form Letters stated:
    ``The big banks and their allies * * * are calling for 
exemptions for a very broad array of companies from the clearing and 
margin requirements of the act. Dodd-Frank already contains an 
exception for legitimate end-users, such as airlines and farmers, 
who are doing commercial hedging as part of their business from 
clearing and exchange trading requirements. We must not broaden this 
narrow, commonsense exception to include financial and commercial 
institutions that want to gamble in the derivatives markets. Doing 
so would allow systemically important companies to enter into risky 
trades in a market with zero transparency and accountability.''
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    In response to the comments from CMC and Riverside seeking a 
broader end-user exception, the Commission notes that the exception to 
the clearing requirement provided by Section 2(h)(7)(A) is based on the 
type of counterparty (e.g., the electing counterparty must not be a 
financial entity) and the type of risk hedged or mitigated (commercial 
risk). The Commission believes the general scope of the rule provides 
an appropriately flexible exception to the clearing requirement for 
commercial entities within the limits of these two parameters 
established in the CEA. In response to Riverside's other comment, the 
Commission notes that Congress specifically required all financial 
entities as defined in Section 2(h)(7)(C) (with certain exceptions 
specifically identified in that section) to submit for clearing swaps 
that are subject to the clearing requirement. Therefore, the Commission 
is adopting Sec.  39.6(a) largely as proposed, except for changes to 
clarify the rule language and to make it consistent with other 
provisions of the rule as finalized.
2. Application of the End-User Exception to Certain Entities
    The Commission received a number of specific requests from 
commenters that the Commission determine that certain entities, or 
types of entities, are able to elect the end-user exception.\8\ The 
commenters asked for relief in one of two ways: (i) That the Commission 
provide an express exemption from the clearing requirement for such 
entity; or (ii) that the Commission determine that the specific entity 
in question is not a financial entity and is hedging commercial risk.
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    \8\ See, e.g., American Securitization Forum (ASF), American 
Public Gas Association (APGA), National Rural Utilities Cooperative 
Finance Corp. (CFC), Coalition of Physical Energy Companies (COPE), 
Dairy Farmers of America (DFA), EDF Trading North America, LLC (EDF 
Trading), Farm Credit Council (FCC), Garkane Energy Cooperative 
(Garkane), Government Finance Officers Association (GFOA), Kraft 
Foods, Inc. (Kraft), National Association of Regulatory Utility 
Commissioners (NARUC), National Council of State Housing Agencies 
(NCSHA), Not for Profit Electricity End-Users (NFPEEU), National 
Milk Producers Foundation (NMPF), and Pacific Gas and Electric Co. 
(PG&E).
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    Regulation 39.6(a), as adopted, sets forth the basic conditions 
that an entity must satisfy to elect the end-user exception. Except 
with respect to foreign governments, foreign central banks, 
international financial institutions, and state and local government 
entities as discussed below, the Commission is declining to determine 
at this time whether certain specific entities, or types of entities, 
are exempt from the clearing requirement or would qualify for the end-
user exception based on their specific circumstances.\9\ This release 
addresses comments and questions that are generally applicable to the 
rule. Any exemptive or interpretive determinations based on the 
specific nature or circumstances of a particular entity can better be 
addressed on a case-by-case basis, with the benefit of all relevant 
facts and circumstances, through the interpretive or exemptive relief 
processes available for such purposes under the CEA and the 
Commission's regulations.
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    \9\ An exemption for small financial institutions from the 
definition of ``financial entity,'' which Congress directed the 
Commission to consider in Section 2(h)(7)(C)(ii) of the CEA, is 
addressed in section II.D hereof.
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3. Definition of ``Financial Entity'' and ``Financial Institution'' for 
Purposes of FDICIA
    The International Energy Credit Association (IECA) requested that 
the Commission clarify the meaning of ``financial entity'' in the 
regulation. According to IECA, because of the implications of being 
labeled a ``financial entity'' under the Dodd-Frank Act, an entity may 
be reluctant to represent that it is a ``financial institution'' for 
purposes of the Federal Deposit Insurance Corporation Improvement Act 
(FDICIA).\10\ IECA recommended that proposed Sec.  39.6(a) be revised 
in part to state that a counterparty may elect the end-user exception 
if the electing counterparty (new language emphasized): ``Is not a 
`financial entity' as defined in section 2(h)(7)(C)(i) of the Act 
(determined without regard to whether such entity believes itself to 
be, or in fact constitutes, a `financial institution' within the 
meaning of FDICIA).''
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    \10\ Public Law 102-242, 105 Stat. 2236 (1991).
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    The Commission declines to revise proposed Sec.  39.6(a) as 
requested by IECA because ``financial entity'' and ``financial 
institution'' are different terms referenced in different statutes. 
Interpreting the meaning and use of ``financial institution'' under 
FDICIA is within the jurisdiction of the Federal Deposit Insurance 
Corporation. Accordingly, the Commission is not inclined to render a 
view on the meaning of that term.
4. Status of Foreign Governments, Foreign Central Banks, and 
International Financial Institutions as ``Financial Entities''
    The Commission received a comment from Milbank, Tweed, Hadley & 
McCloy LLP (Milbank) recommending that foreign governments and their 
agencies be excluded from the definition of ``financial entity.'' 
Milbank cited central banks, treasury ministries, export agencies, and 
housing finance authorities as examples of agencies of foreign 
governments that could be affected. Milbank expressed concern that 
these entities might be treated as ``financial entities'' that would 
not be permitted to use the end-user exception if, for example, they 
are viewed as ``predominately engaged in * * * activities that are 
financial in nature, as defined by Section 4(k) of the Bank Holding 
Company Act of 1956.'' \11\ In a separate letter, the World Bank 
commented that it should not be subject to the clearing requirement 
under Section 2(h)(1) of the CEA.
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    \11\ 12 U.S.C. 1841 et seq.
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    The Commission recognizes that there are important public policy 
implications related to the application of the end-user exception, and 
the clearing requirement generally, to foreign governments,\12\ foreign 
central banks,\13\ and international financial institutions.\14\ The 
Commission expects

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that if any of the Federal Government, Federal Reserve Banks, or 
international financial institutions of which the United States is a 
member were to engage in swap transactions in foreign jurisdictions, 
the actions of those entities with respect to those transactions would 
not be subject to foreign regulation. However, if foreign governments, 
foreign central banks, or international financial institutions were 
subjected to regulation by the Commission in connection with their swap 
transactions, foreign regulators could treat the Federal Government, 
Federal Reserve Banks, or international financial institutions of which 
the United States is a member in a similar manner. The Commission notes 
that the Federal Reserve Banks and the Federal Government are not 
subject to the clearing requirement under the Dodd-Frank Act.
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    \12\ For this purpose, the Commission considers that the term 
``foreign government'' includes KfW, which is a non-profit, public 
sector entity responsible to and owned by the federal and state 
authorities in Germany, mandated to serve a public purpose, and 
backed by an explicit, full statutory guarantee provided by the 
German federal government.
    \13\ For this purpose, the Commission considers the Bank for 
International Settlements, in which the Federal Reserve and foreign 
central banks are members, to be a foreign central bank. See http://www.bis.org/about/orggov.htm.
    \14\ For this purpose, the Commission considers the 
``international financial institutions'' to be those institutions 
defined as such in 22 U.S.C. 262r(c)(2) and the institutions defined 
as ``multilateral development banks'' in the Proposal for the 
Regulation of the European Parliament and of the Council on OTC 
Derivative Transactions, Central Counterparties and Trade 
Repositories, Council of the European Union Final Compromise Text, 
Article 1(4a(a)) (March 19, 2012). There is overlap between the two 
definitions, but together they include the following institutions: 
The International Monetary Fund, International Bank for 
Reconstruction and Development, European Bank for Reconstruction and 
Development, International Development Association, International 
Finance Corporation, Multilateral Investment Guarantee Agency, 
African Development Bank, African Development Fund, Asian 
Development Bank, Inter-American Development Bank, Bank for Economic 
Cooperation and Development in the Middle East and North Africa, 
Inter-American Investment Corporation, Council of Europe Development 
Bank, Nordic Investment Bank, Caribbean Development Bank, European 
Investment Bank and European Investment Fund. (The International 
Bank for Reconstruction and Development, the International Finance 
Corporation and the Multilateral Investment Guarantee Agency are 
parts of the World Bank Group.)
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    Canons of statutory construction ``assume that legislators take 
account of the legitimate sovereign interests of other nations when 
they write American laws.'' \15\ In addition, international financial 
institutions operate with the benefit of certain privileges and 
immunities under U.S. law indicating that such entities may be viewed 
similarly under certain circumstances.\16\ There is nothing in the text 
or history of the swap-related provisions of Title VII of the Dodd-
Frank Act to establish that Congress intended to deviate from these 
traditions of the international system by subjecting foreign 
governments, foreign central banks, or international financial 
institutions to the clearing requirement set forth in Section 2(h)(1) 
of the CEA.\17\
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    \15\ See F. Hoffman-LaRoche, Ltd. v. Empagran S.A., 542 U.S. 
155, 164 (2004), citing Murray v. Schooner Charming Betsy, 2 Cranch 
64, 118, 2 L.Ed. 208 (1804) (``[A]n act of congress ought never to 
be construed to violate the law of nations if any other possible 
construction remains''); Hartford Fire Insurance Co. v. California, 
509 U.S. 764 (1993) (Scalia, J., dissenting). See also Restatement 
(Third) Foreign Relations Law Sec.  403 (scope of a statutory grant 
of authority must be construed in the context of international law 
and comity including, as appropriate, the extent to which regulation 
is consistent with the traditions of the international system).
    \16\ See, e.g., the International Organization and Immunities 
Act (22 U.S.C. 288) and the Foreign Sovereign Immunities Act (28 
U.S.C. 1602). The United States has taken appropriate actions to 
implement international obligations with respect to such immunities 
and privileges. See, e.g., International Bank for Reconstruction and 
Development (the ``World Bank'') and International Monetary Fund (22 
U.S.C. Sec.  286g and 22 U.S.C. 286h), the European Bank for 
Reconstruction and Development (22 U.S.C. 290l-6), the Multilateral 
Investment Guarantee Agency (22 U.S.C. 290k-10), the Africa 
Development Bank (22 U.S.C. 290i-8), the African Development Fund 
(22 U.S.C. 290g-7), the Asian Development Bank (22 U.S.C. 285g), the 
Inter-American Development Bank (22 U.S.C. 283g), the Bank for 
Economic Cooperation and Development in the Middle East and North 
Africa (22 U.S.C. 290o), and the Inter-American Investment 
Corporation (22 U.S.C. 283hh). See, e.g., CFTC Interpretative Letter 
regarding World Bank Group, dated October 30, 1991. ``Based on the 
unique attributes and status of the World Bank Group as a 
multinational member agency, * * * the CFTC believes that the World 
Bank Group need not be treated as a U.S. person for purposes of 
application of the CFTC's Part 30 rules.'' See, also e.g., Board of 
Governors of the Federal Reserve approval of the application of BCI 
to acquire LITCO Bancorporation of New York, Inc., 68 Federal 
Reserve Bulletin 423 (1982) (the Bank Holding Company Act does not 
apply to foreign governments because they are not ``companies'' as 
such term is defined in the Bank Holding Company Act).
    \17\ To the contrary, Section 752(a) of the Dodd-Frank Act 
directs the Commission to consult and coordinate with other 
regulators ``on the establishment of consistent international 
standards with respect to the regulation (including fees) of swaps 
[and] swap entities. * * *''
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    Given these considerations of comity and in keeping with the 
traditions of the international system, the Commission believes that 
foreign governments, foreign central banks, and international financial 
institutions should not be subject to Section 2(h)(1) of the CEA.\18\ 
Accordingly, it is not necessary to determine whether these entities 
are ``financial entities'' under Section 2(h)(7) of the CEA.
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    \18\ The foregoing rationale and considerations do not, however, 
extend to sovereign wealth funds or similar entities due to the 
predominantly commercial nature of their activities. Accordingly, 
the Commission clarifies that sovereign wealth funds and similar 
entities are subject to Section 2(h)(1) of the CEA.
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    The Commission notes, however, that if a foreign government, 
foreign central bank, or international financial institution enters 
into a non-cleared swap with a counterparty who is subject to the CEA 
and Commission regulations with regard to that transaction, then the 
counterparty still must comply with the CEA and Commission regulations 
as they pertain to non-cleared swaps. For example, the party must 
comply with the recordkeeping and reporting requirements under Parts 23 
and 45 of the Commission's regulations.
5. Status of State and Local Government Entities as ``Financial 
Entities''
    NCSHA recommended that the Commission explicitly provide that state 
and local governmental entities, specifically housing finance agencies, 
are not ``financial entities'' as defined in Section 2(h)(7) of CEA. In 
particular, NCSHA expressed concern regarding the applicability of 
Section 2(h)(7)(C)(VIII), which provides that a person is a financial 
entity if the person is ``predominantly engaged in activities that are 
in the business of banking, or in activities that are financial in 
nature, as defined in section 4(k) of the Bank Holding Company Act of 
1956.''
    As an initial matter, the Commission notes that Congress did not 
expressly exclude state and local government entities from the 
``financial entity'' definition. On the contrary, in Section 
2(h)(7)(C)(VII), Congress expressly included employee benefit plans of 
state and local governments in the ``financial entity'' definition, 
thereby prohibiting them from using the end-user exception.\19\ A per 
se exclusion for state and local government entities from the 
``financial entity'' definition is inappropriate. A state or local 
government entity's swap activity may be commercial in nature and such 
entity may also meet the definition of a ``financial entity'' in 
Section 2(h)(7)(C) of the CEA. Under such circumstances, the entity 
would be subject to compliance with the clearing requirement of Section 
2(h)(1)(A). As an example, much like state and local government 
employee benefit plans that are expressly identified in Section 
2(h)(7)(C) as financial entities, other state or local government 
entities that act in the market in the same manner as private asset 
managers, such as local government investment pools, would need to 
comply.
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    \19\ The Commission is not convinced by NCHSA's suggestion that 
Congress would have expressly included in the definition housing 
finance entities and other state and local government entities if it 
had intended for them to be ``financial entities.'' Congress did not 
list every type of entity that is a financial entity, but provided a 
catch-all definition in Section 2(h)(7)(C)(VIII) to capture various 
types of entities it did not specifically list. The reference to 
government employee benefit plans is part of Section 
2(h)(7)(C)(VII), which includes various types of employee benefit 
plans specifically in the definition of ``financial entity,'' does 
not appear to have been intended as a singular identification of the 
only type of governmental entity that could be captured by the 
definition of ``financial entity.''
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    The ``business of banking'' is a term of art found in the National 
Bank Act \20\ and is within the jurisdiction of, and therefore subject 
to interpretation by, the Office of the Comptroller of the

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Currency.\21\ Similarly, Section 4(k) of the Bank Holding Company Act 
is within the jurisdiction of, and therefore subject to interpretation 
by, the Board of Governors of the Federal Reserve System. Accordingly, 
the Commission is not inclined to interpret these provisions. However, 
even assuming that many state and local government entities may engage 
in some limited activities that are in the business of banking or are 
financial in nature as defined by Section 4(k), such activities are 
likely to be incidental, not primary, activities of those entities. 
Therefore, most state and local government entities are not likely to 
be ``financial entities'' under Section 2(h)(7)(C)(VIII), because they 
are not predominantly engaged in activities that are in the business of 
banking, or are financial in nature, as defined by Section 4(k) of the 
Bank Holding Company Act of 1956. Instead, most state and local 
government entities are ``predominantly engaged'' in other, non-banking 
and non-financial, activities related to their core public purposes and 
functions. Such entities therefore would not be ``financial entities'' 
by virtue of Section 2(h)(7)(C)(VIII) of the CEA.
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    \20\ 12 U.S.C. 24 (Seventh).
    \21\ Nationsbank of N.C., N.A. v. Variable Annuity Life Ins. 
Co., 513 U.S. 251, 258 & n.2 (1995).
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    Regarding NCHSA's request for a specific determination for housing 
finance agencies, the Commission is not inclined to make such a 
determination without the opportunity to consider all relevant facts 
and circumstances.
6. Affiliates
    Section 2(h)(7)(D)(i) of the CEA provides that an affiliate of a 
person that qualifies for the end-user exception (including affiliate 
entities predominantly engaged in providing financing for the purchase 
of the merchandise or manufactured goods of the person) may qualify for 
the exception only if the affiliate, acting on behalf of the person and 
as an agent, uses the swap to hedge or mitigate the commercial risk of 
the person or other affiliate of the person that is not a financial 
entity. The clear implication of this provision is that such an 
affiliate may elect the end-user exception, even if it is a financial 
entity, if the swap and the affiliate relationship otherwise comply 
with the requirements of Section 2(h)(7) and in particular, Section 
2(h)(7)(D). Section 2(h)(7)(D)(ii), however, provides that this 
affiliate exception shall not apply to certain types of entities 
including, among others, swap dealers or MSPs.
    Shell Energy North America (US), L.P. (Shell) commented that, 
absent clear guidance by the Commission, potential electing 
counterparties that centralize their risk management through a hedging 
affiliate that is designated as a swap dealer or MSP may be unable to 
benefit from the end-user exception. As a result, many potential 
electing counterparties may need to restructure their businesses and 
risk management techniques, thereby losing the many benefits of 
centralized hedging. According to Shell, such a loss might require 
potential electing counterparties to take on additional risk or to 
transact with third parties.
    In response, the Commission notes that it lacks discretion in this 
regard because Congress specifically defined financial entities (which 
cannot use the end-user exception) to include swap dealers and MSPs, 
and Section 2(h)(7)(D) specifically prohibits swap dealers or MSPs 
acting on behalf of affiliates from using that provision to elect the 
end-user exception.\22\
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    \22\ The Commission notes that the definition of ``major swap 
participant'' in Section 1a(33) of the CEA, in which the term 
``financial entity'' is also used, does not include a provision that 
is similar to Section 2(h)(7)(D). In the absence of such a 
provision, the Commission has defined the term ``financial entity'' 
in Sec.  1.3(mmm)(1) for purposes of the ``major swap participant'' 
definition in Section 1a(33) of the CEA and Sec.  1.3(hhh), to 
exclude certain centralized hedging and treasury entities. See 77 FR 
30596 at 30750 (May 23, 2012). The Commission does not believe it 
would be appropriate to take a similar approach with respect to the 
end-user exception, however, because Section 2(h)(7)(D) specifically 
addresses when affiliates may be eligible for the end-user 
exception.
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    Similarly, Kraft, Philip Morris International, Inc. (Philip 
Morris), and Siemens Corp. (Siemens) commented that the Commission 
should exclude wholly-owned treasury subsidiaries of non-financial 
companies from the ``financial entity'' definition, to the extent that 
they solely engage in swap transactions to hedge or mitigate the 
commercial risks of an entire corporate group. These commenters noted 
in particular that the treasury subsidiaries may be, or are likely to 
be, ``financial entities'' under Section 2(h)(7)(C)(VIII), because they 
are predominantly engaged in activities of a financial nature as 
defined in Section 4(k) of the Bank Holding Company Act. Siemens 
believes the Commission should amend the proposed rule to clarify that 
a financial entity acting as a ``Treasury Affiliate'' satisfies the 
statutory criteria for ``acting on behalf of the person and as an 
agent,'' as required by section 2(h)(7)(D)(i) of the CEA.
    Here too, the Commission notes that Congress specifically defined 
``financial entity'' for purposes of Section 2(h)(7) of the CEA, and 
proposed Sec.  39.6(b)(2) (renumbered as Sec.  39.6(a)(1)(i) in the 
final rule) simply adopts that definition. Likewise, Congress 
specifically set out in Section 2(h)(7)(D) who may qualify as an 
affiliate eligible for the end-user exception. The specificity with 
which Congress defines ``financial entity'' and sets out when 
affiliates, including affiliates that may be financial entities, may 
elect the end-user exception on behalf of an affiliate that is not a 
financial entity (i.e., the treasury affiliate would need to be 
``acting on behalf of the [other affiliate] and as agent''), constrains 
the Commission's discretion in this area.
    However, the Commission notes that it is important to distinguish 
where the treasury function operates in the corporate structure. 
Treasury affiliates that are separate legal entities and whose sole or 
primary function is to undertake activities that are financial in 
nature as defined under Section 4(k) of the Bank Holding Company Act 
are financial entities as defined in Section 2(h)(7)(C)(VIII) of the 
CEA because they are ``predominantly engaged'' in such activities. If, 
on the other hand, the treasury function through which hedging or 
mitigating the commercial risks of an entire corporate group is 
undertaken by the parent or another corporate entity, and that parent 
or other entity is entering into swaps in its own name, then the 
application of the end-user exception to those swaps would be analyzed 
from the perspective of the parent or other corporate entity directly.
    For example, consider a parent company or other corporate entity 
predominantly engaged in manufacturing, agriculture, retailing, energy, 
or other non-``financial entity'' businesses and which is not one of 
the types of financial entities described in Sections 2(h)(7)(C)(I) 
through (VII). If that parent or other corporate entity enters into 
swaps with an affiliate that hedge or mitigate commercial risk of the 
affiliate, the affiliate may elect the end-user exception for those 
inter-affiliate swaps if the affiliate is not a financial entity. If 
the parent or other corporate entity then aggregates the commercial 
risks of those swaps with other risks of the commercial enterprise and 
hedges the aggregated commercial risk using a swap with a swap dealer, 
that entity may, in its own right, elect the end-user exception for 
that hedging swap. The parent or other corporate entity in the example 
is not a ``financial entity'' as defined in Section 2(h)(7)(C)(VIII) of 
the CEA, because that entity is ``predominantly engaged'' in other, 
non-financial activities undertaken to fulfill its core commercial 
enterprise purpose. However, if the parent or other

[[Page 42564]]

corporate entity, including, for example, a separately incorporated 
treasury affiliate, is a ``financial entity,'' then that entity cannot 
elect the end-user exception unless one of the specific affiliate 
provisions of the statute, Section 2(h)(7)(C)(iii) or Section 
2(h)(7)(D), apply.
    CFC recommended that the Commission clarify that the definition of 
``an affiliate of a person'' includes a nonprofit, tax-exempt 
cooperative of which the person is a member and which is not a 
depository institution. Section 2(h)(7)(D)(ii) of the CEA lists certain 
types of entities that do not qualify as affiliates able to elect the 
end-user exception. The Commission declines to determine at this time 
whether specific types of entities would qualify as affiliates able to 
elect the end-user exception because such determinations are best made 
on a case-by-case basis with the benefit of all relevant facts and 
circumstances.
    Cravath, Swaine, and Moore, LLP (Cravath), EDF Trading, The 
Prudential Insurance Company of America (Prudential), and Working Group 
of Commercial Energy Firms (WGCEF) commented that the Commission should 
provide an explicit exemption from clearing and notification 
requirements for inter-affiliate swaps, i.e., swaps between companies 
that are part of a single group of affiliated companies. EEI & EPSA 
recommended that the Commission clarify in the regulatory text that 
``acting on behalf of the person and as an agent'' to hedge or mitigate 
commercial risk includes inter-affiliate transactions.
    As a general matter, the Commission notes that Congress did not 
treat inter-affiliate swaps differently from other swaps in Section 
2(h)(7) of the CEA. Accordingly, the fact that a swap is between two 
affiliates would not change the analysis of whether one of the parties 
to the swap can elect the end-user exception. If one of the affiliates 
is not a financial entity and is using the swap to hedge or mitigate 
commercial risk, even if the other affiliate is a financial entity, the 
non-financial entity affiliate may elect the end-user exception and 
neither affiliate needs to clear the swap. However, whether the 
Commission should provide general clearing relief for inter-affiliate 
swaps for which the statutory requirements of the end-user exception 
are not satisfied is outside the scope of this rulemaking. 
Notwithstanding the foregoing, the Commission acknowledges that 
commenters have raised issues regarding inter-affiliate swaps that 
warrant further review and the Commission is considering other options 
regarding these issues.
7. Captive Finance Companies
    Section 2(h)(7)(C)(iii) of the CEA provides that the definition of 
``financial entity'' in Section 2(h)(7)(C)(i) of the CEA ``shall not 
include an entity whose primary business is providing financing, and 
uses derivatives for the purpose of hedging underlying commercial risks 
related to interest rate and foreign currency exposures, 90 percent or 
more of which arise from financing that facilitates the purchase or 
lease of products, 90 percent or more of which are manufactured by the 
parent company or another subsidiary of the parent company.'' In 
connection with this ``captive finance company'' exception, the U.S. 
Chamber of Commerce and the Coalition for Derivatives End Users (CDEU) 
requested that the Commission interpret the phrase ``90 percent or more 
of which are manufactured by the parent company or another subsidiary 
of the parent company'' to include component parts, attachments, 
systems, and other products that may be manufactured by others, but 
sold together with the company's products as well as attachments and 
labor costs that are incidental to the primary purchase.
    The Commission believes that the captive finance company exception 
must be interpreted in a manner consistent with the plain language of 
the statute. As a result, a person that seeks to fall within the 
captive finance company exception must be in the ``primary business'' 
of providing financing of purchases or leases from its parent company 
or subsidiaries thereof. Consistent with this requirement, the 
Commission states that the captive finance company exception can be 
applied when this financing activity finances the purchase or lease of 
products sold by the parent company or its subsidiaries in a broad 
sense, including service, labor, component parts, and attachments that 
are related to the products.
    A group of captive finance companies or affiliates of captive 
finance companies (the ``Captive Finance Companies'') \23\ asked the 
Commission to create a simple test to determine whether an entity 
qualifies for the captive finance company exception and to clarify 
whether the two ``90 percent'' prongs should be read separately or 
together. The Commission believes the test is set out plainly in the 
statute and only allows for limited interpretation. As to the two 
prongs, the Commission interprets them separately. That is, 90 percent 
or more of the interest rate and currency exposures for which the 
captive finance company is using derivatives to hedge the related 
underlying commercial risks must arise from financing that facilitates 
the purchase or lease of products. Ninety percent or more of the 
products, the purchase or sale of which are being facilitated by the 
financing, must be manufactured by the parent company or its 
subsidiary. An entity must satisfy both prongs in order to be eligible 
for the captive finance company exception.
---------------------------------------------------------------------------

    \23\ American Honda Finance Corp., John Deere Financial 
Services, Inc., Nissan North America, Inc., Toyota Financial 
Services, and Caterpillar Financial Services Corp.
---------------------------------------------------------------------------

    The Captive Finance Companies expressed concern that the Commission 
would require a product, in order to qualify as ``manufactured'' by the 
parent company or a subsidiary, to have 90 percent or more of its 
components manufactured by the parent company or subsidiary. The 
Commission requires only that the final product being purchased or 
sold, regardless of its components, be manufactured by the parent 
company or subsidiary in order to qualify.
    The Captive Finance Companies also asked the Commission whether the 
``financing that facilitates the purchase or lease of products'' should 
be measured on a single-entity or consolidated basis that includes the 
entity's consolidated subsidiaries. They recommended that it be 
measured on a consolidated basis to prevent an entity that is a part of 
a larger group of entities from using corporate structures to 
manipulate the outcome and because most entities manage the reporting 
of their finance and leasing portfolios on that basis. The Commission 
agrees that the financing should be measured on a consolidated basis.
    Further, the Captive Finance Companies discussed the ways in which 
a captive finance company might ``facilitate'' the purchase or lease of 
the parent company's and subsidiaries' products. For example, a captive 
finance company for an engine manufacturer may finance the sale of a 
boat that includes the manufacturer's engine in order to facilitate the 
sale of the engine, even if the boat itself were manufactured by a 
different company. As a second example, a captive finance company may 
provide working capital and related financing to a dealer that sells 
the parent company's products, even though such financing is not 
directly related to the sale of products. The Commission agrees that 
the word ``facilitates'' as used in Section 2(h)(7)(C)(iii) should be 
interpreted

[[Page 42565]]

broadly to include financing that may indirectly help to facilitate the 
purchase or lease of products.
    CFC commented that it should be viewed as a captive finance 
subsidiary of the entities that own it in a cooperative structure. CFC 
also discussed whether the captive finance company exception should be 
available when it provides financing to its member-owners to support 
their general business activities, rather than to finance purchases 
from its member-owners. The Commission is declining to determine at 
this time whether specific entities would qualify for the captive 
finance company exception because such determinations are best made on 
a case-by-case basis with the benefit of all relevant facts and 
circumstances.

B. Reporting Requirements

    Section 2(h)(7)(A)(iii) of the CEA requires that, for the end-user 
exception to apply, one of the counterparties to the swap must notify 
``the Commission in a manner set forth by the Commission how it 
generally meets its financial obligations associated with entering into 
non-cleared swaps.'' Section 2(h)(7)(F) of the CEA allows the 
Commission to ``prescribe such rules or issue interpretations of the 
rules as the Commission determines to be necessary to prevent abuse'' 
of the end-user exception and to ``request information from those 
persons claiming the clearing exception as necessary to prevent 
abuse.'' \24\
---------------------------------------------------------------------------

    \24\ In addition, Section 2(h)(4)(A) requires the Commission to 
prescribe rules as determined by the Commission to be necessary to 
prevent evasion of the clearing requirements.
---------------------------------------------------------------------------

    Proposed Sec.  39.6(b) would implement Section 2(h)(7)(A)(iii) by 
requiring one of the counterparties (the ``reporting counterparty'') to 
provide, or cause to be provided, to a registered SDR, or if no 
registered SDR is available, to the Commission, information about how 
the electing counterparty generally expects to meet its financial 
obligations associated with the non-cleared swap. In addition, proposed 
Sec.  39.6(b) would require the reporting counterparty to provide 
certain information that the Commission will use to monitor compliance 
with, and prevent abuse of, the end-user exception. The reporting 
counterparty would be required to provide the information at the time 
the electing counterparty elects the end-user exception.
1. Frequency of Reporting
    The Commission received numerous comments suggesting that reporting 
of the information specified under proposed Sec.  39.6(b) for each swap 
transaction would be burdensome.\25\ A number of commenters recommended 
that the Commission permit entities to report some or all of the 
required items on an annual or periodic basis with updates for any 
material changes.\26\ According to these commenters, an annual or 
periodic filing would provide sufficient notice to the Commission 
because the reasons for which each entity enters into hedge 
transactions, and the manner in which each entity generally meets its 
financial obligations associated with those transactions, do not change 
materially on a frequent basis.\27\ Several commenters believe that a 
one-time filing of some or all of the required items should 
suffice.\28\
---------------------------------------------------------------------------

    \25\ See, e.g., American Bankers Association (ABA), American Gas 
Association (AGA), APGA, American Petroleum Institute (API), Air 
Transport Association (ATA), CDEU, COPE, Cravath, EDF Trading, 
Edison Electric Institute (EEI), EEI and Electric Power Supply 
Association (EEI & EPSA), Encana Marketing (USA) Inc. (EMUS), IECA, 
Independent Petroleum Association (IPA), National Council of Farmer 
Cooperatives (NCFC), NCSHA, National Energy Marketers Association 
(NEMA), Natural Gas Supply Association (NGSA), NMPF, Noble Energy, 
Inc. (Noble), National Rural Electric Cooperative Association 
(NRECA), Peabody Energy Corp. (Peabody), Retail Energy Supply 
Association (RESA), San Diego Gas and Electric Co. (SDG&E), Shell, 
Swap Financial Group, LLC (SFG), WGCEF, and WSPP, Inc. (WSPP).
    \26\ See, e.g., ABA, AGA, API, ATA, CDEU, CFI Industries, Inc. 
(CFI), Hess Corp. (Hess), NCFC, NCSHA, NFPEEU, Noble, Peabody, 
SDG&E, Shell, and WGCEF.
    \27\ Id.
    \28\ See, e.g., APGA, COPE, Cravath, EDF Trading, EEI & EPSA, 
EMUS, Hess, IECA, IPA, NCSHA, NMPF, Petroleum Marketers Association 
of America and New England Fuel Institute (PMAA & NEFI), RESA, and 
SFG.
---------------------------------------------------------------------------

    Hess suggested that, instead of imposing additional reporting 
requirements, the Commission could prevent abuse of the end-user 
exception by requiring electing counterparties to represent that they 
satisfy the requirements of Sections 2(h)(7) and 2(j) of the CEA in 
swap contracts that they elect not to clear. EEI & EPSA also 
recommended that if the Commission were to require swap-by-swap 
reporting, it should adopt a flexible requirement that establishes 
reasonable time frames for reporting. ATA recommended that the 
Commission streamline the notice requirement by providing that notice 
may be satisfied on a one-time basis as part of the ISDA master 
agreement.
    IECA recommended that the rule be revised to state that if more 
than one, but less than all, parties to a swap are electing 
counterparties, the information specified in proposed Sec.  39.6(b) 
shall be provided with respect to each of the electing counterparties. 
According to IECA, if all parties to a swap are electing 
counterparties, no report should be required.
    NMPF requested that the Commission simplify the reporting 
requirements, especially for those smaller hedgers for whom the typical 
reporting requirements would be burdensome, and exempt agricultural 
swaps between non-financial counterparties from all or most reporting 
requirements. Federal Home Loan Banks (FHL Banks) commented that 
certain non-financial entities should have no reporting obligation.
    As proposed, the swap-by-swap reporting frequency for all 
information to be reported may impose unnecessary burdens, and 
therefore the Commission is revising proposed Sec.  39.6(b) to require 
only swap-by-swap reporting of the election of the end-user exception 
and the identity of the electing counterparty to the swap. The other 
information for which proposed Sec.  39.6(b) would have required 
reporting on a swap-by-swap basis does not have to be reported for each 
swap if the electing counterparty has previously provided the 
information in an annual filing.
    In practice, the reporting counterparty will be required to check 
at least three boxes for each swap for which the end-user exception is 
elected, indicating: (1) The election of the exception; (2) which party 
is the electing counterparty; and (3) whether the electing counterparty 
has already provided the additional required information through an 
annual filing. If the third box is checked ``no,'' the reporting 
counterparty will have to provide the additional required information 
for that swap. The Commission is requiring certain information on a 
swap-by-swap basis so it can verify that the end-user exception is 
being elected in compliance with the CEA and Commission 
regulations.\29\ In addition, if a counterparty is eligible to claim 
the end-user exception for one asset class but not another (for 
example, if the counterparty is a swap dealer granted limited 
designation by the Commission pursuant to Sec.  1.3(ggg)(3)), the 
Commission must be able to distinguish those swaps for which the 
counterparty may legitimately claim the end-user exception from those 
for which it cannot. The Commission does not believe this reporting 
requirement will impose a significant burden on parties because other 
detailed information for every swap must be reported under

[[Page 42566]]

other provisions of the CEA and Commission regulations.\30\
---------------------------------------------------------------------------

    \29\ The Commission's Part 43 rules on real-time public 
reporting of swap transaction data also require the reporting 
counterparty to indicate election of the end-user exception on a 
swap-by-swap basis. See 77 FR 1182 at 1250 (Jan. 9, 2012). 
Indication of the election of the end-user exception will be 
publicly disseminated as required in Part 43, but the additional 
information required under Sec.  39.6(b) will not be.
    \30\ See, e.g., Sections 4(g) and 4(r) of the CEA; and Part 45 
of the Commission's regulations.
---------------------------------------------------------------------------

    The Commission agrees with commenters that an annual filing for the 
remaining information will provide sufficient notice to the Commission 
because the general reasons for which electing counterparties enter 
into hedge transactions, and the manner in which they generally meet 
their financial obligations for those transactions, do not change 
frequently. While this approach may impose additional costs on SDRs and 
the Commission because each will have to establish and maintain two 
reporting alternatives,\31\ the Commission believes that this approach 
will impose lower costs on the swap parties than they would incur if 
all information were required to be reported on a swap-by-swap basis. 
Accordingly, Sec.  39.6(b) is being revised to permit the following 
information to be reported on a swap-by-swap or an annual basis: (1) 
Whether the electing counterparty is a financial entity or a finance 
affiliate (i.e., is a financial entity electing the end-user exception 
by virtue of Sections 2(h)(7)(C)(ii) or (iii) or 2(h)(7)(D) of the 
CEA); (2) whether the swap hedges or mitigates commercial risk (the 
annual filing will state that the electing counterparty will only elect 
the end-user exception for swaps that hedge or mitigate commercial 
risk); (3) how the electing counterparty generally expects to meet its 
financial obligations; and (4) information related to whether the 
electing counterparty is an issuer of securities with board approval to 
not clear the swaps for which the end-user exception is elected.
---------------------------------------------------------------------------

    \31\ The Commission believes that the cost of establishing an 
additional reporting alternative is unlikely to be significant 
because the SDR and the Commission may do so in conjunction with 
establishing numerous other reporting processes, such as those 
required by the Commission's Part 43 rules on real-time public 
reporting of swap transaction data (77 FR 1182 (Jan. 9, 2012)).
---------------------------------------------------------------------------

    The Commission has determined not to grant any exemptions to the 
Sec.  39.6(b) reporting requirements at this time because any such 
determinations require a consideration of all relevant facts and 
circumstances. The modified reporting requirements should reduce some 
of the burdens cited by the commenters and given the low reporting 
burden under the rule and the general swap-by-swap reporting 
requirements in other regulations (e.g., Part 45), the Commission does 
not believe that a special, lesser reporting requirement for smaller 
parties or certain types of swaps is consistent with the statute. The 
Commission believes it would not be appropriate to require contract 
representations instead of reporting, or eliminate all or some 
reporting requirements for certain types of electing counterparties, 
because Section 2(h)(7)(A)(iii) of the CEA specifically requires 
notification to the Commission. Finally, the information required under 
Sec.  39.6(b) will help to prevent abuse of the end-user exception by 
allowing the Commission to track when the exception is elected and who 
is electing it.
2. Identifying the Reporting Counterparty
    As noted above, proposed Sec.  39.6(b) would require one of the 
counterparties to the swap to act as the ``reporting counterparty.'' 
WSPP requested that the Commission clarify who the reporting 
counterparty is. WSPP noted that the Commission indicated in the NPRM 
that the reporting counterparty would be determined in accordance with 
the swap data recordkeeping and reporting rules and that if one of the 
counterparties is an MSP or swap dealer, then that entity would be the 
reporting counterparty. WSPP further noted that proposed Sec.  39.6 
itself would not impose such a requirement, and recommended that the 
Commission either cross-reference the relevant swap reporting rules in 
Sec.  39.6 or define ``reporting counterparty'' for purposes of Sec.  
39.6. WSPP also requested clarification as to how two electing 
counterparties in an electing counterparty-to-electing counterparty 
transaction would determine which counterparty is the reporting 
counterparty, and whether the reporting counterparty would provide 
information on both electing counterparties at the same time.
    The Commission notes that Sec.  45.8 of its swap data recordkeeping 
and reporting rules sets out how the determination of which 
counterparty is the reporting counterparty for a swap is to be 
made.\32\ The Commission is revising Sec.  39.6(b) to include a 
reference to Sec.  45.8.
---------------------------------------------------------------------------

    \32\ See 77 FR 2136 at 2207 (Jan. 13, 2012) (Swap Data 
Recordkeeping and Reporting Requirements; final rule).
---------------------------------------------------------------------------

3. Reporting Methods
    As noted above, proposed Sec.  39.6(b) would require the reporting 
counterparty to provide or cause to be provided to a registered SDR, or 
if no registered SDR is available, to the Commission, the information 
set forth in that paragraph. CFI recommended that the Commission revise 
the proposed rule to permit an electing counterparty to summarize or 
submit copies of ISDA agreements and credit support agreements to the 
Commission to demonstrate how the electing counterparty generally meets 
its financial obligations related to non-cleared swaps. Similarly, EDF 
Trading stated that for transactions where neither party is a swap 
dealer or MSP, the Commission should provide an alternative to SDR 
reporting, such as the opportunity to submit hard copy records.
    Better Markets, Inc. (Better Markets) recommended that the 
Commission require electing counterparties to report directly to the 
Commission, in addition to an SDR. According to Better Markets, this 
would ensure that the Commission receives complete and timely 
information regarding reliance upon the end-user exception. Hess 
requested that the Commission permit electing counterparties who are 
not swap dealers or MSPs to report directly to an SDR or the 
Commission, rather than rely on a swap dealer or MSP counterparty to 
report. Hess commented that such a requirement would be more efficient 
and reliable.
    The Commission has determined not to revise Sec.  39.6(b) in 
response to these comments. As discussed further in the considerations 
of costs and benefits in Section III hereof, the Commission believes 
that adopting alternative approaches to reporting is unnecessary, 
unduly burdensome, and may complicate data management and review. In 
response to Hess' comment, the Commission notes that, as previously 
discussed, the final rule has been revised to permit electing 
counterparties to report much of the information required by the rule 
directly to an SDR or the Commission on an annual basis. For the 
information required to be reported on a swap-by-swap basis, the 
reporting counterparty must be determined in accordance with Sec.  
45.8.
    In the NPRM, the Commission stated that a reporting counterparty 
would provide the information required by proposed Sec.  39.6(b) via a 
``check-the-box'' approach and asked whether such an approach would be 
appropriate.
    EMUS, IECA, National Grain and Feed Association (NGFA), and WSPP 
commented that a check-the-box approach is sufficient to collect the 
information required. IECA recommended that the Commission specify the 
check-the-box system in the rule text.
    In contrast, Professor Michael Greenberger commented that a check-
the-box approach is inadequate. According to Professor Greenberger, 
this

[[Page 42567]]

approach will almost certainly be unreliable because the Commission 
will not have the necessary information to monitor and prevent 
potential abuse of the end-user exception.
    EMUS expressed concern that different reporting counterparties 
could provide the same information to a registered SDR in different 
formats. It recommended that the Commission adopt a yes-or-no schema 
for each of the items set forth in proposed Sec.  39.6(b)(1)-(6). 
According to EMUS, such a system would standardize reporting, which 
would provide more useful information. EMUS also commented that a 
standardized submission format would reduce costs and facilitate 
reporting for electing counterparties.
    The Commission is satisfied that a check-the-box approach is an 
appropriate method to collect the information that the Commission 
requires to exercise regulatory oversight and that it mitigates the 
costs of compliance for the electing and reporting counterparties. In 
addition, a check-the-box approach provides a standardized data 
collection method for voluminous amounts of data, which will facilitate 
effective review by the Commission. It would be inefficient for the 
Commission to monitor and analyze a large volume of unique data points 
from a potentially wide range of electing counterparties.
    The final rule itself does not specify the exact format for 
reporting purposes because the Commission's Part 45 rules establish the 
reporting requirements for all swap data, including the information 
required under Sec.  39.6.
4. Reporting of Inter-Affiliate or Cooperative-to-Member Swaps
    A few commenters raised issues regarding reporting of swaps between 
particular types of counterparties. Shell requested that the Commission 
clarify that swaps between affiliates need not be reported because such 
reporting for inter-affiliate swaps provides no useful information to 
the Commission and would be burdensome.
    NCFC requested clarification regarding who provides the financial 
obligation information in a transaction between a cooperative and its 
members (such as producers or elevators) or customers (e.g., an 
electing counterparty-to-electing counterparty transaction). NCFC also 
questioned whether an SDR or the Commission will accept the data for 
transactions that cooperatives enter into with their members and 
customers and whether the Commission has the resources to accept such 
data.
    In response to Shell's comment, the Commission notes that, although 
Congress expressly addressed in Section 2(h)(7)(D) of the CEA when an 
affiliate executing a swap on behalf of another affiliate may qualify 
for the end-user exception, Congress did not exempt such inter-
affiliate swaps from the reporting requirements. Because inter-
affiliate swaps must be reported, the parties also must provide the 
information required under Sec.  39.6(b) so that the Commission will 
know why a swap that would otherwise be subject to clearing is not 
being cleared. In response to NCFC's request for clarification as to 
who provides the financial obligation information for cooperative-to-
member swaps, the Commission notes that the reporting counterparty in 
such electing counterparty-to-electing counterparty transactions is to 
be determined in accordance with Sec.  45.8, as previously discussed.
5. Finance Affiliates
    As previously noted, Section 2(h)(7)(C)(iii) of the CEA provides 
that the definition of ``financial entity'' ``shall not include an 
entity whose primary business is providing financing, and uses 
derivatives for the purpose of hedging underlying commercial risks 
related to interest rate and foreign currency exposures, 90 percent or 
more of which arise from financing that facilitates the purchase or 
lease of products, 90 percent or more of which are manufactured by the 
parent company or another subsidiary of the parent company.'' Section 
2(h)(7)(D)(i) of the CEA provides that an affiliate of a person that 
qualifies for the end-user exception also may qualify for the exception 
but only if the affiliate, acting on behalf of the person and as an 
agent, uses the swap to hedge or mitigate the commercial risk of the 
person or other affiliate of the person that is not a financial entity. 
Section 2(h)(7)(D)(ii) identifies certain types of financial entities 
that cannot act as an affiliate electing counterparty on behalf of 
another person under Section 2(h)(7)(D)(i), indicating that financial 
entities that are not identified in Section 2(h)(7)(D)(ii) may do so. 
Proposed Sec.  39.6(b)(3) would implement these provisions and require 
the reporting counterparty to report, or cause to be reported, whether 
the electing counterparty is a ``finance affiliate'', i.e., a financial 
entity electing the end-user exception by virtue of Section 
2(h)(7)(C)(iii) or 2(h)(7)(D) of the CEA.
    EMUS requested that the Commission clarify whether the reporting 
counterparty must report that the electing counterparty is an affiliate 
of another person qualifying for the end-user exception under Section 
2(h)(7)(D)(i) of the CEA or a finance affiliate of such a person. 
According to EMUS, the NPRM indicated that the notification requirement 
would apply to all affiliates, while the rule text indicated a 
notification requirement would apply only to finance affiliates.
    In response to EMUS, the Commission is revising Sec.  39.6(b)(3) 
(renumbered in the final rule as Sec.  39.6(b)(1)(iii)(A)(1)) to 
clarify that the notification requirement only applies to financial 
entities acting as affiliates. While identification of financial 
entities acting as affiliates is important because they are an 
exception to the prohibition on financial entities electing the end-
user exception, the Commission does not believe that identification of 
non-financial entities acting as agents for affiliated entities is 
necessary. Similarly, the Commission is further revising this provision 
to add a requirement for electing counterparties to report whether they 
are ``financial entities'' as defined in Section 2(h)(7)(C)(i) of the 
CEA that are nevertheless exempt from the definition of ``financial 
entity'' as described in Sec.  39.6(d). But for the exemption provided 
in Sec.  39.6(d), such entities would be prohibited from electing the 
end-user exception (the exemption in Sec.  39.6(d) is discussed in 
Section D below).
6. Reporting How an Electing Counterparty Generally Meets Financial 
Obligations Associated With Non-Cleared Swaps
    As noted above, Section 2(h)(7)(A)(iii) of the CEA requires that 
the Commission be notified as to how an electing counterparty generally 
meets its financial obligations associated with entering into non-
cleared swaps. Proposed Sec.  39.6(b)(5) would implement this 
provision.
    NGSA recommended that the Commission modify the language of its 
proposed rule to be identical to the statutory language--namely, that 
the words ``expects to meet'' and ``swap'' in proposed Sec.  39.6(b)(5) 
should be replaced with the words ``meets'' and ``swaps,'' 
respectively.
    CFC recommended that the information contained in the notice should 
be general enough to encompass all transactions of an electing 
counterparty, and the notice should contain information as to how 
entities meet the obligations of multiple types of non-cleared swaps, 
not individual swaps.
    CDEU and EMUS commented that the information the Commission 
proposed

[[Page 42568]]

to collect is sufficient. According to CDEU, any additional information 
on meeting obligations would be non-standardized information that is 
not easily captured and reportable in a systematic fashion. CDEU 
commented that non-financial counterparties do not pose systemic risk 
and it is not clear how the reporting of more information on meeting 
financial obligations comports with the legislative intent of the Dodd-
Frank Act.
    Several commenters recommended that the Commission collect 
substantially more information, including specific information such as 
the types of collateral the electing counterparty will use to satisfy 
its financial obligations, the exact collateral terms and arrangements, 
and the contractual terms and provisions.\33\
---------------------------------------------------------------------------

    \33\ See, e.g., Americans for Financial Reform (AFR), American 
Federation of State, County and Municipal Employees (AFSCME), Better 
Markets, PMAA & NEFI, and Professor Greenberger.
---------------------------------------------------------------------------

    The Commission is modifying proposed Sec.  39.6(b)(5) (renumbered 
in the final rule as Sec.  39.6(b)(1)(iii)(C)) to read as follows: 
``How the electing counterparty generally meets its financial 
obligations associated with entering into non-cleared swaps by 
identifying one or more of the following categories, as applicable. * * 
*'' The Commission believes this revision more accurately reflects the 
Dodd-Frank Act's intent that an electing counterparty must demonstrate 
how it ``generally meets its financial obligations'' (emphasis added) 
with respect to non-cleared swaps. Furthermore, the Commission is 
declining to modify proposed Sec.  39.6(b)(5) to require reporting of 
additional, specific information because the statute only requires the 
electing counterparty to provide notice of how it ``generally meets its 
financial obligations.'' The Commission believes that the information 
required by the regulation will enable the Commission to exercise its 
regulatory oversight in an efficient and effective manner given the 
wide variety of different types of swaps and swap hedging strategies 
used by commercial entities.
7. How a Counterparty Meets Its Financial Obligations
    Proposed Sec.  39.6(b)(5)(i) through (v) would set forth categories 
of means by which an electing counterparty could generally meet its 
financial obligations associated with non-cleared swaps.
    The National Rural Electric Cooperative Association (NRECA) asked 
the Commission to confirm that, in representing which swaps are secured 
by collateral, the counterparty should check the box under proposed 
Sec.  39.6(b)(5)(ii) only if all or any portion of the financial 
obligations associated with the reported swap are secured by collateral 
that has been pledged to the swap counterparty at the time the swap is 
entered into. NRECA also asked whether that counterparty should check 
the box under proposed Sec.  39.6(b)(5)(i) only if the obligations 
associated with the reported swap are to be secured in the future by 
collateral that is to be, or may in the future be, pledged to the swap 
counterparty pursuant to a master agreement or other credit support 
agreement applicable to the swap. NRECA also asked whether proposed 
Sec.  39.6(b)(5)(i) is the appropriate box to check when the 
counterparties have in place collateralization arrangements subject to 
agreed-upon unsecured credit thresholds.
    NRECA asked how a reporting counterparty may satisfy proposed Sec.  
39.6(b)(5) where the financial obligations are not satisfied by any of 
the collateral set forth under proposed Sec.  39.6(b)(5)(i) through 
(iii) and the electing counterparty ``intends to generally meet its 
financial obligations associated with non-cleared swaps'' by managing 
its commercial risks prudently, offsetting its obligations under its 
non-cleared swaps against those commercial risks and, for a not-for-
profit electricity provider, passing through its costs and benefits of 
hedging to its retail energy customers during the time period(s) for 
which a swap hedges or mitigates commercial risk. NRECA asked the 
Commission to clarify whether such a reporting counterparty should 
check the box for proposed Sec.  39.6(b)(iv) or (v). NRECA also asked 
whether the financial resources must be ``available'' for purposes of 
proposed Sec.  39.6(b) at the time the swap is executed or by the time 
the swap is expected to settle and hedge or mitigate the commercial 
risk.
    In response to NRECA's comments, the Commission is modifying the 
text of proposed Sec.  39.6(b)(5)(i)-(v) (renumbered in the final rule 
as Sec.  39.6(b)(1)(iii)(C)(1) through (5)) to provide greater clarity 
as follows (new language emphasized): ``(1) A written credit support 
agreement; (2) Pledged or segregated assets (including posting or 
receiving margin pursuant to a credit support agreement or otherwise); 
(3) A written third-party guarantee; (4) The electing counterparty's 
available financial resources; or (5) Means other than those described 
in paragraphs (b)(1)(iii)(C)(1), (2), (3) or (4) of this section * * 
*.''
    In response to the comment regarding reporting of multiple sources, 
the Commission believes the word ``solely'' in proposed Sec.  
39.6(b)(5)(iv) may have created some uncertainty and has deleted this 
word from the final rule text. The NPRM stated that parties are 
required to check multiple boxes if multiple sources of financial 
resources may be used. For clarity, the Commission is modifying the 
text of proposed Sec.  39.6(b)(5) (renumbered as Sec.  
39.6(b)(1)(iii)(C)) to expressly require the checking of all applicable 
categories. In the example provided by NRECA, where the parties have a 
credit support arrangement subject to a threshold, the reporting 
counterparty would check one or more of the following: (1) Proposed 
Sec.  39.6(b)(5)(i) if the credit support arrangement is subject to a 
credit support agreement; (2) proposed Sec.  39.6(b)(5)(ii) if the 
credit support arrangement provided for pledging or segregating assets; 
and (3) proposed Sec.  39.6(b)(5)(iv) if the electing counterparty will 
use available financial resources to cover any amount up to the 
threshold listed in the credit support agreement.
    Finally, the Commission believes that NRECA's example, where no 
collateral is used to satisfy obligations, falls squarely in proposed 
Sec.  39.6(b)(5)(iv). The rule only requires that the electing 
counterparty identify how it generally meets its financial obligations 
with regard to uncleared swaps.
8. Board Approval for SEC Filers
    Under Section 2(j) of the CEA, exemptions from the requirements of 
Section 2(h)(1) to clear a swap and Section 2(h)(8) to execute a swap 
through a board of trade or SEF are available to a counterparty that is 
an issuer of securities that are registered under Section 12 of the 
Securities Exchange Act of 1934 or that is required to file reports 
pursuant to Section 15(d) of the Securities Exchange Act of 1934 (an 
``SEC Filer''), but only if an appropriate committee of the issuer's 
board or governing body has reviewed and approved the decision to enter 
into swaps that are subject to such exemptions. Proposed Sec.  
39.6(b)(6) would implement this provision and require an SEC Filer to 
report, on a swap-by-swap basis, whether an appropriate committee of 
its board of directors (or equivalent body) has reviewed and approved 
the decision not to clear the swap subject to the clearing requirement.
    A number of commenters interpreted proposed Sec.  39.6(b)(6) as 
requiring an SEC Filer's board of directors to approve each decision to 
not clear a swap (i.e., to grant approval on a swap-by-swap basis) and 
commented that Section 2(j)

[[Page 42569]]

of the Dodd-Frank Act does not impose such a requirement.\34\ COPE 
noted that companies generally do not engage in transaction-specific 
board actions.
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    \34\ See, e.g., AGA, API, CDEU, COPE, Cravath, EEI & EPSA, EMUS, 
EPSA, IECA, NFPEEU, NGSA, NRECA, Mr. Steve Quinlivan, RESA, SDG&E, 
WGCEF, and WSPP.
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    According to most of these commenters, swap-by-swap board approval 
would impose excessive costs and burdens on companies.\35\ AGA stated 
that a requirement that a board convene, review, and approve each and 
every decision to enter into a non-cleared swap transaction would be so 
administratively burdensome as to preclude its use.
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    \35\ See, e.g., AGA, COPE, Cravath, EEI, EMUS, Hess, IECA, NGSA, 
NREC, NYCBA, Mr. Quinlivan, SDG&E, and WSPP.
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    Several commenters remarked that boards should be given broad 
discretion over their hedging strategies and how they choose to 
authorize entering into non-cleared swaps.\36\ Commenters also 
recommended that companies should be able to delegate board approval to 
the appropriate board, committee, or corporate official on a general or 
``blanket'' basis for either all swaps or various categories of 
swaps.\37\ For example, COPE recommended that the Commission revise 
proposed Sec.  39.6(b)(6)(ii) to state that a board or committee may 
authorize the company to adopt a policy which grants general and 
continuing authority to enter into one or more swaps which are not 
cleared, and that specific approval is not required before entering 
into each and every swap. NGSA and the Committee on Futures and 
Derivatives Regulation of the New York City Bar Association (NYCBA) 
commented that the Commission should clarify footnote 18 \38\ of the 
NPRM and revise proposed Sec.  39.6(b)(6)(ii) by replacing the words 
``the decision not to clear the swap'' with the words ``the decision 
not to clear such swaps.''
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    \36\ See, e.g., ATA, COPE, EMUS, SDG&E, and WGCEF.
    \37\ See, e.g., AGA, API, ATA, Cope, Cravath, EEI, EEI & EPSA, 
Hess, NFPEEU, NRECA, NYCBA, NGSA, Mr. Quinlivan, SDG&E, and WGCEF.
    \38\ Footnote 18 of the NPRM stated: ``For example, a board 
resolution or an amendment to a board committee's charter could 
expressly authorize such committee to review and approve decisions 
of the electing person not to clear the swap being reported. In 
turn, such board committee could adopt policies and procedures to 
review and approve decisions not to clear swaps, on a periodic basis 
or subject to other conditions determined to be satisfactory to the 
board committee.'' 75 FR at 80750.
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    Cravath commented that the requirements should be flexible enough 
such that companies are able to manage and supervise their non-cleared 
swaps in a manner that is consistent with their existing governance 
policies.
    On the other hand, Better Markets suggested imposing additional 
disclosure requirements on the companies, including specific 
justification for why each swap is not cleared. Better Markets also 
recommended that the SEC Filer's CEO and CFO be required to certify 
that they have conducted a substantive review of the board committee's 
action and decision not to clear the swaps.
    The Commission believes that Section 2(j) of the Dodd-Frank Act 
does not require board approval of each decision by an SEC Filer to 
enter into a swap that is exempt from the clearing requirement. As 
noted above, Section 2(j) of the CEA states that exemptions from 
Sections 2(h)(1) and 2(h)(8) (i.e., the clearing and trade execution 
requirements) shall be available to an SEC Filer ``only if an 
appropriate committee of the [SEC Filer]'s board or governing body has 
reviewed and approved its decision to enter into swaps that are subject 
to such exemptions.'' The Commission interprets this language to allow 
board approval on a general basis. To remove any ambiguity, the 
Commission is modifying proposed Sec.  39.6(b)(6)(ii) (renumbered as 
Sec.  39.6(b)(1)(iii)(D)(2)) to read as follows: ``Whether an 
appropriate committee of that counterparty's board of directors (or 
equivalent body) has reviewed and approved the decision to enter into 
swaps that are exempt from the requirements of sections 2(h)(1) and 
2(h)(8) of the Act.'' This change allows for board approval on a 
general, as opposed to swap-by-swap, basis. Also, the reference to both 
Sections 2(h)(1) and 2(h)(8) makes clear that the board must have 
approved the decision to enter into swaps that are neither cleared nor 
executed on a DCM or SEF, as required by Section 2(j).
    Commenters also discussed how frequently the counterparty should be 
required to provide notice that the board has approved use of the end-
user exception and how frequently the board must renew its approval. A 
number of commenters suggested that an annual certification of board 
approval of a general hedging policy would be sufficient.\39\ NRECA 
stated that annual certification should be sufficient unless there is 
an intervening material change in the board approval information 
previously submitted. AGA commented that the Commission should be 
satisfied if the company's officers and/or risk committee annually 
reports to the board to ensure that the board remains informed of 
hedging activities. Hess, NRECA, and Shell commented that boards or 
board-appointed committees should be able to approve swaps on a 
periodic basis for either several months or years. IECA recommended 
that board approval be required whenever a company enters into a new 
ISDA agreement for swap transactions.
---------------------------------------------------------------------------

    \39\ See, e.g., AGA, EEI, EMUS, Hess, NEMA, and SDG&E.
---------------------------------------------------------------------------

    EEI and RESA recommended a one-time notice that the board has 
approved the use of the end-user exception. WGCEF commented that 
companies should be able to adopt a single continuing resolution 
approving any decision to use the end-user exception. Peabody agreed 
that a single determination by a committee, which would only be 
revisited as the committee deems necessary, is appropriate.
    As noted above, the Commission has revised proposed Sec.  
39.6(b)(6) so that entities have the option to report board approval 
information annually or on a swap-by-swap basis. The Commission would 
expect an SEC Filer's board to set appropriate policies governing the 
SEC Filer's use of swaps subject to the end-user exception and to 
review those policies at least annually and, as appropriate, more often 
upon a triggering event (e.g., a new hedging strategy is to be 
implemented that was not contemplated in the original board approval).
    A number of commenters requested that the Commission clarify some 
of the terms used in proposed Sec.  39.6(b)(6)(ii). NYCBA requested 
clarification as to what constitutes an ``appropriate committee'' for 
purposes of reviewing and approving the decision not to clear a swap. 
AGA asked the Commission to confirm that if a utility is a subsidiary 
of an SEC Filer, then the subsidiary's board committee would authorize 
the swap, not the board of the SEC Filer. IECA recommended that the 
rule be revised to expressly provide that approval must be given by the 
board of the transacting entity, not the board of an affiliate. 
Finally, EMUS requested clarification as to the meaning of ``issuer of 
securities.''
    The Commission considers a committee to be appropriate if it is 
specifically authorized to review and approve the SEC Filer's decision 
to enter into swaps.\40\ The SEC Filer's board would have reasonable 
discretion to determine the appropriate committee for approving 
decisions on swaps for its subsidiaries or affiliates.
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    \40\ See 75 FR at 80750 n. 16.

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[[Page 42570]]

    In response to the comment regarding the meaning of ``issuer of 
securities,'' the Commission notes that Section 2(j) of the CEA refers 
to an ``an issuer of securities that are registered under section 12 of 
the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required 
to file reports pursuant to section 15(d) of the Securities Exchange 
Act of 1934 (15 U.S.C. 78o).'' The SEC has stated that, for purposes of 
its proposed rule governing the end-user exception to mandatory 
clearing of security-based swaps, ``a counterparty invoking the end-
user clearing exception is considered by the [SEC] to be an issuer of 
securities registered under Exchange Act Section 12 or required to file 
reports pursuant to Exchange Act Section 15(d) if it is controlled by a 
person that is an issuer of securities registered under Exchange Act 
Section 12 or required to file reports pursuant to Exchange Act Section 
15(d).'' \41\ The Commission is interpreting this term in the same 
manner as the SEC.
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    \41\ See 75 FR 79992 at 79996 n. 34 (Dec. 21, 2010) (End-User 
Exception to Mandatory Clearing of Security-Based Swaps).
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9. Liability for Reporting
    Several commenters recommended that the Commission provide a safe 
harbor from liability for firms who report on behalf of other 
firms.\42\ These commenters expressed concern that the proposed 
regulations may not protect the electing counterparty from potential 
liability if the reporting counterparty misreports information 
regarding the electing counterparty. These commenters also expressed 
concern that a swap dealer or MSP may be liable if the electing 
counterparty provides the swap dealer or MSP with false information and 
the swap dealer or MSP then provides the false information to an SDR or 
the Commission. NGSA, CDEU, and RESA commented that the Commission 
should authorize a reporting entity to rely on the written 
representations or affirmations of the electing counterparty. NCFC 
stated that the Commission should not require a reporting firm to 
verify the information provided by the electing counterparty. In the 
event that a reporting counterparty incorrectly reports a swap, CDEU 
recommended that the Commission provide a procedure to cure a notice 
failure.
---------------------------------------------------------------------------

    \42\ See, e.g., Cravath, EMUS, IECA, NCFC, NGSA & NCGA, NRECA, 
and Peabody.
---------------------------------------------------------------------------

    The Commission notes that proposed Sec.  23.505 addresses obtaining 
and reporting end-user exception information by swap dealers and 
MSPs.\43\ Under that proposed rule, ``[e]ach swap dealer and major swap 
participant shall obtain documentation sufficient to provide a 
reasonable basis on which to believe that its counterparty meets the 
statutory conditions required for an exception from a mandatory 
clearing requirement, as defined in section 2(h)(7) of the Act and 
Sec.  39.6 of this chapter.''
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    \43\ See 76 FR 6715 at 6726 (Feb. 8, 2011) (Swap Trading 
Relationship Documentation Requirements for Swap Dealers and Major 
Swap Participants).
---------------------------------------------------------------------------

    To provide greater clarification for the end-user exception, the 
Commission is modifying Sec.  39.6 to add Sec.  39.6(b)(3), which 
states: ``Each reporting counterparty shall have a reasonable basis to 
believe that the electing counterparty meets the requirements for an 
exception to the clearing requirement under section 2(h)(7) of the Act 
and this section.'' \44\ The Commission believes that establishing this 
explicit standard will give reporting counterparties greater clarity as 
to how to comply with the requirements of the rule and will help 
prevent abuse of the end-user exception. What constitutes a 
``reasonable basis to believe'' will depend on the applicable facts and 
circumstances. For example, a reporting counterparty that has a long-
standing business relationship with the electing counterparty and knows 
that the electing counterparty is doing the same repetitive swap trades 
for the same commercial risk hedging purposes may be able to rely on 
its due diligence for the initial swap in the series and not need to 
re-establish the due diligence for every subsequent swap trade. As a 
further example, it may be reasonable in many circumstances for the 
reporting counterparty to rely on appropriate representations from the 
electing counterparty. On the other hand, if the reporting counterparty 
has a reasonable basis to believe that the representations of the 
electing counterparty are not accurate for a particular swap being 
considered, then the reporting counterparty may not reasonably rely on 
those representations for that swap.
---------------------------------------------------------------------------

    \44\ Unlike proposed Sec.  23.505, this provision does not 
include a requirement to ``obtain documentation.'' This is because 
proposed Sec.  23.505 applies only to swap dealers and MSPs, whereas 
the reporting counterparty under Sec.  39.6 may be a non-swap 
dealer/MSP. Such entities are less likely to have standardized 
documentation compliance systems in place and therefore obtaining 
documentation may be burdensome. To reduce this burden, the 
Commission has determined to provide greater flexibility in this 
rule.
---------------------------------------------------------------------------

    In response to comments concerning the liability of electing 
counterparties that are dependent on reporting counterparties to 
fulfill the reporting requirements of the rule, the electing 
counterparty is entitled to rely on reasonable representations by the 
reporting counterparty that the notification information has been 
properly transmitted. In such circumstances, the electing counterparty 
would not be subject to adverse consequences and the swap will not be 
deemed ineligible for the end-user exception for failure of the 
reporting counterparty to properly report the information.
    Regarding CDEU's comment on correcting information later determined 
to have been reported incorrectly, the Commission notes that its swap 
data recordkeeping and reporting rules address this issue for reported 
information generally in Sec.  45.14.\45\
---------------------------------------------------------------------------

    \45\ See 77 FR 2136 at 2210 (Jan. 13, 2012) (Swap Data 
Recordkeeping and Reporting Requirements; final rule).
---------------------------------------------------------------------------

10. Commission Approval for Use of the End-User Exception
    NCSHA requested that the Commission clarify how the notification 
and reporting requirements of Sec.  39.6 will affect the approval 
process for eligible counterparties electing the end-user exception. 
According to NCSHA, it is unclear whether the Commission will deny a 
counterparty the right to elect the end-user exception on the basis of 
``insufficiently meeting the Commission's notification and reporting 
requirements.'' NCSHA does not believe the Commission has the authority 
to reject eligible counterparties from electing the end-user exception 
on the basis of a failure to meet the Commission reporting or 
notification standards. However, if the Commission determines that it 
has that authority, NCSHA requested that the Commission provide a 
detailed list of the criteria it deems as necessary for a counterparty 
to sufficiently meet the CEA's notification and reporting requirements.
    The Commission notes that Sec.  39.6 does not include a process for 
approving a counterparty's election of the end-user exception, but a 
potential electing counterparty must meet the notification and 
reporting requirements in order to be eligible to elect the exception.

C. Hedging or Mitigating Commercial Risk

    Section 2(h)(7)(A)(2) of the CEA provides that a swap shall not be 
subject to the clearing requirement if, among other things, one of the 
counterparties to the swap ``is using swaps to hedge or mitigate 
commercial risk * * *.'' Proposed Sec.  39.6(c) provides potential 
electing counterparties with criteria for

[[Page 42571]]

determining whether a swap hedges or mitigates commercial risk.\46\
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    \46\ The phrase ``hedge or mitigate commercial risk'' was also 
the subject of joint rulemaking by the Commission and the SEC for 
purposes of the ``major swap participant'' definition under Section 
1a(33) of the CEA. The overlap of that joint rulemaking and Sec.  
39.6(c) is addressed in Section II.C.11 below.
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1. Breadth of the Criteria
    As noted in the NPRM, the criteria for what constitutes hedging or 
mitigating commercial risk in proposed Sec.  39.6(c) are generally 
designed to allow a wide variety of potential electing counterparties 
to structure their swaps in a manner that fits their particular 
businesses while also providing guidance and a measure of certainty in 
discerning the line between swaps used for hedging or mitigating 
commercial risk and swaps used for other purposes.
    Many commenters supported a broad set of criteria that would 
provide entities with sufficient flexibility to accommodate different 
risk mitigation strategies.\47\ EEI & EPSA stated that a limited set of 
criteria (particularly with regard to hedging financial risks, as 
discussed in Section II.C.2 below) would prevent non-financial entities 
from effectively hedging risks associated with significant parts of 
their commercial businesses and could conflict with Section 737 of the 
Dodd-Frank Act (which concerns position limits). CDEU recommended that 
commercial risk be construed more broadly to incorporate all risks 
associated with an entity's operations, including, but not limited to, 
interest rate risk, currency risk, credit risk, equity price risk, and 
risks arising from the purchase, ownership, production, storage, sale, 
financing, or transportation of commodities.
---------------------------------------------------------------------------

    \47\ See, e.g., CDEU, API, APGA, EEI & EPSA, Kraft, CMC, 
Milbank, and Philip Morris.
---------------------------------------------------------------------------

    Conversely, other commenters suggested that the Commission should 
construe commercial risk more narrowly.\48\ A number of commenters 
recommended that the definition of ``commercial risk'' be narrowly 
tailored to apply only to those entities whose business activities 
expose them to risk from physical commodity price fluctuations.\49\ 
According to these commenters, ``commercial risk'' should not include 
risks that are purely financial in nature. AFR expressed concern that 
the proposed rule construes commercial risk too broadly and would 
provide little direction as to whether a swap position is hedging or 
mitigating commercial risk. In AFR's view, any business risks might 
qualify under the proposed regulations. AFR recommended that the 
Commission provide a narrower, prescriptive definition.
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    \48\ See, e.g., AFR, AFSCME, WDM, IPM&CSA, East Coast Petroleum 
(ECP), Pennsylvania Petroleum Marketers and Convenience Store 
Association (PPMCSA), Commodity Markets Oversight Coalition (CMOC), 
Fuel Merchants of New Jersey (FMNJ), Georgia Oilmen's Association 
(GOA), Skylands Energy Service, Inc. (Skylands), Weiss, Edward M. 
Minicozzi, Medford Heating (Medford), Tobin, Sullivan, Fay & 
Grunebaum, and Form Letters.
    \49\ See, e.g., CMOC, ECP, FMNJ, IPM&CSA, Medford, General 
Utilities, Inc., PPMCSA, and Skylands.
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    The Commission has determined that the criteria described in 
proposed Sec.  39.6(c) should not change except for certain limited 
changes specifically discussed below. The Commission believes that by 
limiting the end-user exception to swaps that hedge or mitigate 
commercial risk, Congress made clear that it did not intend the 
exception to be applicable for all types of risk. Given the wide 
variety of potential electing counterparties, swaps, and hedging 
scenarios, the Commission believes that the rule strikes an appropriate 
balance between providing flexibility for entities to qualify for the 
end-user exception and clarity on the limits of the exception.
2. Treatment of Commodity Risks and Financial Risks
    Proposed Sec.  39.6(c) sets out criteria for hedging certain 
financial risks such as interest, currency, or foreign exchange rate 
risks. The Commission asked in the NPRM whether the rule should only 
apply to swaps involving non-financial commodities.
    Several commenters noted that non-financial entities regularly 
hedge financial risks related to their business operations and that 
limiting the rule to risks related to non-financial commodities would 
be unduly restrictive.\50\ In contrast, other commenters stated that 
the rule should be limited to risks related to physical commodity price 
fluctuations and the principal business of the electing counterparty 
and should not include purely financial risks.\51\ Some commenters 
expressed the view that the end-user exception should be limited so 
that it can only be used in direct proportion to the electing 
counterparty's physical holdings.\52\ These commenters believe this 
approach would prevent an entity that is engaged in commercial activity 
from claiming the end-user exception for risks that are not commercial. 
AFSCME expressed concern about including foreign exchange hedging 
because foreign exchange transactions are alleged to be regularly 
abused and manipulated.
---------------------------------------------------------------------------

    \50\ See, e.g., Independent Community Bankers of America (ICBA), 
COPE, Peabody, WSPP, and SIFMA.
    \51\ See, e.g., WDM, IPM&CSA, ECP, PPMCSA, CMOC, FMNJ, GOA, 
Skylands, General Utilities, Inc., Medford, and Ms. Roselyn Devlin.
    \52\ See, e.g., Skylands, FMNJ, General Utilities, Inc., 
Cochrans, ECP, and Medford.
---------------------------------------------------------------------------

    The Commission declines to revise proposed Sec.  39.6 to exclude 
hedging of commercial ``financial'' risks from the end-user exception. 
The Commission believes that an entity that may elect the end-user 
exception can be subject to financial risks related to its commercial 
activities and that these risks can constitute commercial risks. For 
example, a change in interest rate risk on a non-financial entity's 
debt incurred for commercial business operations (e.g., to fund the 
purchase of inputs or to build a factory for the entity) can constitute 
commercial risk. As a further example, Sec.  39.6(c)(1)(i)(F) addresses 
the risk of a change in interest, currency or foreign exchange risk 
exposures arising from a person's current or anticipated assets or 
liabilities in the ordinary course of business.\53\
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    \53\ Proposed Sec.  39.6(c)(1)(i)(E) addressed similar financial 
risks arising from rate ``movements'' rather than ``exposures.'' 
However, the text of proposed Sec.  39.6(c)(1)(i)(E) inadvertently 
referred only to foreign exchange rates. Accordingly, the final rule 
text has been revised to include interest and currency rates to be 
consistent with Sec.  39.6(c)(1)(i)(F).
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    Furthermore, the Commission does not believe the end-user exception 
was intended to apply only to physical commodity hedging. The 
Commission notes that the Dodd-Frank Act did not limit the end-user 
exception to physical position hedging. However, the Commission 
acknowledges the concern of commenters that allowing the end-user 
exception to be used for financial risk hedging might increase the 
potential for abuse of the exception. The Commission emphasizes that 
the use by non-financial entities of the end-user exception for 
financial risk hedging or mitigation must be an incidental part of 
(i.e., not central to) the electing counterparty's business and must 
fully qualify under all other applicable provisions of the CEA and 
Sec.  39.6. The Commission will monitor the use of the end-user 
exception, particularly when it is used for hedging financial risks. If 
the Commission finds that the end-user exception is being abused in 
this regard, it will take appropriate action.
3. Facts and Circumstances Test
    The Commission noted in the NPRM that it preliminarily believed 
that whether a position is used to hedge or mitigate commercial risk 
should be determined by the facts and circumstances existing at the 
time the

[[Page 42572]]

swap is entered into, and should take into account the person's overall 
hedging and risk mitigation strategies.
    A number of commenters generally agreed with the Commission's 
preliminary view.\54\ EDF Trading suggested that such an approach is 
the only commercially practical way to implement the rule. NRECA 
commented that the Commission should make clear in its rules that it 
will not second-guess the decision of an electing counterparty to enter 
into the swap and the decisions related to the terms of the swap for 
which the end-user exception is elected, and should not provide for 
review of such commercial risk management decisions with the benefit of 
hindsight.
---------------------------------------------------------------------------

    \54\ See, e.g., CDEU, Peabody, Philip Morris, EDF Trading, 
Kraft, NRECA, and AFSCME.
---------------------------------------------------------------------------

    The Commission confirms that counterparties should look to the 
facts and circumstances that exist at the time the swap is executed to 
determine whether a swap satisfies the criteria for hedging or 
mitigating commercial risk as set forth in the final rule. In response 
to NRECA's comment, the Commission does not believe it is necessary to 
expressly set forth the facts and circumstances test in Sec.  39.6. The 
Commission notes that nothing in Sec.  39.6 would require ongoing 
reporting or testing of a swap's hedge effectiveness.\55\ The 
Commission further notes, however, that it may review whether the 
election of the end-user exception was made in compliance with the CEA 
and the Commission's regulations at the time such election was made.
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    \55\ Hedge effectiveness testing is discussed in further detail 
below in section II.C.9.
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4. Commercial Status of the Electing Counterparty
    The Commission received a number of comments on whether 
``commercial'' refers to (i) the underlying activity being hedged or 
(ii) the nature of the general activities of the entity claiming the 
end-user exception. CDEU, ICBA, WSPP, and the Securities Industry and 
Financial Markets Association (SIFMA) agreed with the Commission's 
general view expressed in the NPRM that the determinant of whether a 
risk is ``commercial'' should be based on the underlying activity to 
which the swap relates and not the general nature of the electing 
counterparty's activities. A number of commenters requested that, to 
avoid any uncertainty, the rule language clarify that governmental and 
non-profit entities can incur commercial risks (such as interest rate 
risk associated with debt).\56\ Similarly, Norges Bank Investment 
Management asked the Commission to confirm that use of the word 
``commercial'' does not preclude foreign central banks and other 
sovereign entities from relying on the end-user exception.\57\
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    \56\ See, e.g., SIFMA, SIFMA MFP, SFG, Milbank, NCHSA, and WSPP.
    \57\ Based on the language of some of the comments, it appears 
that part of this concern may arise from the use of the phrase 
``commercial enterprise'' in the proposed rule. That phrase is used 
to be consistent with existing Sec.  1.3(z) of the Commission's 
regulations, which identifies activities that qualify as hedging in 
the futures markets.
---------------------------------------------------------------------------

    In response to a question asked in the NPRM, ICBA commented that 
agricultural cooperatives and non-profit, governmental, or municipal 
entities should not receive any special considerations. ICBA reasoned 
that adding further gradations or special considerations could create 
competitive disadvantages for other entities. ICBA further noted that 
the Dodd-Frank Act contemplates special treatment under the end-user 
exception only for small financial institutions and accordingly, 
special treatment for other types of entities might contravene 
Congressional intent.
    In response to these comments, the Commission confirms that the 
determination of whether the risk being hedged or mitigated is 
``commercial'' will be based on the underlying activity to which the 
risk relates, not on the type of entity claiming the end-user 
exception.\58\ The Commission confirms that this distinction applies to 
all potential electing counterparties including governmental entities, 
both domestic and foreign, and non-profit entities. Their status as 
governmental or non-profit entities does not control the determination 
of whether they are hedging or mitigating ``commercial'' risk. Rather, 
that determination will depend on the nature of the underlying activity 
to which the risk being hedged or mitigated relates.
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    \58\ The exception to this approach is with respect to financial 
entities, which are defined in Section 2(h)(7)(C) of the CEA based 
on who they are or what they do generally. Financial entities are 
prohibited from electing the end-user exception under Section 
2(h)(7)(A)(i) of the CEA.
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    Finally, the Commission believes that any additional language 
adding further gradations or special considerations in this regard 
could create confusion or unintended distinctions among different types 
of entities.
5. ``Economically Appropriate'' Standard
    Under proposed Sec.  39.6(c)(1)(i), a swap is used to hedge or 
mitigate commercial risk if the swap is ``economically appropriate'' to 
the reduction of any of six different categories of commercial risk 
listed in that section.\59\ Kraft commented that the ``economically 
appropriate'' standard should not be further defined because ``bright-
line'' definitions or limitations will result in less effective hedges 
and increased costs.
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    \59\ In the alternative to meeting the requirements of Sec.  
39.6(c)(1)(i), a swap executed by an electing counterparty may also 
be eligible for the end-user exception if the swap qualifies as a 
bona fide hedge for purposes of an exception from position limits 
under the CEA as provided in Sec.  39.6(c)(1)(ii), or if it 
qualifies for hedging treatment under FASB Accounting Standards 
Codification Topic 815 or under GASB Statement 53 as provided in 
Sec.  39.6(c)(1)(iii). Consequently, the universe of swaps that can 
qualify for the exception is broader than the universe of swaps that 
qualify as bona fide hedges for purposes of an exception from 
position limits under the CEA as provided in Sec.  39.6(c)(1)(ii).
---------------------------------------------------------------------------

    Better Markets expressed concern that the proposed ``economically 
appropriate'' standard may allow the end-user exception to be elected 
for swaps that do not hedge commercial risk precisely. Better Markets 
recommended that the Commission adopt a ``congruence'' standard that 
Better Markets believes fits the statutory language better. The 
``congruence'' standard would require each risk in the swap to be 
congruent with a corresponding commercial risk being hedged.
    On the other hand, SFG believes the ``economically appropriate'' 
standard is too narrow and should be replaced with a ``management or 
reduction of risks'' standard.
    The Commission is adopting the ``economically appropriate'' 
standard as proposed. The Commission believes that this standard will 
help interested parties distinguish those swaps that hedge or mitigate 
commercial risks from those that do not, thereby reducing regulatory 
uncertainty and helping prevent abuse of Section 2(h)(7) of the CEA. 
The facts and circumstances will determine whether the swap is 
economically appropriate to hedge or mitigate commercial risks. While 
the Commission acknowledges that this standard leaves room for judgment 
in its application, the Commission believes this flexible approach is 
needed given the wide variety of swaps, potential electing 
counterparties, and hedging strategies to which the rule applies. The 
Commission believes the ``economically appropriate'' standard, together 
with the identification of the six different categories of permissible 
commercial risks listed in proposed Sec.  39.6(c)(1)(i), is specific 
enough, when reasonably applied, to determine whether a swap is being 
used to hedge or mitigate commercial risk.
    The Commission is not adopting a ``congruence'' standard because it

[[Page 42573]]

believes the standard, which would require that each component risk of 
the swap be congruent with each risk being hedged, may be too 
restrictive and difficult to apply given the range of potential 
electing counterparties, types of swaps, and hedging strategies. Nor is 
the Commission adopting a ``management or reduction of risks'' 
standard. SFG's recommendation does not explain what risk 
``management'' means. Furthermore, the Commission is concerned that a 
standard based on ``management'' of risks may be overly inclusive and 
could apply to any swap that changes risk levels, including swaps that 
increase risk contrary to the goals of the Dodd-Frank Act.
6. Hedging Treatment Under Accounting Standards
    Under proposed Sec.  39.6(c)(1)(iii), a swap may be deemed to hedge 
or mitigate commercial risk if the swap qualifies for hedging treatment 
under Financial Accounting Standards Board (FASB) Accounting Standards 
Codification Topic 815. Professor Greenberger commented that 
transactions that meet the definition of hedging under accounting 
standards should qualify as commercial hedges.
    SIFMA, SIFMA's Municipal Financial Products Committee (SIFMA MFP), 
and GFOA asked that the Commission revise the proposed rule to include 
swaps that qualify for hedging treatment under the Governmental 
Accounting Standards Board (GASB) Statement 53, Accounting and 
Financial Reporting for Derivative Instruments (Statement 53). 
Statement 53 is the accounting standard for establishing a bona fide 
hedge under the GASB accounting standards used by many local government 
entities in the United States. Although different from the FASB 
accounting standard for hedging treatment, Statement 53 is similar in 
effect.
    The Commission agrees that entities that use GASB accounting 
standards should be able to use Statement 53 to demonstrate that a swap 
hedges or mitigates commercial risk in the same way that the FASB 
hedging standard is used. Accordingly, the Commission is revising 
proposed Sec.  39.6(c)(1)(iii) to include swaps that qualify for 
hedging treatment under Statement 53.
7. Speculation, Investing, or Trading
    Under proposed Sec.  39.6(c)(2)(i), a swap does not hedge or 
mitigate commercial risk if it is used for a purpose that is in the 
nature of ``speculation, investing, or trading.'' Commenters expressed 
different views on whether swaps held for speculative, investing, or 
trading purposes should qualify as hedging or mitigating commercial 
risk and whether it is practical for the Commission to include the 
limitation in the rule. The Commission also received a number of 
comments that addressed application of the proposed limitation 
specifically to physical commodity swaps.
    A number of commenters agreed that swaps which are used for one or 
more of the purposes of speculation, trading or investing should not 
qualify for the end-user exception.\60\ Philip Morris commented that 
the proposed criteria for hedging or mitigating commercial risk 
sufficiently encompass swaps legitimately used to hedge commercial 
risks, while excluding those used for speculation, trading, or other 
non-hedging purposes. The Form Letters supported the general concept of 
this limitation, noting that the ``common sense'' exception for end 
users should not be broadened to allow institutions to ``gamble'' in 
the derivatives markets. AFR agreed with the Commission's approach as 
explained in footnote 23 of the NPRM, but also expressed concern that 
the proposed rule may be too flexible and could create a loophole for 
speculators claiming to be hedging commercial risk when in fact they 
are not.
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    \60\ See, e.g., BG Americas & Global LNG (BG LNG), Peabody, 
Philip Morris, Form Letters, and Cravath.
---------------------------------------------------------------------------

    Several commenters suggested revising the proposed rule to limit 
the possibility that the provision would be applied in an overly 
restrictive manner. IECA recommended that the words ``investing or 
trading'' be eliminated from Sec.  39.6(c)(2)(i). IECA believes that, 
because swaps are ``traded'' and can appear on an entity's balance 
sheet, it is inappropriate to prohibit swaps used for investing or 
trading purposes. Vitol, Inc. (Vitol) expressed concern that excluding 
speculative or trading activities might preclude commercial firms that 
merchandise commodities or act as intermediaries in the supply chain 
from treating such positions as hedging or mitigating their commercial 
risk.
    Commenters expressed particular concern that the term ``trading'' 
could be interpreted to include entering and exiting swap positions 
used to hedge or mitigate commercial risk and therefore such swaps 
would be ineligible for the end-user exception.\61\ For example, WGCEF 
commented that a ``trading'' position held in anticipation of a 
potential price increase should qualify as hedging commercial risk, but 
under the proposed rule it could be interpreted as a ``trading'' 
position and not qualify for the end-user exception.
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    \61\ See, e.g., Hess, WGCEF, EPSA, and Peabody.
---------------------------------------------------------------------------

    Similarly, BG LNG, API, and WGCEF believe, based on their reading 
of footnote 23 of the NPRM, that certain swaps entered into for the 
purpose of hedging physical market positions could be excluded. 
According to BG LNG and EPSA, any rule that prohibits the end-user 
exception from being applied generally to swaps that hedge physical 
market positions because they are classified as ``trading'' positions 
or ``speculative'' positions would have serious, adverse consequences 
to physical markets for energy and other commodities. Also in reference 
to footnote 23 in the NPRM, WGCEF and BG LNG commented that many swaps 
that represent ``arbitrage'' positions are themselves hedges of 
commercial risk and not the type of speculative swaps that should be 
denied the end-user exception. BG LNG further commented that the 
unwinding or offsetting of such swaps should not change their 
characterization as ``hedging or mitigating commercial risk.''
    API, EPSA, and WGCEF recommended that the Commission clarify that 
swap positions that hedge other speculative or trading swap positions 
are also speculative or trading positions, unless such swap positions 
hedge physical commodity positions.
    Cravath and Riverside commented that ``investments'' should be 
deleted from the limitation, noting that certain swaps that hedge or 
mitigate commercial risks specified in the rule may be treated as 
investments for accounting or other purposes.
    Finally, WGCEF noted that ``trading,'' ``speculation,'' and 
``investing'' were not defined in the proposed rule or the CEA.
    The Commission is adopting Sec.  39.6(c)(2)(i) as proposed. While 
the line between hedging or mitigating commercial risk and other uses 
of swaps can be difficult to discern at times, the Dodd-Frank Act 
nonetheless requires such determinations to be made. The Commission 
believes that explicitly prohibiting the end-user exception for swaps 
entered into for the purpose of speculating, investing, or trading, as 
opposed to swaps used for the purpose of hedging or mitigating 
commercial risk, will help entities to understand the limits of hedging 
or mitigating commercial risk for purposes of Sec.  39.6 and will help 
prevent abuse of the exception.
    The Commission believes that the meaning of Sec.  39.6(c)(2)(i) is 
apparent when read in the overall context of Sec.  39.6(c), which 
addresses the requirement in Section 2(h)(7)(A)(ii) of the CEA that the 
electing counterparty be using the swap to hedge or mitigate commercial 
risk. This requirement

[[Page 42574]]

focuses on the purpose for which the potential electing counterparty is 
using the swap. Swaps executed for the purpose of speculating, 
investing, or trading are not being used to hedge or mitigate 
commercial risk. Such positions are, generally speaking, being executed 
primarily for the purpose of taking an outright view on market 
direction or to obtain an appreciation in value of the swap position 
itself and not primarily for hedging or mitigating underlying 
commercial risks. For example, swap positions held primarily for the 
purpose of generating profits directly upon closeout of the swap, and 
not to hedge or mitigate underlying commercial risk, are speculative or 
serve as investments. Further, as an alternative example, swaps 
executed for the purpose of offsetting potential future increases in 
the price of inputs that the entity reasonably expects to purchase for 
its commercial activities serve to hedge a commercial risk.
    As noted above, several commenters expressed concern regarding the 
inclusion of ``trading'' in Sec.  39.6(c)(2)(i). In the context of the 
rule, ``trading'' is not used to mean simply buying and selling. 
Rather, a party is using a swap for the purpose of trading under the 
rule in this context when the party is entering and exiting swap 
positions for purposes that have little or no connection to hedging or 
mitigating commercial risks incurred in the ordinary course of 
business. ``Trading,'' as used in Sec.  39.6(c)(2)(i), therefore would 
not include simply the act of entering into or exiting swaps if the 
swaps are used for the purpose of hedging or mitigating commercial 
risks incurred in the ordinary course of business.\62\
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    \62\ The Commission further clarifies that merchandising 
activity in the physical marketing channel qualifies as commercial 
activity, consistent with the Commission's longstanding bona fide 
hedging exemption to speculative position limits. See Sec.  
1.3(ttt)(1)(ii).
---------------------------------------------------------------------------

    The Commission acknowledges that some swaps that may be 
characterized as ``arbitrage'' transactions in certain contexts may 
also reduce commercial risks enumerated in Sec.  39.6(c)(1). The 
discussion in footnote 23 of the NPRM was intended to clarify that 
swaps are speculative for purposes of the rule if entered into 
principally and directly for profit and not principally to hedge or 
mitigate commercial risk. The reference to ``arbitrage profits'' in 
footnote 23 was intended to provide an example of what is commonly a 
speculative swap, not to characterize all arbitrage swaps as 
speculative.
    The Commission is not revising Sec.  39.6(c)(2)(i) to provide an 
express exception for swaps related to physical commodity positions. 
Swaps related to physical positions are not always hedging or 
mitigating commercial risk. For example, a swap related to physical 
positions may be a speculative position taking an outright view of the 
underlying commodity market. In limiting the end-user exception to 
swaps that hedge or mitigate commercial risk, Congress did not provide 
an exception from that limitation for swaps related to physical 
positions.
    The Commission also notes that some commenters may have interpreted 
the proposed rule as prohibiting an entity that claims the end-user 
exception with respect to certain swaps from entering into other swaps 
for the purpose of speculation, investing, or trading. The Commission 
reiterates that a party's ability to elect the end-user exception for a 
particular swap is a function of the purpose of the particular swap in 
question. The fact that a party enters into other unrelated swaps for 
the purpose of speculating, investing, or trading will have no effect 
on the counterparty's assessment of whether its other swaps meet the 
requirements of the rule.
8. Swaps Hedging Other Swaps
    Under proposed Sec.  39.6(c)(2)(ii), a swap that hedges or 
mitigates the risk of another swap or security-based swap may qualify 
as hedging or mitigating commercial risk only if the underlying swap or 
security-based swap itself is used to hedge or mitigate commercial 
risk.
    Professor Greenberger generally agreed with the limitation in the 
proposed rule and recommended that the limitation be extended to all 
swaps hedging other swaps. In his view, hedges of other hedging swaps 
are inherently speculative and should not be allowed under the end-user 
exception.
    Reval.com, Inc. (Reval) suggested that swap transactions that are 
executed on a ``matched book'' basis with swaps that are excepted from 
the clearing requirement should also be eligible for the clearing end-
user exception. Several small or regional financial entities commented 
that swaps executed on a matched book or back-to-back basis with swap 
dealers, which hedge swaps executed with non-financial entities who 
themselves are using the swaps to hedge commercial risks, should get 
the benefit of the end-user exception.\63\
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    \63\ See, e.g., Susquehanna Bancshares, Inc., The Private Bank 
and Trust Company, Commerce Bank, Atlantic Capital Bank, Trustmark, 
Webster Bank, UMB Bank, Chatham Financial, and Wintrust.
---------------------------------------------------------------------------

    The Commission considered whether a swap that hedges another swap 
that itself is used to hedge or mitigate commercial risk could qualify 
for the end-user exception. The Commission determined that such a swap 
could qualify if it in fact hedges or mitigates commercial risk for a 
party entering into the swap. In connection therewith, the Commission 
has determined that ``matched book'' or ``back-to-back'' swaps that 
hedge or mitigate risks of other swaps may qualify for the end-user 
exception if the swap is used to reduce risks in the conduct and 
management of a commercial enterprise as set forth in Sec.  39.6(c)(1) 
and the ``other swap'' itself qualifies for the end-user exception. 
This is why Sec.  39.6(c)(2)(ii) provides that a swap that hedges or 
mitigates the risk of another swap or security-based swap may qualify 
as hedging or mitigating commercial risk, so long as the underlying 
swap or security-based swap itself is used to hedge or mitigate 
commercial risk. This provision allows successive swaps in a chain of 
back-to-back swaps to qualify for the end-user exception if the first 
underlying swap qualifies for the exception, and each such successive 
swap is used by a party to that successive swap that qualifies for the 
end-user exception to hedge or mitigate commercial risk. This result is 
only applicable to entities that could otherwise qualify for the end-
user exception. Accordingly, in a chain of qualifying swaps involving 
only qualifying entities, if the ``last'' qualifying entity in the 
chain hedges its qualifying swap (its ``underlying swap'') by entering 
into a qualifying swap with a non-qualifying financial entity (its 
``hedging swap''), then although the qualifying entity can elect to use 
the end-user exception with respect to its hedging swap, that financial 
entity cannot elect the end-user exception for any further swap used by 
that financial entity to hedge or mitigate its position. In effect, the 
chain is then broken.
    Reval's comment indicates that the text of proposed Sec.  
39.6(c)(2) may be unclear. When the wording of proposed Sec.  39.6(c) 
is read as a whole, the proposed rule provides that a swap qualifies 
for the end-user exception if it meets one of the conditions stated in 
proposed Sec.  39.6(c)(1) and if, as stated in proposed Sec.  
39.6(c)(2), the swap is (i) not held for a speculative, investing, or 
trading purpose, or (ii) not hedging another swap unless that swap 
itself is held for hedging purposes. Accordingly, the literal text of 
proposed Sec.  39.6(c)(2) could be interpreted to permit a swap to 
qualify for the end-user exception if the

[[Page 42575]]

swap is not hedging another swap (i.e., if the second clause is 
satisfied), even if the swap is itself held for a speculative, 
investing, or trading purpose (i.e., if the first clause is not 
satisfied).
    The NPRM stated that ``[p]roposed Sec.  39.6(c)(2) further 
provides, however, that a swap is disqualified from the end-user 
exception if it is held for a speculative, investing, or trading 
purpose, or if it hedges another swap unless that swap itself is held 
for hedging purposes.'' \64\ In other words, proposed Sec.  39.6(c)(2) 
provides that a swap would be disqualified from the end-user exception 
if either of two conditions were true: If the swap is held for a 
speculative, investing, or trading purpose, or if the swap hedges 
another swap unless that swap itself is held for hedging or mitigating 
purposes.
---------------------------------------------------------------------------

    \64\ 75 FR at 80752 (footnote omitted).
---------------------------------------------------------------------------

    Accordingly, the Commission is revising the text of Sec.  
39.6(c)(2) to clarify the rule text in accordance with the intended 
purpose by replacing the conjunction ``or'' between clauses (i) and 
(ii) in Sec.  39.6(c)(2) with the conjunction ``and.'' \65\ This 
clarifies that, in order to qualify for the end-user exception, the 
swap must not be used for the purposes stated in Sec.  39.6(c)(2)(i), 
and it must not be used for the purposes stated in Sec.  
39.6(c)(2)(ii). The final rule adopted by the Commission includes this 
change.
---------------------------------------------------------------------------

    \65\ The Commission notes that in the definition of ``hedge or 
mitigate commercial risk'' proposed by the Commission for purposes 
of defining ``major swap participant'' under Section 1a(33) of the 
CEA, there was no conjunction between clauses (i) and (ii). See 
Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant,'' 75 FR 80174, 
80214, 80217 (Dec. 21, 2010) (proposed Sec.  1.3(ttt)(2)). However, 
the Commission added the conjunction in the final definition. See 77 
FR 30596 at 30750 (May 23, 2012) (final Sec.  1.3(kkk)(2)).
---------------------------------------------------------------------------

    In response to Professor Greenberger's comment, the Commission does 
not believe that a swap that hedges an existing hedge is always 
speculative. The CEA does not require that the end-user exception be 
available only if the swap is a perfect or exact hedge. A swap 
originally designed to hedge commercial risk in compliance with the 
criteria of the rule may, over time, no longer fully serve its original 
hedging purpose. For example, if the underlying commercial risk hedged 
by the original swap or security-based swap no longer exists or changes 
as a result of changing market conditions or changes in the business 
needs of the electing counterparty, the risk now posed by the original 
swap or security-based swap itself is like other commercial risks that 
arose in the ordinary course of business because that swap originated 
as a hedge of commercial risk. Accordingly, as the Commission has 
stated that the entities shall evaluate the facts and circumstances 
existing at the time a hedge position is initiated \66\ when electing 
the end-user exception, the entity should have the option to elect the 
end-user exception for swaps that hedge or mitigate risks created by 
the original swap or security-based swap, even if the original risk 
hedged no longer exists or has changed.
---------------------------------------------------------------------------

    \66\ See section II.C.9 herein.
---------------------------------------------------------------------------

9. Portfolio and Dynamic Hedging, and Hedge Effectiveness Testing
    In the NPRM, the Commission asked whether the end-user exception 
should apply to swaps that hedge or mitigate commercial risk on a 
single-risk basis or an aggregate-risk basis or to swaps that 
facilitate dynamic hedging. The Commission also asked whether hedge 
effectiveness should be addressed.
    A number of commenters stated that portfolio hedging and dynamic 
hedging may hedge or mitigate commercial risk, and are commonly used by 
certain potential electing counterparties, and therefore the hedging 
techniques should be eligible for the end-user exception.\67\ WGCEF, 
Shell, and ATA noted that commercial firms in the physical energy and 
other markets often hedge underlying physical assets and related 
positions on a portfolio or aggregate basis and also may dynamically 
hedge. WGCEF stated that in such cases it would be impracticable to 
have one-to-one matching of each swap to a specific physical 
transaction or asset for purposes of complying with the end-user 
exception. EEI & EPSA and WGCEF commented that excluding hedging of 
commercial risks on a portfolio basis or dynamic hedging could 
introduce uncertainty and limit the ability of non-financial entities 
to effectively manage their commercial risks.
---------------------------------------------------------------------------

    \67\ See, e.g., EEI & EPSA, ATA, WGCEF, RESA, Peabody, Kraft, 
and American Public Power Association & Large Public Power Council.
---------------------------------------------------------------------------

    Regarding hedge effectiveness, a number of commenters stated that 
it is important for entities to know at the time a transaction is 
executed whether the end-user exception applies. According to these 
commenters, an effectiveness test should not be used because it can 
only determine whether the swap appropriately hedges or mitigates 
commercial risk at the time of the test and not at the time of swap 
execution.\68\ EDF Trading suggested that ``reasonable efforts to hedge 
commercial risks'' should be considered hedging. EDF Trading noted that 
tracking and analyzing the hedging or mitigating characteristics of a 
swap after its inception would be difficult because the hedging value 
of a swap fluctuates over time and is subject to market forces. EDF 
Trading further noted that such uncertain market fluctuations are the 
principal reason for entering into hedging transactions in the first 
place. EDF Trading believes that requiring an ongoing, periodic 
assessment of a hedge's effectiveness or purpose would be burdensome 
for commercial entities and would do little to reduce systemic risk.
---------------------------------------------------------------------------

    \68\ See, e.g., ATA, APGA, Cravath, EDF Trading, and Kraft.
---------------------------------------------------------------------------

    CFI suggested that a requirement to report the related risk being 
hedged, which would be necessary to test hedge effectiveness, would 
impose an unnecessary burden on electing counterparties. In contrast, 
Better Markets and PMAA & NEFI commented that entities should be 
required to disclose what specific risks they are hedging and how the 
swap hedges those risks so that regulators can police the end-user 
exception. Furthermore, Better Markets stated that entities should have 
to certify that excepted swaps are not entered into for speculation 
either in whole or in part.
    The Commission has determined that a swap that facilitates 
portfolio hedging or dynamic hedging may be eligible for the end-user 
exception if that swap hedges or mitigates commercial risk. The 
Commission acknowledges that portfolio hedging and dynamic hedging \69\ 
can be economically appropriate to hedge or mitigate commercial risk, 
depending on the relevant facts and circumstances.
---------------------------------------------------------------------------

    \69\ Regarding commenters' queries about dynamic hedging, which 
WGCEF described as the ability to modify the hedging structure 
related to physical assets or positions when relevant pricing 
relationships applicable to that asset change, the Commission notes 
that qualification as bona fide hedging does not require that 
hedges, once entered into, must remain static. The Commission 
recognizes that entities may update their hedges periodically when 
pricing relationships or other market factors applicable to the 
hedges change.
---------------------------------------------------------------------------

    The Commission has also determined that parties will not be 
required to demonstrate hedge effectiveness or engage in periodic hedge 
effectiveness testing. The Commission agrees with commenters that 
entities need to know whether the swap is eligible for the end-user 
exception at the time it is executed and should not be subject to 
second guessing if subsequent hedge effectiveness testing finds that 
the swap does not, over time, hedge the intended risk as such 
ineffectiveness may be beyond the control of the electing counterparty. 
Furthermore, the Commission believes that such a

[[Page 42576]]

requirement could potentially add costs and burdens with potentially 
limited added benefit.
    Finally, the Commission has determined not to require entities to 
document and report the risk being hedged. The Commission believes that 
such a requirement would create a large volume of unique data that 
would be difficult to meaningfully review. Although the Commission has 
determined not to modify Sec.  39.6 to address portfolio hedging or 
dynamic hedging at this time, the Commission recognizes that the end-
user exception could be more easily abused in these contexts. The 
Commission intends to monitor use of the end-user exception and if such 
abuse becomes prevalent, it may impose appropriate hedge identification 
and/or hedge effectiveness testing or reporting requirements.
10. Swap-by-Swap or Swap Portfolio Approach
    In a comment submitted prior to publication of the NPRM, NYCBA 
requested clarification as to whether all swaps entered into by a 
party, or only a certain percentage of the party's swap portfolio, must 
hedge or mitigate commercial risk for the party to qualify for the end-
user exception. In proposed Sec.  39.6, whether a commercial risk is 
being hedged or mitigated would be determined for each swap, not for 
all or a portion of a party's swap portfolio.
    As noted above, Section 2(h)(7)(A)(ii) of the CEA provides that a 
swap shall not be subject to the clearing requirement if, among other 
things, one of the counterparties to the swap ``is using swaps to hedge 
or mitigate commercial risk * * *.'' The Commission does not believe 
that Congress intended this language to automatically apply to all 
swaps--no matter how numerous and no matter what their purpose--used by 
an entity that uses some swaps to hedge or mitigate commercial risk. 
Such an interpretation would extend the end-user exception beyond its 
purpose of facilitating the use of swaps for hedging or mitigating 
commercial risk. Conversely, the statutory language does not clearly 
limit the end-user exception to entities that use swaps solely to hedge 
or mitigate commercial risk. Implementation of Section 2(h)(7)(A)(ii) 
thus requires the Commission to determine how the provision should be 
applied to entities that use swaps to hedge or mitigate commercial risk 
but also for other purposes.
    Broadly speaking, there are two possible ways to do this: Either on 
a swap-by-swap basis or based on an entity's overall portfolio of 
swaps. The former approach has a number of important advantages and the 
Commission therefore is adopting the swap-by-swap approach as proposed. 
This approach is consistent with the swap-by-swap clearing requirement 
in Section 2(h)(1) of the CEA. The portfolio approach would present 
numerous issues that would be difficult to overcome or would render the 
end-user exception less effective for achieving the stated goals of the 
Dodd-Frank Act. For example, if the Commission required that a certain 
minimum percentage of a party's swaps must hedge or mitigate commercial 
risk, the end-user exception would be unavailable to parties who do not 
reach the minimum threshold. This could prevent a large number of non-
financial entities from using the end-user exception at all. It is 
unlikely that Congress intended such a result. In addition, if the 
Commission required a high percentage of a party's swap portfolio to 
hedge or mitigate commercial risk, potential electing counterparties 
could be more inclined to abuse the end-user exception and evade 
clearing by classifying non-hedging swaps as hedges to meet the 
threshold set forth in the rule. Another concern is that, if a party's 
swap portfolio satisfied the percentage requirement, the party could 
elect the end-user exception for all swaps, including swaps that do not 
hedge or mitigate commercial risk, thereby undermining the systemic 
risk reduction benefits of the clearing requirement. A swap-by-swap 
approach is thus consistent with Section 2(h)(7)(F), which authorizes 
the Commission to prescribe rules to prevent abuse of the end-user 
exception to the clearing requirement, and Section 2(h)(4)(A), which 
directs the Commission to prescribe rules as determined by the 
Commission to be necessary to prevent evasions of the clearing 
requirement.
    The Commission also believes the percentage approach would be 
difficult to apply as a rule. In addition to determining whether each 
swap hedges or mitigates commercial risk to calculate a swap portfolio 
percentage, each such entity would need to repeatedly measure and 
report portfolio hedging percentages to maintain compliance. A 
percentage-of-portfolio test could lead to significant regulatory 
uncertainty given the difficulty of measuring the percentage of swaps 
that hedge or mitigate commercial risk over time as the portfolio 
changes.
11. Consistency Across Commission Regulations
    The Commission asked in the NPRM whether the criteria for hedging 
or mitigating commercial risk should be consistent across all 
Commission regulations. Section 1a(33) of the CEA, which defines 
``major swap participant,'' provides for an exclusion of certain swap 
positions held for ``hedging or mitigating commercial risk'' from the 
determination of whether an entity maintains a substantial position in 
swaps. For purposes of Section 1a(33) and the Commission's definition 
of ``major swap participant'' in Sec.  1.3(hhh), the Commission has 
adopted Sec.  1.3(kkk) to provide criteria for what constitutes 
``hedging or mitigating commercial risk.'' \70\
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    \70\ 77 FR 30596 at 30750 (May 23, 2012).
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    A number of commenters recommended that the criteria for hedging or 
mitigating commercial risk be consistent across all Commission 
regulations. These commenters do not believe it is appropriate to have 
different hedging criteria under the ``major swap participant'' 
definition and end-user exception.\71\ The ABA recommended that the 
Commission cross-reference the hedging criteria used in the ``major 
swap participant'' definition rather than include separate but 
identical criteria in the end-user exception to avoid the possibility 
of inadvertent or inconsistent amendments and interpretations.
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    \71\ See, e.g., ABA, COPE, EMUS, ICBA, Reval, FHL Banks, Philip 
Morris, and EDF Trading.
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    The ``hedging or mitigating commercial risk'' criteria set forth in 
Sec.  1.3(kkk) and Sec.  39.6(c) are consistent. The Commission has 
determined that the criteria will remain as consistent as possible to 
facilitate consistent interpretation across the CEA and Commission 
regulations. However, application of the phrase ``hedging or mitigating 
commercial risk'' serves similar, but different purposes in the two 
rules. In addition, while the ``major swap participant'' definition 
allows for application of the criteria to financial entities, pursuant 
to the limitations in Section 3(h)(7)(C) of the CEA, the end-user 
exception does not. Accordingly, there is a reasonable possibility that 
the Commission may determine that the two criteria should be modified 
in different ways in the future. Therefore, the Commission has 
determined to publish the criteria in separate rules rather than 
incorporate them by reference.

[[Page 42577]]

D. Exemption of Small Banks, Savings Associations, Farm Credit System 
Institutions, and Credit Unions From the Definition of ``Financial 
Entity''

    Section 2(h)(7)(C)(ii) of the CEA provides that the Commission 
``shall consider whether to exempt from the definition of `financial 
entity' small banks, savings associations, farm credit system 
institutions and credit unions including:
    (I) Depository institutions with total assets of $10,000,000,000 or 
less;
    (II) Farm credit system institutions with total assets of 
$10,000,000,000 or less; or
    (III) Credit unions with total assets of $10,000,000,000 or less.''
    For purposes of this discussion, all banks, savings associations, 
farm credit system institutions, and credit unions, regardless of size, 
are referred to as ``Section 2(h)(7)(C)(ii) institutions'' and the 
subgroup of Section 2(h)(7)(C)(ii) institutions that are eligible for 
exemption from the ``financial entity'' definition are collectively 
referred to as ``small financial institutions'' or ``SFIs.''
    In the NPRM, the Commission requested comment regarding the 
appropriateness, breadth, risk issues, and limits of an exemption for 
Section 2(h)(7)(C)(ii) institutions. The Commission also asked whether 
there are appropriate measures for determining whether a Section 
2(h)(7)(C)(ii) institution qualifies as a small financial institution 
other than the $10 billion or less total assets test referenced in the 
CEA.
    A number of commenters supported defining SFIs broadly,\72\ but AFR 
stated that only those small banks that engage in de minimis swap 
activity should be exempted. CII opposed extending the end-user 
exception to small Section 2(h)(7)(C)(ii) institutions because doing so 
``would help preserve a hole in the oversight and regulation of 
derivatives that would likely be exploited to the detriment of the 
capital markets.''
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    \72\ See, e.g., CUNA, FHL Banks, 19 Small Banks, MBCA, Frost, 
FTNF, ICBA, PCBB, and Reval.
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    A number of commenters \73\ recommended that the Commission provide 
an exemption for SFIs because most small Section 2(h)(7)(C)(ii) 
institutions only offer swaps to customers in connection with loans for 
the customers' commercial business activities, and the related swaps 
hedge interest rate risk. These commenters noted that such swaps are 
not speculative in nature and are generally low risk. The small Section 
2(h)(7)(C)(ii) institutions then enter into swaps with other financial 
institutions, often on a matched or back-to-back swap basis, to hedge 
the underlying risk of those customer swaps. According to these 
commenters, such matched or back-to-back swaps pose less risk to the 
small Section 2(h)(7)(C)(ii) institutions. For example, MBCA commented 
that ``[small Section 2(h)(7)(C)(ii) institutions] participate in the 
swaps markets for purposes of hedging interest rate risk on their 
balance sheets and offering swaps in connection with loans as a means 
to deliver long-term fixed rate financing to commercial borrowers.'' 
Also, these commenters noted that the swaps are often secured by assets 
funded by the loans and those assets are not liquid. The lack of 
liquidity of the security means that the small Section 2(h)(7)(C)(ii) 
institutions cannot simply pass on the security to a DCO as collateral 
for the matched swaps and must fund the collateral posted to DCOs in 
other ways.
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    \73\ See, e.g., ICBA, 19 Small Banks, MBCA, FCC, Chatham, FTNF, 
Trustmark, UMB, Webster Bank, and Wintrust.
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    Commenters also claimed that requiring small Section 2(h)(7)(C)(ii) 
institutions to clear swaps would impose inordinate costs on them. 
Chatham and Webster Bank noted that the fees charged by futures 
commission merchants to clear swaps could be significant for Section 
2(h)(7)(C)(ii) institutions that are ineligible for the end-user 
exception and did not previously clear their swaps, especially those 
institutions that transact only a small number of swaps. They indicated 
that these fees generally take the form of a fixed minimum monthly fee, 
plus a ``ticket'' fee that varies with the volume of swap transactions 
processed.\74\ ABA and ICBA commented that if small Section 
2(h)(7)(C)(ii) institutions have to incur high fixed costs for 
clearing, they might refrain from entering into swaps to avoid having 
to incur such costs.
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    \74\ Chatham indicated that Section 2(h)(7)(C)(ii) institutions 
will spend between $2,500 and $25,000 in legal fees related to 
reviewing and negotiating clearing-related documentation, and a 
Section 2(h)(7)(C)(ii) institution will spend a minimum of between 
$75,000 and $125,000 per year on fees paid to each FCM with which it 
maintains a relationship. Webster Bank corroborated these numbers 
and also noted that a Section 2(h)(7)(C)(ii) institution will incur 
additional costs from DCO fees, which vary based on collateral 
delivered.
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    ABA and 19 Small Banks commented that Section 2(h)(7)(C)(ii) 
institutions should be exempted because applicable banking regulations 
and guidance require banks to establish internal risk management 
policies and procedures for all operations and activities, including, 
in some cases, for swap transactions. ABA also noted that banks are 
limited by the banking regulations applicable to them as to the amount 
of credit they can extend to each individual or entity to a specified 
percentage of capital and reserves.
    FCC recommended that the Commission adopt rules that would permit 
farm credit system (FCS) associations and banks to exercise the end-
user exception. FCC noted that FCS associations have, on average, total 
assets under $10 billion, and that FCS banks may have total assets 
exceeding $10 billion. According to FCC, these FCS institutions are 
cooperatives owned by their members, and a major function of each 
cooperative is to act on behalf of its members in the financial 
markets. FCC further noted that the members of these cooperatives are 
generally either non-financial entities or small financial 
institutions. FCC reasoned that, because an FCS cooperative essentially 
is taking the place of its members to face the larger financial markets 
on behalf of the members, the end-user exception that would be 
available to the cooperative's members should pass through to the 
cooperative. In addition, FCC noted that the Farm Credit Administration 
effectively regulates FCS institutions; FCS institutions only enter 
into safe, non-speculative swaps primarily related to member loans 
backed by collateral; and, unlike large banks, the FCS institutions are 
not as interconnected with other financial entities.
    Regarding the criteria for determining whether a Section 
2(h)(7)(C)(ii) institution is eligible for the exemption, a number of 
commenters recommended that the Commission allow institutions with more 
than $10 billion in assets to qualify for the exemption.\75\ FCC 
commented that Congress provided the Commission with the authority to 
exempt financial institutions with more than $10 billion in assets. A 
number of commenters \76\ suggested raising the threshold to $30 
billion or higher. Frost, FTN, and MBCA recommended a $50 billion 
threshold. 19 Small Banks recommended that institutions with assets 
less than $50 billion and with uncollateralized exposure less than $1 
billion should qualify for the exemption. These commenters suggested 
that historically, the swap activity of financial institutions with 
these higher asset levels is only a small percentage of the total swaps 
market

[[Page 42578]]

and therefore exempting them would not pose risk to the market or the 
financial system.
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    \75\ See, e.g., ABA, FCC, Frost, FTNF, MBCA, Devlin, FHL Banks, 
19 Small Banks, Susquehanna Bancshares, Inc., The Private Bank and 
Trust Company, Commerce Bank, Atlantic Capital Bank, Trustmark, 
Webster Bank, UMB Bank, Chatham Financial, and Wintrust.
    \76\ ABA, Susquehanna Bancshares, Inc., The Private Bank and 
Trust Company, Commerce Bank, Atlantic Capital Bank, Trustmark, 
Webster Bank, UMB Bank, Chatham Financial, and Wintrust.
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    FHL Banks commented that the $10 billion asset level should be the 
baseline for the exemption. For Section 2(h)(7)(C)(ii) institutions 
with more assets, FHL Banks recommended that the Commission establish 
objective criteria for the exemption based on the risk that the 
institution poses to the U.S. financial system. For example, FHL Banks 
suggested that the Commission could look to the institution's current 
uncollateralized exposure as well as its potential future exposure.
    Similarly, FCC commented that the systemic risk created by 
derivatives is not a function of an institution's asset size, but a 
function of the type and amount of derivative activity after netting 
offsetting positions and collateral. According to FCC, small 
institutions that enter into many risky trades pose greater risk to the 
financial system than larger institutions that carefully manage their 
derivatives portfolios. Accordingly, FCC recommended that the 
Commission focus on risk instead of asset size and recommended defining 
``financial entity'' to mean entities with current uncollateralized 
exposure and potential future exposure of $3 billion in rate swaps and 
$1 billion in other major swap categories. FCC noted that such entities 
could be required to report compliance with the risk-based exposure 
test when electing the end-user exception. Similarly, CUNA recommended 
that the Commission should only allow entities with at least $10 
billion in assets and that engage in a ``significant volume'' of swaps 
to qualify for the exemption.
    The Commission is adopting Sec.  39.6(d) to provide an exemption 
from the definition of ``financial entity'' for small Section 
2(h)(7)(C)(ii) institutions. The Commission acknowledges that small 
Section 2(h)(7)(C)(ii) institutions, which tend to serve smaller, local 
markets, are well situated to provide swaps to the customers in their 
markets for the purpose of hedging commercial risk. The Commission also 
acknowledges that historically, as indicated by commenters, a large 
portion of the swaps executed by small Section 2(h)(7)(C)(ii) 
institutions with customers likely hedge interest rate risk associated 
with commercial loans. Many of these loans and the related swaps are 
not secured by cash or other highly liquid collateral, but by less 
liquid assets of the customer such as the property or inventory 
purchased with the loan proceeds. Based on the comments received, it 
appears that small Section 2(h)(7)(C)(ii) institutions typically hedge 
customer swaps by entering into matching swaps in the swap market, and 
if those matched swaps had to be cleared, the small Section 
2(h)(7)(C)(ii) institutions would have to post margin to satisfy the 
requirements of the DCOs.\77\ This arrangement could raise the costs 
for small Section 2(h)(7)(C)(ii) institutions of hedging the risks 
related to these types of customer swaps to the extent they need to 
fund the cost of the margin posted. In addition, the Commission 
acknowledges that some small Section 2(h)(7)(C)(ii) institutions may 
incur initial and annual fixed clearing fees and other expenses that 
may be incrementally higher relative to the small number of swaps they 
execute over a given period of time. Lastly, given the relatively low 
notional volume swap books held by small Section 2(h)(7)(C)(ii) 
institutions \78\ and the commercial customer purposes these swaps 
satisfy, the Commission believes that swaps executed by small Section 
2(h)(7)(C)(ii) institutions are what Congress was considering when it 
directed the Commission to consider an exemption from the ``financial 
entity'' definition for small financial institutions in Section 
2(h)(7)(C)(ii) of the CEA. Accordingly, the Commission believes that it 
is appropriate to exempt small Section 2(h)(7)(C)(ii) institutions from 
the definition of ``financial entity'' in Section 2(h)(7)(C), thereby 
permitting small Section 2(h)(7)(C)(ii) institutions to elect not to 
clear swaps that are otherwise eligible for the end-user exception.\79\
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    \77\ The Commission notes that if a Section 2(h)(7)(C)(ii) 
institution, regardless of its size, executes a swap with a 
customer/counterparty who properly elects the end-user exception for 
that swap, then neither the customer/counterparty nor the Section 
2(h)(7)(C)(ii) institution needs to clear its position in that swap.
    \78\ See Section III.E hereof for information on the volume of 
swaps executed by Section 2(h)(7)(C)(ii) institutions.
    \79\ As noted by the 19 Small Banks in their comment letter, 
``it is important to note that an SFI would not be exempt from 
clearing and trading for any speculative trades. Indeed, SFIs would 
have to meet the same conditions required for the end-user exception 
to mandatory clearing of swaps under Proposed Rule 39.6.''
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    Having determined that an exemption for small Section 
2(h)(7)(C)(ii) institutions is appropriate, the Commission considered 
the comments received regarding whether to use the $10 billion total 
assets threshold identified in Section 2(h)(7)(C)(ii) of the CEA for 
determining what is a ``small'' Section 2(h)(7)(C)(ii) institution, or 
whether to use another test. The Commission has determined to limit the 
exemption to Section 2(h)(7)(C)(ii) institutions with $10 billion in 
total assets or less.\80\ The Commission acknowledges that the $10 
billion level is not required by the CEA. However, the Commission also 
believes that by specifically identifying that asset level three times, 
once for each type of Section 2(h)(7)(C)(ii) institution, Congress 
expressed its clear intent that the Commission should base its 
consideration of what is a ``small'' institution on the $10 billion 
asset level. The Commission therefore believes that it is appropriate 
to use the $10 billion level absent strong and convincing facts or 
circumstances supporting alternative measures.
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    \80\ The Commission's $10 billion threshold is in harmony with 
the SEC's proposed approach to exempt SFIs from clearing security-
based swaps that are subject to mandatory clearing. 75 FR 79992 at 
80011 (Dec. 21, 2010).
---------------------------------------------------------------------------

    The Commission believes that it would be inappropriate to exempt 
Section 2(h)(7)(C)(ii) institutions with substantially higher total 
asset amounts, such as the $30 billion, $50 billion, or higher levels 
recommended by several commenters. Congress has identified large 
financial institutions as more likely to cause systemic risk and has 
directed prudential regulators to consider prudential standards for 
``large'' institutions having assets of $50 billion or more.\81\ 
Although $30 billion in assets is less than the $50 billion level 
identified by Congress as being indicative of ``large'' financial 
institutions, $30 billion is three times greater than the $10 billion 
level identified by Congress in Section 2(h)(7)(C)(ii) as indicative of 
a ``small'' financial institution that should have the benefit of the 
exemption. While some commenters asserted that Section 2(h)(7)(C)(ii) 
institutions with assets in excess of $10 billion have commonly 
executed swaps with customers for the same purposes that smaller 
institutions do, and that these institutions pose less risk to the 
financial system than much larger institutions, these commenters did 
not provide specific data applicable to institutions with $10 billion 
or more of assets that would confirm these assertions.\82\ Accordingly, 
commenters

[[Page 42579]]

did not provide strong and convincing evidence that an asset level 
higher than $10 billion would be more appropriate than the $10 billion 
or less test for distinguishing ``small'' Section 2(h)(7)(C)(ii) 
institutions from others.
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    \81\ See, e.g., Section 165 of the Dodd-Frank Act. (``In order 
to prevent or mitigate risks to the financial stability of the 
United States that could arise from the material financial distress 
or failure, or ongoing activities, of large, interconnected 
financial institutions, the Board of Governors shall, on its own or 
pursuant to recommendations by the Council under section 115, 
establish prudential standards for nonbank financial companies 
supervised by the Board of Governors and bank holding companies with 
total consolidated assets equal to or greater than 
$50,000,000,000.'')
    \82\ Furthermore, although not determinative as to what is 
``small,'' the Commission is concerned that if Section 
2(h)(7)(C)(ii) institutions with assets greater than $10 billion can 
avail themselves of the exemption, these larger institutions, which 
have greater capabilities than institutions with less than $10 
billion of assets, are more likely to increase their swap activities 
at the regional or national level using the commercial advantage 
that the exemption will provide. Accordingly, it is possible that 
the amount of swap activity of these larger institutions could 
increase significantly over time if the exemption were available to 
them.
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    As a basic check on how many institutions could use the exemption 
at the $10 billion total assets level, the Commission looked at how 
many Section 2(h)(7)(C)(ii) institutions had total assets less than $10 
billion and how many had more. Approximately 14,700 Section 
2(h)(7)(C)(ii) institutions were operating in the United States as of 
December 31, 2011. Of those, approximately 120 had total assets greater 
than $10 billion.\83\ The remaining 14,580 institutions had less than 
$10 billion in total assets. In other words, about 99 percent of banks, 
savings associations, farm credit system institutions, and credit 
unions will qualify as SFIs using the $10 billion or less test.\84\ 
While this data did not influence the Commission's consideration of 
what constitutes a ``small'' Section 2(h)(7)(C)(ii) institution, it 
indicates that a high number of Section 2(h)(7)(C)(ii) institutions 
would be able to use the exemption for their hedging swap activities.
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    \83\ Asset level data for banks and savings associations is 
available at fdic.gov, and for credit unions at ncua.gov. Data for 
farm credit system institutions was provided to the Commission by 
the Farm Credit Administration.
    \84\ In mid-2010, the most recent period for which Section 
2(h)(7)(C)(ii) institution swap data could be obtained, 
approximately 1,015 Section 2(h)(7)(C)(ii) institutions had 
outstanding swap exposure. Of those institutions, 138 had total 
assets over $10 billion and 876 had total assets below $10 billion.
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    The Commission also considered whether it should adopt an 
alternative or additional uncollateralized exposure test, as 
recommended by some commenters. As noted above, several commenters 
recommended defining financial institutions that can use the exemption 
based on whether an institution's current and potential future 
uncollateralized swap exposure exceeds a certain threshold. Commenters 
suggested $1 billion or $3 billion as acceptable levels of 
uncollateralized exposure.
    The Commission determined that an uncollateralized exposure test is 
not consistent with the statutory language of Section 2(h)(7)(C) of the 
CEA or the reasons for including a central clearing requirement in the 
Dodd-Frank Act. The Commission takes particular note of the fact that 
in Section 2(h)(7)(C)(ii), Congress focused exclusively on the size of 
the entity, based on total amount of assets, for measuring whether a 
financial institution should be exempt from the ``financial entity'' 
definition. Congress did not direct the Commission to consider whether 
uncollateralized risk exposure should be used for this purpose. 
Furthermore, it is not readily apparent how even full collateralization 
of exposure on a bilateral basis is an effective substitute for 
required clearing in the event of a severe financial shock such as 
occurred in 2008.
    Commenters did not establish how an uncollateralized exposure test 
would be consistent with a definition of ``small'' financial 
institutions. An uncollateralized exposure test based on an entity's 
current and potential future exposure from swaps is not linked to the 
size of the financial institution or its significance to the financial 
system. For example, an uncollateralized exposure test allowing up to 
$1 billion in uncollateralized exposure could allow institutions with 
over $100 billion in assets to qualify as ``small.'' The Commission 
does not believe such a definition would be consistent with the intent 
of allowing an exemption for ``small'' Section 2(h)(7)(C)(ii) 
institutions from the clearing requirement. Had Congress intended such 
a result, it would have directed the Commission to consider exempting 
``low-risk'' institutions.
    In addition, the entity-by-entity uncollateralized exposure tests 
proposed by commenters may not capture the different risks non-cleared 
swaps may pose to the financial system. Any such test would need to 
carefully consider risk factors that the clearing requirement under the 
Dodd-Frank Act addresses, including opaque, non-public risk 
transference among market participants; buildup of risks in individual 
entities (such as the swap dealers with whom Section 2(h)(7)(C)(ii) 
institutions generally hedge swap exposure); effective measurement of 
risk in ever changing markets; and effective risk management frameworks 
for extreme market conditions. In this regard, the Commission does not 
believe that an entity-by-entity uncollateralized exposure test would 
account for: systemic risks that could arise if many Section 
2(h)(7)(C)(ii) institutions are executing non-cleared swaps with only 
one swap dealer that fails, thereby concentrating uncleared 
counterparty risk; whether the Section 2(h)(7)(C)(ii) institutions 
hedging trades are creating other risks because they cannot perfectly 
match the risks being hedged; \85\ rapidly changing market conditions; 
or a systemic liquidity freeze.
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    \85\ For example, if the SFIs internally net large numbers of 
customer trades and then partially hedge the aggregate risk, or use 
hedging swaps based on interest rates or durations that do not match 
the customer swaps precisely, basis risk could be created that could 
become significant in another financial crisis.
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    These risks are mitigated through central clearing. DCOs set margin 
levels and recalculate and collect margin amounts daily (sometimes 
intra-daily) based on changing market conditions. DCOs also use 
established and tested processes to swiftly calculate and cover losses 
resulting from a counterparty default, rapidly closing out or 
transferring the defaulted positions, and using the liquid collateral 
posted as margin by the defaulting party (plus other liquid assets 
available to the DCO, if necessary) to satisfy any losses incurred by 
the DCO in connection with the default. In this way, DCOs are able to 
make whole the market participants using its clearing services, 
notwithstanding a default by a member that may otherwise have been a 
counterparty to many of those market participants on a bilateral 
trading basis. As such, a swap clearing requirement protects the 
financial system from the risks that attend to the interconnectedness 
of the financial system. The interconnectedness of financial 
institutions, particularly large institutions, means that severe shocks 
to the financial system, such as occurred in late 2008, can cause 
liquidity to dry up in a matter of days or change the perceived credit 
quality of institutions overnight, vastly increasing their capital 
requirements. Such rapid changes can cause entities, particularly in 
the banking system, to fail with little or no forewarning. Notably, 
these risks are not necessarily ameliorated by a test that looks at 
uncollateralized exposure, because in the event of a severe financial 
shock, even swaps that are fully collateralized at the mark-to-market 
value on one day can fall into default the next as credit conditions 
change rapidly. In such event, the non-defaulting counterparties become 
exposed to losses that accumulate rapidly, which in turn can lead to 
their default.
    Because the comments have not demonstrated why the Commission 
should interpret ``small'' to mean ``low-risk'' based upon an 
uncollateralized exposure calculus, and why such a calculus is an 
adequate substitute for the benefits provided by required clearing, the 
Commission declines to

[[Page 42580]]

adopt an uncollateralized exposure test at this time.
    With regard to FCC's comments regarding FCS institutions, the 
Commission notes that if any such institution has total assets equal to 
or less than $10 billion, then it is a small financial institution that 
can elect the end-user exception. However, for those FCS institutions 
with assets greater than $10 billion, Section 2(h)(7)(C)(ii) of the CEA 
does not provide special consideration for cooperatives that meet the 
definition of ``financial entity'' and therefore the asset size limit 
applies to them.
    The Commission recognizes that cooperatives exist to serve their 
member owners. The Commission further recognizes that, as described 
above, some cooperatives represent their members in the financial 
markets, and the members of some of these cooperatives are entities 
that could elect the end-user exception if acting alone. Accordingly, 
the Commission may consider providing exemptive relief for financial 
cooperatives through a separate action under its authority in Section 
4(c) of the CEA.

E. Additional Considerations

1. Consultation With Other Regulatory Agencies; Jurisdictional Issues
    Staff of the Federal Energy Regulatory Commission (FERC Staff) 
commented that ``the CFTC should interpret and apply the CEA as amended 
by Dodd-Frank to ensure that CFTC jurisdiction and FERC jurisdiction do 
not overlap.'' FERC Staff believes that, due to FERC's existing 
comprehensive regulation, ``Dodd-Frank terms should be interpreted as 
not applying to any contract or instrument traded in an RTO/ISO market 
pursuant to a FERC accepted or approved rate schedule or tariff. 
Applying Dodd-Frank swaps regulation to RTOs/ISOs is not only 
unnecessary but also potentially harmful.''
    PG&E and SDG&E recommended that the Commission consult and 
coordinate with other regulatory agencies and state commissions (such 
as FERC and the California Public Utilities Commission (CPUC)) to 
assure regulatory consistency and comparability to the extent that 
hedging activities are already regulated. They noted that the costs and 
burdens associated with duplicative or inconsistent regulation would be 
passed through to ratepayers. As an example, PG&E noted that in certain 
instances, the CPUC may direct PG&E, as part of their obligation to 
serve customer load, to perform hedging on behalf of third parties, or 
assist municipalities in making decisions about hedging transactions. 
In such cases where the utility is directed to engage in certain 
derivative transactions by the CPUC, PG&E commented that these 
activities should be exempt from Commission regulation.
    Finally, NRECA stated that the Commission should create a 
``Commission-lite'' regime for non-financial entities that are already 
subject to regulation by energy or environmental federal agencies and 
do not have the infrastructure/personnel of financial entities.
    The Commission has determined not to revise Sec.  39.6 in response 
to these comments. The Commission does not believe the commenters have 
identified a conflict between Sec.  39.6 and other regulations. 
Regulation 39.6 would not prevent entities from entering into swaps 
that do not hedge commercial risk; it would only identify when a swap 
may be excepted from the clearing requirement in accordance with the 
CEA. Accordingly, if other regulators require an entity to enter into 
swaps that do not hedge commercial risk, these entities can still 
execute those swaps and clear them as required under the CEA. However, 
the Commission recognizes that conflict between regulatory regimes may 
arise and the Commission plans to consult with other regulators as 
appropriate.
    Regarding the FERC comment, the Commission notes that Section 
722(f) of the Dodd-Frank Act \86\ provides that the Commission may 
exempt transactions entered into pursuant to, inter alia, a tariff 
approved by FERC or the Public Utility Commission of Texas (which would 
include RTO/ISO transactions) if the Commission determines that such an 
exemption would be consistent with the public interest and the purposes 
of the CEA. Six RTO/ISOs \87\ have submitted a petition for an order of 
exemption pursuant to Section 722(f) of the Dodd-Frank Act. The 
Commission intends to act on this petition expeditiously.
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    \86\ 7 U.S.C. 4(c)(6).
    \87\ The six RTO/ISOs are California Independent System Operator 
Corporation, Electric Reliability Council of Texas, Inc., ISO New 
England Inc., Midwest Independent Transmission System Operator, 
Inc., New York Independent System Operator, Inc., and PJM 
Interconnection, L.L.C.
---------------------------------------------------------------------------

    Regarding FCC's comment, Section 2(h)(7)(C)(ii) of the CEA 
expressly provides the Commission with the authority to exempt certain 
farm credit system institutions from the definition of ``financial 
entity'' along with other SFIs. Such exemptive authority would be 
unnecessary if the clearing requirement was not intended to apply to 
farm credit system institutions.
2. Implementation and Compliance
    The Committee on Capital Markets Regulation (CCMR) and CME Group, 
Inc. (CME) recommended that the end-user exception be finalized early 
in the establishment of the clearing requirement process. CME commented 
that the end-user exception should be finalized early so companies know 
who will be subject to the clearing requirement.
    Other commenters, including EEI & EPSA, Shell, EDF Trading, EEI, 
and CDEU, recommended that the implementation deadline for the Dodd-
Frank Act be extended. EDF Trading and EEI recommended that the 
Commission allow a one-year ``transition period'' following the 
effective date of the Dodd-Frank Act to allow entities to comply with 
the new end-user exception regulations.
    Finally, a number of commenters recommended that the Commission 
delay the Sec.  39.6 reporting requirements. ATA recommended that the 
Commission key implementation of the end-user notification regime to 
the time when SDRs become operational. COPE suggested that the 
reporting requirement not be enforced until reporting systems have been 
largely standardized to avoid the development of multiple, bespoke 
software programs or systems for compliance. NEMA noted that 
significant terms have not been defined and that an overly aggressive 
compliance schedule could force many of its members out of the market 
for financial products because of their concern of being treated as a 
financial entity. NEMA also commented that parties must have sufficient 
time to make the requisite investment in information technology systems 
and to develop compliance plans.
    The Commission has determined that Sec.  39.6 will become effective 
60 days after publication in the Federal Register. However, the 
Commission notes that compliance with Sec.  39.6 will not be necessary 
or possible until swaps become subject to the clearing requirement. The 
Commission's proposed compliance and implementation schedule for the 
clearing requirement gives non-financial entities a minimum of 270 days 
to comply after the Commission issues a clearing requirement 
determination for a swap or group, category, type or class of 
swaps.\88\ Moreover, the Commission has

[[Page 42581]]

stated that no such clearing requirement determinations will become 
effective until the Commission adopts certain related rules.
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    \88\ See 76 FR 58186 (Sept. 20, 2011) (Swap Transaction 
Compliance and Implementation Schedule: Clearing and Trade Execution 
Requirements under Section 2(h) of the CEA).
---------------------------------------------------------------------------

3. Revocation of Election of the End-User Exception
    IECA recommended that the Commission establish regulations that 
would make an election not to clear a swap irrevocable without the 
consent of both parties.
    The Commission notes that Section 2(h)(7)(B) of the CEA provides 
that the application of the end-user exception is solely at the 
discretion of the counterparty to the swap that meets the conditions 
set forth in Section 2(h)(7)(A). Section 2(h)(7) does not address, 
however, whether the electing counterparty may revoke its election and 
choose to clear the swap. The Commission believes that any decision to 
change the clearing status of the swap after it is entered into is a 
contractual matter between the two parties.

III. Consideration of Costs and Benefits

A. Introduction

    The regulations being adopted herein interpret and establish 
qualifying criteria for the end-user exception provided in Section 
2(h)(7) of the CEA from the clearing requirement established in Section 
2(h)(1)(A) of the CEA, as amended by the Dodd-Frank Act. An 
understanding of the costs and benefits of the end-user exception 
requires background understanding of the Section 2(h)(1)(A) clearing 
requirement.\89\
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    \89\ As previously noted, this section states: ``It shall be 
unlawful for any person to engage in a swap unless that person 
submits such swap for clearing to a [DCO] that is registered under 
this Act or a [DCO] that is exempt from registration under [the CEA] 
if the swap is required to be cleared.''
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    Prior to the passage of the Dodd-Frank Act, swap transactions were 
not required to be cleared. In the wake of the financial crisis of 
2008, Congress adopted the Dodd-Frank Act, which, among other things, 
requires the Commission to determine whether a particular swap, or 
group, category, type or class of swaps, shall be required to be 
cleared.\90\ Specifically, Section 723(a)(3) of the Dodd-Frank Act 
amended Section 2(h)(1)(A) of the CEA to make it ``unlawful for any 
person to engage in a swap unless that person submits such swap for 
clearing to a derivatives clearing organization that is registered 
under [the CEA] or a derivatives clearing organization that is exempt 
from registration under [the CEA] if the swap is required to be 
cleared.'' This clearing requirement is designed to reduce counterparty 
risk associated with swaps and, in turn, mitigate the potential 
systemic impact of such risk and reduce the likelihood for swaps to 
cause or exacerbate instability in the financial system.\91\ It 
reflects a fundamental premise of the Dodd-Frank Act: The use of 
properly regulated and functioning central clearing can reduce systemic 
risk.
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    \90\ See Section 2(h)(2) of the CEA, 7 U.S.C. 2(h)(2).
    \91\ When a bilateral swap is moved into clearing, the 
clearinghouse becomes the counterparty to each of the original 
participants in the swap. This standardizes counterparty risk for 
the original swap participants in that they each bear the same risk 
attributable to facing the clearinghouse as counterparty. In 
addition, clearing mitigates counterparty risk to the extent that 
the clearinghouse is a more creditworthy counterparty relative to 
those that each participant in the trade might have otherwise faced. 
Clearinghouses have demonstrated resilience in the face of past 
market stress. Most recently, they remained financially sound and 
effectively settled positions in the midst of turbulent events in 
2007-2008 that threatened the financial health and stability of many 
other types of entities.
---------------------------------------------------------------------------

    Notwithstanding the benefits of clearing, Section 2(h)(7) of the 
CEA provides for the end-user exception if one of the swap 
counterparties: ``(i) Is not a financial entity; (ii) is using swaps to 
hedge or mitigate commercial risk; and (iii) notifies the Commission, 
in a manner set forth by the Commission, how it generally meets its 
financial obligations associated with entering into non-cleared 
swaps.'' Section 2(h)(7)(C)(ii) directs the Commission to consider 
making the end-user exception available to small banks, savings 
associations, credit unions, and farm credit institutions, including 
those institutions with total assets of $10 billion or less, through an 
exemption from the statutory definition of ``financial entity.'' \92\ 
As noted above in section D hereof, for purposes of this final release, 
all banks, savings associations, farm credit system institutions, and 
credit unions, regardless of size, are referred to as ``Section 
2(h)(7)(C)(ii) institutions'' and the subgroup of Section 
2(h)(7)(C)(ii) institutions that are eligible for exemption from the 
``financial entity'' definition are collectively referred to as ``small 
financial institutions'' or ``SFIs.''
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    \92\ See CEA 2(h)(7)(C)(ii).
---------------------------------------------------------------------------

    In this final rulemaking, the Commission is adopting rules 
implementing the end-user exception. More specifically, the final 
rules: (1) Specify the content and manner to effect the required 
Commission notification (i.e., the reporting requirements); (2) 
establish the criteria for determining whether a swap is ``hedging or 
mitigating commercial risk''; and (3) exclude SFIs from the definition 
of ``financial entity'' for purposes of Section 2(h)(7)(A)(i) of the 
CEA, making it possible for them to avail themselves of the end-user 
exception. It is the costs and benefits of this rulemaking that the 
Commission considers in the discussion that follows.
    Important to the Commission's consideration of costs and benefits 
is that this rulemaking is permissive--that is, the election of the 
end-user exception is at the discretion of the counterparty to the swap 
that meets the requisite conditions set forth in the statute and the 
final rule. In addition, except for the reporting required for those 
electing the end-user exception set forth in Sec.  39.6(b), the final 
rule imposes no substantive obligations on the electing parties. 
Rather, the final rule largely clarifies the statute it implements and 
provides specific criteria for certain key terms in the statute 
including ``financial entity'' and ``hedging or mitigating commercial 
risk.''
    This notice also provides statutory interpretation and guidance to 
potential electing counterparties as to whether they are, for example, 
a ``financial entity.'' Although that term is defined in statute, the 
Commission's response to comments regarding application of the 
definition to certain types of entities should yield a substantial, if 
unquantifiable, benefit by providing clarity and reducing uncertainty 
about a market participant's status for purposes of determining the 
availability of the end-user exception. The added clarity provided by 
the Commission's statutory interpretation and guidance, although beyond 
the scope of the Commission's obligation to consider the costs and 
benefits of its regulations or orders under Section 15(a) of the CEA, 
should nevertheless promote greater confidence and integrity in the 
market.
    In the NPRM, the Commission asked for public comment on the costs 
and benefits of the proposed regulations, and specifically invited 
comments on whether: (1) It would be difficult or prohibitively 
expensive for persons to report the information required under the 
proposed rule; (2) there are more feasible and cost effective ways for 
the Commission to receive notification regarding the use of the end-
user exception; (3) the Commission should consider requiring electing 
counterparties to report additional types of information; (4) 
collecting notice information regarding use of the end-user exception 
through SDRs would create significantly greater burdens for some 
parties to swaps compared to others; and (5) the Commission should

[[Page 42582]]

extend the end-user exception to SFIs.\93\ The Commission also asked 
for commenters to provide an explanation for any preferred alternative 
and data to support their comments.\94\
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    \93\ See 75 FR at 80750-80751.
    \94\ Id. at 80754.
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    The Commission received numerous comments addressing various cost 
and benefit considerations of the proposed rule and sought to 
promulgate a final rule that will help swap market participants apply 
the end-user exception in a uniform and accurate manner, balance the 
tradeoff of costs and benefits associated with the exemption, and 
minimize reporting burdens on market participants who elect the 
exception while still providing the Commission the information that it 
needs to monitor the markets and use of the exception by market 
participants. The Commission adopted a number of the alternatives posed 
by commenters, particularly with regard to the final rule's reporting 
requirements.\95\
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    \95\ See, e.g., sections II.B.1, 6, 7, 8, and 9 and II.C.6.
---------------------------------------------------------------------------

    Informed by commenters, the discussion below considers the rule's 
costs and benefits as well as alternatives to the rule. The discussion 
concludes with a consideration of the rule's costs and benefits in 
light of the five factors specified in Section 15(a) of the CEA.

B. Requirement To Consider the Costs and Benefits of the Commission's 
Action Under Section 15(a) of the CEA

    Section 15(a) of the CEA \96\ requires the Commission to consider 
the costs and benefits of its actions before promulgating a regulation 
under the CEA or issuing certain orders. Section 15(a) further 
specifies that the costs and benefits shall be evaluated in light of 
five broad areas of market and public concern: (1) Protection of market 
participants and the public; (2) efficiency, competitiveness and 
financial integrity of futures markets; (3) price discovery; (4) sound 
risk management practices; and (5) other public interest 
considerations. The Commission considers the costs and benefits 
resulting from its discretionary determinations with respect to the 
Section 15(a) factors.
---------------------------------------------------------------------------

    \96\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    In the sections that follow, the Commission considers the costs and 
benefits of final Sec.  39.6, namely: (1) The costs and benefits of the 
reporting requirements; and (2) the costs and benefits of the 
established criteria for determining whether a swap hedges or mitigates 
commercial risk for purposes of Section 2(h)(7)(A)(ii). The former is 
in large part amenable to quantification, but the latter is not due to 
a lack of data about the manner in which swaps are currently being used 
to hedge or mitigate commercial risk and the economic terms thereof. 
Nevertheless, the Commission provides qualitative consideration of the 
costs and benefits of its approach to establishing criteria for 
determining whether a swap hedges or mitigates commercial risk. 
Finally, as required by Sections 2(h)(7)(C)(ii) and 15(a) of the CEA, 
the Commission considers the costs and benefits of exempting SFIs with 
total assets of $10 billion or less from the definition of ``financial 
entity.''
    The costs and benefits of the Commission's action in this 
rulemaking are measured against the level of costs and benefits that 
would exist absent this rulemaking. With respect to each of this 
rulemaking's three elements this is as follows:
     Establishing the reporting requirements. The requirement 
that counterparties availing themselves of the end-user exception 
provide notification to the Commission remains a statutory requisite to 
invoke the exemption, albeit one that is not self-executing.\97\ Thus, 
the foundation against which this rulemaking's costs and benefits are 
measured is the minimum notification that the Commission could 
prescribe to meet the statutory requirement.
---------------------------------------------------------------------------

    \97\ See Section 2(h)(7)(A)(iii) of the CEA.
---------------------------------------------------------------------------

     The ``hedge or mitigate commercial risk'' element. Absent 
this rulemaking, ``hedging or mitigating commercial risk'' remains a 
statutory requisite to invoke the end-user exception.\98\ This 
rulemaking clarifies the Commission's interpretation of the term for 
purposes of implementing and enforcing the CEA's statutory 
requirements. Thus, the foundation against which this rulemaking's 
costs and benefits are measured is the statutory requirement standing 
alone without the clarification that the rulemaking provides.
---------------------------------------------------------------------------

    \98\ See Section 2(h)(7)(A)(ii) of the CEA.
---------------------------------------------------------------------------

     Excluding qualifying SFIs from the definition of 
``financial entity.'' Absent this rulemaking, all financial entities as 
defined in Section 2(h)(7)(C) of the CEA, including all SFIs, are 
statutorily disqualified from the end-user exception pursuant to 
Section 2(h)(7)(A)(i) of the CEA, which specifies that to qualify for 
the end-user exception the counterparty must not be a financial entity. 
Thus, the foundation against which this rulemaking's costs and benefits 
are measured is the statutory requirement that SFIs, as financial 
entities, remain subject to the clearing requirement of Section 
2(h)(1)(A) of the CEA.
    Additionally, with respect to the second and third elements, the 
Commission considers the rulemaking's costs and benefits relative to 
alternatives besides that of abstaining from action. In the case of 
articulating reporting requirements, which is statutorily required, the 
Commission considers the rulemaking's costs and benefits relative to 
prescribing the minimum obligation.
    As discussed in more detail below, the Commission is able to 
estimate certain reporting costs. The dollar estimates are offered as 
ranges with upper and lower bounds, which is necessary to accommodate 
the uncertainty that surrounds them. The Commission notes that the most 
likely outcome with respect to each estimate is a cost above the lower 
bound and below the upper bound. The costs and benefits associated with 
compliance with the Commission's interpretation of the term ``hedging 
or mitigating commercial risk,'' as well as those that result from the 
exemption for SFIs, however, are not readily susceptible to meaningful 
quantification because the requisite data is not available.
    For example, to reasonably estimate quantifiable costs and benefits 
of compliance with this rule's interpretation of ``hedging or 
mitigating commercial risk,'' relative to alternatives, the Commission 
would need sufficient information to determine what swaps would be or 
would not be eligible for the end-user exception under different 
approaches considered by the Commission. This would require the 
Commission to identify a representative sample of market participants 
and collect detailed proprietary information regarding each swap 
position currently on their books, as well as the economic terms of the 
swap transactions entered into by those entities over a certain period 
of time. The Commission would also need detailed information regarding 
each sample member's business practices, current assets, anticipated 
acquisition or disposition of assets, and other financial positions 
related to their commercial operations to determine what swaps are 
``hedging or mitigating commercial risk'' under various approaches 
considered by the Commission.
    To estimate the costs and benefits related to the exemption for 
SFIs, the Commission would need similar information regarding SFIs, 
including detailed information regarding the swap positions and 
activities of those entities and sufficient knowledge of their business 
models, as well as their current and future assets, to determine what

[[Page 42583]]

swaps constitute ``hedging or mitigating commercial risk.'' Again, the 
data necessary to calculate such estimates is largely proprietary, not 
available to the Commission, and was not provided by commenters. 
Notwithstanding these limitations, the Commission identifies and 
considers the costs and benefits of these aspects of the rule in 
qualitative terms.

C. Reporting Requirements

1. Introduction
    Under Section 2(h)(7)(A)(iii) of the CEA, a condition to electing 
the end-user exception is that the electing counterparty ``notifies the 
Commission in a manner set forth by the Commission how it generally 
meets its financial obligations associated with entering into non-
cleared swaps.'' Regulation 39.6(b) provides a mechanism for such 
reporting to the Commission and also requires the reporting 
counterparty to report that the end-user exception is being elected, 
who the electing counterparty is, and that the swap hedges or mitigates 
commercial risk. In addition, Section 2(j) of the CEA provides that any 
exception to the clearing requirement of Section 2(h)(1) of the CEA and 
the trading requirement of Section 2(h)(8) of the CEA are only 
available to an SEC Filer if the decision to enter into swaps subject 
to such exceptions has been reviewed by an appropriate committee of the 
governing body of the SEC Filer. Regulation 39.6(b)(1)(iii)(D)(2) would 
require reporting of confirmation by the SEC Filer that such review has 
occurred. The information reported under Sec.  39.6(b) is needed for 
the Commission to be able to determine when the end-user exception is 
being used and to monitor compliance with the exception.
    In the NPRM, the Commission contemplated swap-by-swap reporting of 
all the information required. As described below, the Commission 
received comments in response suggesting that the reporting 
requirements were burdensome and that less costly options may be 
available. In response to those comments, the Commission has made 
changes to the final rule that allow an electing counterparty to report 
certain information on an annual basis and to clarify that SEC Filers 
can obtain general approval of the end-user exception. The Commission 
believes that these changes will create significant cost reductions and 
benefits for electing and reporting counterparties, as described below. 
In addition, as described in more detail in Section II.B.3 above, the 
Commission has confirmed that the simple ``check-the-box'' reporting 
mechanism proposed in the NPRM may be used. A number of commenters 
agreed that this mechanism would greatly minimize the reporting burden 
and would provide standardized information that will be easily 
reviewable for regulatory purposes.
    The discussion below of the rule's reporting requirements is 
divided into three parts. The first part covers the reporting 
requirements under the rule generally, the second addresses the SEC 
Filer reporting requirements, and the third provides specific cost 
estimates. Consideration of alternatives is incorporated within the 
first two parts.
2. Reporting Generally
    In the NPRM, the Commission contemplated requiring the reporting 
counterparty to provide all information required under the rule on a 
swap-by-swap basis. The Commission received comments that swap-by-swap 
reporting of all information required to be reported under the rule 
could be more burdensome than necessary and that other alternatives are 
available, such as annual or other periodic reporting, submission of 
contracts or contract summaries, separate reduced reporting 
requirements for certain small entities, or reliance on contract 
representations by electing counterparties instead of reporting.\99\
---------------------------------------------------------------------------

    \99\ See, e.g., Cravath, AGA, APGA, SFG, Noble, NCHSA, API, 
CDEU, Shell, SDG & E, Peabody, FHL Banks, NRECA, WSPP, IPA, COPE, 
WGCEF, EDF Trading, Hess, EEI & EPSA, API, IECA, and NMPF.
---------------------------------------------------------------------------

    After consideration of these comments, the Commission believes that 
certain information required to be reported by Sec.  39.6(b) could be 
reported on an annual basis without significantly compromising its 
value to the Commission and the public, and that such an approach is 
likely to be more cost-effective. Therefore, in response to these 
comments, the Commission revised the rule to require reporting of the 
following for each swap for which the end-user exception is elected: 
(1) That the election of the exception is being made; (2) which party 
is the electing counterparty; and (3) certain information specific to 
the electing counterparty unless that information has already been 
provided by the electing counterparty through an annual filing. The 
third set of information comprises data that is likely to remain 
relatively constant for many electing counterparties and therefore can 
be reported less frequently.
    In making this change in the final rule, the Commission believes 
that allowing the third set of information to be reported on either a 
swap-by-swap basis or on an annual basis is likely to mitigate 
reporting costs from the solely swap-by-swap approach proposed in the 
NPRM because entities will be able to select the most cost-effective 
option.
    As an estimate of cost savings, the Commission expects that the 
annual report will take approximately 30 minutes to 90 minutes to 
complete, but then that information will not have to be reported on a 
swap-by-swap basis, generating incremental savings of one to five 
minutes per transaction. The Commission does not have adequate data to 
estimate these costs in the aggregate. However, the Commission believes 
that the number of swap transactions subject to this rule is likely to 
be quite large, and therefore, the aggregate savings of one to five 
minutes per transaction could be significant. Also, the approach has 
benefits for market participants generally in that the form of data 
provided to the Commission will enable it to exercise its regulatory 
oversight in an efficient and effective manner given the wide variety 
of different types of swaps and swap hedging strategies used by 
potential electing counterparties. Lastly, standardized reports make it 
more feasible for the Commission to conduct periodic auditing, which 
will be less costly to regulators than examining on a case-by-case 
basis possibly unstructured financial data or different contract 
security provisions submitted by electing counterparties.
    The Commission considered the other reporting frequency and 
mechanism alternatives proposed in the comments, but other than the 
annual reporting option provided in Sec.  39.6(b)(2) of the rule, 
determined not to adopt them for several reasons. First, as mentioned 
above, Section 2(h)(7)(A) of the CEA requires an electing counterparty 
to notify the Commission how the counterparty meets its financial 
obligations associated with entering into non-cleared swaps as a 
condition to electing the end-user exception. Accordingly, the 
requirement to report some information is statutory and beyond the 
discretion of the Commission. Second, for swaps that are subject to the 
clearing requirement but are not being cleared, the Commission needs 
notice that the end-user exception is being elected and certain other 
information to assess compliance with Sections 2(h)(1) and (2)(h)(7) of 
the CEA and Sec.  39.6. Third, delivery of agreements to the Commission 
would be almost as burdensome as the check-the-box approach (and in 
some cases more so) and would provide information in non-standard 
formats that would be

[[Page 42584]]

difficult to review for regulatory purposes. Standardized data, on the 
other hand, will facilitate effective review by the Commission. Fourth, 
given the low reporting burden under these rules and the general swap-
by-swap reporting requirements in other regulations (e.g., Part 45), 
the Commission does not believe that a special, lesser reporting 
requirement for smaller parties would result in a materially lower 
burden while still maintaining compliance with the CEA. And last, the 
Commission believes that the check-the-box reporting method, and 
addition of the annual reporting option described above (together with 
the fact that various other information will already be reported for 
each swap pursuant to other provisions of the CEA and other regulations 
promulgated thereunder), minimize the reporting burden.
    EDF Trading, API, MarkitSERV, and COPE raised another concern about 
the costs of reporting. They commented that some potential electing 
counterparties may bear costs in order to implement new reporting 
systems to comply with the reporting requirements. The Commission notes 
that electing counterparties will only incur such costs if they engage 
in swaps with other electing counterparties. If the electing 
counterparty enters into swaps with a swap dealer or a major swap 
participant, the swap dealer or major swap participant will be the 
reporting counterparty.\100\ Based on historical experience, the 
Commission believes that electing counterparties will generally enter 
into swaps with swap dealers and major swap participants, and therefore 
will not be responsible for reporting the swap-by-swap information 
required in this rule. Moreover, even in the absence of this rule, if 
electing counterparties entered into swaps with one another they would 
be required to implement reporting systems in order to meet other swap-
by-swap reporting requirements in the CEA and Commission regulations 
promulgated thereunder. Therefore, the Commission believes that the 
large majority of costs to implement reporting systems are properly 
recognized as the result of swap-by-swap reporting requirements that 
are beyond the scope of this rule. Accordingly, this rule will only 
result in costs to modify those reporting systems in order to provide 
the additional information required by this rule.
---------------------------------------------------------------------------

    \100\ See 77 FR 2136 at 2207 (Jan. 13, 2012) (Swap Data 
Recordkeeping and Reporting Requirements; final rule).
---------------------------------------------------------------------------

    NGSA, NRECA, IECA, and EEI recommended that the Commission provide 
a safe harbor from liability for firms who report on behalf of the 
electing counterparty. The Commission expects that if the electing 
counterparty has not filed an annual report to provide the information 
required in Sec.  39.6(b)(1)(iii), the reporting counterparty may 
choose to conduct some measure of due diligence in order to develop a 
reasonable basis for believing that the information it reports on 
behalf of the electing counterparty is accurate and the swap is 
eligible for the end-user exception. These costs are likely to vary 
depending on the number of electing counterparties with whom each 
reporting counterparty transacts, and the amount of due diligence that 
they choose to conduct, which can vary substantially depending on 
whether the electing counterparty has done an annual filing, the number 
of swaps the reporting counterparty executes within a year, and how 
well the reporting party already knows the electing counterparty's 
financial strategies and policies. The Commission does not believe that 
there is sufficient data to estimate the burden hours that will result 
from this requirement, but believes that: (1) The cost is likely to be 
relatively low; and (2) such information will frequently be collected 
along with other information the reporting counterparty will gather 
from the electing counterparty as part of the process of executing the 
swap and reporting other details required by the CEA and Commission 
regulations. Moreover, it is important to consider these costs in light 
of the benefits achieved by the requirement. The Commission believes 
that the ``reasonable basis'' standard is likely to deter abuse of the 
end-user exception, which could mitigate risks and costs that market 
participants and the public might otherwise face. If the end-user 
exception were abused, it would lead to reduced clearing and 
counterparty protection. If such abuse became widespread, it could also 
reduce the ability of clearinghouses to mitigate the transfer of 
financial instability among counterparties, thereby increasing risks to 
the public.
    Some commenters favored requiring more information regarding the 
types of collateral, exact collateral terms and arrangements, and swap 
contractual terms and provisions.\101\ The Commission determined not to 
require additional information because, on the one hand, the 
information would be costly for counterparties to provide and on the 
other, any such requirement would provide little benefit because it 
would be difficult to capture much of this information in a 
parameterized form, making it challenging to review the information in 
a systematic way.
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    \101\ See, e.g., AFR, AFSCME, Better Markets, PMAA & NEFI, and 
Professor Greenberger.
---------------------------------------------------------------------------

    According to EMUS, the NPRM indicated that the notification 
requirement would apply to all affiliates, while the rule text 
indicated a notification requirement would apply only to finance 
affiliates. In response to EMUS, the Commission is revising proposed 
Sec.  39.6(b)(3) to clarify that the notification requirement only 
applies to financial entities acting as affiliates. The Commission is 
also adding a requirement that electing counterparties report whether 
they are ``financial entities'' as defined in Section 2(h)(7)(C)(i) of 
the CEA that are nevertheless exempt from the definition of ``financial 
entity'' as described in Sec.  39.6(d). For entities affected by these 
provisions, the total impact is the removal or addition of one check-
box when reporting.
3. SEC Filers
    In accordance with Section 2(j) of the CEA, the proposed rule 
required a committee of the board of directors (or equivalent body) of 
an SEC Filer to approve the decision not to clear the swap for which 
the end-user exception would be elected. The Commission received 
comments that requiring swap-by-swap board approval would impose excess 
costs and burdens on SEC Filers.\102\ The Commission determined that 
any additional benefit of a swap-by-swap approval, as compared to a 
more general approval, was insufficient to justify such an approach and 
accordingly, has revised the final rule to only require reporting (in 
the annual or swap-by-swap filing) whether such committee has generally 
approved entering into swaps subject to an exception to the clearing 
and trading requirements. The Commission believes this change will 
mitigate the potential burdens commenters raised by allowing such 
committees to provide blanket or more limited approvals for the end-
user exception on a periodic basis as they deem appropriate for such 
approval and in a manner that may be consistent with general corporate 
practice. At the same time, the reporting requirement, while limited, 
still confirms that a committee of the governing board of the SEC Filer 
using the end-user exception has

[[Page 42585]]

considered such exceptions as required by Section 2(j) of the CEA.
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    \102\ See, e.g., Hess, EEI & EPSA, NGSA, CDEU, EMUS, SDG & E, 
WGCEF, Mr. Quinlivan, Cravath, AGA, EMUS, COPE, NYCBA, Shell, ATA, 
Noble, WSPP, IPA, Hess, IECA, EEI, PMAA & NEFI, CDEU, and NYCBA.
---------------------------------------------------------------------------

4. Cost Estimates \103\
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    \103\ As discussed above, the statute itself requires some level 
of reporting. Absent an ability to demarcate between the minimum 
reporting that the statute would require and that resulting from 
this rule, the Commission has estimated the costs attributable to 
this rule from a base of zero, recognizing that the costs 
attributable to its discretion in this action must necessarily start 
from some higher base. Accordingly the costs attributable to the 
Commission's action in this rulemaking are necessarily something 
below the estimates provided. Also, because the statute requires 
some reporting, the Commission has not articulated separate benefits 
attributable to this rulemaking. However, to the extent benefits 
distinguish this rule from considered alternatives, they are 
considered in the preceding discussion.
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    The Commission lacks data to estimate the precise number of non-
financial entities that may be eligible for the end-user exception, and 
therefore cannot estimate total reporting costs with great accuracy. 
However, for informational purposes, the Commission has endeavored, 
where feasible, to estimate quantifiable costs. It has done so by using 
assumptions to define what it believes to be reasonable parameters for 
various uncertainties. At times, as noted with more specificity in the 
discussion that follows, the uncertainties are such that costs are 
reasonably estimable only within a wide range. For the purposes of 
these estimates, the Commission assumes a total of 30,000 electing 
counterparties (which includes SFIs), and that approximately 1,000 of 
them will function as reporting counterparties in any given year. The 
Commission further estimates that approximately 125 swap dealers and 
major swap participants will function as reporting counterparties for 
swaps for which the end-use exception is elected each year. All of 
these reporting counterparties likely will need to modify their 
reporting systems in order to accommodate the additional data fields 
required by this rule. The Commission estimates that those 
modifications will create a one-time expense of approximately one to 
ten burden hours per entity, for a total of approximately 1,125 to 
11,250 burden hours. The hourly wage for a senior programmer is $292, 
which means that the aggregate one-time cost for modifying reporting 
systems is likely to be between $328,811 and $3,288,110.\104\
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    \104\ All salaries in these calculations are taken from the 2010 
SIFMA Report on Management and Professional Earnings in the 
Securities Industry. Annual wages were converted to hourly wages 
assuming 2,000 work hours per year (40 hours per week for 50 weeks), 
and then multiplying by 5.35 to account for bonuses, firm size, 
employee benefits and overhead. The remaining calculations used in 
these cost-benefit considerations are also derived from this source 
and modified in the same manner.
    In addition, for each range of aggregate costs presented in this 
discussion, the lower bound would be the aggregate cost if every 
relevant entity experienced the minimum per entity cost, and the 
upper bound would be the aggregate cost if every relevant entity 
experienced the maximum per entity cost. It is highly improbable 
that every entity would experience either the minimum or the maximum 
per entity cost, and as a consequence, the actual aggregate cost to 
market participants is likely to lie somewhere in the midst of each 
range that has been estimated in this section.
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    Furthermore, the 29,000 electing counterparties who do not function 
as reporting counterparties may, at certain times, need to communicate 
information to their respective reporting counterparties in order to 
facilitate reporting. That information may include, among other things, 
whether the electing counterparty has filed an annual report pursuant 
to Sec.  39.6(b)(2) and information to facilitate any due diligence 
that the reporting counterparty may conduct. These costs will likely 
vary substantially depending on the number of different reporting 
counterparties with whom an electing counterparty conducts 
transactions, how frequently the electing counterparty enters into 
swaps, whether the electing counterparty undertakes an annual filing, 
and the due diligence that the reporting counterparty chooses to 
conduct. Therefore, the Commission believes that it is very difficult 
to estimate these costs reliably at this time. However, the Commission 
has endeavored to do so given the concerns commenters expressed about 
relying on other parties to provide information and to report the 
information. Accordingly, the Commission estimates that non-reporting 
electing counterparties will incur between five minutes and ten hours 
of annual burden hours. The hourly wage for a compliance attorney is 
$320, which means that the annual per entity cost for communicating 
information to the reporting counterparty is likely to be between $27 
and $3,210. Given the unknowns associated with this cost estimate noted 
above, the Commission does not believe this wide range can be narrowed 
at this time.
    Also, the Commission estimates that approximately two-thirds of 
electing counterparties (or 20,000 electing counterparties) will choose 
to file an annual report pursuant to Sec.  39.6(b)(2). The annual 
filing option was added in the final rule and therefore an estimate of 
costs related thereto was not included in the NPRM. The annual filing 
option will reduce reporting costs overall because it is less costly 
than swap-by-swap reporting. The Commission estimates that it will take 
an average of 30 minutes to 90 minutes to complete and submit this 
filing, for an aggregate total of 10,000 to 30,000 burden hours. The 
average hourly wage for a compliance attorney is $320, which means that 
the aggregate annual cost for submitting the annual report is likely to 
be approximately $3,200,000 to $9,600,000. Other costs and benefits 
associated with the rule's reporting requirements cannot be monetized 
at this time because the Commission lacks adequate information to do 
so.
    The rule requires reporting of the following for each swap for 
which the end-user exception is elected: (1) That the election of the 
exception is being made; (2) which party is the electing counterparty; 
and (3) certain information specific to the electing counterparty 
unless that information has already been provided by the electing 
counterparty through an annual filing. The third set of information 
comprises data that is likely to remain relatively constant for many 
electing counterparties and therefore can be reported either on a 
transaction-by-transaction basis or through an annual report that is 
updated as necessary.
    As a recurring expense, the reporting counterparty will have to 
report the information required in Sec.  39.6(b)(1)(i) and (ii) for 
each swap and the information required in Sec.  39.6(b)(1)(iii) for 
each swap only if the electing counterparty has not filed an annual 
report. To comply with Sec.  39.6(b)(1)(i) and (ii), the reporting 
counterparty will be required to check one box indicating the end-user 
exception is being elected and complete one field identifying the 
electing counterparty. The Commission expects that this information 
will be entered into the appropriate reporting system concurrently with 
additional information that is required under the CEA and other 
Commission regulations promulgated thereunder. Therefore, each 
reporting counterparty is likely to spend 15 seconds to two minutes per 
transaction in incremental time entering the swap-by-swap information 
that is required in Sec.  39.6(b)(1)(i) and (ii) into the reporting 
system. Regarding the Sec.  39.6(b)(1)(iii) information, the Commission 
expects that, for the first swap conducted involving a particular 
electing counterparty, it will take approximately 30 minutes to 90 
minutes to collect and submit the information required and then 
approximately one to five minutes to collect and submit this 
information for subsequent transactions with that same counterparty. 
The Commission does not have sufficient data to estimate the number of 
swaps that will be subject to this rule, so it is not possible to 
estimate these costs in the aggregate.

[[Page 42586]]

D. Hedging or Mitigating Commercial Risk

1. Introduction
    Regulation 39.6(c) provides a broad set of criteria for determining 
what constitutes hedging or mitigating commercial risk for the end-user 
exception to apply. The Commission's flexible set of criteria allows 
counterparties to use the end-user exception when appropriate given 
their specific circumstances. At the same time, the criteria are 
designed to prevent abuse of the end-user exception, which would hinder 
one of the primary goals of the Dodd-Frank Act: Moving swaps into 
central clearing, thereby reducing counterparty risk and its potential 
to create instability in the financial system.
    Congress prescribed ``hedging or mitigating commercial risk'' as a 
condition for applying the end-user exception, without providing 
further statutory definition of its meaning. The Commission is 
exercising its discretion to do so. Thus, relative to the statutory 
requirement, the costs and benefits of the rule are those attributable 
to clarifying the Commission's understanding of the term for 
implementation and enforcement purposes rather than implementing and 
enforcing the condition without clarifying its interpretation. Relative 
to other alternatives that the Commission could have selected, the 
costs or benefits of the rule are generally a function of whether the 
Commission adopts a more- or less-inclusive approach in articulating 
what constitutes hedging or mitigating commercial risk for purposes of 
the end-user exception relative to the theoretically optimal level that 
Congress presumably intended the statutory language to effect.\105\ In 
addition, a potential electing counterparty will incur some costs in 
applying the standard set forth in the rule to determine whether a 
specific swap qualifies as hedging or mitigating commercial risk. Each 
category--clarification costs and benefits, inclusion costs and 
benefits, and determination costs--is discussed below.
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    \105\ In either case, costs and benefits are not readily 
quantifiable. Such quantification would require data and information 
that the Commission does not possess nor have at its disposal. This 
includes data regarding the number, characteristics, and notional 
value of swaps that are impacted by these decisions, as well as 
information about the required margin for the swaps if they are 
cleared or not cleared, the type and amount of collateral that 
counterparties require for the swaps, estimates for the affected 
firms of the cost of capital used to post margin, and pricing for 
cleared swaps and non-cleared swaps.
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2. Clarification Costs and Benefits
    As stated above, even in the absence of this rulemaking, ``hedging 
or mitigating commercial risk'' is a necessary condition for being 
eligible to claim the end-user exception with respect to a particular 
swap. By clarifying the Commission's interpretation of this term, this 
rule provides market participants with the benefit of greater 
regulatory certainty, which will reduce costs associated with, for 
example, legal opinions to interpret the term or the costs of foregoing 
the end-user exception to which market participants might otherwise be 
entitled.
3. Inclusion Costs and Benefits
    Regulation 39.6(c)(1)(i) identifies six possible sources of 
commercial risk and sets forth an ``economically appropriate'' standard 
for assessing the correspondence between a given swap and the 
commercial risk that it hedges or mitigates.\106\
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    \106\ In the alternative to meeting the requirements of Sec.  
39.6(c)(1)(i), a swap executed by an electing counterparty may also 
be eligible for the end-user exception if the swap qualifies as a 
bona fide hedge for purposes of an exception from position limits 
under the CEA as provided in Sec.  39.6(c)(1)(ii), or if it 
qualifies for hedging treatment under FASB Accounting Standards 
Codification Topic 815 or under GASB Statement 53 as provided in 
Sec.  39.6(c)(1)(iii). No comments raised cost/benefit issues 
regarding these two bases for electing the end-user exception other 
than supporting the benefits offered by including these additional 
alternatives.
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    As noted above, the Commission has determined not to provide a 
bright-line definition of ``economically appropriate'' to allow greater 
flexibility in application of the standard. The Commission cannot 
anticipate and account for all of the types of potential electing 
counterparties, swaps, and strategies that might be used to hedge or 
mitigate commercial risk, so a bright-line approach not allowing for 
judgment and consideration of all relevant facts and circumstances 
would likely lead to outcomes in some circumstances that 
inappropriately include or exclude certain swaps from the end-user 
exception, particularly with respect to custom swaps and unique hedging 
strategies.\107\ Therefore, the Commission did not adopt alternatives 
that relied on a bright-line approach.
---------------------------------------------------------------------------

    \107\ The Commission agrees with Kraft that ``[a]ny bright-line 
definition or exclusion, such as those previously discussed, would 
infringe on a swap counterparty's ability to effectively hedge or 
mitigate its commercial risk. * * *''
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    In addition, the Commission described the six categories of 
commercial risk in a way that it believes are inclusive of the many 
different types of commercial risk that can be hedged or mitigated. At 
the same time, by delineating specific types of commercial risk that 
can be hedged or mitigated for the end-user exception to apply, the 
Commission has created boundaries that provide greater clarity for 
application of the exception and prevent abuse or evasion of the 
exception thereby reducing the costs that can result from uncertainty 
or abuse or evasion.
    The Commission has determined that alternative approaches proposed 
by commenters that are significantly more or less inclusive assign 
undue weight to various costs and benefits that increase or decrease 
with varying degrees of inclusiveness. The ``management or reduction of 
risks'' standard proposed by SFG would create the possibility that 
swaps could be excepted from clearing when they are merely being used 
to ``manage'' risks. That approach would be contrary to the statute 
because it could include swaps that are used to increase risk rather 
than to hedge or mitigate commercial risks. On the other hand, as 
explained above in Section II.C.5, the ``congruence'' standard proposed 
by Better Markets would require ``an exact match'' between each 
component of commercial risk being hedged and the swap that hedges it. 
However, a hedge does not have to be economically perfect in order to 
reduce rather than increase risk. Moreover, commenters emphasized the 
prevalence and necessity of dynamic hedging strategies, which 
continually rebalance hedges in light of changes or anticipated changes 
in underlying positions and their alignment with the hedges that offset 
their risk.\108\ In light of this, the Commission believes that the 
additional costs created by a ``congruence standard'' would not be 
justified by its benefits and therefore has not adopted that 
alternative.\109\
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    \108\ See, e.g., Kraft, RESA, WGCEF, Peabody, NRECA, American 
Public Power Association & Large Public Power Council, and EEI & 
EPSA.
    \109\ See section II.C.5 above.
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    Several commenters suggested that excluding swaps that hedge or 
mitigate financial risks would prevent abuse of the end-user exception 
by making the exception unavailable for speculative swaps.\110\ 
However, as stated above, the Commission acknowledges that there are 
various financial risks that may be commercial risks for potential 
electing counterparties. Section 2(h)(7) of the CEA clearly allows 
swaps used by qualifying entities to hedge or mitigate commercial risks 
to be excepted out of the clearing requirement. The

[[Page 42587]]

Commission believes that imposing such a limitation on using the end-
user exception for financial swaps without consideration of whether 
they in fact do hedge or mitigate commercial risk would be inconsistent 
with the statute, and therefore has not adopted that alternative and 
accordingly, this alternative is beyond the reach of consideration 
under Section 15(a) of the CEA.
---------------------------------------------------------------------------

    \110\ See, e.g., Tobin, Sullivan, Fay & Grunebaum, CMOC, 
Skylands, IPM & CSA, and FMNJ.
---------------------------------------------------------------------------

    Various commenters suggested that Sec.  39.6(c)(2)(i), which 
prohibits use of the end-user exception for swaps used for the purpose 
of speculation, trading, and investing, would prevent use of the 
exception for swaps that hedge or mitigate commercial risk.\111\ Some 
of these comments also indicate that the meaning of ``speculation, 
trading or investing'' is unclear, which could cause some regulatory 
uncertainty, leading participants to refrain from electing the end-user 
exception in appropriate circumstances or to avoid entering into some 
swaps that hedge or mitigate commercial risk altogether.
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    \111\ See section II.C.7 above.
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    The Commission has addressed these concerns by clarifying how Sec.  
39.6(c)(2)(i) is to be applied in the context of the entire rule. As 
explained in greater detail in section II.C.7 above, the focus of the 
limitation is on the purpose of the swap for the potential electing 
counterparty, i.e., if it is principally used for hedging or mitigating 
commercial risk as characterized in the rule, then the end-user 
exception may be elected notwithstanding how the swap may otherwise be 
characterized, but if it is used for speculative, trading or investing 
purposes with little or no intent to hedge or mitigate commercial risk, 
then the end-user exception is not available. Accordingly, the 
Commission believes that this provision, if applied as intended, 
provides a benefit to market participants by clarifying the 
circumstances under which they may claim the end-user exception in 
accordance with the general requirement in Section 2(h)(7)(A)(ii) of 
the CEA that the swap must ``hedge or mitigate commercial risk''.
4. Determination Costs
    To avail themselves of the end-user exception, potential electing 
counterparties must determine whether the specific swap in question is 
being used to ``hedge or mitigate commercial risk'' under the 
rule.\112\ The Commission expects that entities will incur direct costs 
in the form of personnel hours devoted to analyzing this question. The 
cost of determining whether a specific swap is being used to ``hedge or 
mitigate commercial risk'' will depend on the nature of the entity's 
hedging activities in the relevant situation. Some entities will incur 
relatively few costs in confirming that they are hedging or mitigating 
commercial risk. Others will incur little or no cost confirming that 
they are not covered by the definition. However, for some entities, 
especially those that use swaps to hedge in a variety of ways and 
circumstances, the determination could be more complex and may require 
that personnel with financial and legal expertise review the 
circumstances of the entity's swap activities to make the determination 
of whether the swap in question is being used to hedge or mitigate 
commercial risk.
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    \112\ Entities will also have to determine whether or not they 
are financial entities according to Section 2(h)(7)(C) of the CEA. 
Such costs result from the requirements of the Dodd-Frank Act and 
therefore do not arise as a result of the exercise of discretion by 
the Commission.
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    Notably, entities would incur determination costs regardless of the 
terms of the rule, because they must in any event interpret the 
statutory definition to determine whether they, and the swap in 
question, are eligible. Thus, at a minimum, a significant portion of 
the costs discussed here are attributable to the inclusion in the Dodd-
Frank Act of a restriction on eligible swaps to those that ``hedge or 
mitigate commercial risk,'' and not from any aspect of this rule. 
Indeed, the final rule mitigates these costs by providing guidance 
about the application of the statutory requirements.
    The time and resources that must be expended by an entity on this 
exercise will vary considerably depending on a number of factors, 
including (1) whether the entity in question must determine whether it 
is a financial entity; (2) the number and diversity of swaps executed 
by the entity; and (3) the complexity of the swap strategies being used 
by the entity. The Commission did not receive any comments quantifying 
the costs that an entity may incur in making these determinations. The 
Commission believes that, for most entities and swaps, making the 
determinations necessary will involve little or no cost because the 
nature of the electing counterparty and the use of the swaps in the 
context of the rule will be readily apparent. The Commission also 
recognizes that for some swaps and entities that have mixed purposes or 
that have unique characteristics, there will be determination costs; 
and in limited cases, such costs could be significant. However, it is 
not possible to estimate such costs for the entire market because the 
Commission does not have available to it detailed data for the swap 
market that would be needed to make such an estimate and also because 
such determinations are highly fact specific and can vary substantially 
from one swap to the next.

E. Exemption for Small Financial Institutions

    Section 2(h)(7)(C)(ii) of the CEA directs the Commission to 
consider exempting small banks, savings associations, farm credit 
institutions, and credit unions with $10 billion or less in total 
assets from the definition of ``financial entity.'' As discussed above, 
the Commission is adopting such an exemption in Sec.  39.6(d).\113\ The 
Commission notes that as of December 31, 2011, there were approximately 
14,700 Section 2(h)(7)(C)(ii) institutions operating in the United 
States. Of those institutions, approximately 120 of them had total 
assets greater than $10 billion, while the remaining 14,580 
institutions had less than $10 billion in total assets making them SFIs 
that could elect the end-user exception when using swaps to hedge or 
mitigate commercial risk.\114\ In other words, about 99 percent of 
banks, savings associations, farm credit system institutions, and 
credit unions will qualify as SFIs using the $10 billion level.\115\ In 
addition, analysis conducted by the Commission suggests that 99 percent 
of Section 2(h)(7)(C)(ii) institutions with less than $10 billion in 
total assets that had open swap positions had gross notional swap books 
of $2 billion or less. While this data did not influence the 
Commission's consideration of what constitutes a ``small'' Section 
2(h)(7)(C)(ii) institution, it does indicate how many institutions may 
benefit from the exemption as adopted by the Commission.
---------------------------------------------------------------------------

    \113\ See Section II.D.
    \114\ Asset level data for banks and savings associations is 
available at fdic.gov, and credit unions at ncua.gov. Data for farm 
credit system institutions was provided to the Commission by the 
Farm Credit Administration.
    \115\ In mid-2010, the most recent period for which Section 
2(h)(7)(C)(ii) institution swap data could be obtained, 
approximately 1,015 Section 2(h)(7)(C)(ii) institutions had 
outstanding swap exposure. Of those institutions, 138 had total 
assets over $10 billion and 876 had total assets below $10 billion.
---------------------------------------------------------------------------

    Commenters suggested alternative approaches to the exemption for 
SFIs, such as asset test thresholds above $10 billion, or a test that 
focuses on uncollateralized exposure. However, commenters did not 
provide sufficient quantitative or qualitative evidence to persuade the 
Commission that a threshold greater than $10 billion in

[[Page 42588]]

assets would provide benefits that justify any corresponding costs. In 
the absence of compelling evidence for a threshold other than that 
which was suggested by Congress, the Commission has adopted the 
threshold identified in the statute.

F. Consideration of Section 15(a) Factors

1. Protection of Market Participants and the Public
    The reporting requirements help to discourage abuse of the end-user 
exception by requiring electing counterparties to provide, or cause to 
be provided, information to the Commission that demonstrates compliance 
with the legal conditions for using the exception. This helps protect 
market participants and the public. If the end-user exception were 
abused or evaded (i.e., if entities wrongfully avoided clearing and 
trading on an exchange swaps that were required to be cleared and 
traded), market participants would be exposed to additional 
counterparty risk. Moreover, the public could be exposed to systemic 
risk, and the costs associated with large-scale financial system 
failure, if large aggregate positions of non-cleared, speculative swaps 
were to accumulate in systemically important institutions.
    Although reporting counterparties will incur reporting costs, the 
rule seeks to minimize these costs and provide flexibility as to the 
frequency at which the information is reported. The Commission has 
promulgated rules that require electing counterparties to provide, or 
cause to be provided, the limited information needed to effectively 
regulate the end-user exception and meet the statutory requirements. In 
addition, certain reporting requirements may be satisfied by submitting 
the required information on a swap-by-swap or annual basis. This 
enables entities to adopt reporting practices that reduce their 
reporting costs without compromising the Commission's ability to 
regulate the market.
    The rules also help to protect market participants and the public 
because they permit boards of SEC Filers to approve swaps on a swap-by-
swap or more general basis. The Commission believes that either basis 
is sufficient to ensure that members of the board are aware that the 
end-user exception may be elected and to ensure that such an election 
has been appropriately considered at the top of the corporate 
responsibility hierarchy. The Commission recognizes that swap-by-swap 
approval might reduce risk to market participants and the public to a 
somewhat greater degree than general approval, but it agrees with 
commenters that any such incremental improvement does not warrant the 
additional burden.
    The ``reasonable basis'' standard required of reporting 
counterparties is likely to create some costs for market participants 
who are reporting entities.\116\ The Commission expects that if a 
reporting counterparty is not the electing counterparty and is 
reporting all information on a swap-by-swap basis, reporting 
counterparties may choose to conduct some due diligence in order to 
verify that their counterparty and the swap meet the requirements for 
eligibility. However, the Commission expects that most reporting 
entities are likely to know their customers, which will mitigate any 
costs associated with due diligence. Moreover, these costs must be 
considered in light of the benefits of such a requirement, namely 
enhanced compliance with clearing requirements, which serves to protect 
public interests, as well as the competitiveness and integrity of swap 
markets.
---------------------------------------------------------------------------

    \116\ See, e.g., NGSA, Reval, RESA, NRECA, IECA, and EEI.
---------------------------------------------------------------------------

    Finally, as described above, the ``economically appropriate'' 
hedging standard, together with the six types of commercial risk and 
specific safe harbors for hedging or mitigating risk that are 
recognized in the rule, mitigates the risk that market participants 
could abuse the exception or evade the clearing requirement, which 
could increase counterparty risk and potentially harm market 
participants and the public.
2. Efficiency, Competitiveness, and Financial Integrity of Swap Markets
    Section 2(h)(8) of the CEA provides that swaps that are subject to 
the clearing requirement shall be executed on a board of trade or swap 
execution facility unless no such board or facility makes the swap 
available for trading. Preventing abuse of the end-user exception 
promotes exchange trading as intended by the Dodd-Frank Act by ensuring 
that more swaps that are supposed to be cleared are in fact cleared. 
This is likely to increase liquidity for these swaps, which should 
promote competitiveness by increasing the number of market participants 
that offer certain swaps in any one place. It should also enhance the 
efficiency of swap markets by reducing the amount of time that market 
participants must spend looking for willing counterparties and 
receiving actionable quotes for such swaps.
    Certain provisions of this rule, such as the information required 
to be reported, the requirement for board approval, and the requirement 
that reporting entities gather sufficient information to have a 
reasonable basis for concluding that their counterparty is eligible for 
the end-user exception, will discourage abuse of the exception, thereby 
promoting the financial integrity of swap markets and financial markets 
as a whole. Market participants should have confidence that swaps that 
are not being used to hedge or mitigate commercial risk will be 
cleared.
3. Price Discovery
    As described in greater detail above in Section III.C.1, the 
Commission believes that the rule reduces the potential for abuse or 
evasion (which could result in reduced exchange trading and therefore 
reduced price discovery) while also giving effect to the statutory 
requirement to create an exception from clearing for non-financial 
entities and SFIs using swaps to hedge or mitigate commercial risk. To 
the extent that reducing abuse or evasion results in greater liquidity 
on boards of trade and swap execution facilities, it promotes improved 
price discovery.
4. Sound Risk Management Practices
    The Commission believes that the rule will lead to sound risk 
management practices. By requiring that swaps be ``economically 
appropriate'' to the reduction of the commercial risks that they hedge 
or mitigate, the rule helps to ensure that changes in the value of non-
cleared swaps that otherwise would be subject to clearing are largely 
offset by changes in the value of assets or liabilities that electing 
counterparties have or reasonably expect to have (e.g., future changes 
in variable interest rates, foreign exchange rates, or the price of 
commodities). The offset should partially or fully ensure that the 
electing counterparty has sufficient resources to meet the financial 
commitments incumbent on them by virtue of their hedging positions.
    Electing counterparties may be exposed to certain financial risks 
in the course of ordinary business, such as the risk of exchange rate 
fluctuations related to foreign transactions and interest rate risk 
that could impact a potential electing counterparty's cost of debt 
incurred for commercial business purposes. The rule promotes sound risk 
management practices by mitigating the cost of collateral for entities 
to use swaps to hedge these types of financial risks related to their 
commercial activities.

[[Page 42589]]

    For SEC Filers, the governing board or equivalent body is directly 
responsible to shareholders for the financial condition and performance 
of the firm, and also has access to information that would give them a 
comprehensive picture of the company's financial condition and risk 
management strategies. Therefore, any oversight they provide to the 
firm's risk management strategies is likely to encourage sound 
practices. However, the requirement contemplated in the NPRM that 
boards approve decisions to exempt swaps from clearing on a swap-by-
swap basis could have been difficult for some firms to operationalize, 
and therefore could have undermined a firm's ability to implement risk 
management strategies that take advantage of the end-user exception. In 
other words, there is a tradeoff between the risk management benefits 
associated with more direct and intimate board oversight, and the risk 
management costs of the same. The Commission believes that the addition 
of the option to approve use of the end-user exception on a broad 
basis, rather than swap by swap, effectively balances these concerns, 
retaining direct board involvement in the firm's decision to exercise 
the exemption, but in a manner that does not hinder the firm's ability 
to operationalize their risk management strategies.
5. Other Public Interest Considerations
    For purposes of determining whether a swap hedges or mitigates 
commercial risk, the rule includes swaps that qualify for hedging 
treatment under Statement 53, Accounting and Financial Reporting for 
Derivative Instruments, issued by GASB. This change in the final rule 
expands the range of swaps that state and local government entities can 
except from the clearing requirement to provide a safe harbor for swaps 
that are bona fide hedges under Statement 53. As a consequence, the 
change helps to ensure that U.S. local governmental entities who use 
what are definitively hedging swaps under accounting standards are able 
to take advantage of the end-user exception for such purposes.
    In addition, the Commission provides guidance in Section II.A.4 
that foreign governments, foreign central banks and certain 
international financial institutions will not be subject to the 
clearing requirements of Section 2(h)(1) of the CEA as a matter of 
comity. This guidance is in the public interest because it is premised 
on the expectation that foreign regulators will reciprocate and provide 
similar relief to the Federal Government, the Federal Reserve Banks of 
the United States and the international financial institutions of which 
the United States is a member.

IV. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires federal agencies, in 
promulgating regulations, to consider whether those regulations will 
have a significant economic impact on a substantial number of small 
entities and, if so, provide a regulatory flexibility analysis 
respecting the impact.\117\ As noted in the NPRM, the regulations 
adopted herein would affect eligible contract participants (ECPs) and 
SDRs. The Commission has previously determined that neither ECPs nor 
SDRs are small entities for purposes of the RFA.\118\ Accordingly, the 
Chairman, on behalf of the Commission, certified in the NPRM pursuant 
to 5 U.S.C. 605(b) that these regulations will not have a significant 
economic impact on a substantial number of small entities.
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    \117\ 5 U.S.C. 601 et seq.
    \118\ See 66 FR 20740 at 20743 (Apr. 25, 2001) (regarding ECPs) 
and 75 FR 80898 at 80926 (Dec. 23, 2010) (regarding SDRs).
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B. Paperwork Reduction Act

    The Paperwork Reduction Act (PRA) \119\ imposes certain 
requirements on Federal agencies (including the Commission) in 
connection with conducting or sponsoring any collection of information 
as defined by the PRA. An agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
unless it displays a currently valid control number. This rulemaking 
imposes new collection of information requirements within the meaning 
of the PRA. Accordingly, the Commission requested and the Office of 
Management and Budget (OMB) assigned a control number for the new 
collection of information: OMB control number 3038-0085. The Commission 
has submitted this final rule along with supporting documentation for 
OMB's review. Responses to this collection of information will be 
mandatory.
---------------------------------------------------------------------------

    \119\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    The Commission will protect proprietary information according to 
the Freedom of Information Act and 17 CFR part 145, ``Commission 
Records and Information.'' In addition, section 8(a)(1) of the CEA 
strictly prohibits the Commission, unless specifically authorized by 
the CEA, from making public ``data and information that would 
separately disclose the business transactions or market positions of 
any person and trade secrets or names of customers.'' The Commission is 
also required to protect certain information contained in a government 
system of records according to the Privacy Act of 1974, 5 U.S.C. 552a.
1. Information Provided by Reporting Entities/Persons
    Regulation 39.6 will require an electing counterparty to provide or 
cause to be provided certain information about the swap to a registered 
SDR or, if no registered SDR is available to receive the information, 
the Commission in the form and manner specified by the Commission. The 
reporting will occur only once at the beginning of the swap life cycle. 
If one of the counterparties to the swap is a swap dealer or a major 
swap participant, the electing counterparty would cause such 
information to be reported by that swap dealer or major swap 
participant. The electing counterparty would act as the reporting 
counterparty only if its counterparty is not a swap dealer or a major 
swap participant.
    As noted in the NPRM, the Commission estimates that there are 
approximately 30,000 non-financial entities that are counterparties to 
a swap in a given year. Of those entities, the Commission estimates 
that the majority will not be required to report under Regulation 39.6 
because their counterparty will be a swap dealer or major swap 
participant. In that case, as described above, the swap dealer or major 
swap participant will be required to report on behalf of the electing 
counterparty. Also, the reporting under Regulation 39.6 is only 
required to be made one time for each swap, with no further 
notifications or other reporting required in subsequent years. Reducing 
the number of annual potential electing counterparties by these 
factors, the Commission estimates that there are approximately 1,000 
electing counterparties who will be required to report in a given year. 
The Commission estimates that the report will require between 10 
minutes and one hour of burden, per electing counterparty per year. The 
number of burden hours per electing counterparty may vary depending on 
various factors, such as the number of swaps entered into by that 
electing counterparty in the given year. Therefore, the number of 
estimated aggregate annual burden hours is between 167 and 1,000 hours.
2. Information Collection Comments
    The Commission received a comment from the Electric Trade 
Associations stating that the Commission rulemakings under the Dodd-
Frank Act constitute an accumulation of interrelated regulatory burdens 
and

[[Page 42590]]

costs on nonfinancial small entities and the Commission should conduct 
a comprehensive analysis under the PRA and other statutes. However, the 
comment did not specifically address this rulemaking.

List of Subjects in 17 CFR Part 39

    Business and industry, Reporting requirements, Swaps.

    For the reasons stated in the preamble, amend 17 CFR part 39 as 
follows:

PART 39--DERIVATIVES CLEARING ORGANIZATIONS

0
1. The authority citation for part 39 is revised to read as follows:

    Authority:  7 U.S.C. 2 and 7a-1 as amended by Pub. L. 111-203, 
124 Stat. 1376.

0
2. Add Sec.  39.6 to read as follows:


Sec.  39.6  Exceptions to the clearing requirement.

    (a) Non-financial entities. (1) A counterparty to a swap may elect 
the exception to the clearing requirement under section 2(h)(7)(A) of 
the Act if the counterparty:
    (i) Is not a ``financial entity'' as defined in section 
2(h)(7)(C)(i) of the Act;
    (ii) Is using the swap to hedge or mitigate commercial risk as 
provided in paragraph (c) of this section; and
    (iii) Provides, or causes to be provided, the information specified 
in paragraph (b) of this section to a registered swap data repository 
or, if no registered swap data repository is available to receive the 
information from the reporting counterparty, to the Commission. A 
counterparty that satisfies the criteria in this paragraph (a)(1) and 
elects the exception is an ``electing counterparty.''
    (2) If there is more than one electing counterparty to a swap, the 
information specified in paragraph (b) of this section shall be 
provided with respect to each of the electing counterparties.
    (b) Reporting. (1) When a counterparty elects the exception to the 
clearing requirement under section 2(h)(7)(A) of the Act, one of the 
counterparties to the swap (the ``reporting counterparty,'' as 
determined in accordance with Sec.  45.8 of this part) shall provide, 
or cause to be provided, the following information to a registered swap 
data repository or, if no registered swap data repository is available 
to receive the information from the reporting counterparty, to the 
Commission, in the form and manner specified by the Commission:
    (i) Notice of the election of the exception;
    (ii) The identity of the electing counterparty to the swap; and
    (iii) The following information, unless such information has 
previously been provided by the electing counterparty in a current 
annual filing pursuant to paragraph (b)(2) of this section:
    (A) Whether the electing counterparty is a ``financial entity'' as 
defined in section 2(h)(7)(C)(i) of the Act, and if the electing 
counterparty is a financial entity, whether it is:
    (1) Electing the exception in accordance with section 
2(h)(7)(C)(iii) or section 2(h)(7)(D) of the Act; or
    (2) Exempt from the definition of ``financial entity'' as described 
in paragraph (d) of this section;
    (B) Whether the swap or swaps for which the electing counterparty 
is electing the exception are used by the electing counterparty to 
hedge or mitigate commercial risk as provided in paragraph (c) of this 
section;
    (C) How the electing counterparty generally meets its financial 
obligations associated with entering into non-cleared swaps by 
identifying one or more of the following categories, as applicable:
    (1) A written credit support agreement;
    (2) Pledged or segregated assets (including posting or receiving 
margin pursuant to a credit support agreement or otherwise);
    (3) A written third-party guarantee;
    (4) The electing counterparty's available financial resources; or
    (5) Means other than those described in paragraphs 
(b)(1)(iii)(C)(1), (2), (3), or (4) of this section; and
    (D) Whether the electing counterparty is an entity that is an 
issuer of securities registered under section 12 of, or is required to 
file reports under section 15(d) of, the Securities Exchange Act of 
1934, and if so:
    (1) The relevant SEC Central Index Key number for that 
counterparty; and
    (2) Whether an appropriate committee of that counterparty's board 
of directors (or equivalent body) has reviewed and approved the 
decision to enter into swaps that are exempt from the requirements of 
sections 2(h)(1) and 2(h)(8) of the Act.
    (2) An entity that qualifies for an exception to the clearing 
requirement under this section may report the information listed in 
paragraph (b)(1)(iii) of this section annually in anticipation of 
electing the exception for one or more swaps. Any such reporting under 
this paragraph shall be effective for purposes of paragraph (b)(1)(iii) 
of this section for swaps entered into by the entity for 365 days 
following the date of such reporting. During such period, the entity 
shall amend such information as necessary to reflect any material 
changes to the information reported.
    (3) Each reporting counterparty shall have a reasonable basis to 
believe that the electing counterparty meets the requirements for an 
exception to the clearing requirement under this section.
    (c) Hedging or mitigating commercial risk. For purposes of section 
2(h)(7)(A)(ii) of the Act and paragraph (b)(1)(iii)(B) of this section, 
a swap is used to hedge or mitigate commercial risk if:
    (1) Such swap:
    (i) Is economically appropriate to the reduction of risks in the 
conduct and management of a commercial enterprise, where the risks 
arise from:
    (A) The potential change in the value of assets that a person owns, 
produces, manufactures, processes, or merchandises or reasonably 
anticipates owning, producing, manufacturing, processing, or 
merchandising in the ordinary course of business of the enterprise;
    (B) The potential change in the value of liabilities that a person 
has incurred or reasonably anticipates incurring in the ordinary course 
of business of the enterprise;
    (C) The potential change in the value of services that a person 
provides, purchases, or reasonably anticipates providing or purchasing 
in the ordinary course of business of the enterprise;
    (D) The potential change in the value of assets, services, inputs, 
products, or commodities that a person owns, produces, manufactures, 
processes, merchandises, leases, or sells, or reasonably anticipates 
owning, producing, manufacturing, processing, merchandising, leasing, 
or selling in the ordinary course of business of the enterprise;
    (E) Any potential change in value related to any of the foregoing 
arising from interest, currency, or foreign exchange rate movements 
associated with such assets, liabilities, services, inputs, products, 
or commodities; or
    (F) Any fluctuation in interest, currency, or foreign exchange rate 
exposures arising from a person's current or anticipated assets or 
liabilities; or
    (ii) Qualifies as bona fide hedging for purposes of an exemption 
from position limits under the Act; or
    (iii) Qualifies for hedging treatment under:
    (A) Financial Accounting Standards Board Accounting Standards 
Codification Topic 815, Derivatives and Hedging (formerly known as 
Statement No. 133); or

[[Page 42591]]

    (B) Governmental Accounting Standards Board Statement 53, 
Accounting and Financial Reporting for Derivative Instruments; and
    (2) Such swap is:
    (i) Not used for a purpose that is in the nature of speculation, 
investing, or trading; and
    (ii) Not used to hedge or mitigate the risk of another swap or 
security-based swap position, unless that other position itself is used 
to hedge or mitigate commercial risk as defined by this rule or Sec.  
240.3a67-4 of this title.
    (d) For purposes of section 2(h)(7)(A) of the Act, a person that is 
a ``financial entity'' solely because of section 2(h)(7)(C)(i)(VIII) 
shall be exempt from the definition of ``financial entity'' if such 
person:
    (i) Is organized as a bank, as defined in section 3(a) of the 
Federal Deposit Insurance Act, the deposits of which are insured by the 
Federal Deposit Insurance Corporation; a savings association, as 
defined in section 3(b) of the Federal Deposit Insurance Act, the 
deposits of which are insured by the Federal Deposit Insurance 
Corporation; a farm credit system institution chartered under the Farm 
Credit Act of 1971; or an insured Federal credit union or State-
chartered credit union under the Federal Credit Union Act; and
    (ii) Has total assets of $10,000,000,000 or less on the last day of 
such person's most recent fiscal year.

    Issued in Washington, DC, on July 10, 2012, by the Commission.
David A. Stawick,
Secretary of the Commission.

    Note:  The following appendices will not appear in the Code of 
Federal Regulations.

Appendices to End-User Exception to Mandatory Clearing of Swaps--
Commission Voting Summary and Statements of Commissioners

Appendix 1--Commission Voting Summary

    On this matter, Chairman Gensler and Commissioners Sommers, 
Chilton, O'Malia and Wetjen voted in the affirmative; no 
Commissioner voted in the negative.

Appendix 2--Statement of Chairman Gary Gensler

    I support the final rule on the end-user exception to the 
clearing requirement for swaps. One of the primary goals of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act) was to lower risk to the interconnected financial system 
by requiring standardized swaps between financial entities to be 
cleared.
    Congress provided that non-financial entities, such as farmers, 
ranchers, manufacturers and other end-users, should be able to 
choose whether or not to clear those swaps that hedge or mitigate 
commercial risks. The Commission's final rule implements this 
exception for non-financial entities, establishing criteria for 
hedging or mitigating commercial risk and imposing minimal reporting 
requirements for those swaps that come under the end-user exception. 
The final rule benefited from significant public input, including 
requiring that most of the information be reported annually, rather 
than transaction by transaction as had been proposed.
    In the Dodd-Frank Act, Congress also directed the Commission to 
consider exempting from the definition of ``financial entity'' small 
financial institutions with total assets of $10 billion or less, 
thus making them eligible for the end-user exception. After 
considering the comments received on the end-user exception 
proposal, the Commission is exempting small financial institutions, 
including small banks, savings associations, farm credit system 
institutions and credit unions, at the $10 billion total asset 
level, as identified by Congress.

[FR Doc. 2012-17291 Filed 7-18-12; 8:45 am]
BILLING CODE 6351-01-P