[Federal Register Volume 77, Number 152 (Tuesday, August 7, 2012)]
[Proposed Rules]
[Pages 47170-47222]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-18382]



[[Page 47169]]

Vol. 77

Tuesday,

No. 152

August 7, 2012

Part II





Commodity Futures Trading Commission





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17 CFR Part 50





Clearing Requirement Determination Under Section 2(h) of the CEA; 
Proposed Rule

  Federal Register / Vol. 77 , No. 152 / Tuesday, August 7, 2012 / 
Proposed Rules  

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 50

RIN 3038-AD86


Clearing Requirement Determination Under Section 2(h) of the CEA

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is proposing regulations to establish a clearing requirement under new 
section 2(h)(1)(A) of the Commodity Exchange Act (CEA or Act), enacted 
under Title VII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act). The regulations would require that 
certain classes of credit default swaps (CDS) and interest rate swaps 
(IRS), described herein, be cleared by a derivatives clearing 
organization (DCO) registered with the Commission. The Commission also 
is proposing regulations to prevent evasion of the clearing requirement 
and related provisions.

DATES: Comments must be received on or before September 6, 2012.

ADDRESSES: You may submit comments, identified by RIN number 3038-AD86, 
by any of the following methods:
     The agency's Web site, at http://comments.cftc.gov. Follow 
the instructions for submitting comments through the Web site.
     Mail: David A. Stawick, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as mail above.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    Please submit your comments using only one method.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
http://www.cftc.gov. You should submit only information that you wish 
to make available publicly. If you wish the Commission to consider 
information that you believe is exempt from disclosure under the 
Freedom of Information Act, a petition for confidential treatment of 
the exempt information may be submitted according to the procedures 
established in Sec.  145.9 of the Commission's regulations.\1\
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    \1\ 17 CFR 145.9. Commission regulations referred to herein are 
found on the Commission's Web site.
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    The Commission reserves the right, but shall have no obligation, to 
review, pre-screen, filter, redact, refuse or remove any or all of your 
submission from http://www.cftc.gov that it may deem to be 
inappropriate for publication, such as obscene language. All 
submissions that have been redacted or removed that contain comments on 
the merits of the rulemaking will be retained in the public comment 
file and will be considered as required under the Administrative 
Procedure Act and other applicable laws, and may be accessible under 
the Freedom of Information Act.

FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Deputy Director, 
202-418-5684, [email protected]; Brian O'Keefe, Associate Director, 
202-418-5658, [email protected]; or Erik Remmler, Associate Director, 
202-418-7630, [email protected], Division of Clearing and Risk, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
    A. Financial Crisis
    B. Central Role of Clearing in the Dodd-Frank Act
    C. G-20 and International Commitments on Clearing
    D. Overview of Section 2(h) and Sec.  39.5
    E. Submissions From DCOs
II. Review of Swap Submissions
    A. General Description of Information Considered
    B. Commission Processes for Review and Surveillance of DCOs
    C. Credit Default Swaps
    D. Proposed Determination Analysis for Credit Default Swaps
    E. Interest Rate Swaps
    F. Proposed Determination Analysis for Interest Rate Swaps
III. Proposed Rule
    A. Proposed Sec.  50.1 Definitions
    B. Proposed Sec.  50.2 Treatment of Swaps Subject to a Clearing 
Requirement
    C. Proposed Sec.  50.3 Notice to the Public
    D. Proposed Sec.  50.4 Classes of Swaps Required To Be Cleared
    E. Proposed Sec.  50.5 Clearing Transition Rules
    F. Proposed Sec.  50.6 Delegation of Authority
    G. Proposed Sec.  50.10 Prevention of Evasion of the Clearing 
Requirement and Abuse of an Exception or Exemption to the Clearing 
Requirement
IV. Implementation
V. Cost Benefit Considerations
    A. Statutory and Regulatory Background
    B. Overview of Swap Clearing
    C. Consideration of the Costs and Benefits of the Commission's 
Action
    D. Costs and Benefits of the Rule as Compared to Alternatives
    E. Section 15(a) Factors
VI. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Background

A. Financial Crisis

    In the fall of 2008, a series of large financial institution 
failures triggered a financial and economic crisis that threatened to 
freeze U.S. and global credit markets. As a result of these failures, 
unprecedented governmental intervention was required to ensure the 
stability of the U.S. financial system.\2\ These failures revealed the 
vulnerability of the U.S. financial system and economy to wide-spread 
systemic risk resulting from, among other things, poor risk management 
practices of financial firms and the lack of supervisory oversight for 
a financial institution as a whole.\3\
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    \2\ On October 3, 2008, President Bush signed the Emergency 
Economic Stabilization Act of 2008, which was principally designed 
to allow the U.S. Department of the Treasury and other government 
agencies to take action to restore liquidity and stability to the 
U.S. financial system (e.g., the Troubled Asset Relief Program--also 
known as TARP--under which the U.S. Department of the Treasury was 
authorized to purchase up to $700 billion of troubled assets that 
weighed down the balance sheets of U.S. financial institutions). See 
Public Law 110-343, 122 Stat. 3765 (2008).
    \3\ See Financial Crisis Inquiry Commission, ``The Financial 
Crisis Inquiry Report: Final Report of the National Commission on 
the Causes of the Financial and Economic Crisis in the United 
States,'' Jan. 2011, at xxviii, available at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
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    The financial crisis also illustrated the significant risks that an 
uncleared, over-the-counter (OTC) derivatives market can pose to the 
financial system. As the Financial Crisis Inquiry Commission explained:

    The scale and nature of the [OTC] derivatives market created 
significant systemic risk throughout the financial system and helped 
fuel the panic in the fall of 2008: millions of contracts in this 
opaque and deregulated market created interconnections among a vast 
web of financial institutions through counterparty credit risk, thus 
exposing the system to a contagion of spreading losses and 
defaults.\4\
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    \4\ See id. at 386.

    Certain OTC derivatives, such as CDS, played a prominent role 
during the crisis. According to a white paper by the U.S. Department of 
the Treasury, ``the sheer volume of these [CDS] contracts overwhelmed 
some firms that had promised to provide payment of the CDS and left 
institutions with losses that they believed they had been

[[Page 47171]]

protected against.'' \5\ In particular, AIG reportedly issued uncleared 
CDS transactions covering more than $440 billion in bonds, leaving it 
with obligations that it could not cover as a result of changed market 
conditions.\6\ As a result of AIG's CDS exposure, the Federal 
government bailed out the firm with over $180 billion of taxpayer money 
in order to prevent AIG's failure and a possible contagion event in the 
broader economy.\7\
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    \5\ Financial Regulatory Reform: A New Foundation, June 2009, 
available at: http://www.treasury.gov/initiatives/Documents/FinalReport_web.pdf and cited in S. Rep. 111-176 at 29-30 (Apr. 30, 
2010).
    \6\ Adam Davidson, ``How AIG fell apart,'' Reuters, Sept. 18, 
2008, available at http://www.reuters.com/article/2008/09/18/us-how-aig-fell-apart-idUSMAR85972720080918.
    \7\ Hugh Son, ``AIG's Trustees Shun `Shadow Board,' Seek 
Directors,'' Bloomberg, May 13, 2009, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aaog3i4yUopo&refer=us.
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    More broadly, the President's Working Group (PWG) on Financial 
Policy noted shortcomings in the OTC derivative markets as a whole 
during the crisis. The PWG identified the need for an improved 
integrated operational structure supporting OTC derivatives, 
specifically highlighting the need for an enhanced ability to manage 
counterparty risk through ``netting and collateral agreements by 
promoting portfolio reconciliation and accurate valuation of trades.'' 
\8\ These issues were exposed in part by the surge in collateral 
required between counterparties during 2008, when the International 
Swaps and Derivatives Association (ISDA) reported an 86% increase in 
the collateral in use for OTC derivatives, indicating not only the 
increase in risk, but also circumstances in which positions may not 
have been collateralized.\9\
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    \8\ The President's Working Group on Financial Markets, ``Policy 
Statements on Financial Market Developments,'' Mar. 2008, available 
at http://www.treasury.gov/resource-center/fin-mkts/Documents/pwgpolicystatemktturmoil_03122008.pdf.
    \9\ ISDA, ISDA Margin Survey, 2009, available at http://www.isda.org/c_and_a/pdf/ISDA-Margin-Survey-2009.pdf.
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    With only limited checks on the amount of risk that a market 
participant could incur, great uncertainty was created among market 
participants. A market participant did not know the extent of its 
counterparty's exposure, whether its counterparty was appropriately 
hedged, or if its counterparty was dangerously exposed to adverse 
market movements. Without central clearing, a market participant bore 
the risk that its counterparty would not fulfill its payment 
obligations pursuant to a swap's terms (counterparty credit risk). As 
the financial crisis deepened, this risk made market participants wary 
of trading with each other. As a result, markets quickly became 
illiquid and trading volumes plummeted. The dramatic increase in ``TED 
spreads'' evidenced this mistrust.\10\ These spreads increased from a 
long-term average of approximately 30 basis points to 464 basis 
points.\11\
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    \10\ The TED spread measures the difference in yield between 
three-month Eurodollars as represented by London Interbank Offered 
Rate (LIBOR), and three-month Treasury Bills. LIBOR contains credit 
risk while T-bills do not. As the spread got larger, it meant that 
lenders demanded more return to compensate for credit risk then they 
would need if they loaned the money to the U.S. Department of the 
Treasury without any credit risk.
    \11\ The U.S. Financial Crisis: Credit Crunch and Yield Spreads, 
by James R. Barth et al., page 5, available at: http://apeaweb.org/confer/bei08/papers/blp.pdf.
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    The failure to adequately collateralize the risk exposures posed by 
OTC derivatives, along with the contagion effects of the vast web of 
counterparty credit risk, led many to conclude that OTC derivatives 
should be centrally cleared. For instance, in 2008, the Federal Reserve 
Bank of New York (FRBNY) began encouraging market participants to 
establish a central counterparty to clear CDS.\12\ For several years 
prior, the FRBNY had led a targeted effort to enhance operational 
efficiency and performance in the OTC derivatives market by increasing 
automation in processing and by promoting sound back office practices, 
such as timely confirmation of trades and portfolio reconciliation. 
Beginning with CDS in 2008, the FRBNY and other primary supervisors of 
OTC derivatives dealers increasingly focused on central clearing as a 
means of mitigating counterparty credit risk and lowering systemic risk 
to the markets as a whole. Both regulators and market participants 
alike recognized that risk exposures would have been monitored, 
measured, and collateralized through the process of central clearing.
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    \12\ See Federal Reserve Bank of New York, Press Release, ``New 
York Fed Welcomes Further Industry Commitments on Over-the-Counter 
Derivatives,'' Oct. 31, 2008, available at http://www.newyorkfed.org/newsevents/news/markets/2008/an081031.html, which 
references documents prepared by market participants describing the 
importance of clearing. See also Ciara Linnane and Karen Brettell, 
``NY Federal Reserve pushes for central CDS counterparty,'' Reuters, 
Oct. 6, 2008, available at http://www.reuters.com/article/2008/10/06/cds-regulation-idUSN0655208920081006.
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B. Central Role of Clearing in the Dodd-Frank Act

    Recognizing the peril that the U.S. financial system faced during 
the financial crisis, Congress and the President came together to pass 
the Dodd-Frank Act in 2010. Title VII of the Dodd-Frank Act establishes 
a comprehensive new regulatory framework for swaps, and the requirement 
that swaps be cleared by DCOs is one of the cornerstones of that 
reform. The CEA, as amended by Title VII, now requires a swap: (1) To 
be cleared through a DCO if the Commission has determined that the 
swap, or group, category, type, or class of 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.\13\
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    \13\ The Commission has proposed rules that would establish a 
separate process for determining whether a swap has been made 
``available to trade'' by a DCM or SEF. Those rules, and any 
determinations made under those rules, will be finalized separately 
from the proposed clearing requirements discussed herein. See 
Process for a Designated Contract Market or Swap Execution Facility 
to Make a Swap Available to Trade Under Section 2(h)(8) of the 
Commodity Exchange Act, 76 FR 77728 (Dec. 14, 2011).
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    Clearing is at the heart of the Dodd-Frank financial reform. 
According to the Senate Report:\14\
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    \14\ S. Rep. 111-176, at 32 (April 30, 2010). See also Letter 
from Senators Christopher Dodd and Blanche Lincoln to Congressmen 
Barney Frank and Collin Peterson (June 30, 2010) (``Congress 
determined that clearing is at the heart of reform--bringing 
transactions and counterparties into a robust, conservative, and 
transparent risk management framework.'').

    As a key element of reducing systemic risk and protecting 
taxpayers in the future, protections must include comprehensive 
regulation and rules for how the OTC derivatives market operates. 
Increasing the use of central clearinghouses, exchanges, appropriate 
margining, capital requirements, and reporting will provide 
safeguards for American taxpayers and the financial system as a 
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whole.

    The Commission believes that a clearing requirement will reduce 
counterparty credit risk and provide an organized mechanism for 
collateralizing the risk exposures posed by swaps. According to the 
Senate Report:\15\
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    \15\ S. Rep. 111-176, at 33.

    With appropriate collateral and margin requirements, a central 
clearing organization can substantially reduce counterparty risk and 
provide an organized mechanism for clearing transactions. * * * 
While large losses are to be expected in derivatives trading, if 
those positions are fully margined there will be no loss to 
counterparties and the overall financial system and none of the 
uncertainty about potential exposures that contributed to the panic 
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in 2008.


[[Page 47172]]


Notably, Congress did not focus on just one asset class, such as CDS; 
rather, Congress determined that all swaps that a DCO plans to accept 
for clearing must be submitted to the Commission for a determination as 
to whether or not those swaps are required to be cleared pursuant to 
section 2(h)(2)(D) of the CEA.

C. G-20 and International Commitments on Clearing

    The financial crisis generated international consensus on the need 
to strengthen financial regulation by improving transparency, 
mitigating systemic risk, and protecting against market abuse. As a 
result of the widespread recognition that transactions in the OTC 
derivatives market increased risk and uncertainty in the economy and 
became a significant contributor to the financial crisis, a series of 
policy initiatives were undertaken to better regulate the financial 
markets.
    In September 2009, leaders of the Group of 20 (G-20)--whose 
membership includes the United States, the European Union, and 18 other 
countries--agreed that: (1) OTC derivatives contracts should be 
reported to trade repositories; (2) all standardized OTC derivatives 
contracts should be cleared through central counterparties and traded 
on exchanges or electronic trading platforms, where appropriate, by the 
end of 2012; and (3) non-centrally cleared contracts should be subject 
to higher capital requirements.
    In June 2010, the G-20 leaders reaffirmed their commitment to 
achieve these goals. In its October 2010 report on Implementing OTC 
Derivatives Market Reforms (the October 2010 Report), the Financial 
Stability Board (FSB) made twenty-one recommendations addressing 
practical issues that authorities may encounter in implementing the G-
20 leaders' commitments.\16\ The G-20 leaders again reaffirmed their 
commitments at the November 2011 Summit, including the end-2012 
deadline. The FSB has issued three implementation progress reports. The 
most recent report urged jurisdictions to push forward aggressively to 
meet the G-20 end-2012 deadline in as many reform areas as possible. On 
mandatory clearing, the report observed that ``[j]urisdictions now have 
much of the information they requested in order to make informed 
decisions on the appropriate legislation and regulations to achieve the 
end-2012 commitment to centrally clear all standardised OTC 
derivatives.'' \17\
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    \16\ See ``Implementing OTC Derivatives Market Reforms,'' 
Financial Stability Board, Oct. 25, 2010, available at http://www.financialstabilityboard.org/publications/r_101025.pdf.
    \17\ OTC Derivatives Working Group, ``OTC Derivatives Market 
Reforms: Third Progress Report on Implementation,'' Financial 
Stability Board, June 15, 2012, available at http://www.financialstabilityboard.org/publications/r_120615.pdf.
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    Specifically with regard to required clearing, the Technical 
Committee of the International Organization of Securities Commissions 
(IOSCO) has published a final report, Requirements for Mandatory 
Clearing, outlining recommendations that regulators should follow to 
carry out the G-20's goal of requiring standardized swaps to be 
cleared.\18\
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    \18\ IOSCO's report, published in February 2012, is available at 
https://www.iosco.org/library/pubdocs/pdf/IOSCOPD374.pdf.
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D. Overview of Section 2(h) and Sec.  39.5

    The Commission has promulgated Sec.  39.5 of its regulations to 
implement procedural aspects section 2(h) of the CEA.\19\ Regulation 
39.5 establishes procedures for: (1) Determining the eligibility of a 
DCO to clear swaps; (2) the submission of swaps by a DCO to the 
Commission for a clearing requirement determination; (3) Commission 
initiated reviews of swaps; and (4) the staying of a clearing 
requirement.
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    \19\ See 76 FR 44464 (July 26, 2011); 17 CFR 39.5.
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    This determination and rule proposed today would require that 
certain swaps submitted by Commission-registered DCOs are required to 
be cleared under section 2(h) of the CEA. Under section 2(h)(1)(A), 
``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.'' \20\
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    \20\ See section 2(h) of the CEA. A clearing requirement 
determination also may be initiated by the Commission. Section 
2(h)(2)(A)(i) of the CEA requires the Commission on an ongoing basis 
to ``review each swap, or any group, category, type, or class of 
swaps to make a determination as to whether the swap, category, type 
or class of swaps should be required to be cleared.'' As previously 
noted, the Commission intends to consider swaps submitted by DCOs 
prior to undertaking any Commission-initiated reviews.
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    A clearing requirement determination may be initiated by a swap 
submission. Section 2(h)(2)(B)(i) of the CEA requires a DCO to ``submit 
to the Commission each swap, or any group, category, type or class of 
swaps that it plans to accept for clearing, and provide notice to its 
members of the submission.'' In addition under section 2(h)(2)(B)(ii) 
of the CEA, ``[a]ny swap or group, category, type, or class of swaps 
listed for clearing by a [DCO] as of the date of enactment shall be 
considered submitted to the Commission.''

E. Submissions From DCOs

    On February 1, 2012, Commission staff sent a letter requesting that 
DCOs submit all swaps that they were accepting for clearing as of that 
date, pursuant to Sec.  39.5.\21\ The Commission received submissions 
relating to CDS and IRS clearing from: the International Derivatives 
Clearinghouse Group (IDCH) on February 17, 2012; the CME Group (CME), 
ICE Clear Credit, ICE Clear Europe, each dated February 22, 2012, and a 
submission from LCH.Clearnet Limited (LCH) on February 24, 2012.\22\
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    \21\ The letter made it clear that DCOs should submit both pre-
enactment swaps and swaps for which DCOs have initiated clearing 
since enactment of the Dodd-Frank Act. Pre-enactment swaps refer to 
those swaps that DCOs were accepting for clearing as of July 21, 
2010, the date of enactment of the Dodd-Frank Act.
    \22\ Other swaps submissions were received from Kansas City 
Board of Trade (KCBT) and the Natural Gas Exchange (NGX). KCBT and 
NGX do not accept any CDS or IRS for clearing.
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    This proposal's clearing requirement determination would cover 
certain CDS and IRS currently being cleared by a DCO. The Commission 
intends subsequently to consider other swaps submitted by DCOs, such as 
agricultural, energy, and equity indices.
    The decision to focus on CDS and IRS in the initial clearing 
requirement determination is a function of both the market importance 
of these swaps and the fact that they already are widely cleared. In 
order to move the largest number of swaps to required clearing in its 
initial determination, the Commission believes that it is prudent to 
focus on those swaps that have the highest market shares and market 
impact. Further, for these swaps there is already a blueprint for 
clearing and appropriate risk management. CDS and IRS fit these 
considerations and therefore are well suited for required clearing 
consideration.\23\
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    \23\ The Commission will consider all other swaps submitted 
under Sec.  39.5(b) as soon as possible after this proposal is 
published. These other swaps include certain CDS that were submitted 
to the Commission subsequent to the initial February 2012 
submissions discussed above. If the Commission determines that 
additional swaps should be required to be cleared such determination 
likely will be proposed as a new class under proposed Sec.  50.4, as 
discussed below.
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    Significantly, market participants have recommended that the 
Commission take this approach. In their joint comment letter to the 
Commission's proposed Compliance and Implementation Schedule for the 
clearing requirement, the Futures Industry Association (FIA), ISDA, and 
the Securities Industry and Financial Markets Association (SIFMA) 
opined

[[Page 47173]]

that CDS and IRS should be required to be cleared first because they 
are already being cleared.\24\ FIA, ISDA, and SIFMA commented further 
that it would make sense for the Commission to require commodity and 
equity swaps to be cleared later because fewer of these swaps are 
currently being cleared. Similarly, the letter sent by the Alternative 
Investment Management Association (AIMA) in response to Commissioner 
O'Malia's request for comment concerning the implementation of the 
clearing requirement \25\ argues that the Commission should first 
review those swaps currently being cleared and then swaps that 
currently trade in large numbers.
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    \24\ FIA/ISDA/SIFMA comment letter to the Notice of Proposed 
Rulemaking, Swap Transaction Compliance and Implementation Schedule: 
Clearing and Trade Execution Requirements under Section 2(h) of the 
CEA, 76 FR 58186 (Sept. 20, 2011). This comment letter is available 
on the Commission's Web site at: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1093&ctl00--ctl00--
cphContentMain--MainContent--gvCommentListChangePage=2.
    \25\ On July 28, 2011, Commissioner O'Malia released a letter 
seeking public comment on the manner in which the Commission should 
determine (i) which swaps would be subject to the clearing 
requirement and (ii) whether to grant a stay of a clearing 
requirement. Commissioner O'Malia's letter, as well as AIMA's 
letter, are available on the Commission's Web site at: http://www.cftc.gov/About/Commissioners/ScottDOMalia/reviewofswaps.
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    IRS accounts for about $500 trillion of the $650 trillion global 
OTC swaps market, in notional dollars--the highest market share of any 
class of swaps.\26\ LCH claims to clear about $302 trillion of those--
meaning that, in notional terms, LCH clears approximately 60% of the 
IRS market.\27\ While CDS indices do not have as prominent a market 
share as IRS, CDS indices are capable of having a sizeable market 
impact, as they did during the 2008 financial crisis. Overall, the CDS 
marketplace has almost $29 trillion in notional outstanding across both 
single and multi-name products.\28\ CDS on standardized indices 
accounts for about $10 trillion of the global OTC market in notional 
dollar amount outstanding.\29\ Since March 2009, the ICE Clear Credit 
and ICE Clear Europe have combined to clear over $30 trillion in gross 
notional for all CDS.\30\ Because of the market shares and market 
impacts of these swaps, and because these swaps are currently being 
cleared, the Commission decided to review CDS and IRS in its initial 
clearing requirement determination. The Commission recognizes that 
while this is an appropriate basis for this initial proposal, swap 
clearing is likely to evolve and clearing requirement determinations 
made at later times may be based on a variety of other factors beyond 
the extent to which the swaps in question are already being cleared.
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    \26\ Bank of International Settlements (BIS) data, December 
2011, available at http://www.bis.org/statistics/otcder/dt1920a.pdf.
    \27\ Id.; LCH data.
    \28\ BIS data, December 2011, available at http://www.bis.org/statistics/otcder/dt1920a.pdf.
    \29\ Id.
    \30\ ICE Clear Credit data, as of the April 26, 2012 clearing 
cycle.
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II. Review of Swap Submissions

A. General Description of Information Considered

    The Commission reviewed each of the submissions in detail. Based on 
these submissions, the Commission was able to consider the ability of 
an individual DCO to clear a given swap, as well as to consider the 
information supplied cumulatively across all submissions for a given 
swap. The analysis included reviews of the DCOs' existing rule 
frameworks and their risk management policies. The Commission relied on 
industry data as available, such as publicly available Depository Trust 
and Clearing Corporation (DTCC) data from the Trade Information 
Warehouse (TIW) on CDS transactions. Other publicly available data 
sources, such as data from the Bank of International Settlements (BIS) 
on the OTC derivatives markets are analyzed and cited throughout this 
notice of proposed rulemaking. The Commission also was able to review 
letters from market participants directly related to the clearing 
requirement.\31\ Other market input on the clearing requirement could 
be taken from comments received with regard to rules relating to the 
proposed Swap Transaction Compliance and Implementation Schedule: 
Clearing and Trade Execution Requirements under Section 2(h) of the CEA 
\32\ and the Process for Review of Swaps for Mandatory Clearing.\33\ 
This notice of proposed rulemaking also reflects consultation with the 
staff of the Securities and Exchange Commission (SEC), prudential 
regulators, and international regulatory authorities. As Sec.  39.5 
provides for a 30-day comment period for any clearing determination, 
the final clearing requirement will be informed by public feedback.
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    \31\ See responses to Commissioner O'Malia's letter of June 28, 
2011 requesting input on the clearing determination available on the 
Commission's Web site, available at http://www.cftc.gov/About/Commissioners/ScottDOMalia/reviewofswaps.
    \32\ See comment file for Swap Transaction Compliance and 
Implementation Schedule: Clearing and Trade Execution Requirements 
under Section 2(h) of the CEA, 76 FR 58186 (Sept. 20, 2011), 
available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1093.
    \33\ See comment file for Process for Review of Swaps for 
Mandatory Clearing, 75 FR 67277 (Nov. 2, 2010), available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=890.
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B. Commission Processes for Review and Surveillance of DCOs

i. Part 39 Regulations Set Forth Standards for Compliance
    Section 2(h)(2)(D)(i) of the CEA provides that the Commission shall 
review whether the submissions are consistent with section 5b(c)(2) of 
the CEA. Section 5b(c)(2) of the CEA sets forth eighteen core 
principles with which DCOs must comply to be registered and to maintain 
registration. The core principles address numerous issues, including 
financial resources, participant and product eligibility, risk 
management, settlement procedures, default management, system 
safeguards, reporting, recordkeeping, public information, and legal 
risk.
    All of the DCOs that submitted swaps for review are registered with 
the Commission and their submissions identify swaps that they are 
already clearing. Consequently, the Commission has been reviewing and 
monitoring compliance by the DCOs with the core principles for the 
submitted swaps. For purposes of reviewing whether the submissions are 
consistent with section 5b(c)(2) of the CEA, the Commission will rely 
on both the information received in the submissions themselves and on 
its ongoing review and risk surveillance programs. These processes are 
summarized below to provide a better understanding of the information 
the Commission uses in its review of consistency of the submissions 
with the core principles. The Commission believes this overview is 
particularly helpful for this rulemaking because the clearing 
requirement proposed herein is the first such undertaking by the 
Commission under the provisions of the Dodd-Frank Act.
    The primary objective of the CFTC supervisory program is to ensure 
compliance with applicable provisions of the CEA and implementing 
regulations, and in particular, the core principles applicable to DCOs. 
A primary concern of the program is to monitor and mitigate potential 
risks that can arise in derivatives clearing activities for the DCO, 
its members, and entities using the DCO's services. Accordingly, the 
CFTC supervisory program takes a risk-based approach.
    In addition to the core principles set forth in section 5b(c)(2) of 
the CEA, section 5c(c) of the CEA governs the procedures for review and 
approval of new products, new rules, and rule amendments submitted to 
the

[[Page 47174]]

Commission by DCOs. Part 39 of the CFTC's regulations implements 
sections 5b and 5c(c) of the CEA by establishing specific requirements 
for compliance with the core principles as well as procedures for 
registration, for implementing DCO rules, and for clearing new 
products. Part 40 of the CFTC's regulations sets forth additional 
provisions applicable to a DCO's submission of rule amendments and new 
products to the CFTC.
    The Commission has means to enforce compliance, including the 
Commission's ability to sue the DCO in federal court for civil monetary 
penalties,\34\ issue a cease and desist order,\35\ or suspend or revoke 
the registration of the DCO.\36\ In addition, any deficiencies or other 
compliance issues observed during ongoing monitoring or an examination 
are frequently communicated to the DCO and various measures are used by 
the Commission to ensure that the DCO appropriately addresses such 
issues, including escalating communications within the DCO management 
and requiring the DCO to demonstrate, in writing, timely correction of 
such issues.
---------------------------------------------------------------------------

    \34\ See section 6c of the CEA.
    \35\ See section 6b of the CEA.
    \36\ See section 5e of the CEA.
---------------------------------------------------------------------------

ii. Initial Registration Application Review and Periodic In-Depth 
Reviews
    Section 5b of the CEA requires a DCO to register with the 
Commission. In order to do so, an organization must submit an 
application demonstrating that it complies with the core principles. 
During the review period, the Commission generally conducts an on-site 
review of the prospective DCO's facilities, asks a series of questions, 
and reviews all documentation received. The Commission may ask the 
applicant to make changes to its rules to comply with the CEA and the 
Commission's regulations.
    After registration, the Commission conducts examinations of DCOs to 
determine whether the DCO is in compliance with the CEA and Commission 
regulations. The examination consists of a planning phase where staff 
reviews information the Commission has on hand to determine whether the 
information raises specific issues and to develop an examination plan. 
The examination team participates in a series of meetings with the DCO 
at its facility. Commission staff also communicates with relevant DCO 
staff, including senior management, and reviews documentation. Data 
produced by the DCO is independently tested. Finally, when relevant, 
walk-through testing is conducted for key DCO processes.
iii. Commission Daily Risk Surveillance
    Commission risk surveillance staff monitors the risks posed to and 
by DCOs, clearing members, and market participants, including market 
risk, liquidity risk, credit risk, and concentration risk. This 
analysis includes reviews of daily, large trader reporting data 
obtained from market participants, clearing members, and DCOs, which is 
available at the trader, clearing member, and DCO levels. Relevant 
margin and financial resources information is also included within the 
analysis.
    Commission staff regularly conducts back-testing to review margin 
coverage at the product level and follows up with the relevant DCO 
regarding any exceptional results. Independent stress testing of 
portfolios is conducted on a daily, weekly, and ad hoc basis. The 
independent stress tests may lead to individual trader reviews and/or 
futures commission merchant (FCM) risk reviews to gain a deeper 
understanding of a trading strategy, risk philosophy, risk controls and 
mitigants, and financial resources at the trader and/or FCM level. The 
traders and FCMs that have a higher risk profile are then reviewed 
during the Commission's on-site review of a DCO's risk management 
procedures.

C. Credit Default Swaps

i. Submissions Provided Information per Sec.  39.5
    Pursuant to Sec.  39.5, the Commission received filings with 
respect to CDS from CME, ICE Clear Credit, and ICE Clear Europe.\37\ 
The CME and ICE Clear Credit submissions included the CDS that each 
clear on North American corporate indices, covering various tenors and 
series. The ICE Clear Europe submission includes, among other swaps, 
the CDS contracts on European corporate indices that they clear, with 
information on each of the different tenors and series. Each of the 
submissions contained information relating to the five statutory 
factors set forth in section 2(h)(2)(D) of the CEA and other 
information required under Sec.  39.5.
---------------------------------------------------------------------------

    \37\ In the case of CME and ICE Clear Europe, the submissions 
also included other swaps beyond those in the CDS and IRS 
categories. These submissions, including a description of the 
specific swaps covered, are available at http://www.cftc.gov/IndustryOversight/IndustryFilings/index.htm.
---------------------------------------------------------------------------

    CME, ICE Clear Credit, and ICE Clear Europe provided notice of 
their Sec.  39.5 swap submissions to their members by posting their 
submissions on their respective Web sites.\38\ The submissions also are 
published on the Commission's Web site.
---------------------------------------------------------------------------

    \38\ Available at: http://www.cmegroup.com/market-regulation/rule-filings.html and https://www.theice.com/publicdocs/regulatory_filings/ICEClearCredit_022212.pdf. ICE Clear Europe did not provide 
a link to its relevant Web page.
---------------------------------------------------------------------------

    Regulation 39.5(b)(3)(viii) also directs a DCO's submission to 
include a summary of any views on the submission expressed by members. 
CME's submission did not address this. In their submissions, ICE Clear 
Credit and ICE Clear Europe stated that neither has solicited nor 
received any comments to date and will notify the Commission of any 
such comments. The Commission expects that DCOs will provide any 
feedback they receive regarding their submissions to the Commission for 
consideration.
ii. Background on Market
    A credit default swap is a bilateral contract that allows the 
counterparties to trade or hedge the risk that an underlying entity 
will default--in most cases, either a corporate or a sovereign 
borrower. The protection buyer makes a quarterly premium payment until 
a pre-defined credit event occurs or until the swap agreement matures. 
In return, the protection seller assumes the financial loss in case the 
reference borrower becomes insolvent or an underlying security 
defaults. In addition to such ``single name'' CDS described above, the 
market also developed CDS to cover multi-name baskets of entities. 
While these baskets can be specifically created by the parties in a 
bespoke swap transaction, the large majority of multi-name baskets are 
based on both standardized indices and standardized swap agreements. 
These index CDS can cover up to 125 reference entities. Each of these 
entities may be weighted equally within the index or have different 
weightings depending on the terms of the specific index. Unlike a 
single name CDS, these contracts generally continue until the swap 
agreement reaches its scheduled termination date. Under the contract, 
the protection seller would assume the financial loss associated with, 
and make payment to the protection buyer on, each of the individual 
entities in the index that suffers a credit event until the swap's 
maturity. Those entities suffering a credit event would be removed from 
the index. The swap would continue on the remaining names, with the 
protection buyer making reduced quarterly premium

[[Page 47175]]

payments based upon the now smaller index covered by the swap.
    The most recent BIS study\39\ found that, as of December 2011, the 
size of the overall CDS marketplace exceeded $28.6 trillion in notional 
amount outstanding. Of that amount, $11.8 trillion was in multi-name 
CDS agreements. Within this sub-category of CDS, CDS on indices 
accounted for more than 89% of the total notional amount outstanding. 
This continues a trend as CDS on standardized indices have seen 
increasing volumes relative to other multi-name instruments such as 
synthetic collateralized debt obligations and other bespoke products.
---------------------------------------------------------------------------

    \39\ See BIS data, available at http://www.bis.org/statistics/otcder/dt1920a.pdf.
---------------------------------------------------------------------------

    Multiple providers have established CDS indices to be used by 
market participants. These providers typically establish an index's 
constituents, as well as standard terms and tenors. They also may 
provide on-going pricing services for their indices. The CDS indices 
owned and managed by Markit have the dominant market share within this 
class of CDS. There are other providers of CDS indices, though to date, 
those indices have not been widely used. Currently none of the indices 
are the basis for any CDS cleared by a DCO.\40\ The Markit CDX family 
of indices is the standard North American credit default swap family of 
indices, with the primary corporate indices being the CDX North 
American Investment Grade (consisting of 125 investment grade corporate 
reference entities \41\) (CDX.NA.IG) and the CDX North American High 
Yield (consisting of 100 high yield corporate reference entities) 
(CDX.NA.HY). The standard currency for CDS on these indices is the U.S. 
dollar.
---------------------------------------------------------------------------

    \40\ S&P/ISDA have, for example, co-branded additional indices 
for use in the CDS marketplace. These indices cover similar classes 
of reference entities as the Markit indices. To date, however, the 
use of these indices by market participants has been limited. With 
insufficient data regarding outstanding notional amounts and trading 
volumes, the Commission does not believe it appropriate to include 
these indices in the mandatory clearing determination. To the extent 
other providers establish indices with demonstrable open interest, 
trading volumes and pricing sources, the Commission will consider 
them for inclusion either within the current proposed classes of 
swaps, or within a separate class of swaps. Exclusion for the 
proposed classes only means that the CDS on such indices are not 
subject to a clearing requirement, and has no other impact on the 
use of such indices by market participants.
    \41\ The term ``reference entities'' refers to those entities 
that form the basis of an index. For the indices discussed in this 
proposal, all of the reference entities are corporate entities. For 
example, when one of those corporate entities declares bankruptcy, 
it may trigger a credit event under the terms of the index. A credit 
event also may be declared when a reference entity fails to pay on 
an outstanding debt.
---------------------------------------------------------------------------

    Additionally, Markit owns and manages the iTraxx indices covering 
reference entities in the European and Asia/Pacific markets. The 
primary indices for the European markets are the iTraxx Europe which 
covers 125 European investment grade corporate reference entities, the 
iTraxx Europe Crossover covering 50 European high yield reference 
entities and the iTraxx Europe High Volatility, which is a 30-entity 
subset of the European investment grade index. These indices are 
generally denominated in euro.
    Beyond those discussed above, Markit provides more granular indices 
covering specific corporate sectors in both the United States and 
Europe. Markit also provides indices that cover non-corporate reference 
entities, including indices of sovereign reference entities from around 
the world, U.S. municipal issuers and structured finance issuers. Some 
of the sector specific CDS, particularly those based on indices in the 
iTraxx family have significant volumes. For example, the iTraxx Europe 
Senior Financials referencing European financial institutions has over 
$13 billion in net notional and 3,711 open contracts for Series 17 
according to DTCC data.\42\ Those contracts are not currently cleared 
by a DCO and thus have not been submitted to the Commission. Therefore, 
these contracts are not being considered as part of the proposed 
clearing requirement determination discussed herein. To the extent 
these contracts were to be cleared by a DCO in the future, the DCO 
would be required to submit those contracts to the Commission for 
review pursuant to Sec.  39.5. If those contracts were not cleared by 
any DCO, they may still be subject to a Commission-initiated review 
pursuant to Sec.  39.5(c) in the future.
---------------------------------------------------------------------------

    \42\ See www.dtcc.com. Data as of May 21, 2012.
---------------------------------------------------------------------------

    As administrator of these indices, Markit reviews the composition 
of underlying reference entities in the indices every six months. Once 
Markit establishes the constituents to be included within the indices, 
a new series of the respective index is created. Additionally, each 
time one of the reference entities within an index suffers a credit 
event, a new version of an existing series of the index is created. In 
addition to the series and version variations that may exist on the 
index, the parties can choose the tenor of the CDS on a given index. 
While the 5-year tenor is the most common, and therefore most liquid, 
other standard tenors may include 1-, 2-, 3-, 7-, and 10-year swaps.
    Beyond these administrative functions, Markit, in conjunction with 
ISDA, has established standardized transaction terms and legal 
documentation in the form of standard terms supplements and 
confirmations for their indices. In the vast majority of cases, 
transactions using the indices are executed using these standard terms, 
although the indices also may be used in connection with non-standard 
transactions. A particular CDS index agreement will only be eligible to 
be cleared by a DCO to the extent the agreement is based upon the 
standard terms. Consistent with the movement of the CDS market to 
standardized contracts and spreads, cleared contracts all use 
standardized spreads of 100 or 500 basis points on the cost of 
protection, with the use of the upfront payments to accurately capture 
the cost of the credit protection on the indices.\43\
---------------------------------------------------------------------------

    \43\ ISDA's Big Bang Protocol in April 2009, in addition to 
providing the ``hardwiring'' necessary for Auction Settlement and 
the establishment of the Credit Derivatives Determination 
Committees, also created a new standardized North American corporate 
CDS contract with fixed scheduled termination dates, fixed payment 
and accrual dates, and standardized coupons. See http://www.isda.org/companies/auctionhardwiring/auctionhardwiring.html.
---------------------------------------------------------------------------

    The CDS cleared by CME, ICE Clear Credit, and ICE Clear Europe that 
were submitted to the Commission are standardized contracts providing 
credit protection on an untranched basis, meaning that settlement is 
not limited to a specific range of losses upon the occurrence of credit 
events among the reference entities included within an index. Besides 
single name CDS, these untranched CDS on indices are the only type of 
CDS being cleared by these DCOs. Other swaps like credit index 
tranches, options, and first- or Nth-to-default baskets on these 
indices are not currently cleared.
    Both CME and ICE Clear Credit have submitted standard untranched 
CDS on the CDX.NA.IG and the CDX.NA.HY indices that they clear. CME 
offers the CDX.NA.IG at the 3-, 5-, 7- and 10-year tenors for each 
series going back to Series 9 for those contracts that have not reached 
their termination date. For the North American high yield index, CME 
offers clearing for Series 11 and each subsequent series at the 5-year 
tenure.
    ICE Clear Credit offers CDX.NA.IG Series 8 and all subsequent 
series of that index that are still outstanding at the 5- and 10-year 
tenors. Additionally, Series 8 to Series 10 are cleared at the 7-year 
tenor. For the high yield index, ICE Clear Credit clears all series 
from the current series through the CDX.NA.HY Series 9 at the 5-year 
tenor.

[[Page 47176]]

    In addition to these indices, ICE Clear Credit has also cleared the 
CDX North American Investment Grade High Volatility (consisting 30 
names from the CDX.NA.IG) (CDX.NA.IG.HVOL). ICE Clear Credit is not 
however clearing Series 18, the most recently established series of the 
CDX.NA.IG.HVOL or Series 17, given the limited trading volumes for this 
swap. ICE Clear Credit only clears the CDX.NA.IG.HVOL for Series 9 
through Series 16, and only at the 5-year tenor.
    ICE Clear Europe, another registered DCO, made a submission 
covering the index CDS that it clears. Similar to the other 
submissions, the contracts that ICE Clear Europe clears are focused on 
corporate reference entities, though in this case, the entities are 
based in Europe. Also, similar to the CME and ICE Clear Credit 
submissions, the swaps cleared by ICE Clear Europe are indices owned 
and administered by Markit. ICE Clear Europe clears the euro-
denominated contracts referencing the iTraxx Europe, the iTraxx Europe 
Crossover, and the iTraxx Europe High Volatility. For the iTraxx Europe 
and Crossover, ICE Clear Europe clears outstanding contracts in the 
Series 7 and 8, respectively, through the current series. For the High 
Volatility index, ICE Clear Europe clears outstanding contracts in the 
Series 9 through the current series. In terms of tenors, ICE Clear 
Europe clears the 5-year tenor for all swaps, as well as the 10-year 
tenor for the iTraxx Europe index.
    Based upon those portions of the CME, ICE Clear Credit, and ICE 
Clear Europe swap submissions relating to the cleared CDS contracts 
discussed above, as well as the analysis conducted by the Commission 
pursuant to Sec.  39.5(b) and set forth below, the Commission is 
reviewing the following classes of swaps for purposes of the clearing 
requirement.
iii. CDS Trading and Risk Management
    The indices were created in the mid-2000s. Parties to these OTC 
contracts could use the indices to express their bullish or bearish 
sentiments on credit as an asset class, or to actively manage their 
credit exposures.\44\ As standardized contracts and indices, they had 
increased liquidity and were cheaper and easier to enter into than a 
customized transaction. Following the financial crisis, the popularity 
of such bespoke transactions like synthetic collateral debt obligations 
decreased and the standardized indices continued to grow.
---------------------------------------------------------------------------

    \44\ Generally the market for all CDS is driven by dealers. 
Recent estimates found that about 74% of CDS trading takes place 
among 20 dealer-banks worldwide, according to data from DTCC., which 
runs a central registry for credit derivatives. See http://www.bloomberg.com/news/2011-11-01/selling-more-insurance-on-shaky-european-debt-raises-risk-for-u-s-banks.html.
---------------------------------------------------------------------------

    Markit licenses its indices to market making financial 
institutions. Notwithstanding that these contracts trade as OTC 
products, the standardization of the contracts has allowed for them to 
be completed and confirmed electronically by a number of service 
providers. The 5-year tenor is the most liquid of the tenors. 
Similarly, the current ``on-the-run'' series tend to see the most 
liquidity, while the older ``off-the-run'' series tend to see less 
liquidity.\45\ Many investors exit positions in an existing series when 
a new series ``rolls,'' explaining increased liquidity in the ``on-the-
run'' series. As noted above, the pricing for the contract is generally 
set at a standardized rate of 100 or 500 basis points, with upfront 
payments exchanged to compensate for the actual price of the credit 
protection being provided.
---------------------------------------------------------------------------

    \45\ The term ``on-the-run'' refers to current series of an 
index, while older series are referred to ``off-the-run.'' Each six 
months when a new series is created (or ``rolls'' using market 
terminology), the new series is considered the ``on-the-run'' index, 
and all others are considered ``off-the-run.''
---------------------------------------------------------------------------

    For the DCOs clearing these swaps, the key factors in managing the 
risk of CDS portfolios that they clear are changes in the price of the 
swaps, the idiosyncratic risk related to the default of a reference 
entity, and the liquidity risk associated with unwinding a portfolio of 
a defaulting clearing member. While differing in the specific margin 
methodologies, each of the DCOs uses methodologies designed to capture 
99% of potential portfolio losses over a five-day period. The DCOs will 
stress CDS portfolios with shifts both up and down in the price of the 
CDS, as well as with changes to the slope of the term structure of the 
CDS pricing curve. Idiosyncratic risk will be captured by a ``jump-to-
default'' analysis in which widely held reference entities are assumed 
to default with limited or no recovery. Liquidity risk seeks to capture 
the cost of liquidating a portfolio, with assumed higher costs 
associated with concentrated portfolios.
    The DCOs conduct end-of-day settlement on the CDS, using prices 
submitted by clearing members that hold a cleared position in that 
swap. According to DCO rules, the submitted prices may be traded 
against, such that members are incentivized to submit accurate pricing 
data. The DCOs analyze the submitted data to remove any outliers.\46\ 
The DCOs then calculate a composite spread or price by aggregating all 
the prices individually submitted, after deleting the outliers.\47\ The 
more liquid a particular swap, the more price submissions will be made.
---------------------------------------------------------------------------

    \46\ Clearing rules generally provide for a mechanism for DCOs 
to levy fines against clearing members for failure to submit 
accurate prices across the full term structure for a given product.
    \47\ The theoretical spread/price of the index may be calculated 
by looking at the spread/price of each of the individual 
constituents in the index, though this may not account for the 
actual demand to buy or sell protection based on the index itself.
---------------------------------------------------------------------------

    In the event of a default of a clearing member, the DCOs have the 
ability to conduct an auction for other members to bid on all or a 
portion of the defaulting member's portfolio of CDS positions. To the 
extent that the DCO was unable to sell the entire portfolio, the 
clearing rules require the non-defaulting clearing members to accept an 
apportionment of such portfolio if required by the DCO. To the extent 
the market for a swap is more liquid, the chances for a successful 
auction would likely be increased. Further, to the extent an auction is 
unsuccessful, a more liquid market would give the clearing member 
receiving such an apportionment a better opportunity to successfully 
sell or otherwise offset the risk associated with the CDS it accepted.
    In addition to the CDS indices, ICE Clear Credit and ICE Clear 
Europe also offer single name CDS \48\ for clearing. Of the $29 
trillion in CDS notional outstanding, approximately $17 trillion is in 
single name swaps according to the latest market survey of BIS.\49\ As 
part of their margining methodology, DCOs are seeking approval to offer 
portfolio margining for the single name CDS and the CDS indices held 
within a given portfolio.\50\ Given that the single name reference 
entities will likely also be constituents of a given index within a 
portfolio, the Commission generally believes that such portfolio 
margining initiatives are consistent with the sound risk management 
policies for DCOs that are required under Sec.  39.13(g)(4). Moreover, 
DCOs such as ICE Clear Credit already use margining methodologies that 
provide for appropriate portfolio margining treatment with regard to 
clearing

[[Page 47177]]

members' proprietary positions.\51\ The Commission is committed to 
working toward establishing similar portfolio margining programs for 
DCOs clearing customer positions in CDS indices and single name CDS.
---------------------------------------------------------------------------

    \48\ Such single name CDS are defined as ``security-based 
swaps'' under section 721(a) of the Dodd-Frank Act.
    \49\ See BIS data, available at http://www.bis.org/statistics/otcder/dt1920a.pdf.
    \50\ See ICE Clear Credit's petitions to the Commission and SEC, 
dated October 4, 2011. The petition to the Commission is available 
at http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/iceclearcredit100411public.pdf.
    \51\ See ICE Clear Credit's certification to the Commission, 
dated as of November 25, 2011. The certification is available at 
http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/rul112511icecc001.pdf.
---------------------------------------------------------------------------

iv. CDS Classes Based on Key Specifications
    Under Sec.  39.5, the decision of the Commission to require that a 
group, category, type, or class of swaps be required to be cleared is 
informed by a number of factors. As an initial matter, the Commission 
looks to the submissions of the DCO themselves with regard to the swaps 
they submit. After analyzing the key attributes of the swaps submitted, 
the Commission is proposing to establish two classes of CDS subject to 
the clearing requirement. The first class is based on the North 
American untranched indices and the second class is based on the 
European untranched indices.
    Given the different markets that the CDS indices cover, the 
different currencies and other logistical differences in how the CDS 
markets and documentation work, the Commission believes this is an 
appropriate basis for separate classes. In the case of the submissions 
received to date, the U.S. dollar-denominated CDS covering North 
America corporate credits would be a separate class of CDS from a euro-
denominated CDS referencing European obligations.
    The nature of the underlying reference entities for the CDS serve 
to establish the another specification. Each index referenced was a 
broad-based pool of corporate entities. These indices included both 
investment grade and high yield corporate entities and they were not 
limited by a specific sector type. The data available for corporate CDS 
transactions, including the CDS indices, is substantial. As new swaps 
are cleared and considered by class, the nature of the underlying index 
will continue to be a factor in the establishment of such classes.
    As noted above, the regional differences in the way CDS indices are 
traded and cleared warrant a separate specification based upon common 
market standards established within the regions. Beyond different 
currencies, the key terms of the underlying CDS, including the relevant 
credit events, may differ with direct impact on the clearing and risk 
management of these products by DCOs.
    The actual indices included within a class are also specified. As 
only certain indices for a type of reference entity may have 
significant trading volumes and be cleared within a particular region, 
it is necessary to identify those specific indices within the classes.
    The classes are also being defined by particular tenors for the 
various indices included within the class. Given varying outstanding 
notional amounts and trading volumes on different tenors of existing 
indices, the Commission has analyzed the impact of including all or 
only select tenors within a given class. In addition, applicable series 
are identified within each tenor so that market participants can 
identify whether a particular series of given index is required to be 
cleared.
    Finally, the nature of the CDS itself referencing the underlying 
indices will be a factor as well. Each of the submissions dealt only 
with untranched CDS on the indices. There is a significant market for 
tranched swaps using the indices, where parties to the CDS contract 
agree to address only a certain range of losses along the entire loss 
distribution curve. Other swaps such as first or ``Nth'' to default 
baskets, and options, also exist on the indices.
v. Identification of Specifications
    The Commission is proposing two classes of CDS contracts subject to 
the clearing requirement. The first class would be untranched CDS 
contracts referencing corporate entities in North America via Markit's 
CDX.NA.IG and CDX.NA.HY indices. The second class would include 
untranched CDS referencing European corporate entities via Markit's 
iTraxx Europe, iTraxx Europe Crossover and iTraxx Europe High 
Volatility. The following table sets forth the specific specifications 
of each class:

                                 Table 1
------------------------------------------------------------------------
 
------------------------------------------------------------------------
               North American Untranched CDS Indices Class
------------------------------------------------------------------------
           Specification
 
1. Reference Entities.............  Corporate.
2. Region.........................  North America.
3. Indices........................  CDX.NA.IG.
                                    CDX.NA.HY.
4. Tenor..........................  CDX.NA.IG: 3Y, 5Y, 7Y, 10Y.
                                    CDX.NA.HY: 5Y.
5. Applicable Series..............  CDX.NA.IG 3Y: Series 15 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    CDX.NA.IG 5Y: Series 11 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    CDX.NA.IG 7Y: Series 8 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    CDX.NA.IG 10Y: Series 8 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    CDX.NA.HY 5Y: Series 11 and all
                                     subsequent Series, up to and
                                     including the current Series.
6. Tranched.......................  No.
------------------------------------------------------------------------
                  European Untranched CDS Indices Class
------------------------------------------------------------------------
           Specification
 
1. Reference Entities.............  Corporate.
2. Region.........................  Europe.
3. Indices........................  iTraxx Europe.
                                    iTraxx Europe Crossover.
                                    iTraxx Europe HiVol.
4. Tenor..........................  iTraxx Europe: 5Y, 10Y.
                                    iTraxx Europe Crossover: 5Y.
                                    iTraxx Europe HiVol: 5Y.
5. Applicable Series..............  iTraxx Europe 5Y: Series 10 and all
                                     subsequent Series, up to and
                                     including the current Series.

[[Page 47178]]

 
                                    iTraxx Europe 10Y: Series 7 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    iTraxx Europe Crossover 5Y: Series
                                     10 and all subsequent Series, up to
                                     and including the current Series.
                                    iTraxx Europe HiVol 5Y: Series 10
                                     and all subsequent Series, up to
                                     and including the current Series.
6. Tranched.......................  No.
------------------------------------------------------------------------

    The Commission is proposing to separate the classes of corporate 
swaps between the North American contracts and European contracts. The 
Commission believes that indices based on other types of entities would 
be viewed as a separate class and would be subject to a separate 
determination by the Commission. For example, given the differences 
that exist with regard to volumes and risk management of indices based 
on sovereign issuers, it is likely that such CDS would represent their 
own class of swaps. Similarly, to the extent indices from other regions 
were submitted by a DCO, it is likely that the Commission would take 
the view that they are part of their own class of swaps as well.
    The Commission believes it appropriate to define the classes of 
swaps as untranched CDS contracts referencing the broad-based corporate 
indices of Markit. These corporate indices have the most net notional 
outstanding, the most trading volumes, and the best available pricing. 
The risk management frameworks for the corporate index swaps are the 
most well-established, and have the most available data in terms of CDS 
spreads and corporate default studies for analysis of the underlying 
constituents of the indices. Agreements based on these indices also are 
widely accepted and use standardized terms.\52\
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    \52\ To the extent other vendors successfully develop similar 
indices, the Commission would conduct the analysis required by Sec.  
39.5, either on its own initiative or based on a DCO submission. If 
based on that analysis the Commission issued a clearing requirement 
determination, it is likely that such indices would be considered to 
be part of an existing class of CDS that are required to be cleared.
---------------------------------------------------------------------------

    Both of the CDS classes presented herein assume that the relevant 
CDS agreement will use the standardized terms established by Markit/
ISDA with regard to the specific index and be denominated in a currency 
that is accepted for clearing by DCOs. To the extent that a CDS 
agreement on an index listed within the classification is not accepted 
for clearing by any DCO because it uses non-standard terms or is 
denominated in a currency that makes it ineligible for clearing, that 
CDS would not be subject to the requirement that it be cleared, 
notwithstanding that the CDS is based on such index.
    With regard to the specific indices, the Commission has not 
included the CDX.NA.IG.HVOL within the North American swap class. While 
older series of this swap were cleared at the 5-year tenor by ICE Clear 
Credit, neither of the two most recent series has been cleared, given 
the lack of trading volume in this swap. The swap is not offered for 
clearing by CME. To the extent that any DCO decides to clear future 
series of this particular indice, it would need to be submitted 
pursuant to Sec.  39.5, at which time, the Commission would be able to 
revisit the profile of the underlying index and determine whether swap 
contracts associated with this index should be subject to a clearing 
requirement.
    ICE Clear Europe continues to clear the iTraxx Europe High 
Volatility through the current series at the 5-year tenor, 
notwithstanding declines in the volume for the recent series. Overall, 
the outstanding notional amounts and trading volumes are substantially 
less than those of the other iTraxx swaps. Recent DTCC data indicates 
that the gross notional amounts on contracts on the iTraxx Europe High 
Volatility index was $1.8 billion, representing less than 1% of those 
volumes for the European investment grade index and approximately 2.5% 
of the European high yield index for the same series.\53\
---------------------------------------------------------------------------

    \53\ See www.dtcc.com. Data as of May 21, 2012.
---------------------------------------------------------------------------

    Notwithstanding the relatively small volumes, the Commission is 
proposing to include the iTraxx Europe High Volatility index within the 
class of European corporate indices subject to required clearing at 
this time. Because the current on-the-run series of this particular 
index is cleared, unlike the similar North American contract, the 
Commission believes the contract should be included within the class of 
European corporate swaps that is required to be cleared.
    With regard to tenors, Markit, as administrator of the indices, 
publishes the initial spreads on the roll for each of the tenors 
offered for a given indice. For the CDX.NA.IG, it publishes spreads for 
the 1-, 2-, 3-, 5-, 7-, and 10-year tenors. For the CDX.NA.HY, the 
spreads are set for the 3-, 5-, 7-, and 10-year tenors. For the iTraxx 
Europe, Crossover and High Volatility, spreads are similarly set for 
the 3-, 5-, 7-, and 10-year tenors.
    Notwithstanding these various tenor offerings, the 5-year tenor for 
all indices is by far the most liquid tenor in the CDS marketplace. As 
a result, each DCO clears the 5-year tenor of the CDS index swaps that 
they clear. CME additionally offers clearing for 3-, 7-, and 10-year 
tenors on the CDX.NA.IG. ICE Clear Credit offers clearing on the 10-
year tenor for the North American investment grade swap in addition to 
the 5-year contract. In the past, ICE Clear Credit has cleared the 7-
year tenor of that index, but has not offered that tenor since Series 
10. For the iTraxx indices, ICE Clear Europe offers the 10-year tenor 
on the investment grade index, in addition to the 5-year tenor.
    Based upon its analysis of the Sec.  39.5 factors, the Commission 
is proposing that each of the 3-, 5-, 7-, and 10-year tenors be 
included within the class of swaps subject to the clearing requirement 
determination for CDX.NA.IG. While the DCO submissions indicate varying 
degrees of trading volumes among the indices at tenors other than the 
5-year tenor, there are clearly large notional volumes and trading 
activity across the products as a whole. The risk management frameworks 
and methodologies employed by the DCOs should not be substantially 
impacted or can be adjusted to accommodate additional tenors. The 
remaining factors should be unchanged.
    The Commission is proposing to exclude the 1- and 2-year tenors of 
the CDX.NA.IG from the class at this point. The Commission would like 
to see more data on the volumes of these tenors. Importantly, these 
tenors of swaps have not been submitted to the Commission by a DCO, so 
the Commission could review them when submitted by a DCO or on its own 
initiative pursuant to the Sec.  39.5(c). Because many investors use 
the 5-year tenor to take a view on credit as an asset class, and then 
exit the position when the new index rolls rather than hold a less 
liquid position in an off-the-run swap, the Commission is concerned 
that those seeking to avoid clearing may shift to the 1- or 2-year 
tenor to take a position on credit. The Commission will monitor volumes 
in the swaps at these tenors and evaluate

[[Page 47179]]

whether a change in the class of swaps to include these tenors is 
warranted.
    With regard to the CDX.NA.HY, the Commission's proposal will be 
limited to the 5-year tenor, the predominant tenor in this 
contract.\54\ Similarly, the Commission's proposal with regard to the 
iTraxx indices will capture only those tenors that are currently 
offered for clearing--the 5- and 10-year tenors for the iTraxx Europe, 
and the 5-year tenors for the iTraxx Crossover and the iTraxx High 
Volatility.
---------------------------------------------------------------------------

    \54\ After its initial submission, ICE Clear Credit added the 
CDX.NA.HY, Series 15, 3-year contract to its list of CDS contracts 
eligible for clearing. The Commission has reviewed this contract, 
but is not including this particular contract within its proposed 
determination. The Commission will monitor volumes in the product at 
these tenors and evaluate whether a change in the class of swaps to 
include additional tenors is warranted.
---------------------------------------------------------------------------

    The Commission's proposed clearing determination will be limited to 
only those series of a given index, which are currently being cleared. 
Therefore, no swaps referencing a series prior to Series 8 for the 
CDX.NA.IG and CDX.NA.HY would be required to be cleared. For the iTraxx 
Europe and iTraxx Europe Crossover, no contracts referencing a series 
prior to Series 7 would be required to be cleared, and in the case of 
the iTraxx Europe High Volatility, no series prior to Series 9 would be 
required to be cleared.\55\
---------------------------------------------------------------------------

    \55\ As discussed in further detail below, the clearing 
requirement would not require existing swaps in the older series to 
be cleared. The requirement is prospective, only requiring newly 
executed swaps in these older series to be cleared.
---------------------------------------------------------------------------

    Further, to the extent that any contract is of a tenor such that it 
is scheduled to terminate prior to July 1, 2013, such contract would 
not be part of this proposed clearing determination. Given the 
implementation periods provided for under Sec.  50.25, discussed below 
in Section IV, the Commission does not want to create a situation where 
certain market participants would be required to clear a contract based 
upon their status under the implementation provisions, but other 
parties would never be required to clear that same contract before its 
scheduled termination.
    The Commission also is proposing that the classes be limited to 
untranched CDS agreements on the aforementioned indices where the 
contract covers the entire index loss distribution of the index and 
settlement is not linked to a specified number of defaults. Tranched 
swaps, first- or ``Nth'' to-default, options, or any other product 
variations on these indices are excluded from these classes. These 
other swaps based on the indices, such as tranches, have very different 
profiles in terms of the Sec.  39.5 analysis. Besides very different 
notional and trading volumes, the risk management processes and 
operations may be significantly different. The Commission believes it 
appropriate to consider tranched swaps and other variations on the 
indices as outside of the classes of swaps proposed herein. Such swaps, 
if submitted, likely would be viewed as a separate class.

D. Proposed Determinations Analysis for Credit Default Swaps

    Section 2(h)(2)(D)(i) of the CEA requires the Commission to review 
whether a swap submission under section 2(h)(2)(B) is consistent with 
section 5b(c)(2) of the CEA. Section 2(h)(2)(D)(ii) of the CEA also 
requires the Commission to consider five factors in a determination 
based on a Commission initiated review or a swap submission: (1) The 
existence of significant outstanding notional exposures, trading 
liquidity, and adequate pricing data; (2) the availability of rule 
framework, capacity, operational expertise and resources, and credit 
support infrastructure to clear the contract on terms that are 
consistent with the material terms and trading conventions on which the 
contract is then traded; (3) the effect on the mitigation of systemic 
risk, taking into account the size of the market for such contract and 
the resources of the DCO available to clear the contract; (4) the 
effect on competition, including appropriate fees and charges applied 
to clearing; and (5) the existence of reasonable legal certainty in the 
event of the insolvency of the relevant DCO or one or more of its 
clearing members with regard to the treatment of customer and swap 
counterparty positions, funds, and property.
i. Consistency With Core Principles for Derivatives Clearing 
Organizations
    Section 2(h)(2)(D)(i) of the CEA requires the Commission to review 
whether a submission is consistent with the core principles for DCOs. 
Each of the DCO submissions relating to CDS provided data to support 
the Commission's analysis of the five factors under section 2(h)(2)(D) 
of the CEA. The Commission also was able to call upon independent 
analysis conducted with regard to CDS market, as well as its knowledge 
and reviews of the registered DCOs' operations and risk management 
processes, covering items such as product selection criteria, pricing 
sources, participant eligibility, and other relevant rules. The 
discussion of all of these factors is set forth below.
    The swaps submitted by CME, ICE Clear Credit, and ICE Clear Europe 
pursuant to Sec.  39.5(b) are currently being cleared by those 
organizations. As discussed above, the risk management, rules, and 
operations used by each DCO to clear these swaps are subject to review 
by the Commission risk management, legal, and examinations staff on an 
on-going basis.
    Additionally, each of the DCOs has established procedures for the 
review of any new swaps offered for clearing. Before the indices 
referenced herein were accepted for clearing by any of the DCOs, they 
were subject to review by the risk management functions of those 
organizations. Such analysis generally focuses on the ability to risk 
manage positions in the potential swaps and on any specific operational 
issues that may arise from the clearing of such swaps. In the case of 
the former, this involves ensuring that adequate pricing data is 
available, both historically and on a ``going forward'' basis, such 
that a margining methodology could be established, back-tested, and 
used on an on-going basis. Operational issues may include analysis of 
additional contract terms for new swaps that may require different 
settlement procedures. Each of the contracts submitted by CME, ICE 
Clear Credit, and ICE Clear Europe and discussed herein has undergone 
an internal review process by the respective DCO and has been 
determined to be within their product eligibility standards.
    As part of their rule frameworks, each of the DCOs also maintains 
participant eligibility requirements. On April 20, 2012, CME filed its 
amended rule concerning CDS Clearing Member Obligations and 
Qualifications (Rule 8H04). Pursuant to the amended rule, published to 
comply with Commission Regulation 39.12(a)(2), a CDS clearing member 
would have to maintain at least $50 million of capital. The amended 
rule would also require a CDS clearing member's minimum capital 
requirement to be ``scalable'' to the risks it poses. Further, CME 
already has client clearing available for its CDS index contracts.
    Similarly, on March 23, 2012, ICE Clear Credit filed its amended 
Rule 201(b) to incorporate the $50 million minimum capital requirement 
for clearing members. ICE Clear Credit also has client clearing 
available for its CDX index contracts.
    ICE Clear Europe has adopted similar rules to comply with Sec.  
39.12(a)(2), and has instituted changes to its rules to permit client 
clearing of its iTraxx contracts.
    In their submissions, CME and ICE Clear Credit enclosed their risk 
management procedures. In its submission, ICE Clear Europe references

[[Page 47180]]

its risk management procedures, which it had previously submitted to 
the Commission in connection with its application to register as a DCO. 
As part of its risk management and examination functions, the 
Commission reviews each DCO's risk management procedures, including its 
margining methodologies.
    ICE Clear Credit uses a multi-factor model to margin the indices 
discussed herein, as well as single name CDS. The margining methodology 
is designed to capture the risk of movements in credit spreads, 
liquidation costs, jump-to-default risk for those names on which credit 
protection has been sold, large position concentration risks, interest 
rate sensitivity, and basis risk associated with offsetting index 
derived single names and opposite ``outright'' single names. These 
factors are similarly used by ICE Clear Europe to calculate the 
margining requirements for their iTraxx swap listings and the 
underlying single name constituents. The CME's CDS model also weighs a 
number of factors to calculate the initial margin for a portfolio of 
CDS positions. These include macro-economic risk factors, such as 
movements associated with systematic risk resulting in large shifts in 
credit spreads across a portfolio, shifts in credit spreads based on 
tenors and changes in relative spreads between investment grade and 
high yield spreads. Additional factors include specific sector risks, 
the idiosyncratic risk of extreme moves in particular reference 
entities and the liquidity risk associated with unwinding the 
portfolio. In all cases, the methodologies are designed to protect 
against any 5-day move in the value of the given CDS portfolio, with a 
99% confidence level.
    In addition to initial margin, each of the clearinghouses collects 
variation margin on a daily basis to capture changes in the mark-to-
market value of the positions. To do this, the clearinghouses calculate 
end-of-day settlement prices using clearing member price submissions 
for cleared swaps. Each of the clearinghouses maintains processes for 
ensuring the quality of member price submissions, including the ability 
to compel trades at quoted prices on a random basis and to enforce 
fines on incomplete or incorrect submissions. ICE Clear Credit and ICE 
Clear Europe also use Markit services for CDX and iTraxx submissions. 
CME uses other third party data providers for pricing support as 
necessary on its cleared CDS products.
    In addition to the end-of-day settlement, each of the 
clearinghouses monitors positions throughout the day and maintains the 
ability to require margin on an intraday basis. Triggers may be set 
based upon the erosion of margin to a specific level or a call may be 
made at the discretion of the clearinghouse. When necessary, DCOs apply 
concentration charges to a clearing member's house or customer account 
in order to address situations where the DCO believes a given position 
may be under-collateralized because the size of the position relative 
to the size of the market may increase the cost of liquidating the 
position.
    In addition to the initial margin and variation margin collected by 
each DCO, each of the clearinghouses maintains a separate guaranty fund 
for its CDS clearing business. Using a combination of factors from 
their margining methodologies, positions are stressed to replicate 
extreme but plausible market conditions. Using these stressed results, 
each of the clearinghouses sizes its guaranty fund to cover the 
positions of its two largest debtor clearing members. Clearing members 
are required to contribute to the guaranty fund based on their relative 
positions.
    To the extent a clearing member was unable to meet a margin call, 
or otherwise violated clearinghouse rules, each of the clearinghouses 
has the ability to find a clearing member in default. In such cases, 
each of the clearinghouses has established procedures by which it 
attempts to minimize the risk associated with a defaulting member's 
positions. A clearinghouse would activate its default committee, 
seconding traders from clearing participants, to work to partition the 
portfolio for sale and for hedging purposes. The clearinghouse would 
then conduct an auction among its clearing participants for the sale of 
the portfolio. To the extent certain positions were unsold, each of the 
clearinghouses has the ability to allocate such positions to the 
remaining clearing members.
    While other resources of the clearinghouse would be available in 
the event of a default of a clearing member, including clearinghouse 
contributions, the initial margin and guaranty fund contributions make 
up the primary financial resources of the clearinghouses. In total, 
CFTC-registered DCOs are currently holding more than $20 billion in 
aggregate in initial margin to cover cleared CDS positions.\56\ 
Additionally, publicly available data shows that CME's CDS guaranty 
fund has approximately $629 million; ICE Clear Credit has a guaranty 
fund equal to $4.4 billion; and ICE Clear Europe has a guaranty fund 
[euro]2.7 billion for its CDS business.\57\ In addition to the guaranty 
fund contributions made by clearing members, each of the clearinghouses 
also makes contributions to their respective funds, ranging in amounts 
from $50 to $100 million.\58\
---------------------------------------------------------------------------

    \56\ Based on Commission data for registered DCOs as of May 10, 
2012.
    \57\ See http://www.cmegroup.com/clearing/cme-clearing-overview/safeguards.html for data regarding CME's guaranty fund, as of May 
10, 2012; https://www.theice.com/clear_credit.jhtml for data on the 
size of ICE Clear Credit's guaranty fund; and https://www.theice.com/clear_europe_cds.jhtml for data on the size of ICE 
Clear Europe's guaranty fund for CDS, as of May 10, 2012.
    \58\ Many DCOs also have rules allowing for an assessment of the 
remaining clearing members in the event of a default.
---------------------------------------------------------------------------

    Based upon the Commission's on-going risk management and rule 
reviews, and its annual examinations of the DCOs, the Commission 
believes that the submissions of CME, ICE Clear Credit, and ICE Clear 
Europe are consistent with section 5b(c)(2) of the CEA and the related 
Commission regulations. In analyzing the CDS products submissions 
discussed herein, the Commission does not believe that a clearing 
determination with regard to the specified CDS products would be 
inconsistent with CME, ICE Clear Credit, or ICE Clear Europe's 
continued ability to maintain such compliance with the DCO core 
principles.
ii. Consideration of the Five Statutory Factors for Clearing 
Requirement Determinations
    a. Outstanding Notional Exposures, Trading Liquidity, and Adequate 
Pricing Data
    Section 2(h)(2)(D)(ii)(I) of the CEA requires the Commission to 
take into account the existence of outstanding notional exposures, 
trading liquidity, and adequate pricing data. As discussed earlier, the 
most recent BIS data has shown significant growth in the use of CDS on 
index products, with notional amounts growing by 40% over the most 
recent annual reporting period. Overall, CDS on index products account 
for 37% of all notional amounts of CDS contracts outstanding, with over 
$10 trillion in notional outstanding.
    The predominant provider of CDS indices is Markit. Markit has 
indices covering corporate and sovereign entities, among others, in the 
United States, Europe, and Asia. Recent Markit data shows daily 
transaction volumes of 1,561 transactions using its licensed family of 
CDX indices, and 1,266 daily transactions using its European iTraxx 
index swaps.\59\ Further, it shows a rolling monthly average of $663 
billion in gross notional amount for the CDX family of indices and 
[euro]499 billion for

[[Page 47181]]

the iTraxx family. Nearly all of the CDX contracts and volumes come 
from indices that would be subject to the proposed clearing requirement 
determination. For the iTraxx, more than 79% of those daily contract 
volumes and 82% of the daily gross notional volumes come from the 
iTraxx investment grade and high yield indices contemplated by the 
proposed clearing requirement determination.
---------------------------------------------------------------------------

    \59\ Based on data published on www.markit.com as of May 23, 
2012.
---------------------------------------------------------------------------

    One point highlighted by this data, however, is the declining 
trading liquidity in the off-the-run series that can occur. Of the 
volumes noted by Markit, nearly 60% was in the current on-the-run 
series, as compared to all other outstanding series combined. The 
submissions of ICE Clear Credit, ICE Clear Europe, and CME also note 
the decline in average weekly gross notional amounts and contracts for 
benchmark tenors for off-the-run indices. The decline however can be 
more precipitous among older off-the-run indices. While many market 
factors can contribute to the actual volumes for a specific off-the-run 
contract, subject to certain exceptions, the trend is generally toward 
lower volumes.
    Set forth below is a table of data taken from DTCC as of May 22, 
2012, highlighting the net notional amounts and outstanding contracts 
across all tenors available for each series in the proposed 
determination.\60\
---------------------------------------------------------------------------

    \60\ Data available at www.dtcc.com. In 2006, DTCC began 
providing warehouse services for confirmed CDS trades through its 
Trade Information Warehouse (TIW). With the commitment of global 
market participants in 2009 to ensure that all OTC derivatives 
trades are recorded by a central repository, TIW has become a global 
repository for all CDS trades. With all major market participants 
submitting their trades to the TIW, it is estimated that 98% of all 
CDS trades are included within the warehouse, making it the primary 
source of CDS transaction data.
---------------------------------------------------------------------------

BILLING CODE 6351-01-P

[[Page 47182]]

[GRAPHIC] [TIFF OMITTED] TP07AU12.000

    Notwithstanding the declining volumes that occur when an index is 
no longer on-the-run, the Commission does not believe that is 
sufficient reason to exclude the older series from the classes of CDS. 
As the DTCC data indicates, there are still significant volumes of 
outstanding notional amounts in each of these series. From the 
perspective of the clearinghouse, the risk management of the older 
series of swaps should not provide significant additional challenges. 
With the significant notional and contract volumes still outstanding at 
DTCC, many clearing members already have these positions on their books 
and are meeting their risk management requirements, even in the face of 
declining trading volumes. Finally, while the volumes may decline, the 
data included in the submissions indicates that volume still does 
exist, and parties should be able trade as necessary. Additionally, as 
discussed further below, the clearing requirement would apply only to 
new swaps executed in the off-the-run indices.
    Given the contract and notional volumes listed above, there is 
adequate data available on pricing. The pricing for the CDS on these 
indices is fairly consistent across clearinghouses. The clearinghouses 
generally require a clearing member with open interest in a particular 
index to provide a price on that index for end of day settlement 
purposes. After applying a process to remove clear outliers, a 
composite price is calculated using the remaining prices. To ensure the 
integrity of the submissions, clearing members' prices may be 
``actionable,'' meaning that they may form the basis of an actual trade 
that the member will be forced to enter. Clearinghouses also have 
compliance programs that may result in fines for clearing members that 
fail to submit accurate pricing data.
    Beyond clearing member submissions, there are a number of third-
party vendors that provide pricing services on these swaps. Third-party 
vendors typically source their data from a broader range of dealers. 
The data includes both direct contributions as well as feeds to 
automated trading systems. This data is reviewed for outliers and 
aggregated for distribution.

[[Page 47183]]

b. Availability of Rule Framework, Capacity, Operational Expertise and 
Resources, and Credit Support Infrastructure
    Section 2(h)(2)(D)(ii)(II) of the CEA requires the Commission to 
take into account the availability of rule framework, capacity, 
operational expertise and resources, and credit support infrastructure 
to clear the contract on terms that are consistent with the material 
terms and trading conventions on which the contract is then traded. The 
Commission preliminarily has determined that this factor is satisfied 
by each of CME, ICE Clear Credit, and ICE Clear Europe.
    CME, ICE Clear Credit, and ICE Clear Europe, respectively, 
currently are clearing the swaps each submitted under Sec.  39.5. As 
such, they have developed respective rule frameworks, capacity, 
operational expertise and resources, and credit support infrastructure 
to clear the contracts on terms that are consistent with the material 
terms and trading conventions on which the contracts currently are 
trading. The Commission believes that these are scalable and that CME, 
ICE Clear Credit, and ICE Clear Europe would be able to risk manage the 
additional swaps that might be submitted due to the clearing 
requirement determination.
    Following the financial crisis, the major market participants 
committed in 2009 to the substantial reforms to the OTC derivatives 
markets.\61\ Among the commitments from CDS dealers and buy side 
participants was to actively engage with central counterparties to 
broaden the range of cleared swaps and market participants. These 
changes were in addition to those generated through organizations like 
ISDA and their protocols impacting CDS. For broadly traded swaps like 
the CDS indices, the ultimate impact of these initiatives was 
operational platforms, rule frameworks, and other infrastructure 
initiatives that replicated the bilateral market and supported the move 
of these CDS to a centrally cleared environment. In this way, the CDS 
clearing services offered by DCOs, including CME, ICE Clear Credit, and 
ICE Clear Europe, were designed to be cleared in a manner that is 
consistent with the material terms and trading conventions of a 
bilateral, uncleared market.
---------------------------------------------------------------------------

    \61\ See the June 2, 2009 letter to The Honorable William C. 
Dudley, President of the Federal Reserve Bank of New York, available 
at http://www.newyorkfed.org/newsevents/news/markets/2009/060209letter.pdf.
---------------------------------------------------------------------------

    In addition, CME, ICE Clear Credit, and ICE Clear Europe are 
registered DCOs. To be registered as such, CME, ICE Clear Credit, and 
ICE Clear Europe have, on an on-going basis, demonstrated to the 
Commission that they are each in compliance with the core principles 
set forth in the CEA and Commission regulations, as discussed above. As 
a general matter, any DCO that does not have the rule framework, 
capacity, operational expertise and resources, and credit support 
infrastructure to clear the swaps that are subject to mandatory 
clearing is not in compliance with the core principles or the 
Commission regulations promulgating these principles.
    The Commission requests comment on all aspects of this factor, 
including whether or not commenters agree that an applicant's status as 
a registered DCO is sufficient for meeting the factor's requirements.
c. Effect on the Mitigation of Systemic Risk
    Section 2(h)(2)(D)(ii)(III) of the CEA requires the Commission to 
take into account the effect on the mitigation of systemic risk, taking 
into account the size of the market for such contract and the resources 
of the DCO available to clear the contract. The Commission agrees with 
the Sec.  39.5 swap submissions of the CME, ICE Clear Credit, and ICE 
Clear Europe that requiring certain classes of CDS to be cleared would 
reduce systemic risk in this sector of the swaps market. As CME noted, 
the 2008 financial crisis demonstrated the potential for systemic risk 
arising from the interconnectedness of OTC derivatives market 
participants and the limited transparency of bilateral, i.e. uncleared, 
counterparty relationships. According to the Quarterly Report (Third 
Quarter 2011) on Bank Trading and Derivatives Activities of the Office 
of the Comptroller of the Currency (OCC Report),\62\ CDS index products 
account for a significant percentage of the notional value of swaps 
positions held by financial institutions. According to ICE Clear 
Credit, the CDS indices it offers for clearing are among the most 
actively traded swaps with the largest pre-clearing outstanding 
positions, and ICE Clear Credit's clearing members are among the most 
active market participants. ICE Clear Credit also noted that its 
clearing members clear a significant portion of their clearing-eligible 
portfolio.
---------------------------------------------------------------------------

    \62\ Available at: http://occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq311.pdf.
---------------------------------------------------------------------------

    Clearing the CDS indices subject to this proposal will reduce 
systemic risk in the following ways: Mitigating counterparty credit 
risk because the DCO would become the buyer to every seller of CDS 
indices subject to this proposal and vice versa; providing 
counterparties with daily mark-to-market valuations and exchange of 
variation margin pursuant to a risk management framework; posting 
initial margin with the clearinghouse in order to cover potential 
future exposures in the event of a default; achieving multilateral 
netting, which substantially reduces the number and notional amount of 
outstanding bilateral positions; reducing swap counterparties' 
operational burden by consolidating collateral management and cash 
flows; and eliminating the need for novations or tear-ups because 
clearing members may offset opposing positions.
    As discussed previously, the clearinghouses collect substantial 
amounts of collateral in the form of initial margin and guaranty fund 
contributions to cover potential losses on CDS portfolios. The 
methodologies for calculating these amounts are based on covering 5-day 
price movements on a portfolio with a 99% confidence level for initial 
margin, and longer liquidation periods and higher confidence levels 
under ``extreme but plausible'' conditions in the case of guaranty fund 
requirements. Beyond these financial resources, the clearinghouses have 
in place established risk monitoring processes, system safeguards, and 
default management procedures, which are subject to testing and review, 
to address potential systemic shocks to the financial markets.
    The Commission requests comment on all aspects of this factor, 
including the risk mitigation associated with proposed clearing 
determination.
d. Effect on Competition
    Section 2(h)(2)(D)(ii)(IV) of the CEA requires the Commission to 
take into account the effect on competition, including appropriate fees 
and charges applied to clearing. Of particular concern to the 
Commission is whether this proposed determination would harm 
competition by creating, enhancing, or entrenching market power in an 
affected product or service market, or facilitating the exercise of 
market power.\63\ Under U.S. Department of Justice guidelines, market 
power is viewed as the ability ``to raise price [including clearing 
fees and charges], reduce output, diminish innovation, or otherwise 
harm customers as a result of

[[Page 47184]]

diminished competitive constraints or incentives.'' \64\
---------------------------------------------------------------------------

    \63\ See U.S. Department of Justice and the Federal Trade 
Commission, Horizontal Merger Guidelines [hereinafter ``Horizontal 
Merger Guidelines''] at Sec.  1(Aug. 19, 2010), available at http://www.justice.gov/atr/public/guidelines/hmg-2010.pdf.
    \64\ Id.; see also U.S. Department of Justice (DOJ) and the 
Federal Trade Commission (FTC), Antitrust Guidelines for 
Collaborations Among Competitors at Sec.  1.2 (April 2000), 
available at http://www.ftc.gov/os/2000/04/ftcdojguidelines.pdf 
(``The central question is whether the relevant agreement likely 
harms competition by increasing the ability or incentive profitably 
to raise price above or reduce output, quality, service, or 
innovation below what likely would prevail in the absence of the 
relevant agreement'').
---------------------------------------------------------------------------

    The Commission has identified the following putative product and 
service markets as potentially affected by this proposed clearing 
determination: A DCO service market encompassing those clearinghouses 
that currently (or with relative ease in the future could) clear the 
CDS subject to this proposal, and a CDS product market or markets 
encompassing the CDS that are subject to this determination.\65\ 
Without defining the precise contours of these markets at this 
time,\66\ the Commission recognizes that, depending on the interplay of 
several factors, this proposed swap determination potentially could 
impact competition within the affected markets. Of particular 
importance to whether any impact is, overall, positive or negative, is: 
(1) Whether the demand for these clearing services and swaps is 
sufficiently elastic that a small but significant increase above 
competitive levels would prove unprofitable because users of the CDS 
products and DCO clearing services would substitute other products/
clearing services co-existing in the same market(s), and (2) the 
potential for new entry into these markets. The availability of 
substitute products/clearing services to compete with those encompassed 
by this proposed determination, and the likelihood of timely, 
sufficient new entry in the event prices do increase above competitive 
levels, each operate independently to constrain anticompetitive 
behavior.
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    \65\ Included among these could be a separate product market for 
CDS indices licensing.
    \66\ The federal antitrust agencies, the DOJ and FTC, use the 
``hypothetical monopolist test'' as a tool for defining antitrust 
markets for competition analysis purposes. The test ``identif[ies] a 
set of products that are reasonably interchangeable with a 
product,'' and thus deemed to reside in the same relevant antitrust 
product or service market. ``[T]he test requires that a hypothetical 
profit-maximizing firm, not subject to price regulation, that was 
the only present and future seller of those products (`hypothetical 
monopolist') likely would impose at least a small but significant 
and non-transitory increase in price (`SSNIP') on at least one 
product in the market.'' In most cases, a SSNIP of five percent is 
posited. If consumers would respond to the hypothesized SSNIP by 
substituting alternatives to a significant degree to render it 
unprofitable, those alternative products/services are included 
within the relevant market. This methodological exercise is repeated 
until it has been determined that consumers have no further 
interchangeable products/services available to them. Horizontal 
Merger Guidelines at Sec.  4.1.
---------------------------------------------------------------------------

    Any competitive import would likely stem from the fact that 
proposed determination would (1) remove the alternative of not clearing 
the CDS subject to this proposal, and/or (2) single out Markit indices 
and certain tenors for determination. The proposed determination would 
not specify what CDS products (or products that compete with the 
proposed CDS classes) may or may not be offered, traded, or voluntarily 
cleared; or who may or may not compete to provide clearing services for 
the CDS subject to this proposal (as well as those not required to be 
cleared). With respect to the first potential area of competitive 
import, to the extent that parties to the CDS subject to this proposal 
consider clearing the transactions reasonably interchangeable with not 
clearing them, the proposed determination would eliminate at least one 
competitive substitute within the clearinghouse services market for the 
CDS subject to this proposal. Given the risk-mitigation purpose and 
benefit of migration to voluntary CDS clearing, however, the Commission 
sees some basis to doubt that, under the ``hypothetical monopolist'' 
methodology,\67\ counterparties to cleared swaps would consider the 
alternative of not clearing CDS under this proposal as a reasonable 
substitute to a degree sufficient that they should be viewed as 
populating the same relevant market.\68\ And, if the alternative of not 
clearing the proposed classes of CDS falls outside of the relevant 
services market that includes clearing, the proposed clearing 
determination should not impact competition in the clearing services 
market. The Commission requests comment on the extent to which 
foregoing clearing is considered reasonably interchangeable with 
clearing the CDS subject to this proposal and, in particular, if 
parties transacting cleared swaps in these classes would forego 
clearing if clearinghouses raised the price of clearing five percent. 
The Commission also requests comment on whether a different percentage 
than five percent should be used.
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    \67\ See id.
    \68\ In other words, the Commission questions that, faced with a 
five percent non-transitory increase in the price of clearing the 
identified CDS classes, including fees and other charges, that the 
parties to these CDS transactions would forego clearing in 
sufficient volume to render the price increase unprofitable.
---------------------------------------------------------------------------

    Moreover, even if cleared and non-cleared transactions in the 
proposed CDS clearing requirement are now within the same relevant 
market, removing the uncleared option through this proposed rulemaking 
is not determinative of negative competitive impact. Other factors--
including the availability of other substitutes within the market or 
potential for new entry into the market--may constrain market power.
    The Commission recognizes that currently no DCO clears CDS indices 
licensed by any other provider than Markit, suggesting the possibility 
that currently the clearing service market may be limited to the three 
providers (CME, ICE Clear Credit, and ICE Clear Europe) now clearing 
CDS indices licensed by Markit. This could be indicative, but is not 
dispositive, of whether a concentrated clearing services market 
susceptible to exercises of market power exists. The possibility 
remains that uncleared transactions on other indices, as well as 
cleared and uncleared transactions on Markit indices of tenors not 
included within the proposed determination, may also populate the 
affected clearing services market to constrain CME, ICE Clear Credit, 
and ICE Clear Europe from exercising market power.\69\ The Commission 
requests comment on the extent to which uncleared transactions on non-
Markit indices, and cleared and uncleared transactions on Markit 
indices of tenors not included within the proposed determination, are 
considered reasonably interchangeable with clearing the CDS subject to 
this proposal; and, in particular, if parties transacting cleared CDS 
subject to this proposal would substitute uncleared transactions on 
non-Markit indices and/or transactions on Markit CDS tenors not subject 
to this proposal if clearinghouses raised the price of clearing the CDS 
required to be cleared five percent.
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    \69\ Stated another way, competitive or potentially competitive 
CDS indices other than Markit, or for Markit CDS tenors other than 
those subject to this proposal, may offer a reasonably 
interchangeable substitute for cleared transactions in the proposed 
classes proposed, particularly if the price of clearing the required 
classes increased five percent.
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    Additionally, the potential for new entry may constrain market 
power in an otherwise concentrated clearing services market. The 
Commission does not foresee that the proposed determination constructs 
barriers that would deter or impede new entry into a clearing services 
market.\70\ Indeed, there is some

[[Page 47185]]

basis to expect that the determination could foster an environment 
conducive to new entry. For example, the proposed clearing 
determinations, and the prospect that more may follow, is likely to 
reinforce, if not encourage, growth in demand for clearing services. 
Demand growth, in turn, can enhance the sales opportunity, a condition 
hospitable to new entry.\71\ Further, this proposed determination may 
increase the incentive of competing indices providers (for illustration 
purposes, Standard & Poor's) to support a new clearing services entrant 
through some form of partnership or other sponsorship effort. The 
Commission requests comment on the extent to which (1) entry barriers 
currently do or do not exist with respect to a clearing services market 
for the identified CDS classes; (2) the proposed determinations may 
lessen or increase these barriers; and (3) the proposed determinations 
otherwise may encourage, discourage, facilitate, and/or dampen new 
entry into the market.
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    \70\ That said, the Commission recognizes that (1) to the extent 
the clearing services market for the CDS subject to this proposal, 
after foreclosing uncleared swaps, would be limited to a 
concentrated few participants with highly aligned incentives, and 
(2) the clearing services market is insulated from new competitive 
entry through barriers--e.g., high sunk capital cost requirements; 
high switching costs to transition from embedded, incumbents; and 
access restrictions, the proposed determination could have a 
negative competitive impact by increasing market concentration.
    \71\ See, e.g., Horizontal Merger Guidelines at Sec.  9.2 (entry 
likely if it would be profitable which is in part a function of 
``the output level the entrant is likely to obtain'').
---------------------------------------------------------------------------

    Also, while the proposed rule does single out Markit indices and 
certain CDS tenors for required clearing, for reasons similar to those 
discussed above, this does not foreclose competition from CDS on other 
indices or tenors, and may in fact encourage it. For example, the 
Commission anticipates that an attempt by Markit to increase indices 
licensing fees would present a competitive opportunity for current and 
potential future indices providers to capture market share and/or 
entrants to leverage from market entry. The Commission requests comment 
on the extent to which competition in identified Markit CDS product 
markets may be impacted, including any expected impact on the price of 
Markit indices licenses, cost of swaps in the required classes, and 
entry conditions.
    In addition to what is noted above, the Commission requests 
comment, and quantifiable data, on whether the required clearing of any 
or all of these swaps will create conditions that create, increase, or 
facilitate an exercise of (1) clearing services market power in CME, 
ICE Clear Credit, ICE Clear Europe, and/or any other clearing service 
market participant, including conditions that would dampen competition 
for clearing services and/or increase the cost of clearing services, 
and/or (2) market power in any product markets for Markit indices and 
CDS tenors, including conditions that would dampen competition for 
these product markets and/or increase the cost of CDS involving the 
proposed clearing requirement. The Commission seeks comment, and 
quantifiable data, on the likely cost increases associated with 
clearing, particularly those fees and charges imposed by DCOs, and the 
effects of such increases on counterparties currently participating in 
the market. The Commission also seeks comment regarding the effect of 
competition on risk management by DCOs. The Commission welcomes comment 
on any other aspect of this factor.
e. Legal Certainty in the Event of the Insolvency
    Section 2(h)(2)(D)(ii)(V) of the CEA requires the Commission to 
take into account the existence of reasonable legal certainty in the 
event of the insolvency of the relevant DCO or one or more of its 
clearing members with regard to the treatment of customer and swap 
counterparty positions, funds, and property. The Commission is 
proposing this clearing requirement based on its view that there is 
reasonable legal certainty with regard to the treatment of customer and 
swap counterparty positions, funds, and property in connection with 
cleared swaps, namely the CDS indices subject to this proposal, in the 
event of the insolvency of the relevant DCO (CME, ICE Clear Credit, or 
ICE Clear Europe) or one or more of the DCO's clearing members.
    The Commission concludes that, in the case of a clearing member 
insolvency at CME or ICE Clear Credit, subchapter IV of Chapter 7 of 
the U.S. Bankruptcy Code (11 U.S.C. 761-767) and Part 190 of the 
Commission's regulations would govern the treatment of customer 
positions.\72\ Pursuant to section 4d(f) of the CEA, a clearing member 
accepting funds from a customer to margin a cleared swap, must be a 
registered FCM. Pursuant to 11 U.S.C. 761-767 and Part 190 of the 
Commission's regulations, the customer's CDS positions, carried by the 
insolvent FCM, would be deemed ``commodity contracts.'' \73\ As a 
result, neither a clearing member's bankruptcy nor any order of a 
bankruptcy court could prevent either CME or ICE Clear Credit from 
closing out/liquidating such positions. However, customers of clearing 
members would have priority over all other claimants with respect to 
customer funds that had been held by the defaulting clearing member to 
margin swaps, such as the customers' positions in CDS indices subject 
to this proposal.\74\ Thus, customer claims would have priority over 
proprietary claims and general creditor claims. Customer funds would be 
distributed to swaps customers, including CDS customers, in accordance 
with Commission regulations and section 766(h) of the Bankruptcy Code. 
Moreover, the Bankruptcy Code and the Commission's rules thereunder (in 
particular 11 U.S.C. 764(b) and 17 CFR 190.06) permit the transfer of 
customer positions and collateral to solvent clearing members.
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    \72\ The Commission observes that an FCM or DCO also may be 
subject to resolution under Title II of the Dodd-Frank Act to the 
extent it would qualify as covered financial company (as defined in 
section 201(a)(8) of the Dodd-Frank Act).
    \73\ If an FCM is also registered as a broker-dealer, certain 
issues related to its insolvency proceeding would also be governed 
by the Securities Investor Protection Act.
    \74\ Claims seeking payment for the administration of customer 
property would share this priority.
---------------------------------------------------------------------------

    Similarly, 11 U.S.C. 761-767 and Part 190 would govern the 
bankruptcy of a DCO, in conjunction with DCO rules providing for the 
termination of outstanding contracts and/or return of remaining 
clearing member and customer property to clearing members.
    With regard to ICE Clear Europe, the Commission understands that 
the default of a clearing member of ICE Clear Europe would be governed 
by the rules of that DCO. ICE Clear Europe, a DCO based in the United 
Kingdom, has represented that under English law its rules would 
supersede English insolvency laws. Under its rules, ICE Clear Europe 
would be permitted to close out and/or transfer positions of a 
defaulting clearing member that is an FCM pursuant to the U.S. 
Bankruptcy Code and Part 190 of the Commission's regulations. According 
to ICE Clear Europe's submission, the insolvency of ICE Clear Europe 
itself would be governed by both English insolvency law and Part 190.
    ICE Clear Europe has obtained legal opinions that support the 
existence of such legal certainty in relation to the protection of 
customer and swap counterparty positions, funds, and property in the 
event of the insolvency of one or more of its clearing members. In 
addition, ICE Clear Europe has obtained a legal opinion from U.S. 
counsel regarding compliance with the protections afforded to FCM 
customers under New York law.
    The Commission requests comment on its conclusions with regard to 
legal certainty in the event of an insolvency of CME, ICE Clear Credit, 
ICE Clear

[[Page 47186]]

Europe, or one of such DCOs' clearing members.
Request for Comment
    The Commission requests comment on all aspects of the proposed 
classes of CDS to be included within the clearing requirement and the 
proposed determination. The Commission may consider alternatives to the 
proposed CDS classes and is requesting comment on the following 
questions:
     Should the Commission include all tenors, such as the 1- 
or 2-year tenor for Markit indices, for each index included within the 
class, notwithstanding the fact that those are tenors not currently 
cleared by a DCO? Will market participants be incentivized to use such 
contracts to avoid the clearing requirement?
     Should the Commission limit its determination to the most 
liquid tenors of the CDX.NA.IG such as the 5- and 10-year tenors, and 
exclude other tenors such as the 3- and 7-year tenors, which are less 
liquid?
     Is the Commission correct in believing that risk 
management frameworks and methodologies supporting existing cleared 
offerings can be adjusted to address additional tenors with limited 
changes?
     Should the Commission structure its clearing requirement 
such that indices that become older off-the-run indices are no longer 
subject to the requirement? In such a proposal, how should the 
Commission treat those off-the-run indices, such CDX.NA.IG Series 9, 
that have remained extremely active notwithstanding being off-the-run? 
Should the Commission establish some type of threshold of trading to 
exclude off-the-run indices from the requirement? How would the 
Commission construct a rule to indicate that an off-the-run index is no 
longer subject to clearing?
     To the extent off-the-run indices were excluded from the 
clearing requirement, would market participants be incentivized to 
trade in older off-the-run indices, as opposed to current on-the-run 
indices?
     The CDS indices proposed to be included within the 
clearing requirement are currently offered by DCOs and are among the 
most liquid CDS. Is there any factor within the five statutory that do 
not support inclusion with the clearing requirement? Are there other 
factors outside of those five factors with regard to these particular 
offerings that weigh against inclusion in a clearing determination?

E. Interest Rate Swaps

i. Introduction
    Interest rate swaps are agreements wherein counterparties agree to 
exchange payments based on a series of cash flows over a specified 
period of time typically calculated using two different rates 
multiplied by a notional amount. As of June 2011, the BIS estimated 
that over $500 trillion in notional amount of single currency interest 
rate swaps were outstanding \75\ representing 75 to 80%of the total 
estimated notional amount of derivatives outstanding.\76\ Based on 
these factors and on the swap submissions received under Sec.  39.5(b), 
the Commission believes that interest rate swaps represent a 
substantial portion of the swaps market and warrant consideration by 
the Commission for required clearing.
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    \75\ BIS, OTC Derivatives Market Activity in the First Half of 
2011, November 2011, Table 1 [hereinafter ``BIS data'']. The BIS 
data provides the broadest market-wide estimates of interest rate 
swap activity available to the Commission.
    \76\ Id.
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    The Commission's consideration of the interest rate swap 
submissions (IRS submissions) is presented in two parts. The first 
part, this Section II.E, discusses the Commission's rationale for 
determining how to classify and define the interest rate swaps 
identified in the DCO submissions to be considered for the clearing 
requirement. The second part, Section II.F, presents the Commission's 
consideration of the IRS submissions in accordance with section 
2(h)(2)(D) of the CEA.
    Unlike certain CDS or futures contracts, there are a large number 
of different, variable contract specifications available and used in 
interest rate swap transactions. As an indication of this variability, 
the Commission notes that over 10,500 different combinations of 
significant interest rate swap terms were identified for trades 
executed in a single three month period in 2010.\77\ This variability 
creates a challenge for DCOs to specify the interest rate swaps for 
which clearing services are available and for the Commission to define 
what kinds of interest rate swaps will be subject to the clearing 
requirement. Notwithstanding this variability in swap terms, parties 
generally seek common economic results when entering into interest rate 
swaps, and there are common contract definitions and conventions that 
make classifying and clearing interest rate swaps possible. Identifying 
and analyzing these commonalities is necessary for effective 
classification of the swaps that will be subject to a proposed clearing 
requirement determination for interest rate swaps. Accordingly, a 
summary of the DCO submissions received by the Commission is followed 
by a discussion of how interest rate swaps are traded and risk managed 
and an analysis of the primary interest rate swap classes that are 
cleared and the product specifications used to identify interest rate 
swap products within each class. Thereafter, in Section II.F the 
Commission considers each of the interest rate swap classes and the 
primary specifications that are identified in the IRS submissions using 
the five factors identified in section 2(h)(2)(D) of the CEA to 
determine which interest rate swaps shall be required to be cleared.
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    \77\ Federal Reserve Bank of New York Staff Reports, ``An 
Analysis of OTC Interest Rate Derivatives Transactions: Implications 
for Public Reporting'' (March 2012) at 3 [hereinafter ``NY Fed 
Analysis''], available at http://www.newyorkfed.org/research/staff_reports/sr557.pdf.
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ii. Submissions Received
    The Commission received submissions from three DCOs eligible to 
clear interest rate swaps (IRS submissions): LCH.Clearnet Limited 
(LCH), the clearing division of the Chicago Mercantile Exchange Inc. 
(CME), and International Derivatives Clearinghouse, LLC (IDCH).\78\
---------------------------------------------------------------------------

    \78\ The IRS submissions received by the Commission are 
available at http://www.cftc.gov/IndustryOversight/IndustryFilings/index.htm. Submission materials marked by the submitting DCO for 
confidential treatment pursuant to Sec. Sec.  39.5(b)(5) and 
145.9(d) are not available for public review.
---------------------------------------------------------------------------

    The following table summarizes the interest rate swap classes and 
significant specifications identified in the IRS submissions as 
currently available for clearing by each DCO. The classes and swap 
specifications are described in more detail below.

[[Page 47187]]



                                 Table 3--Interest Rate Swap Submissions Summary
----------------------------------------------------------------------------------------------------------------
                                                LCH                         CME                     IDCH
----------------------------------------------------------------------------------------------------------------
Swap Classes......................  Fixed-to-floating, basis,   Fixed-to-floating.........  Fixed-to-floating,
                                     forward rate agreements                                 basis, FRAs, OIS.
                                     (FRAs), overnight index
                                     swaps (OIS).
Currencies \79\...................  USD, EUR, GBP, JPY, AUD,    USD, EUR, GBP, JPY, CAD,    USD.
                                     CAD, CHF, SEK, CZK, DKK,    and CHF.
                                     HKD, HUF, NOK, NZD, PLN,
                                     SGD, and ZAR.
Rate Indexes......................  For Fixed-to-floating,      USD-LIBOR, CAD-BA, CHF-     USD-LIBOR.
                                     basis, FRAs: LIBOR in       LIBOR, GBP-LIBOR, JPY-
                                     seven currencies, BBR-      LIBOR, and EURIBOR.
                                     BBSW, BA-CDOR, PRIBOR,
                                     CIBOR-DKNA13, CIBOR2-
                                     DKNA13, EURIBOR-Telerate,
                                     EURIBOR-Reuters, HIBOR-
                                     HIBOR, HIBOR-HKAB, HIBOR-
                                     ISDC, BUBOR-Reuters,
                                     NIBOR, BBR-FRA, BBR-
                                     Telerate, PLN-WIBOR, PLZ-
                                     WIBOR, STIBOR, SOR-
                                     Reuters, JIBAR.
                                    For OIS: FEDFUNDS, SONIA,
                                     EONIA, TOIS.
Maximum Stated Termination Dates..  For Fixed-to-floating,      USD, EUR, GBP out to 50     For Fixed-to-
                                     basis, FRAs: USD, EUR,      years, and CAD, JPY, CHF,   floating: 30 years.
                                     and GBP out to 50 years,    AUD out to 30 years.
                                     AUD, CAD, CHF, SEK and
                                     JPY out to 30 years and
                                     the remaining nine
                                     currencies out to 10
                                     years.
                                    For OIS: USD, EUR, GBP,     ..........................  For OIS, and FRAs:
                                     and CHF out to two years.                               two years.
----------------------------------------------------------------------------------------------------------------

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

    \79\ In this proposal, currencies are identified either by their 
full name or by the three letter ISO currency designation for the 
currency.
---------------------------------------------------------------------------

    Each of the IRS submissions provided information specified under 
Sec.  39.5(b) for such swap submissions or provided references to Web 
sites or other sources for such information, including, for example, 
information previously provided to the Commission for other purposes. 
Each submitter also has described how it provided notice to its members 
as required by Sec.  39.5(b)(3)(viii).
    LCH has been clearing OTC interest rate swaps since 1999 through 
its SwapClear service. In its IRS submission, LCH indicates that it 
clears more than 50% of the interest rate swap market by notional 
amount.\80\ As of its submission date, February 24, 2012, LCH reported 
that it had cleared and held outstanding about one million trades with 
an aggregate notional amount over $283 trillion. LCH accepted for 
clearing fixed-to-floating and basis swaps in seventeen currencies 
(including variable notional swaps in three currencies), overnight 
index swaps in four currencies, and forward rate agreements in 10 
currencies. Swaps accepted for clearing must have certain product 
specifications identified by LCH, which help it administer clearing and 
manage risk appropriately.\81\ Of the three interest rate swap 
submitters, LCH has been clearing the longest, clears the broadest 
range of interest rate swaps, and clears the largest portion of the 
interest rate swap market at this time. As of March 2011, LCH 
implemented client clearing in both Europe and the U.S. Prior to that 
date, both parties to a swap had to be LCH members to be able to clear 
a swap with LCH.
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    \80\ LCH letter, dated February 24, 2012, at 1, stating that the 
market share percentage estimate is based upon BIS statistics and 
SwapClear volumes as of January 31, 2012.
    \81\ These specifications can be found on LCH's Web site at 
http://www.lchclearnet.com/Images/General%20Regulations_tcm6-43737.pdf.
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    CME began clearing interest rate swaps on October 18, 2010. CME's 
IRS submission indicates that CME is currently clearing fixed-to-
floating swaps in six currencies with an identified set of product 
specifications and has open interest in three currencies. In its 
submission, CME recommended a clearing requirement determination for 
all non-option interest rate swaps denominated in a currency cleared by 
any qualified DCO.
    In September 2010, IDCH amended its rule book to provide for 
clearing interest rate swaps. IDCH is eligible to clear U.S. dollar 
denominated fixed-to-floating swaps, overnight index swaps, and forward 
rate agreements, which have certain product specifications as 
identified in its submission. IDCH had no outstanding cleared positions 
for these swaps as of the date of this proposal.
    Furthermore, the interest rate swaps identified in the three IRS 
submissions are all single currency swaps with no optionality, as 
defined by the applicable DCO.
iii. Interest Rate Swap Market Conventions and Risk Management
    Unlike certain CDS for which highly standardized terms have been 
developed, or futures, the terms of which are set by the exchanges, 
interest rate swaps are broad in scope and present a wide range of 
variable product classes and product specifications within each class. 
A data set of interest rate swaps electronically recorded over a three 
month period in 2010 by 14 large dealers for which one of those dealers 
was a party to each swap, contained over 10,500 different combinations 
of product classes, currencies, tenors, and forward periods.\82\ The 
data set also included eight different general product classes (e.g., 
fixed-to-floating, basis, forward rate agreements, swaptions, etc.), 28 
currencies, 53 different rate indexes, and stated termination dates 
from one month to 55 years. In addition, dozens of different contract 
term conventions were identified.
---------------------------------------------------------------------------

    \82\ See ``ODSG data'' described below. The ODSG data set, while 
the broadest available providing trade-by-trade details, is limited 
in that it excludes trades that needed to be manually confirmed or 
that did not include a G14 Dealer.
---------------------------------------------------------------------------

    Notwithstanding the large variety of contracts, there are 
commonalities that make it possible to categorize interest rate swaps 
for clearing purposes. Firstly, the vast majority of interest rate 
swaps use the ISDA definitions and contract conventions that allow 
market participants to agree quickly on common terms for each 
transaction. In fact, the three DCOs clearing interest rate swaps all 
use ISDA definitions in their product specifications.
    Secondly, counterparties enter into swaps to achieve particular 
economic results. While the results desired may differ in small ways 
depending on each

[[Page 47188]]

counterparty's specific circumstances and goals, there are certain 
common swap conventions that are used to identify and achieve commonly 
desired economic results when entering into interest rate swaps. For 
example, a party that is trying to hedge variable interest rate risk 
may enter into a fixed rate to floating rate swap, or a party that is 
seeking to fix interest rates for periods in the future may enter into 
a forward rate agreement.
    The IRS submissions classify interest rate swaps on this basis by 
identifying commonly known classes of swaps that they clear including: 
fixed rate to floating rate swaps, that are sometimes referred to as 
plain vanilla swaps (fixed-to-floating swaps); floating rate to 
floating rate swaps, also referred to as basis swaps (basis swaps); 
overnight index swaps (OIS); and forward rate agreements (FRAs).\83\ 
These class terms are also being used in industry efforts to develop a 
taxonomy for interest rate swaps.\84\
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    \83\ These are sometimes also referred to as ``types,'' 
``categories,'' or ``groups.'' For purposes of this determination, 
the Commission is using the term ``class,'' in order to be 
consistent with the approach taken by the European Securities and 
Markets Authority (ESMA) in its Discussion Paper, ``Draft Technical 
Standards for the Regulation on OTC Derivatives, CCPs, and Trade 
Repositories,'' (Feb. 16, 2012), available at http://www.esma.europa.eu/system/files/2012-95.pdf. It is also noted that 
other categorizations are sometimes used for certain purposes. 
However, these four classes are common terms used by the DCOs and 
are common terms used in industry taxonomies.
    \84\ See, e.g., ISDA Swap Taxonomies, available at http://www2.isda.org/identifiers-and-otc-taxonomies/; Financial Products 
Markup Language, available at http://www.fpml.org/; and the NY Fed 
Analysis.
---------------------------------------------------------------------------

    Furthermore, within these general classes, certain specifications 
such as currency, reference interest rate index, and stated termination 
date (also referred to as maturity date), are essential for defining 
the economic result that will be achieved. For example, a party located 
in the United States who seeks to hedge interest rate risk that is in 
U.S. dollars will most likely enter into a U.S. dollar swap as opposed 
to a swap in different currency. The party will also enter into a swap 
whose interest rate index correlates with the floating rate the party 
is trying to hedge and will specify a termination date that coincides 
with when the subject interest rate risk terminates. Each of the IRS 
submissions naturally use these common specifications when identifying 
the swaps that the DCO clears. Within each of those specifications, 
there are common terms used by the DCOs, which allows for further 
classification of the full range of interest rate swaps that are 
executed.
    Accordingly, while there are a wide variety of interest rate swaps 
when taking into account all possible contract specifications, certain 
specifications are commonly used by the DCOs and market participants. 
This allows for the identification of classes of swaps and primary 
specifications within each class that reflect the economic goals market 
participants seek to achieve and that are based on market conventions 
used by the DCOs to define which interest rate swap products they will 
clear. For example, fixed-to-floating swaps comprise roughly 50% of 
interest rate swaps, U.S. dollar denominated swaps account for 
approximately 35% of the total outstanding notional amount of swaps, 
and U.S. dollar LIBOR is the floating rate index used for approximately 
80% of U.S. dollar swaps traded.\85\
---------------------------------------------------------------------------

    \85\ See below for a discussion of available market sources.
---------------------------------------------------------------------------

    The DCOs also risk manage interest rate swaps collectively on a 
portfolio basis rather than on a transaction or product specific basis. 
All three DCOs primarily assess risk at the portfolio-level. In other 
words, when looking at the risk posed by an interest rate swap 
portfolio, DCOs do not assess the risk of any one particular swap or 
swap class within the portfolio. Instead, the DCOs analyze the 
cumulative risk of a position's components. This concept of risk 
aggregation is also used within the context of the DCOs' margining 
methodologies. All three DCOs use margin methodologies based on 
portfolio margining as opposed to margining individual swaps or swap 
categories and subsequently developing offsets and charges across 
different swaps or classes of swaps.
    By looking at risk on a portfolio basis, the DCOs take into account 
how swaps with different attributes, such as underlying currency, 
stated termination dates, underlying floating rate indexes, swap 
classes, etc., are correlated and thus can offset risk across 
attributes. This is possible because, although individual transactions 
may have unique contract terms, given the commonalities of transactions 
as discussed above, swap portfolios can be risk managed on a cumulative 
value basis taking into account correlations among the cleared swaps. 
Consequently, DCOs can be expected to fairly, rapidly, and efficiently 
manage the risk of interest rate swaps in a default scenario through a 
small number of large hedging transactions that hedge large numbers of 
similarly correlated positions held by the defaulting party.\86\ As 
such, liquidity for specific, individual swaps is not the focus of DCOs 
from a risk management perspective. Rather, liquidity is viewed as a 
function of whether a portfolio of swaps has common specifications that 
are determinative of the economics of the swaps in the portfolio such 
that a DCO can price and risk manage the portfolio through block 
hedging and auctions in a default situation.
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    \86\ After putting on these hedging positions, the DCO has the 
time needed to address any residual risk of the defaulted portfolio 
through auctioning off the defaulted portfolio together with the 
hedging transactions.
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    A real life example of how this works is provided by LCH's 
management of the Lehman Brothers cleared interest rate swap portfolio 
following Lehman's bankruptcy in September 2008. Upon Lehman's default, 
LCH needed to risk manage a portfolio of approximately 66,000 interest 
rate swaps, which it hedged with approximately 100 new trades in less 
than five days. Once LCH executed these initial hedges, it was left 
with a relatively risk neutral portfolio. However, some risk still 
remained given that the hedges did not match the original trades 
exactly. Once the portfolio was hedged, LCH asked clearing members to 
price and bid on all, or subdivided portions, of the original Lehman 
portfolio with the hedging trades. For example, clearing members with 
live open positions in U.S. dollar swaps were asked to bid for the 
relatively hedged U.S. dollar portfolio. Through the bidding process, 
LCH was able to hedge and auction off all risk related to Lehman's 
interest rate swap portfolio existing at the time of its bankruptcy and 
only used approximately 35% of the initial margin Lehman had 
posted.\87\
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    \87\ See LCH IRS submission, at 4.
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iv. Interest Rate Swap Classification for Clearing Requirement 
Determinations
    Section 2(h)(2)(A) of the CEA provides that the Commission ``shall 
review each swap, or any group, category, type, or class of swaps to 
make a determination as to whether'' any thereof shall be required to 
be cleared. In reviewing the IRS submissions, the Commission has 
considered whether its clearing requirement determination should 
address individual swaps, or categories, types, classes, or other 
groups of swaps.
    Based on the market conventions as discussed above, and the DCO 
recommendations in the IRS submissions, the Commission is proposing a 
clearing requirement for four classes of interest rate swaps: fixed-to-
floating swaps, basis swaps, OIS, and

[[Page 47189]]

FRAs. According to the IRS submissions, LCH offers all four classes for 
clearing, IDCH offers three of them for clearing, and CME offers one of 
them for clearing.\88\
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    \88\ LCH clears all four classes of swap products; IDCH is 
eligible to clear fixed-to-floating swaps, OIS, and FRAs; and CME 
clears fixed-to-floating swaps.
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    These four classes represent a substantial portion of the interest 
rate swap market. The following table provides an indication of the 
outstanding positions in each class.

                       Table 4--Interest Rate Swaps Notional and Trade Count by Class \89\
----------------------------------------------------------------------------------------------------------------
                                                     Notional     Gross notional                    Total trade
                   Swap class                       amount (USD     percent of      Total trade    count percent
                                                       BNs)            total           count         of total
----------------------------------------------------------------------------------------------------------------
Fixed-to-Floating...............................        $299,818              52       3,239,092              75
FRA.............................................          67,145              12         202,888               5
OIS.............................................          43,634               8         109,704               3
Basis...........................................          27,593               5         119,683               3
Other...........................................         132,162              23         617,637              14
                                                 ---------------------------------------------------------------
    Total.......................................         570,352             100       4,289,004             100
----------------------------------------------------------------------------------------------------------------

     
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    \89\ TriOptima data, as of March 16, 2012. See Section II.F 
below for a description of the TriOptima Data. The TriOptima data 
provides information on nine other classes of swaps, none of which 
is included in the IRS submissions. Notably, one other type, 
swaptions, exceeded FRAs and basis swaps in terms of number of 
transactions completed in the sample. On a notional amount basis, 
swaptions represented less than half the notional amount of FRAs 
traded and a little less than the notional amount of basis swaps. 
Regardless, because swaptions are not being cleared by any DCOs at 
this time, they are not being considered in this proposal.
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    At this time, there are no standard definitions in federal statutes 
or existing Commission regulations for these interest rate swap 
classes. In addition, while various class definitions are used in the 
derivatives literature, there are no commonly used definitions in the 
market. Accordingly, for purposes of discussing the clearing 
requirement determination in this proposal, the Commission has 
developed the following class definitions based on information provided 
by the submitting DCOs and market conventions.
    To define the four interest rate swap classes in a manner that 
works across all three DCOs making IRS submissions and for the interest 
rate swap market generally, it is useful first to summarize how 
interest rate swaps work. As noted above, in an interest rate swap, the 
parties exchange payments based on a series of cash flows over a 
specified period of time calculated using two different interest rates 
multiplied by a notional amount. One party to the swap agrees to pay 
the amount equal to one of the interest rates specified multiplied by 
the notional amount and the other party agrees to pay the amount equal 
to the other interest rate specified times the notional amount.\90\ 
Each such payment stream is typically referred to as one ``leg'' or 
``side'' of the swap transaction.
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    \90\ By contract, the two parties to an OTC swap often (but not 
always) agree that only one payment is due and owing on each payment 
date equal to the net positive amount equal to the excess amount of 
the larger amount due from one party over the smaller amount due 
from the other party. For cleared swaps, generally speaking, the 
amount payable to or by a party on any given day is determined based 
on the aggregate net amount due from or owed to the party for all of 
its positions that are cleared.
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    Using this background, the four classes of swaps are defined as 
follows, for purposes of this proposal:
    1. ``Fixed-to-floating swap'': A swap in which the payment or 
payments owed for one leg of the swap is calculated using a fixed rate 
and the payment or payments owed for the other leg are calculated using 
a floating rate.
    2. ``Floating-to-floating swap'' or ``basis swap'': A swap in which 
the payments for both legs are calculated using floating rates.
    3. ``Forward Rate Agreement'' or ``FRA'': A swap in which payments 
are exchanged on a pre-determined date for a single specified period 
and one leg of the swap is calculated using a fixed rate and the other 
leg is calculated using a floating rate that is set on a pre-determined 
date.
    4. ``Overnight indexed swap'' or ``OIS'': A swap for which one leg 
of the swap is calculated using a fixed rate and the other leg is 
calculated using a floating rate based on a daily overnight rate.
    The LCH and CME IRS submissions addressed issues of classification 
for purposes of the interest rate swap clearing requirement. In its 
submission, LCH discussed the classification of interest rate swaps and 
recommended establishing clearing requirements for classes of interest 
rate swaps. LCH stated:

    We believe that it is counterproductive to define every single 
attribute and combination that could be found in an [interest rate] 
swap, and furthermore it would always be possible to create 
additional attributes that would move a swap outside of the mandate. 
We do not believe that the Commission should define the almost 
limitless combination of swap attributes currently used by the 
market. We recommend defining a subset of easily identifiable 
features that determine a swap subject to mandatory clearing if that 
swap is cleared by a registered DCO that satisfies the five factors 
in the Act and the Commission's regulations.

    More specifically, LCH recommended that the Commission use the 
following specifications to classify interest rate swaps for purposes 
of making a clearing determination: (i) Swap class (i.e., what the two 
legs of the swap are (fixed-to-floating, basis, OIS, etc.)), (ii) 
floating rate definitions used, (iii) the currency in which the 
notional and payment amounts are specified, (iv) stated final term of 
the swap (also known as maturity), (v) notional structure over the life 
of the swap (constant, amortizing, roller coaster, etc.), (vi) floating 
rate frequency, (vii) whether optionality is included, and (viii) 
whether a single currency or more than one currency is used for 
denominating payments and notional amount. In effect, LCH recommended 
the use of a set of basic product specifications to identify and 
describe each class of swaps subject to the clearing requirement.
    CME recommended a clearing determination for all non-option 
interest rate swaps denominated in a currency cleared by any qualified 
DCO. CME's request is similar to LCH's recommendation in that CME 
identifies currency and optionality as factors to consider. In 
addition, CME's request focuses on defining swaps subject to the

[[Page 47190]]

clearing requirement in a manner that can be used by all DCOs and not 
by reference to a specific DCO. IDCH did not recommend a particular 
approach for structuring the clearing determination.
    The Commission agrees with the general approach suggested by LCH 
and is proposing to establish a clearing requirement for classes of 
swaps, rather than for individual swap products.
    As an alternative, the Commission considered whether to establish 
clearing requirements on a product-by-product basis. Such a 
determination would need to identify the multitude of legal 
specifications of each product that would be subject to the clearing 
requirement. Although the industry uses standardized definitions and 
conventions, the product descriptions would be lengthy and require 
counterparties to compare all of the legal terms of their particular 
swap against the terms of the many different swaps that would be 
included in a clearing requirement. In this regard, LCH stated that the 
clearing requirement ``would be sub-optimal for the overall market if 
participants are forced to read pages of rules to decipher whether or 
not a swap is required to be cleared, or to have to make complex and 
time consuming decisions at the point of execution.'' \91\ The 
Commission shares this view and believes that for interest rate swaps, 
a product-by-product determination could be unnecessarily burdensome 
for market participants in trying to assess whether each swap 
transaction is subject to the requirement. A class-based approach would 
allow market participants to determine quickly whether they need to 
submit their swap to a DCO for clearing by checking initially whether 
the swap has the basic specifications that define each class subject to 
the clearing requirement.\92\
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    \91\ LCH IRS submission, at 6.
    \92\ In addition, as noted by LCH, a product-by-product 
requirement may be evaded more easily because the specifications of 
a particular swap contract would need to match the specifications of 
each product subject to a clearing requirement. The clearing 
requirement could be evaded by adding, deleting, or modifying one or 
more of the contract's specifications, including minor 
specifications that have little or no impact on the economics of the 
swap. By using a class-based approach that allows for ranges of 
contract specifications established by the DCOs within each class, 
the Commission is reducing the potential for evasion in accordance 
with section 2(h)(4)(A) of the CEA, which directs the Commission to 
prescribe rules necessary to prevent evasion of the clearing 
requirements.
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    A product-by-product designation also would be difficult to 
administer because the Commission would be required to consider each 
and every product submitted. On the other hand, designating classes of 
interest rate swaps for the clearing requirement provides a cost 
effective, workable method for the Commission to review new swap 
products that DCOs will submit for clearing determinations on a going 
forward basis without undertaking a full Commission review of each and 
every swap product. For each new swap, or group, class, type, or 
category of swap submitted, the DCO can identify whether it believes 
the submission falls within a class of swaps already subject to the 
clearing requirement. For such swaps, as described in greater detail 
below, the Commission is proposing to delegate to the Director of the 
Division of Clearing and Risk, with the consultation of the General 
Counsel, the authority to confirm whether the swap fits within the 
identified class and is therefore subject to the clearing requirement. 
In this way, DCOs will not be required to submit lengthy submissions, 
and the Commission need not review swaps that are already part of a 
class of swaps that the Commission has determined are subject to a 
clearing requirement pursuant to section 2(h)(2) of the CEA. Only swaps 
that are in a new swap class that has not previously been reviewed, 
because it contains one or more class level specifications that are not 
contained within a class that has previously been reviewed, would be 
subject to full Commission review.
Request for Comment
    The Commission invites comment on the interest rate swaps class 
definitions.
     Are the definitions in harmony with industry practice?
     Should the Commission establish a clearing requirement for 
classes of swaps or for individual swap products?
     Would a product-by-product determination impose a greater 
burden on market participants than the proposed class-based approach?
v. Interest Rate Swap Specifications
    After consideration of the IRS submissions received, the practical 
considerations of classifying swaps as described in the preceding 
section, the portfolio-based risk management approaches used by DCOs, 
and existing market practice for classifying and trading swap products 
based on common economic results, the Commission has analyzed the IRS 
submissions received pursuant to section 2(h)(2)(D) of the CEA and 
Sec.  39.5, and is proposing to classify the interest rates swaps 
submitted using the following affirmative specifications for each 
class: (i) Currency in which the notional and payment amounts are 
specified; (ii) rates referenced for each leg of the swap; and (iii) 
stated termination date of the swap. The Commission also is proposing 
three ``negative'' specifications for each class: (i) No optionality 
(as specified by the DCOs); (ii) no dual currencies; and (iii) no 
conditional notional amounts.\93\
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    \93\ The term ``conditional notional amount'' refers to notional 
amounts that can change over the term of a swap based on a condition 
established by the parties upon execution such that the notional 
amount of the swap is not a known number or schedule of numbers, but 
may change based on the occurrence of some future event. This term 
does not include what are commonly referred to as ``amortizing'' or 
``roller coaster'' notional amounts for which the notional amount 
changes over the term of the swap based on a schedule of notional 
amounts known at the time the swap is executed. Furthermore, it 
would not include a swap containing early termination events or 
other terms that could result in an early termination of the swap if 
a DCO clears the swap with those terms.
---------------------------------------------------------------------------

    The Commission has chosen these three affirmative specifications 
because it believes that they are fundamental specifications used by 
counterparties to determine the economic result of a swap transaction 
for each party. Counterparties enter into swaps to achieve particular 
economic results. For example, counterparties may enter into interest 
rate swaps to hedge an economic risk, to facilitate a purchase, or to 
take a view on the future direction of an interest rate. The 
counterparties enter into a swap that they believe will best achieve 
their desired economic result at a reasonable cost.
    The classes of swaps reflect general categories of desired economic 
results. As noted above, the IRS submissions identified four different 
classes of swap contracts that are being cleared at this time: Fixed-
to-floating swaps, basis swaps, OIS, and FRAs. These classes of 
interest rates swaps reflect industry categorization and allow 
counterparties to achieve a particular economic result. For example, a 
fixed-to-floating swap may be used by a counterparty to hedge interest 
rate risk related to bonds it has issued or which it owns. Because the 
categorization of interest rate swaps into one of these basic classes 
reflects fundamental characteristics of a particular swap, 
counterparties can immediately assess whether a particular swap they 
are considering might be of a class that is subject to required 
clearing.
    All three submitters also identified currency as a specification 
for distinguishing swaps that are subject to clearing.\94\ A swap that 
requires

[[Page 47191]]

calculation or payment in a currency different than the currency of the 
related underlying purposes of the swap would introduce currency 
risk.\95\ Thus, the currency designated for the swap is a basic factor 
in precisely achieving the economic results of the swap desired by each 
party. For example, if a party wants to hedge a commercial business 
risk denominated in dollars, then the party is likely to enter into a 
swap calculated and payable in dollars. Entering into a swap in a 
currency that is different from the currency in which the risk to be 
hedged is denominated would unnecessarily introduce currency risk and 
reduce the effectiveness of the swap.
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    \94\ As noted above, the notional amount of the swap is a 
critical element to pricing every swap because it is the amount by 
which the interest rate for each leg is multiplied by to calculate 
the payment streams for each counterparty. However, the notional 
amount is not really a specification that differentiates one class 
of swaps from another because every swap has a notional amount. By 
contrast, the currency in which the notional and payment amounts are 
specified does distinguish one class of swaps from others.
    \95\ For example, parties seeking to hedge interest rate risk in 
connection with bonds or to invest funds using swaps are more likely 
to enter into swaps that designate the same currency in which the 
bonds are payable or that the funds to be invested are held.
---------------------------------------------------------------------------

    The swaps listed by all three DCOs in their IRS submissions all 
identified the interest rates used for each leg of the swap as a basic 
term that defines the swap. The rates are basic determinants of the 
economic value of each stream of payments of an interest rate swap. It 
is therefore an important determinant for achieving each party's 
desired economic result. For example, if a party wants to hedge a loan 
obligation for which the interest rate is based on the London Interbank 
Offered Rate (commonly referred to as LIBOR), then the party can 
accurately hedge that risk by entering into a swap for which it 
receives LIBOR to offset its variable LIBOR risk. Using a different 
variable rate index would unnecessarily add basis risk to the swap and 
inhibit the party's desired result of hedging the risk inherent in 
changes in LIBOR over the life of its loan.
    Finally, the stated termination date, or maturity, of a swap is a 
basic specification for establishing the value of a swap transaction 
because interest rate swaps are based on an exchange of payments over a 
specified period of time ending on the stated termination date. The 
value of a swap at any one point in time depends in part on the value 
of each payment stream over the remaining life of the swap. For 
example, if a party wants to hedge variable interest rate risk for 
bonds it has issued that mature in ten years, it will generally enter 
into a swap with a stated termination date that matches the final 
maturity date of the bonds being hedged.\96\ To terminate the swap 
prior to such date would result in only a partial hedge and to execute 
a swap with a stated termination date that is later than the final bond 
maturity date would simply create exposed rate risk during the extended 
period beyond the final maturity date of the bonds.
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    \96\ Although hedging an economic risk expected to remain 
outstanding for ten years with a matching ten year swap may 
generally be the most efficient and precise approach, the Commission 
recognizes that parties may achieve a similar result by using swaps 
with different stated termination dates. However, such substitution 
generally provides a less precise hedge.
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    As a general matter, the four class-defining specifications 
identified by the Commission are used by all three submitters when 
identifying the swaps they clear. By using these basic specifications 
to identify the swaps subject to the clearing requirement, 
counterparties contemplating entering into a swap can determine quickly 
as a threshold matter whether the particular swap may be subject to a 
clearing requirement. If the swap has the basic specifications of a 
class of swaps subject to a clearing requirement, the parties will know 
that they need to verify whether a DCO will clear that particular swap. 
This will reduce the burden on swap counterparties related to 
determining whether a particular swap may be subject to the clearing 
requirement.
    The Commission also considered whether to define classes of swaps 
on the basis of other product specifications. Other potential 
specifications are numerous because of the nearly limitless alternative 
interest rate swaps that are theoretically possible. These alternative 
specifications fall into two general categories: Specifications that 
are commonly used to address mechanical issues for most swaps, and 
specifications that are less common and address idiosyncratic issues 
related to the particular needs of a counterparty. Examples of 
specifications that are commonly used to address mechanical issues for 
most swaps considered by the Commission include: Floating rate reset 
tenors, floating rate reset dates, reference city for business days, 
business day convention, day count fraction, spread added or subtracted 
from the variable rate, compounding method, effective date, averaging 
method, payment dates, period end dates, upfront payments, and consent 
to legal jurisdiction. These specifications are specifically identified 
for most swap transactions executed today. While these specifications 
may affect the value of the swap in a mechanical way, they are not, 
generally speaking, fundamental to determining the economic result the 
parties are trying to achieve. For example, the day count fraction 
selected affects calculation periods and therefore the amounts payable 
for each payment period. However, the parties, and the DCOs, can make 
mechanical adjustments to period pricing at the time a swap is cleared 
based on the day count fraction alternative selected by the parties and 
the day count fraction does not drive the economic result the parties 
are trying to achieve.
    Furthermore, DCOs can provide clearing for the standard 
alternatives of each of these specifications without affecting risk 
management. Using the same day count fraction example, LCH will accept 
U.S. dollar-LIBOR trades for clearing with nine alternative day count 
fractions based on the common day count fractions used in the 
market.\97\ While this specification, and other specifications of this 
kind, may affect the amounts owed on a swap, they can be accounted for 
mechanically in the payment amount calculations and do not change the 
substantive economic result the parties want to achieve.
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    \97\ Each DCO identifies the standard term or range of terms it 
will accept for each specification. Accordingly, swap counterparties 
can review the DCO's product specifications to determine whether a 
swap will satisfy the DCO's requirements for these specifications. 
Additionally, DCOs are likely to develop a screening mechanism by 
which a party can enter the terms of a specific swap and determine 
whether the DCO will clear it. It is also likely that third-party 
vendors will develop or are developing similar screeners to apply to 
multiple DCOs. If counterparties want to enter into a swap that is 
in a class subject to required clearing and no DCO will clear the 
swap because it has other specifications that the DCOs will not 
accept, then the parties can still enter into that transaction on an 
uncleared basis.
---------------------------------------------------------------------------

    Examples of the latter are special representations added to address 
particular legal issues, unique termination events, special fees, and 
conditions tied to events specific to the parties. None of the DCOs 
clear interest rate swaps with terms in the second group. Accordingly, 
such specifications are not included in the classes of swaps subject to 
the clearing requirement proposed by this rule, and the Commission 
considered only the first group of more common specifications that are 
identified by the submitting DCOs in their product specifications.
    In short, the Commission recognizes that these other specifications 
may have an effect on the economic result to be achieved with the 
swap.\98\ However, it

[[Page 47192]]

believes that counterparties may account for the effects of such 
specifications with adjustments to other specifications or in the price 
of the swap. Furthermore, DCOs account for various alternatives or 
range of alternatives for these terms without impairing risk 
management. Finally, as described above in more detail, including these 
specifications in the description of the swaps subject to a clearing 
requirement could increase the burden on counterparties when checking 
whether a swap may be subject to required clearing. Accordingly, the 
Commission has determined not to include other, non-class defining 
specifications in the swap class definition.
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    \98\ LCH recommended in its submission that floating rate tenor 
(also known as frequency) also be a class level specification and 
the Commission acknowledges that floating rate tenor can, in some 
cases, be a fundamental specification for achieving the economic 
benefits of an interest rate swap. However, it is the Commission's 
preliminary view that floating rate tenor is more akin to the other 
non-class specifications in that it is not fundamental to all 
economic results that may be considered by parties when 
contemplating a swap and it is a specification for which the DCOs 
can fairly easily offer all of the standard tenors that parties may 
consider.
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    The Commission also considered whether there are product 
specifications that the Commission should explicitly exclude from the 
initial clearing requirement determination. In this regard, the 
Commission considered swaps with optionality, multiple currency swaps, 
and swaps with conditional notional amounts. The Commission determined 
that these three specifications should be included as so-called 
``negative'' specifications.
    Optionality and swaps referencing more than one currency for 
calculation or payment purposes, raise concerns regarding adequate 
pricing measures and consistency across swap contracts that make them 
difficult for DCOs to effectively risk manage. LCH, CME, and IDCH 
currently do not clear interest rate swaps with such specifications. 
Furthermore, LCH and CME indicated that interest rate swaps with 
optionality or that reference multiple currencies should not be 
included for consideration of a clearing requirement at this time. LCH 
noted that, at this time, there is a lack of reliable market data and 
no market consensus on valuation models for swaps with these 
specifications, which significantly impairs a DCO's ability to set 
margin levels effectively for such products. Given these factors, the 
Commission is proposing to exclude swaps with optionality or that 
reference multiple currencies from this clearing requirement 
determination.
    Finally, LCH recommended that the Commission exclude from the 
clearing requirement swaps whose notional amount over the term of the 
swap is conditional, and therefore, at the time of execution, cannot be 
definitively identified by a number or schedule of numbers for the term 
of the swap. For example, the parties may agree to a formula for 
calculating the notional amount based on an index or the occurrence of 
future events such as prepayments on a pool of mortgages. The IRS 
submissions indicated that all three submitters would clear swaps with 
constant notional amounts through the final termination date. LCH also 
clears amortizing and roller coaster notional schedules for certain 
classes of swaps so long as the notional amounts for the contract are 
known at the time the swap is cleared. None of the DCOs clears swaps 
for which the notional amount throughout the term of the swap is not 
specifically known at the time the swap is executed. The Commission 
understands that conditional notional amount swaps are, at this time, 
difficult for DCOs to price effectively and risk manage. Accordingly, 
while this may change over time if certain market conventions develop 
in this area, conditional notional amount swaps cannot be subject to 
the clearing requirement determination.
    To reach a determination as to which interest rate swaps shall be 
subject to the clearing requirement, the Commission will consider in 
the following section the IRS submissions received pursuant to section 
2(h)(2)(D) of the CEA and Sec.  39.5 within the framework of the 
classes and specifications identified. In summary, the Commission will 
consider four classes of interest rate swaps for the clearing 
requirement: Fixed-to-floating swaps, basis swaps, FRAs, and OIS. 
Within each class, the Commission will further consider the following 
product specifications to define which swaps shall be required to be 
cleared: Currency, floating rate indexes referenced, stated termination 
dates, use of dual currencies, optionality, and notional amount 
certainty.
Request for Comments
     The Commission invites comment on the six principle swap 
specifications identified by the Commission as being used by 
counterparties to determine the economic result of a swap transaction 
within each class.
     Should more specifications be added? If so, what are they 
and how are they fundamental to determining the economic result of a 
swap? Should any of the specifications be eliminated?

F. Proposed Determination Analysis for Interest Rate Swaps

i. Consistency With Core Principles for Derivatives Clearing 
Organizations
    Section 2(h)(2)(D)(i) of the CEA requires the Commission to review 
whether a swap submission is consistent with the core principles for 
DCOs in making its clearing determination. LCH, CME, and IDCH already 
clear all swaps identified in their respective IRS submissions and 
therefore each is subject to the Commission's review and surveillance 
procedures summarized above. Accordingly, the three DCOs already are 
required to comply with the core principles set forth in section 
5b(c)(2) of the CEA with respect to the swaps being considered by the 
Commission for the clearing requirement.
    To monitor compliance, the Commission has conducted periodic 
examinations of LCH, CME, and IDCH. During an examination, the 
Commission requests certain data regarding cleared transactions, fund 
transfers, margin requirement calculations, risk management testing and 
other issues that is provided as of a specific review date. In this 
manner, the Commission gets a snap-shot of information that the 
Commission staff uses to reconcile selected accounts and other 
information. Subsequently, the Commission goes onsite, typically for 
several days, to interview relevant parties and to test whether various 
policies and procedures established by the DCOs in their respective 
rule books comply with the CEA's core principles for DCOs and other 
regulatory requirements.
    As discussed above, following the review of data and the onsite 
visits, the Commission undertakes extensive analysis and discusses any 
questions and potential deficiencies with staff and management of the 
DCO to address any deficiencies and improvements that can be 
implemented by the DCO. To ensure that the DCOs are in compliance with 
the core principles, a detailed analysis is done to assess the DCO's 
policies and procedures regarding pricing, margining, back-testing, and 
their IRS portfolio risk management procedures. Furthermore, the 
Commission assesses the DCOs' procedures and policies regarding: (1) 
Onboarding new clearing members; (2) establishing the financial 
resources available to the DCOs and testing the sufficiency of those 
resources; and (3) assessing the default management and settlement 
procedures.
    More specifically, the DCOs give the Commission documentation that 
details relevant official policies and

[[Page 47193]]

procedures. The DCOs also provide evidence (such as margining, pricing 
data, and back-testing results) that confirms that the policies and 
methodologies are effective. Finally, the Commission goes onsite to the 
DCOs and interviews relevant parties and observes the procedures real-
time to confirm that the DCOs are in effect following their stated 
policies. Additionally, the Commission, if feasible, will independently 
verify the analysis of any data provided by the DCOs.
    The Commission's Risk Surveillance Group (RSG) conducts daily risk 
management surveillance of all DCOs.\99\ If any issues arise, the RSG 
and the DCOs work in concert to understand and quickly address those 
issues. CME, LCH, and IDCH have worked collaboratively with the 
Commission in this regard and have provided accessible points of 
contact within the DCOs' respective organizations to expedite 
information flow.
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    \99\ The only exception is IDCH. At this time, RSG does not 
actively monitor the risk posed by IDCH and its participants because 
IDCH does not have any open interest.
---------------------------------------------------------------------------

    All three submitting DCOs have asserted that they are capable of 
maintaining compliance with the core principles following a clearing 
requirement determination for the swaps that they clear, and the 
Commission has no reason to believe such assertions are not accurate at 
this time. The Commission does not believe that subjecting any of the 
interest rates swaps identified in the IRS submissions to a clearing 
requirement would alter compliance by the respective DCOs with the core 
principles. Accordingly, the Commission believes that each of the IRS 
submissions are consistent with section 5b(c)(2) of the CEA.
Request for Comment
     The Commission requests comment on whether the proposed 
interest rate swaps clearing requirement determination would alter any 
DCO's ability to comply with the DCO core principles.
ii. Consideration of the Five Statutory Factors for Clearing 
Requirement Determinations
    As explained above, section 2(h)(2)(D)(ii) of the CEA identifies 
five factors the Commission shall take into account in making a 
clearing requirement determination. The process for submission and 
review of swaps for a clearing requirement determination is further 
detailed in Sec.  39.5. This section provides the Commission's 
consideration of the five factors in the context of the requirements of 
Sec.  39.5 for interest rate swaps.
a. Outstanding Notional Exposures, Trading Liquidity, and Adequate 
Pricing Data
    Section 2(h)(2)(D)(ii)(I) of the CEA requires the Commission to 
take into account the existence of outstanding notional exposures, 
trading liquidity, and adequate pricing data. For purposes of this 
factor, the Commission considered the market data regarding outstanding 
notional amounts, trade liquidity, and pricing. Unlike CDS for which 
substantially all of the trading data has been collected and is stored 
in one place, there is no single data source for notional exposures and 
trading liquidity for the entire interest rate swap market.\100\ 
However, the Commission considered several sources of data on the 
interest rate swap market that collectively provides the information 
the Commission needs to make a clearing requirement determination. The 
data sources considered include: general quarterly estimates published 
by the Bank for International Settlements (BIS data); market data 
published weekly by TriOptima (TriOptima data) covering swap trade 
information submitted voluntarily by 14 large derivatives dealers (G14 
Dealers); trade-by-trade data provided voluntarily by the G14 Dealers 
to the OTC Derivatives Supervisors Group for a three month period 
between June and August 2010 (ODSG data); and trade-by-trade data 
provided by LCH for the first calendar quarter of 2012 and summary 
cleared swap open interest information (LCH data).\101\ The G14 Dealers 
and LCH trade-by-trade data was provided to the Commission on a 
confidential basis and consent was granted for publication of the 
summary information in this proposal.
---------------------------------------------------------------------------

    \100\ See Bank of England, ``Thoughts on Determining Central 
Clearing Eligibility of OTC Derivatives,'' Financial Stability Paper 
No. 14, March 2012, at 11, available at http://www.bankofengland.co.uk/publications/Documents/fsr/fs_paper14.pdf.
    \101\ All DCOs are required to begin providing daily trade-by-
trade data to the Commission as of November 8, 2012. CME also 
provided some information in this area, but because CME clears a 
small set of interest rate swaps for a relatively short period of 
time, CME's data is considered too limited to provide any indication 
of the complete interest rate swap market. The Commission recognizes 
that the LCH data also has limited value for its consideration of 
the first factor because it includes only cleared swaps, and not 
uncleared swaps. However, because LCH clears a large portion of the 
swaps products it offers clearing for (based on available 
information, LCH has cleared approximately 50 to 90 percent of the 
dealer open interest in the different interest rate swap products 
that it clears), its data provides some indication of the possible 
notional exposures and liquidity in the products submitted by LCH 
that the Commission is considering. Given the limitations on other 
available data, the Commission believes it is useful to consider the 
LCH data along with the market-wide BIS data, ODSG data, and 
TriOptima data.
---------------------------------------------------------------------------

    Each of these data sources has a number of limitations that are 
important to understand when considering the data. The following is a 
brief discussion of these limitations and how the data sets, when 
considered together, provide a more complete picture of outstanding 
notional amounts, trade liquidity, and pricing for the Commission's 
consideration of the swaps submitted.
    The BIS data set covers the largest portion of the interest rate 
swap market over time and therefore is useful for reaching general 
conclusions regarding full market size and longer term market trends. 
However, the BIS data provides only summary information that is not 
granular enough to inform the clearing requirement considerations at 
the proposed class level.
    TriOptima's data set updates are published weekly and provide more 
detail than the BIS data covering most of the class level 
specifications considered by the Commission. The TriOptima data is 
limited to the extent it only contains information gathered by 
TriOptima and therefore does not include all OTC interest rate swaps. 
Also, the TriOptima data shows outstanding notional and trade numbers 
as of a set date and does not provide an indication of trade liquidity 
over time.\102\
---------------------------------------------------------------------------

    \102\ The TriOptima data does not indicate how many trades are 
new for each reporting period rather than carry-over trades from the 
prior period. Accordingly, it is not possible to determine the 
amount of new trading activity from one reporting period to the 
next.
---------------------------------------------------------------------------

    The ODSG data provided detailed information on a trade-by-trade 
basis, thereby providing sufficient information for class-level 
consideration. This information is useful for considering trading 
liquidity. However, the ODSG data set is limited in several ways that 
can skew analysis of the data. The ODSG data covered transactions 
confirmed on the MarkitWire platform, a trade confirmation service 
offered by MarkitSERV, between June 1, 2010 and August 31, 2010, where 
at least one party was a G14 Dealer. The dataset does not include 
transactions that took place between two non-G14 Dealer parties, with 
such parties representing an estimated 11% of the notional volume 
activity in MarkitSERV.\103\ The number of non-G14 Dealer swap trades 
that are not entered on MakitSERV has not been estimated and could be 
significant. The omission of certain classes of participants and trades 
in the

[[Page 47194]]

sample will bias transaction and notional volume statistics downward. 
It may also distort the proportions of products seen relative to each 
other.
---------------------------------------------------------------------------

    \103\ NY Fed Analysis at 6.
---------------------------------------------------------------------------

    The ODSG dataset also does not include transactions that were 
manually confirmed either by choice or necessity. It is estimated that 
the data set represents roughly 78% of G14 Dealer interest rate 
transaction activity.\104\ The three-month time frame in 2010 also 
introduces limitations into analysis of the data set. This time frame 
represented a period in the midst of historically low central bank 
interest rate policy across major currencies and novel liquidity 
measures taken in response to the 2008 financial crisis. The short 
period also could be affected by seasonal patterns, and the possibility 
exists that the markets have fundamentally changed since the data was 
gathered. The lack of manually confirmed trades in the data suggests an 
overrepresentation of standardized transactions such as OIS and plain 
vanilla interest rate swaps and underrepresentation of non-standard 
classes such as exotics and basis swaps. For instance, exotic product 
structures not eligible for electronic matching are estimated to make 
up 2% of the OTC interest rate derivative market.\105\
---------------------------------------------------------------------------

    \104\ Id. at 6.
    \105\ Id. at 5.
---------------------------------------------------------------------------

    The LCH data provides summary data on outstanding notional amounts 
for different classes of swaps and the first quarter 2012 data provide 
detailed information on a trade-by-trade basis thereby providing 
sufficient information for class-level consideration. The LCH data is 
limited in that it only includes swaps cleared by LCH. It is noted, 
however, that LCH has cleared about 50% of the interest rate swap 
market and higher levels of certain kinds of swaps indicating a 
reasonably high inclusion rate. This data set also has the advantage of 
being more current than the ODSG data and BIS data and is specific to 
the swaps that are under consideration in this Commission 
determination.
    The TriOptima data and ODSG data are both based, in large part, on 
data provided by the G14 Dealers. Additionally, the TriOptima data is 
published by TriOptima in formats that, for the class specifications 
considered by the Commission, can be analyzed in a manner similar to 
the analysis of the ODSG data. In fact, the Commission has found the 
TriOptima data and the ODSG data to be complementary in some ways. The 
TriOptima data is current and provides fairly detailed information 
about the gross notional amounts and total trade numbers for each class 
specification considered in this proposal. However, the TriOptima data 
does not provide enough information to assess periodic trade liquidity 
for each specification. Because the ODSG data is provided on a trade-
by-trade basis, the Commission and other regulators have been able to 
make more granular assessments of this information, particularly for 
purposes of considering trading liquidity. Accordingly, although the 
ODSG data is nearly two years old, it is useful for confirming whether 
observations based on the current TriOptima data are consistent with 
historical trends and also to indicate trading liquidity.
    For this proposal, the Commission is considering only the swaps 
identified in the DCOs' IRS submissions. Accordingly, where possible, 
the Commission presents and discusses only the data for swaps 
identified in the submissions. For example, although the ODSG data 
identifies twenty-eight different currencies in which swaps were traded 
during the period covered by the data set, only the seventeen 
currencies identified in the submissions were considered. In addition, 
the ODSG data shows all transactions recorded on MarkitServ including 
not only new, price-forming transactions, but also administrative 
transactions such as amendments, assignments, compression trades, and 
internal, inter-affiliate trades that may not be price forming.\106\ 
Because the Commission is considering notional amounts and trading 
liquidity, non-price-forming trades have been removed from the ODSG 
data presented below.
---------------------------------------------------------------------------

    \106\ The NY Fed Analysis noted that for the ODSG interest rate 
swap data set the number and volume of non-price-forming trades were 
significantly greater than the number and volume of trades that were 
new economic activity. NY Fed Analysis, at 8.
---------------------------------------------------------------------------

    The following analysis of interest rate swap data is presented 
based on the four swap classes and class specifications discussed 
above. This information is used by the Commission to determine whether 
there exists significant outstanding notional amounts, trading 
liquidity, and pricing data to include each class and specification 
identified in the IRS submissions.
1. Interest Rate Swap Class
    The Commission first considered data relevant to the different 
interest rate swap classes included in the IRS submissions starting 
with the BIS data.
---------------------------------------------------------------------------

    \107\ BIS data.
    \108\ This row excludes FRAs and options.

                           Table 5--Bank for International Settlements Interest Rate Swaps Outstanding Notional by Class \107\
                                                          [Amounts in billions of U.S. dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                             June 2009       Dec. 2009       June 2010       Dec. 2010       June 2011       Dec. 2011
--------------------------------------------------------------------------------------------------------------------------------------------------------
All Derivatives.........................................        $594,553        $603,900        $582,685        $601,046        $706,884        $647,762
Interest Rate Swaps \108\...............................         341,903         349,288         347,508         364,377         441,201         402,611
FRAs....................................................          46,812          51,779          56,242          51,587          55,747          50,576
Options.................................................          48,513          48,808          48,081          49,295          56,291          50,911
                                                         -----------------------------------------------------------------------------------------------
    Total interest rate swaps...........................         437,228         449,875         451,831         465,260         553,240         504,098
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The BIS data shows only notional amounts for three large 
categories: FRAs, swaps with options, and other interest rate swaps. It 
does not provide information on daily trading liquidity or break out 
other kinds of interest rate swaps such as basis swaps, OIS, or 
inflation swaps.
    However, the BIS data is useful in providing certain big picture 
information. It indicates that interest rate swaps in total constitute 
nearly 80% of the derivatives market and interest rate swap notional 
amounts generally increased for all three kinds of swaps between 2008 
and 2011. Additionally, all three classes of swaps identified by the 
BIS data have substantial notional amounts outstanding. As of December 
2011, FRAs had about $50.5 trillion outstanding, options had about $51 
trillion outstanding, and other interest rate swaps had about $403 
trillion

[[Page 47195]]

outstanding. Furthermore, the BIS data shows that over the three year 
period covered in Table 5, total interest rate swaps reported grew by 
about 15%. Given this information, none of the kinds of swaps 
identified by the BIS should be eliminated from consideration by the 
Commission for a clearing requirement based on the BIS data alone. 
However, the BIS data does not provide enough detail to reach further 
determinations regarding the swaps identified in the IRS submissions.
---------------------------------------------------------------------------

    \109\ TriOptima data, as of March 16, 2012. The TriOptima data 
provides information on nine other classes of swaps, none of which 
is included in the submissions. Notably, one other type, swaptions, 
exceeded FRAs and basis swaps in terms of number of transactions 
completed in the sample. On a notional amount basis, swaptions 
represented less than half the notional amount of FRAs traded and a 
little less than the notional amount of basis swaps. Regardless, 
because swaptions were not included in the list of swaps cleared in 
the IRS submissions, swaptions are not being considered for the 
clearing requirement determination because no DCO is clearing 
swaptions at this time.
    \110\ NY Fed Analysis at 7. The ODSG data includes swaps entered 
into between June and August, 2010 as voluntarily reported by the 
G14 Dealers. The ODSG data provides information on other classes of 
swaps, none of which is included in the submissions.

         Table 6--TriOptima Data Interest Rate Swaps Outstanding Notional and Trade Count by Class \109\
----------------------------------------------------------------------------------------------------------------
                                                     Notional                                       Percent of
                   Swap class                      amount  (USD     Percent of      Total trade     total trade
                                                       BNs)       total notional       count           count
----------------------------------------------------------------------------------------------------------------
Fixed-to-Floating...............................        $299,818           52          3,239,092              75
FRA.............................................          67,145           12            202,888               5
OIS.............................................          43,634            8            109,704               3
Basis Swap......................................          27,593            5            119,683               3
Other...........................................         132,162           23            617,637              14
                                                 ---------------------------------------------------------------
    Total.......................................         570,352          100.00       4,289,004             100
----------------------------------------------------------------------------------------------------------------


                     Table 7--ODSG Data Interest Rate Swaps Trading Activity by Class \110\
----------------------------------------------------------------------------------------------------------------
                                                                                      Average
                                                     Notional                         weekly          Average
                   Swap class                      amount traded  Trade count in     notional     weekly  number
                                                    in quarter        quarter      traded  (USD     of  trades
                                                     (USD BNs)                         BNs)
----------------------------------------------------------------------------------------------------------------
Fixed-to-Floating...............................         $15,858         123,337          $1,201           9,344
OIS.............................................          16,563          12,792           1,255             969
FRA.............................................           6,931           5,936             525             450
Basis Swap......................................           2,307           3,173             175             240
Other...........................................           2,820          16,073             214           1,218
                                                 ---------------------------------------------------------------
    Total.......................................          44,479         161,311           3,370          12,221
----------------------------------------------------------------------------------------------------------------

    The TriOptima data and the ODSG data identify notional amounts and 
trade counts for all four classes of swaps identified in the IRS 
submissions. Outstanding notional amounts are provided in the TriOptima 
data and BIS data. Trading liquidity as an indication of how 
effectively DCOs can risk manage a portfolio of swaps can be evidenced 
in several ways. The data available for this purpose includes total 
notional amount outstanding, total number of swaps outstanding, and the 
average number of transactions over a given period of time. The 
TriOptima data indicates liquidity through the total notional amount 
outstanding and total number of trades outstanding at a given time. The 
ODSG data provides an indication of liquidity in terms of the number of 
trades during the calendar quarter covered by the data and the average 
weekly number of trades during the period.
    The TriOptima data shows that all four classes have significant 
outstanding notional amounts with basis swaps being the lowest at about 
$27.6 trillion and the highest being fixed-to-floating swaps at $288.8 
trillion. Total trade counts for each type are also significant with 
the lowest being 109,704 for OIS and the highest being fixed-to-
floating swaps at 3,239,092. The ODSG data confirms these observations 
historically.
    The average number of swap trades per week for each class of swaps 
is shown in the last column of Table 7. According to the ODSG data set, 
basis swaps were traded at the lowest frequency compared to the other 
three classes at 240 times on average each week during the ODSG data 
period. Because the ODSG data is from the summer of 2010 and gross 
notional amounts and trading activity in interest rate swaps have both 
increased generally, the Commission believes that trading activity has 
likely increased for all classes.
---------------------------------------------------------------------------

    \111\ The data covers swaps cleared by LCH during the first 
calendar quarter, 2012. Total Notional Outstanding Cleared is as of 
March 31, 2012.

       Table 8--LCH Data Interest Rate Swaps Notional Outstanding and Trade Count Cleared by Classes \111\
----------------------------------------------------------------------------------------------------------------
                                                                      Average
                                     Notional        Number of        weekly          Average     Total notional
           Swap class               cleared in     swaps cleared     notional     weekly  number    outstanding
                                   Quarter (USD     in quarter     traded  (USD      of trades       (USD BNs)
                                       BNs)                            BNs)
----------------------------------------------------------------------------------------------------------------
Fixed-to-Floating...............         $17,022         117,780          $1,309           9,060        $226,016
FRA.............................          11,271          31,630             867           2,433          27,707
OIS.............................           8,731           6,848             672             527          36,510

[[Page 47196]]

 
Basis...........................           1,610           2,940             124             226          11,378
                                 -------------------------------------------------------------------------------
    Total.......................          38,634         159,198           2,972          12,246         301,612
----------------------------------------------------------------------------------------------------------------

    The LCH data generally confirms the assessment of market-wide data. 
There is substantial outstanding notional volumes and trade liquidity 
for each of the four classes already being cleared at LCH.
    LCH cleared the following percentage of each class of swap as 
reported by TriOptima: \112\
---------------------------------------------------------------------------

    \112\ Percentages are calculated based on total notional amount 
cleared by LCH divided by total notional outstanding as reported by 
TriOptima. The TriOptima data is used because it is the most current 
data set that provides data broken out according to the classes 
currently being cleared.
---------------------------------------------------------------------------

     75% of the Fixed-to-Floating swaps,
     41% of FRAs,\113\
---------------------------------------------------------------------------

    \113\ LCH started clearing FRAs in December 2011 and cleared 
volumes have increased significantly each month since the start 
date.
---------------------------------------------------------------------------

     84% of OIS, and
     41% of Basis Swaps.

Accordingly, a substantial portion of each class is already being 
cleared voluntarily.
Swap Class Conclusion
    The Commission concludes that the four classes of swaps currently 
being cleared have significant outstanding notional amounts and trading 
liquidity. The Commission further notes that a substantial percentage 
of each of the four classes is already cleared by DCOs.
2. Currency
    As discussed above in Section II.E, the currency in which the 
notional and payment amounts are specified is a primary product 
specification and all four data sources provide interest rate swap data 
by currency.
---------------------------------------------------------------------------

    \114\ BIS data.

                               Table 9--Bank for International Settlements: Interest Rate Swaps Notional by Currency \114\
                                                    (Amounts Outstanding in Billions of U.S. Dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                             June 2009       Dec 2009        June 2010       Dec 2010        June 2011       Dec 2011
--------------------------------------------------------------------------------------------------------------------------------------------------------
EUR.....................................................        $160,668        $175,790        $161,515        $177,831        $219,094        $184,702
USD.....................................................         154,174         153,373         164,119         151,583         170,623         161,864
JPY.....................................................          57,452          53,855          55,395          59,509          65,491          66,819
GBP.....................................................          32,591          34,257          36,219          37,813          50,109          43,367
CAD.....................................................           3,227           3,427           4,411           4,247           6,905           6,397
SEK.....................................................           5,294           4,696           4,461           5,098           5,832           5,844
CHF.....................................................           4,713           4,807           4,650           5,114           6,170           5,395
Other...................................................          19,108          19,669          21,061          24,064          29,017          29,709
All Currencies..........................................         437,228         449,875         451,831         465,260         553,240         504,098
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The BIS data addresses seven of the seventeen currencies identified 
in the submissions individually. All seven currencies have substantial 
outstanding notional amounts as of December 2011, ranging from nearly 
$5.4 trillion for the Swiss franc to about $185 trillion in euro. 
Although several currencies showed decreases in total notional 
outstanding from one reporting period to the next, most such decreases 
were around ten percent or less, and, after such decreases, total 
notional amounts for those currencies generally rebounded.\115\ For all 
currencies, the outstanding notional amounts were higher at the end of 
the most recent three-year period as compared to the beginning of the 
period.
---------------------------------------------------------------------------

    \115\ To some extent, such decreases may have resulted from 
increased trade compression exercises during the subsequent 
reporting period.
    \116\ TriOptima data, as of March 16, 2012.
---------------------------------------------------------------------------

    The Commission believes that the BIS data supports the conclusion 
that there exists significant outstanding notional amounts in each 
currency identified in the BIS data and that there is no indication 
that notional amounts in those currencies are decreasing at a rate that 
would warrant elimination of those currencies from consideration for a 
clearing requirement.

       Table 10--TriOptima Data Interest Rate Swaps Outstanding Notional and Trade Count by Currency \116\
----------------------------------------------------------------------------------------------------------------
                                                     Notional                                       Percent of
                    Currency                        amount (USD     Percent of      Total trade     total trade
                                                     BNs Eqv.)    total notional       count           count
----------------------------------------------------------------------------------------------------------------
Euro............................................        $176,481              36       1,115,504              28
US Dollar.......................................         175,777              35       1,300,862              33
Yen.............................................          64,083              13         568,871              14
British Pound...................................          43,337               9         419,611              11
Other \117\.....................................         36,4905               7         536,887              14
                                                 ---------------------------------------------------------------

[[Page 47197]]

 
    Total.......................................         496,168             100       3,941,735             100
----------------------------------------------------------------------------------------------------------------


               Table 11--ODSG Data Interest Rate Swaps Notional Trading Activity by Currency \118\
----------------------------------------------------------------------------------------------------------------
                                                                                      Average
                                                     Notional                         weekly          Average
                    Currency                         traded in    Trade count in     notional     weekly  number
                                                   quarter (USD       quarter       traded (USD     of  trades
                                                       BNs)                            BNs)
----------------------------------------------------------------------------------------------------------------
EUR.............................................         $18,410          45,114          $1,395           3,418
USD.............................................          11,013          48,876             834           3,703
GBP.............................................           7,248          16,282             549           1,233
JPY.............................................           4,263          18,799             323           1,424
Other \119\.....................................           3,048          20,412             231           1,546
                                                 ---------------------------------------------------------------
    Total.......................................          43,982         149,483           3,332          11,324
----------------------------------------------------------------------------------------------------------------

    The TriOptima data shows that total outstanding notional amounts as 
of March 16, 2012, ranged from $400 billion for Czech koruna to over 
$176 trillion notional amount for euros.\120\ While there may be 
sufficient outstanding notional amounts in all seventeen currencies, 
the Commission takes note that there is a clear demarcation between the 
four currencies with the highest outstanding notional amounts: euro, 
U.S. dollar, British pound, and yen, and all other currencies. As Table 
10 shows, the four top currencies range from about 9% to 36% of the 
total notional amount of all interest rate swaps outstanding and 11%to 
33% of the total number of trades. The remaining currencies range from 
about 2% down to 0.1% of the total notional amount traded and 3% down 
to 0.2%of total number of trades. In fact, the four major currencies 
accounted for about 93% of the total notional amount outstanding in the 
TriOptima data set.
---------------------------------------------------------------------------

    \117\ Thirteen other currencies are cleared by LCH: AUD, CHF, 
SEK, CAD, ZAR, NZD, NOK, HKD, PLN, SGD, HUF, DKK, and CZK.
    \118\ The ODSG data includes swaps entered into between June and 
August 2010 as voluntarily reported by the G14 Dealers.
    \119\ Includes the 13 other currencies cleared by LCH identified 
in its IRS submission. The ODSG data identified an additional 11 
other currencies that were not cleared by any of the submitters.
    \120\ TriOptima data, as of March 16, 2012.
---------------------------------------------------------------------------

    The ODSG data provides an indication of trading liquidity in terms 
of average weekly notional amount traded and number of new trades 
completed during the period covered by the data set. Of the four major 
currencies, Japanese yen had the lowest weekly average notional at $323 
billion and the British pound had the lowest average number of trades 
each week at 1,233.
    The TriOptima data provides an overall, more current view of trades 
outstanding, which provides a broader picture of the trading potential 
for each currency for purposes of DCO risk management. As of March 16, 
2012, all but one of the seventeen currencies had outstanding trade 
counts in excess of 14,000 with the exception being the Danish krone at 
6,849. Again, the four highest currencies by trade count: euro, U.S. 
dollar, British pound, and yen, accounted for about 85% of the total 
number of trades recorded and outstanding at the time the data was 
collected.

                          Table 12--LCH Data Interest Rate Swaps Notional Outstanding and Trade Count Cleared by Currency \121\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                Notional cleared   Number of swaps   Average weekly    Average weekly    Total notional
                           Currency                                 in quarter       cleared  in     notional traded      number of        outstanding
                                                                    (USD BNs)          quarter          (USD BNs)          trades           (USD BNs)
--------------------------------------------------------------------------------------------------------------------------------------------------------
EUR...........................................................           $19,207            61,039            $1,477             4,695          $115,695
USD...........................................................            12,111            51,710               932             3,978           107,734
GBP...........................................................             2,801            12,976               216               998            25,339
JPY...........................................................             2,799            12,374               215               952            37,696
Other.........................................................             1,716            21,099               132             1,623            15,146
                                                               -----------------------------------------------------------------------------------------
    Total.....................................................            38,634           159,198             2,972            12,246           301,612
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The LCH data shows that the relative notional amount and number of 
swaps in each currency cleared is generally correlated with the 
notional amount and number of swaps of each currency reported by the 
more general market data sets. As a percentage of the total notional 
amount outstanding as reported by TriOptima, LCH cleared the following 
percentages: \122\
---------------------------------------------------------------------------

    \121\ The data covers swaps cleared by LCH during the first 
calendar quarter, 2012. Total Notional Outstanding is as of March 
31, 2012.
    \122\ The TriOptima data is used for this calculation because it 
is the most current data set that provides data broken out according 
to the classes currently being cleared.
---------------------------------------------------------------------------

     66% of euro,
     61% of U.S. dollars,

[[Page 47198]]

     58% of British pounds,
     59% of Japanese yen, and
     42% of other currencies.
    Of the interest rate swaps identifying U.S. dollars, euro, British 
pounds or yen as the applicable currency, significantly more than half 
are already being cleared by LCH. While the level of clearing of other 
currencies is, on a combined basis reasonably high at 42%, the 
Commission notes the level is noticeably lower than the percentage of 
swaps being cleared for the top four currencies.
    Currency Specification Conclusion
    The Commission believes that all of the data sets demonstrate the 
existence of significant outstanding notional amounts and trading 
liquidity in the seventeen currencies identified in the submissions. 
However, the Commission notes that swaps using the four currencies with 
the highest outstanding notional amounts and trade frequency: euro, 
U.S. dollar, British pound, and yen, account for an outsized portion of 
both notional amounts outstanding and trading volumes. Furthermore, the 
Commission notes that these four currencies are already being cleared 
more than the other currencies generally.
    While it is important that this determination include a substantial 
portion of the interest rate swaps traded to have a substantive, 
beneficial impact on systemic risk, the Commission also recognizes that 
the proposed rule is the Commission's first swap clearing requirement 
determination. As noted in the phased implementation rules for the 
clearing requirement, the Commission believes that introducing too much 
required clearing too quickly could unnecessarily increase the burden 
of the clearing requirement on market participants. In recognition of 
these considerations, the Commission will focus the remainder of this 
initial clearing requirement determination analysis on swaps 
referencing the four most heavily traded currencies. The Commission 
notes that the decision not to include the other thirteen currencies at 
this time does not limit the Commission's authority to reconsider 
required clearing of those currencies in the future.
    The Commission requests comment on whether any of the other 
thirteen currencies identified above should be included in the initial 
clearing requirement determination for interest rate swaps.
3. Floating Rate Index Referenced
    The ODSG data and LCH data provide an indication of the rate 
indices used on a transaction-by-transaction basis. Rate indexes are 
currency specific. However, the BIS data and the TriOptima data do not 
provide information on the different rate indices referenced in 
interest rate swaps. The following tables present trading activity data 
for each rate index identified in the IRS submissions as being cleared 
for each of the four currencies the Commission is proposing to include 
in the clearing requirement determination.
---------------------------------------------------------------------------

    \123\ The ODSG data includes swaps entered into between June and 
August, 2010 as voluntarily reported by the G14 Dealers. This table 
includes only rate indexes used for the G4 currencies and that are 
cleared by LCH.
    \124\ ``Eur-Euribor'' category includes both Eur-Euribor-Reuters 
and Eur-Euribor-Telerate, which are both cleared by LCH.
    * ``EONIA'', ``SONIA'', and ``FedFunds'' are floating rate 
indexes used to calculate OIS amounts only. The other indexes listed 
in the table are used for fixed-to-floating swaps, basis swaps, and 
FRAs.
    \125\ The data includes swaps cleared by LCH during the first 
calendar quarter, 2012.

                  Table 13--ODSG Data Interest Rate Swaps Trading Activity by Rate Index \123\
----------------------------------------------------------------------------------------------------------------
                                       Notional traded                        Average weekly
             Rate Index                in quarter (USD    Trade count  for   notional traded     Average weekly
                                             BNs)             quarter           (USD BNs)       number of trades
----------------------------------------------------------------------------------------------------------------
EUR-EURIBOR \124\...................             $9,366             38,213               $710              2,895
USD-LIBOR...........................              9,080             46,620                688              3,532
EUR-EONIA *.........................              9,022              6,496                684                492
GBP-SONIA *.........................              4,934              2,011                374                152
JPY-LIBOR...........................              4,015             18,491                304              1,401
GBP-LIBOR...........................              2,296             12,417                174                941
USD-FedFunds *......................              1,887              1,951                143                148
EUR-LIBOR...........................                  1                  5                  0                  0
                                     ---------------------------------------------------------------------------
    Total...........................             40,602            126,204              3,076              9,561
----------------------------------------------------------------------------------------------------------------


         Table 14--LCH Data Interest Rate Swaps Notional Outstanding and Trade Count by Rate Index\125\
----------------------------------------------------------------------------------------------------------------
                                       Notional cleared   Number of swaps     Average weekly
      Rate index (by currency)         in quarter (USD       cleared in      notional traded     Average weekly
                                             BNs)             quarter           (USD BNs)      number of  trades
----------------------------------------------------------------------------------------------------------------
EURO
    EURIBOR.........................            $13,444             57,157             $1,034              4,397
    EONIA...........................              5,763              3,882                443                299
US Dollar
    LIBOR...........................             10,905             50,197                839              3,861
    FEDFUND.........................              1,206              1,513                 93                116
GBP
    LIBOR...........................              1,067             11,550                 82                888
    SONIA...........................              1,734              1,426                134                110
Yen
    LIBOR...........................              2,799             12,374                215                952
Other Indexes.......................              1,716             21,099                132              1,623
                                     ---------------------------------------------------------------------------
        Total.......................             38,634            159,198              2,972             12,246
----------------------------------------------------------------------------------------------------------------


[[Page 47199]]

    The ODSG data shows minimal activity for EUR-LIBOR with about 1 
billion of notional amount and five trades made for the three-month 
period in 2010 that the ODSG data covers. EUR-LIBOR does not appear on 
the LCH data table because, although swaps referencing that index can 
be cleared at LCH, LCH had no open interest for that index as of March 
31, 2012. Given the minimal notional amounts and trade liquidity for 
the EUR-LIBOR index, the Commission has determined not to include EUR-
LIBOR under the clearing requirement.
    The other rate indexes all show significant notional amounts and 
trading liquidity. The rates with the least activity, the U.S. dollar 
Fedfund index and British pound-LIBOR index, each have over one 
trillion dollars in notional outstanding already cleared at LCH and on 
a weekly basis, $93 billion and $82 billion in notional amount, 
respectively, were cleared per week on average. In terms of number of 
trades cleared at LCH, swaps referencing Fedfunds were cleared on 
average 116 times per week and swaps referencing British pound-LIBOR 
were cleared 888 times per week on average. All of the other indices 
currently cleared have similar or substantially higher number of trades 
and notional amounts cleared.\126\
---------------------------------------------------------------------------

    \126\ British pound-SONIA has about the same number of trades 
and per week trading average as Fedfunds, but has a higher 
outstanding notional amount at $1.734 trillion.
---------------------------------------------------------------------------

    The rate indexes used for OTC interest rate swaps and the interest 
rate swaps identified for clearing by the DCOs reference not only the 
generic index, but a reference definition for the index such as the 
ISDA definition or Reuters definition. These reference definitions 
refer to the generic index and in addition, typically identify 
specifically where the calculating party shall look up the index and 
sometimes at what time the calculating party shall look up the index 
for calculation purposes. Additionally, these reference indices provide 
a standard alternative if the index is not available from the 
designated source at the designated time. While the Commission 
recognizes the importance of these features of the reference 
definitions and that each swap, both cleared and uncleared, should have 
these features, such features need not be included in the index rate 
specification for the Commission's clearing requirement determination 
because they are not definitive for the economic result achieved. 
Rather, the generic index itself is. If the parties to a swap identify 
a specific reference definition for an index, they need only confirm 
whether the DCO accepts that reference definition. If it does not, then 
the swap in question is not accepted for clearing and it is not subject 
to the clearing requirement.
Rate Index Specification Conclusion
    The Commission concludes that with the exception of the EURO-LIBOR 
index, all of the rate indexes identified in the IRS submissions have 
significant outstanding notional amounts and trading liquidity. The 
Commission further notes that significant notional amounts of these 
rate indexes are already cleared by DCOs.
4. Stated Termination Dates
    Stated termination date (sometimes referred to as ``maturities'') 
data is often presented by aggregating stated termination dates for 
swaps into specified term periods or ``buckets.'' The IRS submissions 
show that the DCOs have been clearing interest rate swaps with final 
termination dates out to at least ten years for all seventeen 
currencies and out to 50 years for some classes and currencies cleared.
    The use of maturity buckets eases the discussion of the range of 
termination dates. As the tables below show, interest rate swaps can be 
multi-year contracts with termination dates out to fifty years or more 
depending on the class and currency of the swap. Also, stated 
termination dates can fall on any day of the year. Given this continuum 
of termination dates, the DCOs have indicated that they manage the 
cleared swap portfolio risk using a swap curve.\127\ Swap curves are 
also used by market participants to price interest rate swaps. By 
pricing swaps in this way, the economic results of an interest rate 
swap can be fairly closely approximated, and therefore hedged, using 
two or more other swaps with different maturities principally by 
matching the weighted average duration of those swaps with the duration 
of the swap being hedged.\128\ In the same manner, a large portfolio of 
interest rate swaps can be hedged fairly closely with a small number of 
hedging swaps that have the same duration as the entire portfolio or 
subsets of related swaps within the portfolio. In effect, for DCO risk 
management purposes, the termination dates of interest rate swaps are 
assessed based on how they affect the overall duration aspects of the 
portfolio of swaps cleared.\129\ Accordingly, the primary determination 
with respect to the stated termination date specification is, for each 
class and currency, at what point, if any, along the continuum of swap 
maturities is there insufficient notional outstanding and trading 
liquidity to structure the swap curve effectively for DCO risk 
management purposes.
---------------------------------------------------------------------------

    \127\ The ``swap curve'' is the term generally used by market 
participants for interest rate swap pricing and is similar to, and 
is sometimes established, in part, based on, ``yield curves'' used 
for pricing bonds.
    \128\ Other factors, such as convexity, may also be taken into 
account in determining the appropriate hedge ratio between the 
initial swap and the other swaps used to hedge its exposure.
    \129\ For further discussion of the use of portfolio risk 
management by DCOs, see the discussion of interest rate swap market 
conventions and risk management in Section II.E above.
---------------------------------------------------------------------------

    The TriOptima data provided sufficient detail to discern notional 
amounts and trade counts only for each swap class. The ODSG data 
provided sufficient detail to discern notional amounts and trade counts 
only for each currency. The LCH data provided enough detail for both 
swap class and currency.
    Regarding maturity buckets, the BIS data only provides information 
for interest rate swaps in three periods: up to one year, between one 
year and five years, and more than five years. Because the BIS data 
does not provide granular detail beyond the five year maturity date, it 
does not provide enough detail to inform the Commission's determination 
regarding the IRS submissions under consideration. Accordingly, the BIS 
data was not considered for the stated termination date specification.

                                Table 15--TriOptima Data Interest Rate Swaps Notional by Maturity Period and Class \130\
                                                          [U.S. dollar equivalent in billions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          Maturity  0<=2   Maturity 2<=5  Maturity 5<=10     Maturity        Maturity      Maturity 30+
                      Product type                             years           years           years       10<=20 years    20<=30 years        Years
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fixed-to-Floating:
    --Notional..........................................        $118,523         $80,101         $66,049         $19,872         $13,207          $2,067

[[Page 47200]]

 
    --Trade Count.......................................         823,434         890,622         908,880         303,927         270,074          42,155
FRA:
    --Notional..........................................         $66,040          $1,060             $45              $0              $0              $0
    --Trade Count.......................................         201,164           1,646              78               0               0               0
OIS:
    --Notional..........................................         $41,783          $1,450            $258             $64             $74              $4
    --Trade Count.......................................          77,982          26,067           3,740           1,376             510              29
Basis Swap:
    --Notional..........................................         $17,324          $6,032          $2,633            $950            $561             $94
    --Trade Count.......................................          39,632          34,080          24,590          12,638           8,197             546
--------------------------------------------------------------------------------------------------------------------------------------------------------


                         Table 16--LCH Data: Interest Rate Swaps Notional Outstanding Cleared by Maturity Period and Class\131\
                                                          [U.S. dollar equivalent in billions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          Maturity  0<=2   Maturity 2<=5  Maturity 5<=10     Maturity        Maturity        Maturity
                      Product type                             years           years           years       10<=20 years    20<=30 years    30<=50 years
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fixed-to-Floating:
    --Notional..........................................          $7,773          $4,448          $3,569            $747            $463             $52
    --Trade Count.......................................          22,431          34,930          40,086           8,551          10,701           1,127
FRA:
    --Notional..........................................         $11,184              $0              $0              $0              $0              $0
    --Trade Count.......................................          31,584               0               0               0               0               0
OIS:
    --Notional..........................................          $8,714              $0              $0              $0              $0              $0
    --Trade Count.......................................           6,848               0               0               0               0               0
Basis Swap:
    --Notional..........................................          $1,423            $129             $37             $14              $5              $1
    --Trade Count.......................................           1,485             736             394             226              84              15
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The TriOptima data and LCH data presented above is useful in 
considering the distribution of final termination dates based on swap 
class. For fixed-to-floating swaps and basis swaps, there was 
significant outstanding notional amounts and number of trades for all 
maturity buckets.
---------------------------------------------------------------------------

    \130\ TriOptima data, as of March 16, 2012.
    \131\ The data covers swaps cleared by LCH during the first 
calendar quarter, 2012.
---------------------------------------------------------------------------

    For FRAs, the TriOptima data shows a steep drop off after two 
years, although there is still over $1 trillion dollars of outstanding 
notional amount in the 2<=5 year bucket and 1,646 trades. The notional 
amount outstanding falls below $50 billion after the five year 
maturity. The LCH data shows substantial outstanding notional amounts 
out to two years and none thereafter. The IRS submissions provide that 
the DCOs do not clear FRAs with payment dates beyond three years. 
Accordingly, the Commission need not consider FRAs with maturities 
beyond three years until such time as a DCO submits such swaps for 
clearing.
    For OIS, the TriOptima data shows notional amounts for all maturity 
buckets, but the drop off was steep beyond two years. After ten years, 
outstanding notional amounts drop below $100 billion for each maturity 
bucket. The LCH data shows no outstanding notional amounts cleared 
beyond two years. The IRS submissions provide that the DCOs do not 
accept for clearing OIS swaps beyond two years. Accordingly, the 
Commission is not considering OIS swaps beyond two years in this 
clearing requirement determination.
---------------------------------------------------------------------------

    \132\ The ODSG data includes swaps entered into between June and 
August, 2010 as voluntarily reported by the G14 Dealers. Only 
currencies and swap classes identified in the IRS submissions are 
included.

                             Table 17--ODSG Data: Interest Rate Swaps Trading Activity by Maturity Period and Currency \132\
                                                          [U.S. dollar equivalent in billions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          Maturity  0<=2  Maturity  2<=5     Maturity        Maturity        Maturity        Maturity
                        Currency                               years           years        5<=10 years    10<=20 years    20<=30 years    30<=50 years
--------------------------------------------------------------------------------------------------------------------------------------------------------
EUR.....................................................         $14,596          $1,699          $1,510            $447            $287             $34
USD.....................................................           6,796           1,991           1,999             247             220               5
GBP.....................................................           6,521             348             263              72              54              17
JPY.....................................................           2,970             782             448              91              16               0
Other...................................................           2,597             325             142              16               3               0
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................          33,480           5,143           4,362             872             580              56
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 47201]]


                        Table 18--LCH Data Interest Rate Swaps Notional Outstanding Cleared by Maturity Period and Currency \133\
                                                          [U.S. Dollar Equivalent in Billions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                          Maturity  0<=2  Maturity  2<=5     Maturity        Maturity        Maturity        Maturity
                        Currency                               years           years        5<=10 years    10<=20 years    20<=30 years    30<=50 years
--------------------------------------------------------------------------------------------------------------------------------------------------------
EUR.....................................................         $14,697          $1,922          $1,759            $477            $269             $35
USD.....................................................           8,850           1,796           1,176             154             133               2
GBP.....................................................           2,143             256             268              59              51              16
JPY.....................................................           2,204             254             262              56              12               0
Other...................................................           1,200             349             141              13               3               0
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................          29,094           4,577           3,606             760             468              53
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The ODSG data and LCH data in the two preceding tables show 
notional amounts traded for maturity buckets by currency. As shown, 
there were traded and cleared notional amounts for euro, U.S. dollars 
and British pounds out to the 30 to 50 year bucket and for yen out to 
the twenty to thirty year bucket. The LCH data confirms that 
substantial notional amounts of euros, U.S. dollars and British pounds 
are being cleared out to fifty years and yen out to 30 years.
---------------------------------------------------------------------------

    \133\ The data covers swaps cleared by LCH during the first 
calendar quarter, 2012.
---------------------------------------------------------------------------

Stated Termination Date Specification Conclusion
    For the classes of swaps, the TriOptima data show that there is 
significant outstanding notional amounts and number of trades out to 50 
years for fixed-to-floating swaps and basis swaps, out to three years 
for OIS, and out to two years for FRAs. With respect to currencies, the 
ODSG data set and LCH data show significant outstanding notional 
amounts and number of trades out to 50 years for U.S. dollars, euros, 
and British pounds and out to 30 years for yen.
5. Adequate Pricing Data
    In reaching its proposed determination, the Commission also is 
taking into account the adequacy of the pricing data for the four 
classes of interest rate swaps. LCH submits there is adequate pricing 
data for its risk and default management. It explains that its risk and 
default management is based on the following factors under normal and 
stressed conditions:
     Outstanding notional, by maturity bucket and currency;
     Number of participants with live open positions, by 
maturity bucket and currency;
     Notional throughput of the market, by maturity bucket and 
currency;
     Size tradable by maturity bucket that would not adjust the 
market price;
     Number of potential direct clearing members clearing the 
products that are part of the mutualized default fund and default 
management process;
     Interplay between on-the-run and off-the-run contracts; 
and
     Product messaging components and structure.
    LCH carries out a fire drill of its default management procedures 
and readiness twice a year. According to LCH, the fire drill presents 
an opportunity to further benchmark market liquidity and behavior and 
for models and assumptions to be recalibrated based on practitioner 
input. LCH also tests liquidity assumptions from the outset when 
developing clearing capabilities for a new product and thereafter, on a 
daily basis. This testing informs how LCH develops and modifies its 
risk management framework to provide adequate risk coverage in 
compliance with the core principles applicable to DCOs. Based on this 
framework, LCH contends that there is adequate pricing data for the 
swaps offered for clearing.
    IDCH submits that there is adequate pricing data to produce the 
IDCH-generated discount curve (the IDCH Curve). IDCH values each open 
position at the end of each trading day by valuing each leg of the cash 
flows of the contract (fixed and floating) according to discount 
factors produced by the IDCH Curve. The IDCH Curve is a zero-coupon 
yield curve that is updated on a continual basis and includes a 
composite of swap rates. IDCH generates a unique IDCH Curve for each 
reference rate that is available for clearing and calibrates each of 
these IDCH Curves to the discount curve to value at-market instruments 
at par.
    CME publicly represents that its interest rate swap valuations are 
fully transparent and rely on pricing inputs obtained from wire service 
feeds. Further, CME uses conventional pricing methodologies, including 
OIS discounting, to produce its zero coupon curve. In addition, 
customers are provided with direct access to daily reports showing 
curve inputs, daily discount factors, and valuations for each cleared 
swap position.
    It is also worth noting that those interest rate swaps that are the 
subject of this proposal are capable of being priced off of deep and 
liquid debt markets. Because of the stability of access to pricing data 
from these markets, the pricing data for non-exotic interest rate swaps 
that are currently being cleared is generally viewed as non-
controversial.
Based on consideration of the existence of significant outstanding 
notional exposures, trading liquidity, and adequate pricing data, the 
Commission preliminarily has determined to include interest rate swaps 
with the following specifications in the clearing requirement rule.

                                   Table 19--Interest Rate Swap Determination
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                          Fixed-to-Floating Swap Class
----------------------------------------------------------------------------------------------------------------
          Specification
 
1. Currency.....................  U.S. Dollar (USD).  Euro (EUR)........  Sterling (GBP)....  Yen (JPY).
2. Floating Rate Indexes........  LIBOR.............  EURIBOR...........  LIBOR.............  LIBOR.
3. Stated Termination Date Range  28 days to 50       28 days to 50       28 days to 50       28 days to 30
                                   years.              years.              years.              years.

[[Page 47202]]

 
4. Optionality..................  No................  No................  No................  No.
5. Dual Currencies..............  No................  No................  No................  No.
6. Conditional Notional Amounts.  No................  No................  No................  No.
----------------------------------------------------------------------------------------------------------------
                                                Basis Swap Class
----------------------------------------------------------------------------------------------------------------
          Specification
 
1. Currency.....................  U.S. Dollar (USD).  Euro (EUR)........  Sterling (GBP)....  Yen (JPY).
2. Floating Rate Indexes........  LIBOR.............  EURIBOR...........  LIBOR.............  LIBOR.
3. Stated Termination Date Range  28 days to 50       28 days to 50       28 days to 50       28 days to 30
                                   years.              years.              years.              years.
4. Optionality..................  No................  No................  No................  No.
5. Dual Currencies..............  No................  No................  No................  No.
6. Conditional Notional Amounts.  No................  No................  No................  No.
----------------------------------------------------------------------------------------------------------------
                                          Forward Rate Agreement Class
----------------------------------------------------------------------------------------------------------------
          Specification
1. Currency.....................  U.S. Dollar (USD).  Euro (EUR)........  Sterling (GBP)....  Yen (JPY).
2. Floating Rate Indexes........  LIBOR.............  EURIBOR...........  LIBOR.............  LIBOR.
3. Stated Termination Date Range  3 days to 3 years.  3 days to 3 years.  3 days to 3 years.  3 days to 3 years.
4. Optionality..................  No................  No................  No................  No.
5. Dual Currencies..............  No................  No................  No................  No.
6. Conditional Notional Amounts.  No................  No................  No................  No.
----------------------------------------------------------------------------------------------------------------
                                           Overnight Index Swap Class
----------------------------------------------------------------------------------------------------------------
          Specification
1. Currency.....................  U.S. Dollar (USD).  Euro (EUR)........  Sterling (GBP)....
2. Floating Rate Indexes........  FedFunds..........  EONIA.............  SONIA.............
3. Stated Termination Date Range  7 days to 2 years.  7 days to 2 years.  7 days to 2 years.
4. Optionality..................  No................  No................  No................
5. Dual Currencies..............  No................  No................  No................
6. Conditional Notional Amounts.  No................  No................  No................
----------------------------------------------------------------------------------------------------------------

Request for Comments
     Should the Commission consider other data to determine 
whether there are outstanding notional exposures, trading liquidity, or 
adequate pricing data to support the proposed clearing requirements? If 
so, please provide or identify any additional data that may assist the 
Commission in this regard.
     Do the four classes of interest rate swaps that would be 
subject to the proposed clearing requirement have significant 
outstanding notional amounts and trading liquidity?
     Should the Commission include the other thirteen 
currencies currently being cleared in its initial clearing requirement 
determination?
     Should the Commission include stated termination dates 
that are shorter than those that are listed, particularly for the 
fixed-to-floating and basis swaps?
     If the option in an interest rate swaption is exercised 
and not cash settled, should the resulting swap be subject to the 
clearing requirement if it meets the specifications included in the 
proposed clearing requirement?
     Is there adequate pricing data for DCO risk and default 
management of the interest rate swaps that would be subject to the 
proposed rule?
    b. Availability of Rule Framework, Capacity, Operational Expertise 
and Resources, and Credit Support Infrastructure
    Section 2(h)(2)(D)(ii)(II) of the CEA requires the Commission to 
take into account the availability of rule framework, capacity, 
operational expertise and resources, and credit support infrastructure 
to clear the proposed classes of swaps on terms that are consistent 
with the material terms and trading conventions on which they are now 
traded. The Commission believes that LCH, CME, and IDCH have developed 
rule frameworks, capacity, operational expertise and resources, and 
credit support infrastructure to clear the interest rate swaps they 
currently clear on terms that are consistent with the material terms 
and trading conventions on which those swaps are being traded. The 
Commission notes that LCH already clears more than half the global 
interest rate swaps in the four proposed classes of the clearing 
requirement and that CME and IDCH also already clear the more commonly 
traded swaps under this clearing requirement proposal.
    Importantly, the Commission notes that the three DCOs each 
developed their interest rate swap clearing offerings in conjunction 
with market participants and in response to the specific needs of the 
marketplace. In this manner, the clearing services of each DCO are 
designed to be consistent with the material terms and trading 
conventions of a bilateral, uncleared market.
    LCH submits that it has the capability and expertise to not only 
manage the risks inherent in the current book of interest rate swaps 
cleared, but also the capability to manage the increased volume that 
the clearing requirement for all of its currently clearable products 
could generate. LCH states that its clearing model seamlessly allows 
interest rate swaps to be cleared on identical terms for both new and 
existing, bilateral OTC swaps. Existing bilateral swaps are regularly 
back loaded into LCH's cleared swaps book. In order to be able to 
securely risk manage, and technologically and operationally process 
this volume of trades and diversity of underlying product (i.e., all of 
the unique underlying features of every single swap), LCH has developed 
operational models, controls, and risk algorithms to ensure that it can 
process trades, and is capable of calculating the level of risk it has 
with any counterparty--both direct clearing members and their 
customers. LCH believes its SwapClear service is proof that the 
interest rate swap market and all of its features can

[[Page 47203]]

be safely cleared with the right systems, controls, risk management, 
operational framework, and expertise, and it points to the orderly and 
successful close out of the Lehman Brothers International Europe's 
interest rate swap portfolio. LCH notes that in so doing, no other 
clearing member or clearing member's customer was harmed and, less than 
half of the defaulter's initial margin was used.
    CME's submission cites to its rule books to demonstrate the 
availability of rule framework, capacity, operational expertise and 
resources, and credit support infrastructure to clear qualified, 
interest rate swap contracts on terms that are consistent with the 
material terms and trading conventions on which the contracts are then 
traded.
    IDCH submits that its rule book provides a rule framework for 
clearing members and customers of clearing members to clear U.S. dollar 
interest rate swaps on terms that are consistent with the material 
terms and trading conventions on which they would trade interest rate 
swaps and forward rate agreements in the OTC market. The IDCH rule book 
also sets forth clearing member criteria and obligations, and 
descriptions of the clearing process, the settlement process (including 
the collection of performance bond and protection of customer 
collateral), and the default process.
    IDCH also claims that it has the capacity, operational expertise 
and resources, and credit support infrastructure to clear U.S. dollar 
interest rate swaps on terms that are consistent with the material 
terms and trading conventions on which interest rate swaps and forward 
rate agreements are traded in the OTC market. IDCH states that it has 
the financial capacity to clear such swaps as demonstrated by the 
financial resources backing its obligations under the cleared 
contracts, which includes initial margin posted by clearing members 
(for their proprietary account and customer accounts), guaranty fund 
deposits posted by clearing members, and assessment powers against 
clearing members. IDCH notes that it has been registered as a DCO since 
2008 and has dedicated tremendous resources to developing its 
operational capacity to clear interest rate swaps. It claims that the 
capacity of the IDCH clearing systems is scalable and has been tested 
to manage the anticipated volume of interest rate contracts. IDCH also 
says that its clearing systems presently have the capacity to manage 
the clearing of up to 220,000 contracts with 550 value-at-risk (VaR) 
scenarios being used for portfolio revaluation. The architecture of the 
systems is designed to be scalable with hardware and has been tested to 
manage the clearing of up to two million interest rate swaps using the 
same 550 VaR scenarios for revaluation.
    Having taken into account the three DCOs' availability of rule 
framework, capacity, operational expertise and resources, and credit 
support infrastructure, the Commission is proposing the determination 
and rules described below.
Request for Comments
     The Commission requests comment on all aspects of this 
factor, including whether or not commenters agree that the three DCOs 
clearing interest rate swaps can satisfy the factor's requirements.
     Has the Commission sufficiently taken into account the 
three DCOs' availability of rule framework, capacity, operational 
expertise and resources, and credit support infrastructure? Are there 
additional or alternative considerations that should be reviewed by the 
Commission?
c. Effect on the Mitigation of Systemic Risk
    Section 2(h)(2)(D)(ii)(III) of the CEA requires the Commission to 
take into account the effect on the mitigation of systemic risk, taking 
into account the size of the market for such contract and the resources 
of the DCO available to clear the contract. CME, LCH, and IDCH submit 
that subjecting interest rate swaps to central clearing would help 
mitigate systemic risk. As noted above, the Commission believes that 
the market for these swaps is significant and mitigating counterparty 
risk through clearing likely would reduce systemic risk in that market 
and in the industry, generally.
    According to LCH, if all clearable swaps are required to be 
cleared, the inevitable result will be a less disparate marketplace 
from a systemic risk perspective. CME submits that the 2008 financial 
crisis demonstrated the potential for systemic risk arising from the 
interconnectedness of OTC derivatives market participants and submits 
that centralized clearing will reduce systemic risk.
    IDCH submits that, given the tremendous size of the interest rate 
derivatives market, the potential mitigation of systemic risk through 
centralized clearing of interest rate swaps is significant. IDCH argues 
that clearing such swaps brings the risk mitigation and collateral and 
operational efficiency afforded to cleared and exchange-traded futures 
contracts to bilaterally negotiated OTC interest rate derivatives. The 
submission of interest rate swaps for clearing affords the parties the 
credit, risk management, capital, and operational benefits of central 
counterparty clearing of such transactions, and facilitates collateral 
efficiency. Cleared swaps allow market participants to free up 
counterparty credit lines that would otherwise be committed to open 
bilateral contracts. Additionally, according to IDCH, an efficient 
system for centralized clearing allows parties to mitigate the risk of 
a bilateral OTC derivative. Instead of holding offsetting positions 
with different counterparties and being exposed to the risk of each 
counterparty, a party may enter into an economically offsetting 
position that is cleared. Although the positions are not offset, the 
initial margin requirement will be reduced to close to zero. To 
eliminate risk without using centralized clearing, the party must enter 
into a tear-up agreement with the counterparty, or enter into a 
novation.
    While the clearing requirement would remove a large portion of the 
interconnectedness of current OTC markets that leads to systemic risk, 
the Commission notes that central clearing, by its very nature, 
concentrates risk in a handful of entities. However, the Commission 
observes that central clearing was developed and designed to handle 
such concentration of risk.
    LCH has extensive experience risk managing very large volumes of 
interest rate swaps; as noted above, it is believed that about half of 
the interest rate swaps are cleared by LCH. CME submits that it has the 
necessary resources available to clear the swaps that are the subject 
of its submission. The Commission notes that CME or its predecessors 
have cleared futures since 1898 and is the largest futures 
clearinghouse in the world. CME has not defaulted during that time. 
IDCH submits that the IDCH framework provides IDCH with scalable 
financial resources sufficient to clear a large volume of interest rate 
swaps.
    Accordingly, the Commission believes that LCH, CME, and IDCH would 
be able to manage the risk posed by clearing swaps that are required to 
be cleared. In addition, the Commission believes that the central 
clearing of the interest rate swaps that are the subject of this 
proposal would serve to mitigate counterparty credit risk thereby 
having a positive effect on the reducing systemic risk. Having taken 
into account the effect on the mitigation of systemic risk, the 
Commission is proposing the determination and rules described below.

[[Page 47204]]

Request for Comments
     Would the proposed clearing requirement reduce systemic 
risk?
     Would the proposed clearing requirement increase the risk 
to LCH, CME, or IDCH? If so, please explain why.
     Are LCH, CME, and IDCH capable of handling any increased 
risk that would result from the proposed clearing requirement?
d. Effect on Competition
    Section 2(h)(2)(D)(ii)(IV) of the CEA requires the Commission to 
take into account the effect on competition, including appropriate fees 
and charges applied to clearing. As discussed above, of particular 
concern to the Commission is whether this proposed determination would 
harm competition by creating, enhancing, or entrenching market power in 
an affected product or service market, or facilitating the exercise of 
market power. Market power is viewed as the ability to raise price, 
including clearing fees and charges, reduce output, diminish 
innovation, or otherwise harm customers as a result of diminished 
competitive constraints or incentives.\134\
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    \134\ See Section II.D above for more detailed discussion.
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    The Commission has identified one putative service market as 
potentially affected by this proposed clearing determination: A DCO 
service market encompassing those clearinghouses that currently (or 
with relative ease in the future could) clear the interest rate swaps 
subject to this proposal. Without defining the precise contours of this 
market at this time, the Commission recognizes that, depending on the 
interplay of several factors, this proposed clearing requirement 
potentially could impact competition within the affected market. Of 
particular importance to whether any impact is, overall, positive or 
negative, is: (1) Whether the demand for these clearing services and 
swaps is sufficiently elastic that a small but significant increase 
above competitive levels would prove unprofitable because users of the 
interest rate swap products and DCO clearing services would substitute 
other clearing services co-existing in the same market(s); and (2) the 
potential for new entry into this market. The availability of 
substitute clearing services to compete with those encompassed by this 
proposed determination, and the likelihood of timely, sufficient new 
entry in the event prices do increase above competitive levels, each 
operate independently to constrain anticompetitive behavior.
    Any competitive import would likely stem from the fact that the 
proposed determination would remove the alternative of not clearing for 
interest rate swaps subject to this proposal. The proposed 
determination would not specify who may or may not compete to provide 
clearing services for the interest rate swaps subject to this proposal 
(as well as those not required to be cleared).
    To the extent that parties to interest rate swaps subject to this 
proposal consider clearing the swaps reasonably interchangeable with 
not clearing them, the proposed determination would eliminate at least 
one competitive substitute within the clearinghouse services market for 
the interest rate swaps identified in this proposal. Given the risk-
mitigation purpose and benefit of migration to voluntary interest rate 
swap clearing, however, the Commission sees some basis to doubt that 
counterparties to cleared swaps would consider the alternative of not 
clearing interest rate swaps subject to this proposal as a reasonable 
substitute to a degree sufficient that they should be viewed as 
populating the same relevant market.\135\ Furthermore, if the 
alternative of not clearing the interest rate swaps subject to this 
proposal falls outside of the relevant services market that includes 
clearing, the proposed clearing determination should not impact 
competition in the clearing services market. The Commission requests 
comment on the extent to which foregoing clearing is considered 
reasonably interchangeable with clearing the interest rate swaps 
subject to this proposal and, in particular, if parties transacting 
interest rate swaps subject to this proposal would forego clearing if 
clearinghouses raised the price of clearing five percent. The 
Commission also requests comment on whether a different percentage than 
five percent should be used.
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    \135\ In other words, the Commission questions that, faced with 
an assumed five percent non-transitory increase in the price of 
clearing the identified interest rate swaps, including fees and 
other charges, that the parties to these interest rate swap 
transactions would forego clearing in sufficient volume to render 
the price increase unprofitable.
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    Moreover, even if cleared and non-cleared transactions of the type 
subject to this proposal are now within the same relevant market, 
removing the uncleared option through this proposed rulemaking is not 
determinative of negative competitive impact. Other factors--including 
the availability of other substitutes within the market or potential 
for new entry into the market--may constrain market power.
    Additionally, the potential for new entry may constrain market 
power in an otherwise concentrated clearing services market. The 
Commission does not foresee that the proposed determination constructs 
barriers that would deter or impede new entry into a clearing services 
market.\136\ Indeed, there is some basis to expect that the 
determination could foster an environment conducive to new entry. For 
example, the proposed clearing determinations, and the prospect that 
more may follow, is likely to reinforce, if not encourage, growth in 
demand for clearing services. Demand growth, in turn, can enhance the 
sales opportunity, a condition hospitable to new entry.\137\ The 
Commission requests comment on the extent to which: (1) Entry barriers 
currently do or do not exist with respect to a clearing services market 
for the interest rate swaps subject to this proposal; (2) the proposed 
determinations may lessen or increase these barriers; and (3) the 
proposed determinations otherwise may encourage, discourage, 
facilitate, and/or dampen new entry into the market.
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    \136\ That said, the Commission recognizes that (1) to the 
extent the clearing services market for the interest rate swaps 
identified in this proposal, after foreclosing uncleared swaps, 
would be limited to a concentrated few participants with highly 
aligned incentives, and (2) the clearing services market is 
insulated from new competitive entry through barriers--e.g., high 
sunk capital cost requirements; high switching costs to transition 
from embedded, incumbents; and access restrictions--the proposed 
determination could have a negative competitive impact by increasing 
market concentration.
    \137\ See, e.g., Horizontal Merger Guidelines at Sec.  9.2 
(entry likely if it would be profitable which is in part a function 
of ``the output level the entrant is likely to obtain'').
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Request for Comments
    In addition to what is noted above, the Commission requests 
comment, and quantifiable data, on whether the required clearing of any 
or all of these swaps will create conditions that create, increase, or 
facilitate an exercise of: (1) Clearing services market power in LCH, 
CME, and IDCH, and/or any other clearing service market participant, 
including conditions that would dampen competition for clearing 
services and/or increase the cost of clearing services; and/or (2) 
market power in any product markets for interest rate swaps, including 
conditions that would dampen competition for these product markets and/
or increase the cost of interest rate swaps involving the interest rate 
swaps identified in this proposal. The Commission seeks comment, and 
quantifiable data, on the likely cost increases associated with 
clearing, particularly those fees and charges

[[Page 47205]]

imposed by DCOs, and the effects of such increases on counterparties 
currently participating in the market. The Commission also seeks 
comment regarding the effect of competition on DCO risk management. The 
Commission also welcomes comment on any other aspect of this factor.
e. Legal Certainty in the Event of the Insolvency
    Section 2(h)(2)(D)(ii)(V) of the CEA requires the Commission to 
take into account the existence of reasonable legal certainty in the 
event of the insolvency of the relevant DCO or one or more of its 
clearing members with regard to the treatment of customer and swap 
counterparty positions, funds, and property. The Commission is 
proposing this clearing requirement based on its view that there is 
reasonable legal certainty with regard to the treatment of customer and 
swap counterparty positions, funds, and property in connection with 
cleared swaps, namely the interest rate swaps subject to this proposal, 
in the event of the insolvency of the relevant DCO (CME, LCH, or IDCH) 
or one or more of the DCO's clearing members.
    The Commission concludes that, in the case of a clearing member 
insolvency at CME or IDCH, subchapter IV of Chapter 7 of the U.S. 
Bankruptcy Code (11 U.S.C. 761-767) and Part 190 of the Commission's 
regulations would govern the treatment of customer positions.\138\ 
Pursuant to section 4d(f) of the CEA, a clearing member accepting funds 
from a customer to margin a cleared swap, must be a registered FCM. 
Pursuant to 11 U.S.C. 761-767 and Part 190 of the Commission's 
regulations, the customer's interest rate swap positions, carried by 
the insolvent FCM, would be deemed ``commodity contracts.'' \139\ As a 
result, neither a clearing member's bankruptcy nor any order of a 
bankruptcy court could prevent either CME or IDCH from closing out/
liquidating such positions. However, customers of clearing members 
would have priority over all other claimants with respect to customer 
funds that had been held by the defaulting clearing member to margin 
swaps, such as the interest rate swaps subject to this proposal.\140\ 
Thus, customer claims would have priority over proprietary claims and 
general creditor claims. Customer funds would be distributed to swap 
customers, including interest rate swap customers, in accordance with 
Commission regulations and section 766(h) of the Bankruptcy Code. 
Moreover, the Bankruptcy Code and the Commission's rules thereunder (in 
particular 11 U.S.C. 764(b) and 17 CFR 190.06) permit the transfer of 
customer positions and collateral to solvent clearing members.
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    \138\ The Commission observes that an FCM or DCO also may be 
subject to resolution under Title II of the Dodd-Frank Act to the 
extent it would qualify as covered financial company (as defined in 
section 201(a)(8) of the Dodd-Frank Act).
    \139\ If an FCM is also registered as a broker-dealer, certain 
issues related to its insolvency proceeding would also be governed 
by the Securities Investor Protection Act.
    \140\ Claims seeking payment for the administration of customer 
property would share this priority.
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    Similarly, 11 U.S.C. 761-767 and Part 190 would govern the 
bankruptcy of a DCO, in conjunction with DCO rules providing for the 
termination of outstanding contracts and/or return of remaining 
clearing member and customer property to clearing members.
    With regard to LCH, the Commission understands that the default of 
a clearing member of LCH would be governed by the rules of that DCO. 
LCH, a DCO based in the United Kingdom, has represented that under 
English law its rules would supersede English insolvency laws. Under 
its rules, LCH would be permitted to close out and/or transfer 
positions of a defaulting clearing member that is an FCM pursuant to 
the U.S. Bankruptcy Code and Part 190 of the Commission's regulations. 
According to LCH's submission, the insolvency of LCH itself would be 
governed by both English insolvency law and Part 190.
    LCH has obtained legal opinions that support the existence of such 
legal certainty in relation to the protection of customer and swap 
counterparty positions, funds, and property in the event of the 
insolvency of one or more of its clearing members. In addition, LCH has 
obtained a legal opinion from U.S. counsel regarding compliance with 
the protections afforded to FCM customers under New York law.
Request for Comments
    The Commission invites comment regarding whether there is 
reasonable legal certainty in the event of an insolvency of a DCO or 
one or more of its clearing members with regard to the treatment of 
customer and swap counterparty positions, funds, and property.

III. Proposed Rule

    The Commission is proposing the following rules under section 
2(h)(2), as well as its authority under sections 5b(c)(2)(L) and 8a(5) 
of the CEA. In issuing a determination regarding whether a swap or 
class of swaps is required to be cleared, ``the Commission may require 
such terms and conditions to the requirement as the Commission 
determines to be appropriate.'' \141\
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    \141\ Section 2(h)(2)(D)(iii) of the CEA.
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A. Proposed Sec.  50.1 Definitions

    Proposed Sec.  50.1 sets forth two defined terms: ``business day'' 
and ``day of execution.'' The definition of business day would exclude 
Saturdays, Sundays, and legal holidays. This definition is being 
proposed as a means of addressing situations where executing 
counterparties are located in different time zones. It is intended to 
avoid difficulties associated with end-of-day trading by deeming swaps 
executed after 4:00pm, or on a day other than a business day, to have 
been executed on the immediately succeeding business day. The 
Commission recognizes that market participants should not be required 
to maintain back-office operations 24 hours a day or 7 days a week in 
order to meet the proposed deadline for submitting swaps that are 
required to be cleared to a DCO. The Commission also is attempting to 
be sensitive to possible concerns about timeframes that may discourage 
trade execution late in the day. To account for time-zone issues, the 
``day of execution'' has been defined to be the calendar day of the 
party to the swap that ends latest, giving the parties the maximum 
amount of time to subject their swaps to a DCO while still requiring 
such submission on a same-day basis.

B. Proposed Sec.  50.2 Treatment of Swaps Subject to a Clearing 
Requirement

    Proposed Sec.  50.2(a) would require all persons, other than those 
who elect the exception for non-financial entities in accordance with 
Sec.  39.6, to submit a swap that is part of the class described in 
Sec.  50.4 for clearing by a DCO as soon as technologically practicable 
and no later than the end of the day of execution. The objective of 
this provision is to ensure that swaps subject to a clearing 
requirement are submitted to DCOs for clearing in a timely manner. The 
Commission notes that this proposal regarding timing of submission to a 
DCO is consistent with the real-time public reporting rules and the 
rules mandating deadlines for the reporting of swap data to SDRs, both 
of which use ``as soon as technologically practicable'' as the 
applicable standard.\142\
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    \142\ See 17 CFR 43.2, Real-Time Public Reporting of Swap 
Transaction Data, 77 FR 1182, 1243-44 (Jan. 9, 2012); and 17 CFR 
45.3, Swap Data Recordkeeping and Reporting Requirements, 77 FR 
2136, 2199-2200 (Jan. 13, 2012).
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    For purposes of this rule, the Commission clarifies that submission 
of a swap by a market participant to its FCM clearing member would be 
deemed

[[Page 47206]]

to meet the requirements for submitting the swap to a DCO. Once a 
customer submits a swap to its FCM, the timeliness considerations are 
governed by other straight-through-processing rules recently finalized 
by the Commission.\143\ Under Sec.  1.74(a), FCMs that are clearing 
members of DCOs shall coordinate with DCOs to establish systems that 
enable the FCM or DCO to accept or reject each trade submitted for 
clearing by a customer of the FCM as quickly as would be 
technologically practicable if fully automated systems were used. 
Similarly, under Sec.  1.74(b), FCM clearing members must accept or 
reject each trade submitted to it by a customer as quickly as would be 
technologically practicable if fully automated systems were used. Those 
market participants that clear on their own behalf would be required to 
submit their swaps to a DCO directly and pursuant to the proposed 
timeframe.
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    \143\ Customer Clearing Documentation, Timing of Acceptance for 
Clearing, and Clearing Member Risk Management, 77 FR 21278, 21307 
(Apr. 9, 2012).
---------------------------------------------------------------------------

    Proposed Sec.  50.2(b) would require persons subject to Sec.  
50.2(a) to undertake reasonable efforts to determine whether a swap is 
required to be cleared. The Commission would consider such reasonable 
efforts to include checking the Commission's Web site or the DCO's Web 
site for verification of whether a swap is required to be cleared. 
Similarly, market participants could consult third-party service 
providers for such verification. This reasonable efforts standard is 
intended to provide market participants with clarity as to what is 
expected of them when they enter into a swap that has the 
specifications of one of the classes identified in proposed Sec.  50.4.
    Ideally, DCOs will design and develop systems that will enable 
market participants and trading platforms to check whether or not their 
swap is subject to a clearing requirement and be provided with an 
answer within seconds (or faster). This technology would provide a 
single-stop solution for the market with regard to checking eligibility 
under a required clearing regime.

C. Proposed Sec.  50.3 Notice to the Public

    Proposed Sec.  50.3(a) would require each DCO to post on its Web 
site a list of all swaps that it will accept for clearing and clearly 
indicate which of those swaps the Commission has determined are 
required to be cleared pursuant to part 50 of the Commission's 
regulations and section 2(h)(1) of the CEA. The proposed rule builds 
upon the requirements of Sec.  39.21(c)(1), which requires each DCO to 
disclose publicly information concerning the terms and conditions of 
each contract, agreement, and transaction cleared and settled by the 
DCO. Proposed Sec.  50.3(b) would require the Commission to post on its 
Web site a list of those swaps it has determined are required to be 
cleared and all DCOs that are eligible to clear such classes of swaps. 
The Commission believes that this will provide market participants with 
sufficient notice regarding which swaps are subject to a clearing 
requirement.

D. Proposed Sec.  50.4 Classes of Swaps Required To Be Cleared

    As discussed at length above, proposed Sec.  50.4 sets forth the 
classes of interest rate swaps and CDS that the Commission has 
determined are required to be cleared. Proposed Sec.  50.4(a) includes 
a table listing those types of interest rate swaps the Commission would 
require to be cleared; proposed Sec.  50.4(b) includes a table listing 
those types of CDS indices the Commission would require to be cleared. 
The Commission believes that this format provides market participants 
with a clear understanding of which swaps are required to be cleared. 
By using basic specifications to identify the swaps subject to the 
clearing requirement, counterparties contemplating entering into a swap 
can determine quickly as a threshold matter whether or not the 
particular swap may be subject to a clearing requirement. If the swap 
has the basic specifications of a class of swaps determined to be 
subject to a clearing requirement, the parties will know that they need 
to verify whether a DCO will clear that particular swap. This will 
reduce the burden on swap counterparties related to determining whether 
a particular swap may be subject to the clearing requirement.

E. Proposed Sec.  50.5 Clearing Transition Rules

    Proposed Sec.  50.5 would codify section 2(h)(6) of the CEA. Under 
proposed Sec.  50.5(a), swaps that are part of a class described in 
Sec.  50.4 but were entered into before the enactment of the Dodd-Frank 
Act would be exempt from clearing so long as the swap is reported to an 
SDR pursuant to Sec.  44.02 and section 2(h)(5)(A) of the CEA. 
Similarly, under proposed Sec.  50.5(b), swaps entered into after the 
enactment of the Dodd-Frank Act but before the application of the 
clearing requirement would be exempt from the clearing requirement if 
reported pursuant to Sec.  44.03 and section 2(h)(5)(B) of the Act.

F. Proposed Sec.  50.6 Delegation of Authority

    Proposed Sec.  50.6(a) would delegate to the Director of the 
Division of Clearing and Risk, or the Director's designee, with the 
consultation of the General Counsel or the General Counsel's designee, 
the authority to determine whether a swap falls within a class of swaps 
described in Sec.  50.4 and to communicate such a determination to the 
relevant DCOs. The Commission believes that the Division of Clearing 
and Risk has the requisite expertise to make such a determination and 
that the most expeditious way for the marketplace to be apprised of a 
such a determination would be for the Division of Clearing and Risk to 
make the determination itself and to communicate it directly to the 
relevant DCOs.
    Swaps that contain the specifications described in Sec.  50.4 would 
be presumed to fall within a class of swaps already subject to a 
clearing requirement. In this manner, the Commission hopes to 
facilitate DCOs' ability to add new swaps to particular classes without 
undue burden.

G. Proposed Sec.  50.10 Prevention of Evasion of the Clearing 
Requirement and Abuse of an Exception or Exemption to the Clearing 
Requirement

    The Commission is proposing Sec.  50.10 to prevent evasion of the 
clearing requirement and prevent abuse of any exemption or exception to 
the clearing requirement under the Commission's new rulemaking 
authority provided in the Dodd-Frank Act amendments to sections 
2(h)(4)(A) \144\ (Prevention of Evasion) and 2(h)(7)(F) \145\ (Abuse of 
the End-User Exception) of the CEA and under the Commission's existing 
rulemaking authority in section 8a(5) \146\ (General Rulemaking 
Authority) of the CEA. Proposed Sec.  50.10 would prohibit (a) evasions 
of the requirements of section 2(h), (b) abuse of the end-user 
exception to the clearing requirement, and (c) abuse of any exemption 
or exception to the requirements of section 2(h), including any 
exemption or exception that the Commission may provide by rule, 
regulation, or order.
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    \144\ Section 2(h)(4) of the CEA, 7 U.S.C. 2(h)(4).
    \145\ Section 2(h)(7)(F) of the CEA, 7 U.S.C. 2(h)(7)(F).
    \146\ Section 8a(5) of the CEA, 7 U.S.C. 12a(5).
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    Section 2(h) of the CEA provides two express rulemaking provisions 
specifically addressing prevention of evasion and prevention of abuse 
of the clearing requirement. Section 2(h)(4)(A) states that the 
Commission shall prescribe rules and issue interpretations

[[Page 47207]]

of rules as determined by the Commission to be necessary to prevent 
evasions of the clearing requirements under section 2(h) of the CEA. 
Section 2(h)(7)(F) provides that the Commission may prescribe such 
rules or issue interpretations of the rules as the Commission 
determines to be necessary to prevent abuse of the exceptions to the 
clearing requirement. The Commission preliminarily views evasion of the 
clearing requirement and abuse of an exemption or exception to the 
clearing requirement, including the end-user exception, to be related 
concepts and are informed by new enforcement authority under the Dodd-
Frank Act, which added new sections 6(e)(4)-(5) \147\ and 9(a)(6) \148\ 
to CEA.
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    \147\ Section 6(e)(4)-(5) of the CEA, 7 U.S.C. 9a(4)-(5).
    \148\ Section 9(a)(6) of the CEA, 7 U.S.C. 13(a)(6).
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    Proposed Sec.  50.10(a) would make it unlawful for any person to 
knowingly or recklessly evade, participate in, or facilitate an evasion 
of any of the requirements of section 2(h) of the CEA. Proposed Sec.  
50.10(a) is informed by and consistent with section 6(e)(4) and (5) of 
the CEA, which states that any DCO, SD, or MSP that ``knowingly or 
recklessly evades or participates in or facilitates an evasion of the 
requirements of section 2(h) shall be liable for a civil monetary 
penalty in twice the amount otherwise available for a violation of 
section 2(h).'' Proposed Sec.  50.10(a), however, would apply to any 
person. In addition, proposed Sec.  50.10(a) would apply to any 
requirement under section 2(h) of the CEA or any Commission rule or 
regulation promulgated thereunder. These requirements include the 
clearing requirement under section 2(h)(1), reporting of data under 
section 2(h)(5), and the trade execution requirement under section 
2(h)(8), among other requirements.\149\
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    \149\ For example, it would be a violation of proposed Sec.  
50.10(a) for a SEF to knowingly or recklessly evade or participate 
in or facilitate an evasion of the trade execution requirement under 
section 2(h)(8).
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    The Commission notes, however, that section 2(h)(1)(A) \150\ of the 
CEA provides that it ``shall be unlawful for any person to engage in a 
swap unless that person submits such swap for clearing'' to a DCO if 
the swap is required to be cleared. Unlike the knowing or reckless 
standard under proposed Sec.  50.10(a), section 2(h)(1)(A) imposes a 
non-scienter standard on swap market participants. Therefore, any 
person engaged in a swap that is required to be cleared under section 
2(h) and proposed Part 50 of the Commission's Regulations, and such 
person did not submit the swap for clearing, absent an exemption or 
exception, would be subject to a Commission enforcement action 
regardless of whether the person knowingly or recklessly failed to 
submit the swap for clearing.
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    \150\ Section 2(h)(1)(A) of the CEA, 7 U.S.C. 2(h)(1)(A).
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    Proposed Sec.  50.10(b) makes it unlawful for any person to abuse 
the end-user exception to the clearing requirement as provided under 
section 2(h)(7) of the CEA and Sec.  39.6.\151\ Proposed Sec.  50.10(b) 
is adopted under the authority in both section 2(h)(4)(A) and section 
2(h)(7)(F). The Commission preliminarily believes that an abuse of the 
end-user exception to the clearing requirement may also, depending on 
the facts and circumstances, be an evasion of the requirements of 
section 2(h). The Commission's view is informed by section 9(a)(6) of 
the CEA, which cross-references both the prevention of evasion 
authority in section 2(h)(4) and prevention of abuse of the exception 
to the clearing requirement in section 2(h)(7)(F). Section 9(a)(6) 
states that it ``shall be a felony punishable by a fine of not more 
than $1,000,000 or imprisonment for not more than 10 years, or both, 
together with the costs of prosecution, for * * * [a]ny person to abuse 
the end user clearing exemption under section 2(h)(4), as determined by 
the Commission.'' Therefore, the Commission is proposing to interpret a 
violation of section 9(a)(6) of the CEA to also be a violation of 
proposed Sec.  50.10(b).
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    \151\ See End-User Exception to the Clearing Requirement for 
Swaps, adopted by the Commission on July 10, 2012, available at 
www.cftc.gov.
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    Proposed Sec.  50.10(c) makes it unlawful for any person to abuse 
any exemption or exception to the requirements of section 2(h) of the 
CEA, including any exemption or exception, as the Commission may 
provide by rule, regulation, or order. This provision is informed by 
the Dodd-Frank Act amendments in section 2(h)(4)(A) to prescribe rules 
necessary to prevent evasions of the clearing requirements, section 
2(h)(7)(F) to prescribe rules necessary to prevent abuse of the 
exceptions to the clearing requirements, and the Commission's general 
rulemaking authority in section 8a(5) to promulgate rules that, in the 
judgment of the Commission, are reasonably necessary to accomplish any 
purposes of the CEA. Therefore, the Commission preliminarily believes 
that proposed Sec.  50.10(c) is necessary to prevent abuses of any 
exemption or exception to the requirements of section 2(h).
    The Commission believes a ``principles-based'' approach to proposed 
Sec.  50.10 is appropriate. The Commission is not proposing to provide 
a bright-line test of non-evasive or abusive conduct, because such an 
approach may be a roadmap for engaging in evasive or abusive conduct or 
activities. Nevertheless, the Commission is proposing additional 
guidance regarding evasion and abuse in order to provide clarity to 
market participants.\152\
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    \152\ Examples described in the guidance are illustrative and 
not exhaustive of the transactions, instruments, or entities that 
could be considered evasive. In considering whether a transaction, 
instrument, or entity is evasive, the Commission will consider the 
facts and circumstances of each situation.
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    The Commission proposes to interpret these rules in a manner 
similar to its interpretation of the anti-evasion rules that it 
recently adopted in its rulemaking to further define the term 
swap.\153\ The Commission proposes to determine on a case-by-case 
basis, whether particular transactions or other activities constitute 
an evasion of the requirements of section 2(h) of the CEA or the 
regulations promulgated thereunder or an abuse of any exemption or 
exception to the requirements of section 2(h). Each such transaction or 
activity would be evaluated on a case-by-case basis with consideration 
given to all the facts and circumstances.
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    \153\ See Further Definition of ``Swap,'' ``Security-Based 
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps; 
Security-Based Swap Agreement Recordkeeping, Section VII, adopted by 
the Commission on July 10, 2012, available at www.cftc.gov.
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    Similar to its approach in the rules further defining the term 
``swap,'' the Commission proposes that it would not consider 
transactions or other activities structured in a manner solely 
motivated by a legitimate business purpose to constitute evasion or 
abuse. Additionally, when determining whether particular conduct is an 
evasion of the requirements of section 2(h) or an abuse of any 
exemptions or exceptions to those requirements, the Commission will 
consider the extent to which the conduct involves deceit, deception, or 
other unlawful or illegitimate activity.
    The Commission recognizes that market participants may engage in 
conduct or activities, such as structuring a transaction in a 
particular way, for legitimate business purposes, without any intention 
to evade the requirements of section 2(h) of the CEA or abuse any 
exemptions or exceptions thereunder. Thus, in evaluating whether a 
person has evaded such requirements or abused

[[Page 47208]]

an exemption or exception, the Commission proposes to consider the 
extent to which a person has a legitimate business purpose in 
connection with the relevant conduct or activities. This proposed 
analytical method will be useful in the overall analysis of potentially 
knowingly or recklessly evasive conduct or abusive conduct. The 
Commission proposes to view legitimate business purpose considerations 
on a case-by-case basis in conjunction with all other relevant facts 
and circumstances.
    Moreover, the Commission recognizes that it is possible that a 
person intending to evade the requirements of section 2(h) or abuse an 
exemption or exception thereunder may attempt to justify its actions by 
claiming that such actions are legitimate business practices in its 
industry. Therefore, the Commission proposes to retain the flexibility, 
via an analysis of all relevant facts and circumstances, to confirm not 
only the legitimacy of the business purpose of those actions but 
whether the actions could still be determined to be evasive or abusive. 
Because market participants engage in conduct and activities, such as 
structuring transactions and instruments, in a particular way for 
various reasons, it is essential that all relevant facts and 
circumstances be considered, including legitimate business purposes, 
before reaching any conclusion as to evasion or abuse.
    When determining whether a particular activity constitutes an 
evasion of the requirements of section 2(h) or an abuse of any 
exemption or exception to such requirements, the Commission proposes to 
consider the extent to which the activity involves deceit, deception, 
or other unlawful or illegitimate activity. The Commission believes 
that although it is likely that fraud, deceit, or unlawful activity 
will be present where evasion or abuse has occurred, these factors are 
not prerequisites to finding a violation of proposed rule Sec.  50.10. 
Rather, fraud, deceit, or unlawful activity is one circumstance the 
Commission proposes to consider when evaluating a person's conduct or 
activities.
    Finally, when considering all the relevant facts and circumstances 
under a potential violation of proposed rule Sec.  50.10, the 
Commission would not consider the form, label, or written documentation 
of any relevant agreement, contract or transaction to be dispositive. 
This approach is intended to prevent evasion and abuse through clever 
draftsmanship of a form, label, or other written documentation. 
Therefore, the Commission proposes to look beyond the form of the 
agreement, contract or transaction to examine its actual substance and 
purpose to prevent any evasion or abuse through clever draftsmanship.
    In addition to the prohibitions under proposed Sec.  50.10, the 
Commission notes that additional provisions of the CEA may also be 
applicable to evasive or abusive practices. For example, the Commission 
notes that swaps, whether cleared or uncleared, must be reported to a 
registered SDR, or if no SDR will accept the swap, to the 
Commission.\154\ In that regard, the Commission has proposed that to be 
eligible to qualify for certain exceptions or to be able to rely on 
certain exemptions, at least one party to the swap must report certain 
information to an SDR or to the Commission. Regulation 39.6(b)(4), for 
example, requires at least one party to a swap that has elected to use 
the end-user exception to the clearing requirement to report whether 
the swap is used to hedge or mitigate commercial risk.\155\
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    \154\ See section 2(a)(13)(G) of the CEA, 7 U.S.C. 2(a)(13)(G), 
and section 4r(a)(1) of the CEA, 7 U.S.C. 6r(a)(1).
    \155\ See End-User Exception to the Clearing Requirement for 
Swaps, adopted by the Commission on July 10, 2012, available at 
www.cftc.gov.
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    Considering this regulatory regime, certain evasive or abusive 
practices, such as making false statements or submission in connection 
with the clearing requirement, may also violate other provisions of the 
CEA. For example, section 6(c)(2) \156\ of the CEA, which makes it 
unlawful for any person to make any false or misleading statement of 
material fact to the Commission, including in any report filed with the 
Commission or any other information relating to a swap. Furthermore, 
section 9(a)(4) \157\ of the CEA makes it a felony for any person to 
willfully falsify a material fact, make any false or fraudulent 
statements or representations, or make or use any false writing or 
document or fraudulent statement or entry to an SDR. Thus, the 
Commission may bring enforcement actions under proposed Sec.  50.10, 
section 6(c)(2), and section 9(a)(4), among other statutory provisions 
and rules, to prevent evasions of the requirements of section 2(h) and 
abuses of any exemption or exception to such requirements.
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    \156\ Section 6(c)(2) of the CEA, 7 U.S.C. 9(c)(2).
    \157\ Section 9(a)(4) of the CEA, 7 U.S.C. 13(a)(4). See also 
section 9(a)(3) of the CEA, 7 U.S.C. 13(a)(3).
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comment on all aspects of the proposed 
rules and specifically on:
     Should the Commission clarify in the proposed rules that 
the clearing requirement applies to all new swaps and all changes in 
the ownership of a swap, such as assignment, novation, exchange, 
transfer, or conveyance?
     Is proposed Sec.  50.10 and the guidance set forth in this 
section sufficient to address concerns of evasion of the requirements 
of section 2(h) or an abuse of any exemption or exception to such 
requirements? Is further guidance necessary? If so, what further 
guidance would be appropriate?
     Should the Commission prohibit certain specific practices 
that would be evasions of the requirements of section 2(h)?
     Should the Commission prohibit certain specific practices 
that would be an abuse of the end-user exception?
     Should the Commission prohibit certain specific practices 
that would be an abuse of any other exemption or exception to the 
requirements of section 2(h)?

IV. Implementation

    The Commission is proposing to require compliance with the clearing 
requirement for the classes of swaps identified in proposed Sec.  50.4 
according to the compliance schedule contained in Sec.  50.25.\158\ 
Under this schedule, compliance with the clearing requirement will be 
phased by type of market participant entering into a swap subject to 
the clearing requirement.
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    \158\ The Commission proposed a compliance schedule for the 
clearing requirement in September 2011, 76 FR 58186 (Sept. 20, 
2011), and is finalizing 17 CFR 50.25 concurrently.
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V. Cost Benefit Considerations

A. Statutory and Regulatory Background

    The regulations contained in this proposal identify certain classes 
of swaps that are required to be cleared pursuant to the Dodd-Frank 
Act's \159\ clearing requirement incorporated within amended section 
2(h)(1)(A) of the CEA.\160\ This clearing requirement is designed to 
standardize and reduce counterparty risk associated with swaps, and, in 
turn, mitigate the potential

[[Page 47209]]

systemic impact of such risks and reduce the likelihood for swaps to 
cause or exacerbate instability in the financial system. It reflects a 
fundamental premise of the Dodd-Frank Act: the use of properly 
functioning central clearing can reduce systemic risk.
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    \159\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Public Law 111-203, 124 Stat. 1376 (2010).
    \160\ 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 derivatives clearing organization that is registered 
under this Act or a derivatives clearing organization that is exempt 
from registration under this Act if the swap is required to be 
cleared.''
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    Regulation 39.5 provides an outline for the Commission's review of 
swaps for required clearing.\161\ Regulation 39.5 allows the Commission 
to review swaps submitted by DCOs or those swaps that the Commission 
opts to review on its own initiative.\162\ Under section 2(h)(2)(D) of 
the CEA, in reviewing swaps for required clearing, the Commission must 
take into account the following factors: (1) Significant outstanding 
notional exposures, trading liquidity and adequate pricing data, (2) 
the availability of rule framework, capacity, operational expertise and 
credit support infrastructure, (3) the effect on the mitigation of 
systemic risk, (4) the effect on competition and (5) the existence of 
reasonable legal certainty in the event of the insolvency of the DCO or 
one or more of its clearing members.\163\ Regulation 39.5 also directs 
DCOs to provide to the Commission other information, such as product 
specifications, participant eligibility standards, pricing sources, 
risk management procedures, a description of the manner in which the 
DCO has provided notice of the submission to its members and any 
additional information requested by the Commission. This information is 
designed to assist the Commission in identifying those swaps that are 
required to be cleared.
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    \161\ 76 FR 44464 (July 26, 2011).
    \162\ See Sec.  39.5(b), Sec.  39.5(c). Under section 
2(h)(2)(B)(ii) of the CEA, ``[a]ny swap or group, category, type, or 
class of swaps listed for clearing by a [DCO] as of the date of 
enactment shall be considered submitted to the Commission.''
    \163\ Section 2(h)(2)(D) of the CEA and Sec.  39.5(b)(ii).
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B. Overview of Swap Clearing

i. How Clearing Reduces Risk
    When a bilateral swap is cleared, 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--i.e., the 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 the original swap 
participants. 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.
    Given the variety of effective clearinghouse tools to monitor and 
manage counterparty risk, the Commission believes that DCOs will 
continue to be some of the most creditworthy counterparties in the swap 
markets. These tools include the contractual right to: (1) Collect 
initial and variation margin associated with outstanding swap 
positions; (2) mark positions to market regularly (usually one or more 
times per day) and issue margin calls whenever the margin in a 
customer's account has dropped below predetermined levels set by the 
DCO; (3) adjust the amount of margin that is required to be held 
against swap positions in light of changing market circumstances, such 
as increased volatility in the underlying product; and (4) close out 
the swap positions of a customer that does not meet margin calls within 
a specified period of time.
    Moreover, in the event that a clearing member defaults on their 
obligations to the DCO, the latter has a number of remedies to manage 
associated risks, including transferring the swap positions of the 
defaulted member, and covering any losses that may have accrued with 
the defaulting member's margin on deposit. In order to transfer the 
swap positions of a defaulting member and manage the risk of those 
positions while doing so, the DCO has the ability to: (1) Hedge the 
portfolio of positions of the defaulting member to limit future losses; 
(2) partition the portfolio into smaller pieces; (3) auction off the 
pieces of the portfolio, together with their corresponding hedges, to 
other members of the DCO; and (4) allocate any remaining positions to 
members of the DCO. In order to cover the losses associated with such a 
default, the DCO would typically draw from (in order): (1) The initial 
margin posted by the defaulting member; (2) the guaranty fund 
contribution of the defaulting member; (3) the DCO's own capital 
contribution; (4) the guaranty fund contribution of non-defaulting 
members; and (5) an assessment on the non-defaulting members. These 
mutualized risk mitigation capabilities are largely unique to 
clearinghouses, and help to ensure that they remain solvent and 
creditworthy swap counterparties even when dealing with defaults by 
their members or other challenging market circumstances.
ii. Movement of Swaps Into Clearing
    There is significant evidence that some parts of the OTC swap 
markets (the IRS and CDS markets in particular) have been migrating 
into clearing over the last few years in response to natural market 
incentives as well as in anticipation of the Dodd-Frank Act's clearing 
requirement. LCH Clearnet data, for example, shows that the outstanding 
volume of interest rate swaps cleared by LCH has grown steadily since 
at least November 2007, as has the monthly registration of new trade 
sides. Data provided to the Commission shows that the notional amount 
of cleared IRS is approximately $72 trillion as of January 2007, and 
just over $236 trillion in September 2010, an increase of 228% in three 
and a half years.\164\ Together, those facts indicate increased demand 
for LCH clearing services related to interest rate swaps, a portion of 
which preceded the Dodd-Frank Act.\165\ Data available through CME and 
TriOptima indicate similar patterns of growing demand for interest rate 
swap clearing services, though their publically available data does not 
provide a picture of demand prior to the passage of the Dodd-Frank 
Act.\166\
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    \164\ Data provided to the Commission by LCH.
    \165\ See http://www.lchclearnet.com/swaps/volumes/.
    \166\ See http://www.cmegroup.com/trading/interest-rates/cleared-otc/index.html#data and http://www.trioptima.com/repository/historical-reports.html.
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    In addition to IRS clearing, major CDS market participants are 
clearing their CDS indices and single names in significant volumes. As 
explained above, in 2008, the Federal Reserve Bank of New York (FRBNY) 
began encouraging market participants to establish a central 
counterparty to clear CDS.\167\ In the past four years, CDS clearing 
has grown significantly. In total, CFTC-registered DCOs are currently 
holding more than $20 billion in aggregate in initial margin to cover 
cleared CDS positions.\168\ Additionally, publicly available data shows 
that CME's CDS guaranty fund has approximately $629 million; ICE Clear 
Credit has a guaranty fund equal to $4.4 billion; and ICE Clear Europe 
has a

[[Page 47210]]

guaranty fund [euro]2.7 billion for its CDS business.\169\
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    \167\ See Federal Reserve Bank of New York, Press Release, ``New 
York Fed Welcomes Further Industry Commitments on Over-the-Counter 
Derivatives,'' Oct. 31, 2008, available at http://www.newyorkfed.org/newsevents/news/markets/2008/an081031.html, which 
references documents prepared by market participants describing the 
importance of clearing. See also Ciara Linnane and Karen Brettell, 
``NY Federal Reserve pushes for central CDS counterparty,'' Reuters, 
Oct. 6, 2008, available at http://www.reuters.com/article/2008/10/06/cds-regulation-idUSN0655208920081006.
    \168\ Based on Commission data for registered DCOs as of May 10, 
2012.
    \169\ See http://www.cmegroup.com/clearing/cme-clearing-overview/safeguards.html for data regarding CME's guaranty fund, as 
of May 10, 2012; https://www.theice.com/clear_credit.jhtml for data 
on the size of ICE Clear Credit's guaranty fund; and https://www.theice.com/clear_europe_cds.jhtml for data on the size of ICE 
Clear Europe's guaranty fund for CDS, as of May 10, 2012.
---------------------------------------------------------------------------

    Notably, the move toward central clearing has been particularly 
pronounced during times of crisis, as market participants have 
voluntarily used central clearing as a way of protecting against 
counterparty credit risk. The bankruptcy of Enron, in 2001, led to the 
emergence of clearing for OTC energy swaps in the United States. After 
Enron's failure, many counterparties to energy swaps realized the 
benefits of substituting the creditworthiness of a clearing house for 
that of their bilateral counterparties. Much of the impetus for moving 
OTC energy swaps into clearing resulted from the credit crisis that 
developed following Enron's collapse.\170\ According, to CME, its 
ClearPort service ``filled a major void in the aftermath of the Enron 
collapse, particularly in the OTC market for natural gas, which was 
left without a central OTC marketplace.'' \171\
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    \170\ ``Has OTC Energy Clearing Finally Taken Off?'' in Markets 
03, a publication from FIA available at: http://www.futuresindustry.org/downloads/Outlook/OTCenergy.pdf. See also, 
``Energy: An example for regulators to study,'' Financial Times, Nov 
3, 2011, available at http://www.ft.com/intl/cms/s/0/c5bfba26-fb3e-11e0-8df6-00144feab49a.html#axzz1zkpvIkJd.
    \171\ CME Group, ``Stepping Out of Uncertainty,'' (2009), 
available at http://www.cmegroup.com/company/history/magazine/Summer2009/steppingout.html.
---------------------------------------------------------------------------

iii. The Clearing Requirement and Role of the Commission
    In the Dodd-Frank Act, Congress directed that clearing shift from a 
voluntary practice to a mandatory practice for certain swaps and gave 
the Commission responsibility for determining which swaps would be 
required to be cleared. Therefore, the costs and benefits of required 
clearing are attributable, in part, to the Act itself, and, in part, to 
Commission action, taking the form of an exercise of discretion to 
determine which swaps are required to be cleared. Because the 
requirements of the Dodd-Frank Act and the discretion of the Commission 
operate in concert in this way, it is impossible to distinguish 
precisely between those costs and benefits that result from the Dodd-
Frank Act's clearing requirement, considered in the abstract, and those 
that result from the Commission's determinations that particular types 
of swaps will be required to be cleared. Also, because voluntary 
clearing of swaps has increased over past years (may be due in part to 
anticipation of the clearing requirement to be imposed under the Dodd-
Frank Act, but may also be due in part to a realization of the benefits 
of clearing after the financial crisis), it is impossible to determine 
precisely the extent to which any increased use of clearing would 
result from statutory or regulatory requirements, as compared to swap 
market participants' desires to use clearing to obtain its risk-
reducing benefits.\172\
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    \172\ It is also possible that some market participants would 
respond to the proposed rule's requirement that certain types of 
swaps be cleared by decreasing their use of such swaps. This 
possibility contributes to the uncertainty regarding how the 
proposed rule will affect the quantity of swaps that are cleared.
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    The Commission also recognizes that there might not be a linear 
relationship between the quantity of swaps that are cleared (whether 
measured by number of swaps, the notional value of swaps or some other 
measure of swap quantity, such as the exposure resulting from the 
swaps) and the costs and benefits resulting from clearing. For example, 
if the Commission were to assume that the proposed rule would result in 
a doubling of the quantity of a certain type of swap that is cleared, 
it would not necessarily be the case that the costs and benefits of 
clearing that type of swap would double. Rather, the relationship could 
be non-linear for a variety of reasons (such as variations among the 
users of that type of swap). In fact, it may be reasonable to assume 
that where the costs of clearing are relatively low and the benefits 
are relatively high, market participants already voluntarily clear 
swaps even in the absence of a clearing requirement. The Commission 
requests comment on the relationship between the requirement that the 
swaps identified in the proposal be cleared and the costs and benefits 
of that requirement, including on whether that relationship is linear 
or non-linear.
    For all these reasons, the Commission has determined that the costs 
and benefits related to the required clearing of the classes of IRS and 
CDS subject to this proposal are attributable, in part to (1) 
Congress's stated goal of reducing systemic risk by, among other 
things, requiring clearing of swaps and (2) the Commission's discretion 
in selecting swaps or classes of swaps in order to achieve those ends. 
The Commission will discuss the costs and benefits of the overall move 
from voluntary clearing to required clearing for the swaps subject to 
this proposal.
    The Commission requests comment on this assumption, and in 
particular on the extent to which swap market participants' use of 
clearing results from a regulatory requirement that specific swaps be 
cleared (i.e., the rules proposed here), the Dodd-Frank Act's general 
clearing requirement, or other motivations for the use of clearing, 
including, among other things, independent business reasons and 
incentives from other regulators, such as prudential authorities.

C. Consideration of the Costs and Benefits of the Commission's Action

i. CEA Section 15(a)
    Section 15(a) of the CEA 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 
the following 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. Accordingly, the Commission considers the 
costs and benefits resulting from its own discretionary determinations 
with respect to the section 15(a) factors.
    In the sections that follow the Commission considers: (1) Costs and 
benefits of required clearing for the classes of swaps identified in 
this proposal; (2) alternatives contemplated by the commission and 
their costs and benefits relative to the approach proposed herein; (3) 
the impact of required clearing for the proposed classes of swaps on 
the 15(a) factors.
ii. Costs and Benefits of Required Clearing Under the Proposal
    In order to clear swaps in the classes identified in this proposal, 
certain market participants are likely to face certain startup and 
ongoing costs relating to technology and infrastructure, new or updated 
legal agreements, ongoing fees from service providers, and costs 
related to collateralization of their positions. The per-entity costs 
related to changes in technology, infrastructure, and legal agreements 
are likely to vary widely, depending on each market participant's 
existing technology infrastructure, legal agreements, operations, and 
anticipated needs in each of these areas. For market participants that 
already use clearing, some of these costs may be expected to be lower, 
while the opposite would

[[Page 47211]]

likely be true for market participants that begin to use clearing only 
because of the requirement. The costs of collateralization, on the 
other hand, are likely to vary depending on whether an entity is 
subject to capital requirements or not, and the differential between 
the cost of capital for the assets they uses as collateral, and the 
returns they realize on those assets. Commenters are requested to 
address the extent to which factors such as these will affect the costs 
of clearing for various market participants.
    There are also significant benefits associated with increased 
clearing, including reducing and standardizing counterparty risk, 
increased transparency, and easier access to the swap markets. These 
effects together will contribute significantly to the stability and 
efficiency of the financial system. It is impossible, at this point, to 
quantify these benefits with any degree of precision. The Commission 
notes, however, that the extraordinary financial system turbulence of 
2008 has had profound and long-lasting adverse effects on the real 
economy, and therefore reducing systemic risk provides significant, if 
unquantifiable, benefits.\173\ Also, as is the case for the costs 
related to clearing, these benefits would be relatively less to the 
extent that market participants are already using clearing in the 
absence of a requirement. Commenters are requested to address this 
aspect of the analysis as well.
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    \173\ For example, the PEW Economic Policy Group estimates total 
costs of the acute stage of the crisis for U.S. interests were 
approximately $12.04 trillion, including lost GDP, wages, real 
estate wealth, equity wealth, and fiscal costs. Their estimates 
include $7.4 trillion in losses in the equity markets between June 
2008 and March 2009, but do not include subsequent gains in equity 
markets that restored markets to their mid-2008 levels by the end of 
2009. In addition, their calculations do not include continued 
declines in real estate markets subsequent to March 2009. See Pew 
Economic Policy Group, ``The Cost of the Financial Crisis: The 
Impact of the September 2008 Economic Collapse,'' March 2010. The 
IMF estimated that the cost to the banking sector of the financial 
crisis through 2010 was approximately $2.2 trillion and reported a 
range of estimates for total cost to the taxpayer of GSE bailouts 
that ranged from $160 billion (Office of Management and Budget, 
February 2010) to $500 billion (Barclays Capital, December 2009). 
See IMF, ``Global Financial Stability Report: Responding to the 
Financial Crisis and Measuring Systemic Risks,'' October 2010. Both 
studies acknowledge that the estimates are subject to uncertainties.
---------------------------------------------------------------------------

a. Technology, Infrastructure, and Legal Costs
    With respect to technology, for market participants that already 
use swap clearing or transact in futures, many of the backend 
requirements for technology that supports cleared swaps are likely to 
be quite similar, and therefore necessary changes to those systems are 
likely to require a relatively lower costs. Market participants that 
are not currently using clearing for swaps or transacting in futures, 
however, may need to implement appropriate middleware to connect with 
an FCM that will clear their transactions.
    Similarly for legal fees, the costs related to clearing the swaps 
that are subject to the proposed clearing requirement are likely to 
vary widely depending on whether market participants already use 
clearing or transact in futures. For those market participants that 
have not already engaged an FCM, it has been estimated that smaller 
financial institutions will spend between $2,500 and $25,000 reviewing 
and negotiating legal agreements when establishing a new business 
relationship with an FCM.\174\ The Commission does not have information 
necessary to confirm these estimates or determine to what degree these 
estimates would apply to larger entities establishing a relationship 
with an FCM. In addition, the Commission does not have information to 
determine costs associated with entities that already have established 
relationships with one or more FCMs but need to revise those 
agreements. In all cases such costs are likely to depend significantly 
on the specific business needs of each entity and therefore are 
expected to vary widely among market participants.
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    \174\ See Chatham Financial letter at 2, available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=58077 and 
Webster Bank letter at 3, available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=58076.
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    In addition, the Commission is exercising the anti-evasion 
rulemaking authority granted to it by the Dodd-Frank Act. Generally, 
proposed rule Sec.  50.10 states that it is unlawful for any person to 
knowingly or recklessly evade or participate in or facilitate an 
evasion of the requirements of section 2(h) of the CEA, to abuse the 
exception to the clearing requirement as provided under section 2(h)(7) 
of the CEA and Commission rule Sec.  39.6, or to abuse any exemption or 
exception to the requirements of section 2(h) of the CEA, including any 
exemption or exception as the Commission may provide by rule, 
regulation, or order.
    Although proposed rule Sec.  50.10 does not set forth a bright line 
test to define evasion or abuse, the proposed rule is expected to help 
ensure that would-be evaders cannot engage in conduct or activities 
that constitute an evasion of the requirements of section 2(h) or an 
abuse of any exemption or exception to such requirements. The 
Commission also proposes guidance as to how it would determine if such 
evasion or abuse has occurred, while at the same time preserving the 
Commission's ability to determine, on a case-by-case basis, with 
consideration given to all the facts and circumstances, that other 
types of transactions or activities constitute an evasion or abuse 
under proposed Sec.  50.10.
    The Commission proposes that participants in the markets should 
already have policies and procedures in place to ensure that their 
employees, affiliates, and agents will refrain from engaging in 
activities, including devising transactions, for the purpose of 
evading, or in reckless disregard of, the requirements of section 2(h) 
of the CEA and Commission rules and regulations promulgated thereunder 
or to abuse any exemption or exception to such requirements. Given that 
the proposed rule imposes no affirmative duties (i.e., reporting or 
recordkeeping), it is unlikely that it will impose any additional 
ongoing costs beyond the pre-existing costs associated with ensuring 
that the firm is not engaging in unlawful conduct. In that regard, the 
Commission believes that it will not be necessary for firms that 
currently have adequate compliance programs to hire additional staff or 
significantly upgrade their systems to comply with the proposed rule. 
Firms may, however, incur some one-time costs such as costs associated 
with training traders and staff on the proposed rule. In addition, 
market participants may incur costs when deciding whether particular 
conduct or activity could be construed as being an evasion of the 
requirements of section 2(h) or an abuse of any exemption or exception 
to such requirements. However, the proposed rules and proposed guidance 
explain what constitutes evasive or abusive conduct, which should serve 
to mitigate such costs.
    The Commission requests comment, including any quantifiable data 
and analysis, on the changes that market participants will have to make 
to their technological and legal infrastructures in order to clear the 
swaps that are subject to the proposed clearing requirement. How many 
market participants may have to establish new relationships with FCMs, 
or significantly upgrade those relationships? What updates to legal 
documentation are necessary, if any, for entities that already have an 
existing FCM relationship? If commenting on this subject, please 
clarify whether the comment relates to market participants that 
currently transact in: (1) Uncleared

[[Page 47212]]

swaps without margin agreements; (2) uncleared swaps with margin 
agreements; (3) cleared swaps; and/or (4) futures. If possible, please 
quantify costs and the specific platforms being implemented, or changes 
being made to existing platforms.
b. Ongoing Costs Related to FCMs and Other Service Providers
    In addition to costs associated with technological and legal 
infrastructure, market participants transacting in swaps subject to the 
proposed clearing requirement will bear ongoing costs associated with 
fees charged by FCMs. Regarding fees, DCOs typically charge FCMs an 
initial transaction fee for each of the FCM's customers' IRS that are 
cleared, as well as an annual maintenance fee for each of their 
customers' open positions. Not including customer-specific and volume 
discounts, the transaction fees for IRS at the CME range from $1 to $24 
per million notional amount for IRS and the maintenance fees are $2 per 
year per million notional amount for open positions.\175\ LCH 
transaction fees for IRS range from $1-$20 per million notional amount, 
and the maintenance fee ranges from $5-$20 per swap per month, 
depending on the number of outstanding swap positions that an entity 
has with the clearinghouse.\176\ For CDS, ICE Clear Credit charges an 
initial transaction fee of $6 per million notional amount. There is no 
maintenance fee charged by ICE for maintaining open CDS positions.\177\
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    \175\ See CME pricing charts at: http://www.cmegroup.com/trading/cds/files/CDS-Fees.pdf;
     http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Customer-Fee.pdf;
     and http://www.cmegroup.com/trading/interest-rates/files/CME-IRS-Self-Clearing-Fee.pdf [hereinafter ``CME Pricing Charts''].
    \176\ See LCH pricing for clearing services related to OTC IRS 
at: http://www.lchclearnet.com/swaps/swapclear_for_clearing_members/fees.asp.
    \177\ See ICE Clear Credit fees for CDS at: https://www.theice.com/publicdocs/clear_credit/circulars/ICEClearCredit%20Fee%20Schedule%20Notice_FINAL.pdf.
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    FCMs will also bear additional fees with respect to their house 
accounts at the DCO to the extent that they clear more swaps due to the 
clearing requirement. For example, for IRS that they clear through CME, 
clearing members are charged a transaction fee that ranges from $0.75 
to $18.00 per million notional, depending on the transaction 
maturity.\178\ Members, however, are not charged annual maintenance 
fees for their open house positions.\179\ For CDS, clearing members at 
ICE Clear Credit are charged $5 per transaction per million notional 
and there is no maintenance fee.\180\
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    \178\ See CME Pricing Charts.
    \179\ See id.
    \180\ See LCH pricing for clearing services related to OTC IRS 
at: http://www.lchclearnet.com/swaps/swapclear_for_clearing_members/fees.asp.
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    As discussed above, it is difficult to predict precisely how the 
proposed requirement to clear the classes of swaps covered by this 
proposed rule will increase the use of swap clearing, as compared to 
the use of clearing that would occur in the absence of the requirement. 
However, the Commission expects that application of the clearing 
requirement to the swaps covered by the proposed rule will generally 
increase the use of clearing, leading to the ongoing transaction costs 
noted above.
    In addition, the Commission understands that FCM customers that 
only transact in swaps occasionally are typically required to pay a 
monthly or annual fee to each FCM that ranges from $75,000 to $125,000 
per year.\181\ Again, although it is impossible to predict precisely 
how many FCM customers would be subject to such fees based on the 
proposed clearing requirement for CDS and IRS, the Commission expects 
that some market participants that previously did not use clearing 
would be subject to the requirements of the proposed rule.
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    \181\ See letters from Chatham and Webster Bank.
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    The Commission requests comment on whether the cited fee 
information is accurate and typical, as well as, the extent to which 
such fees are expected to result from the requirement to clear the 
classes of swaps subject to the proposed rule. Comment is also 
requested on whether the increased use of clearing that may result is 
expected to change such fees, and if so, how. The Commission also 
requests additional comment, data, and analysis regarding the fee 
structures of FCMs in general, and in particular as they relate to the 
clearing of the types of swaps covered by the proposed rule. 
Specifically, the Commission requests comment on the following:
     Do the fees described above typically include fees charged 
by the DCO to the FCM for the FCM customer's swap positions?
     Do FCMs typically charge a similar fee to customers that 
are more active in trading swaps, and are such fees are generally 
greater, lesser, or similar to the fees charged to less active 
institutions?
     Do such maintenance fees exist for larger customers, and 
if so, approximately how much charged?
c. Costs Related to Collateralization of Cleared Swap Positions
    As mentioned above, market participants that enter into the classes 
of swaps covered by the proposed rule will be required to post 
collateral at the DCO. Of course, the incremental cost of collateral 
resulting from the application of the proposed clearing requirement 
depends on the extent to which such swaps are already being cleared 
(even in the absence of the requirement) or otherwise collateralized. 
The incremental cost also depends on whether such swaps are, if not 
collateralized, priced to include implicit contingent liabilities and 
counterparty risk born by the counterparty to the swap.
    A conservative approach would be to assume that the swaps that 
would be covered by the proposed clearing requirement currently are 
uncleared, completely uncollateralized, and not priced to include 
implicit contingent liabilities and counterparty risk born by the 
counterparty. In this case, imposition of the clearing requirement for 
those types of swaps would create additional costs due to: (1) The 
spread between cost of capital and returns on that capital for assets 
posted to meet initial margin for the entire term of the swap; and (2) 
the spread between cost of capital and returns on that capital for 
assets posted to meet the variation margin to the extent a party is 
``out of the money'' on each swap. Under the assumptions mentioned 
above, if every IRS and CDS that is not currently cleared were moved 
into clearing, the maximum additional initial margin that would need to 
be posted is approximately $19.2 billion for IRS and $53 billion for 
CDS. However, for the reasons described below, these numbers likely 
overestimate the amount of additional initial margin that would need to 
be posted.\182\
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    \182\ There also is a possibility that the numbers calculated 
above under-estimate the amount of additional initial margin that 
will need to be posted under a required clearing regime for IRS and 
CDS. For instance, there may be numerous market participants with 
directional portfolios that will be unable to benefit from margin 
offsets. However, the Commission continues to believe that its 
estimates are more likely to overstate the required additional 
margin.
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    The Commission calculated its estimated additional initial margin 
amounts based on the following assumptions. According to 
representations made to the Commission by LCH, they clear approximately 
51% of the IRS market. The total amount of initial margin on deposit at 
LCH for IRS is approximately $20 billion.\183\ Therefore, if all 
remaining IRS were moved into

[[Page 47213]]

clearing, approximately $19.2 billion ($20B/0.51-$20B = 19.2B) would 
have to be posted in initial margin.
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    \183\ The total amount of initial margin on deposit at CME for 
IRS is $5 billion, but for purposes of this estimate, the Commission 
is not including that amount.
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    Similarly, the initial margin related to CDS currently on deposit 
at CME, ICE Clear Credit, and ICE Clear Europe is approximately $21.4 
billion.\184\ This amount includes initial margin based on both index-
based CDS and single-name CDS positions. BIS data indicates that 
approximately 36.6% of the CDS market comprises index-based CDS.\185\ 
If we assume that approximately 36.6% of the overall portfolio-based 
CDS margin (i.e., CDS indices and single-name CDS margined together) 
currently held by DCOs for CDS positions is related to index-based CDS, 
and then add any margin held by DCOs attributable solely to index-based 
CDS, we can estimate that approximately $9.0 billion in margin 
currently held by those DCOs is related to index-based CDS. ISDA data 
indicates that 14.5% of the index-based CDS market is currently 
cleared.\186\ Therefore, if the entire index-based CDS market moved 
into clearing, $53 billion ($9.0/.145-$9.0 = $53) in initial margin 
would have to be posted at DCOs.\187\ Again, it is highly probable that 
these estimates significantly overstate the amount of additional 
capital that would be posted for a number of reasons described below.
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    \184\ The total amount of initial margin on deposit only 
includes those amounts reported to the Commission by registered 
DCOs. Other clearinghouses, such as LCH.Clearnet.SA, clear the 
indices included in the proposed determination, however, the 
relative size of the open interest in the relevant CDS indices is 
substantially smaller than each of the DCOs included in this 
calculation.
    \185\ BIS estimates that the gross notional value of outstanding 
CDS contracts is $28.6 trillion, and that $10.5 trillion of that is 
index related CDS. See BIS data, available at http://www.bis.org/statistics/otcder/dt21.pdf.
    \186\ ISDA has estimated that 14.5% of the index-based CDS 
market is currently being cleared, whereas the total outstanding 
notional at CME, ICE Clear Europe, and ICE Clear Credit represents 
approximately 7.5% of the global index-based CDS market estimated by 
BIS. Such a discrepancy would be expected if one or more of the 
following occurred: (1) If ISDA overestimated the percentage of the 
index-based CDS that is currently being cleared; (2) if BIS 
overestimated the size of the global index-based swap market; (3) if 
a significant amount of compression occurs as index-based CDS are 
moved into clearing; and/or (4) if a significant portion of the 
cleared index-based CDS market is held at clearinghouses other than 
CME, ICE Clear Europe, and ICE Clear Credit. The Commission believes 
that the compression of CDS positions moving into clearing is the 
most likely explanation, and therefore has used the ISDA estimate. 
However, the Commission also requests comment from the public 
regarding the accuracy of ISDA and BIS estimates regarding index-
based CDS markets, and requests from the public any additional data 
for purposes of determining with greater certainty how much of the 
index-based CDS market is currently being cleared.
    \187\ Both estimates assume that additional IRS brought into 
clearing would have similar margin requirements per unit of notional 
to those IRS that are already in clearing, and assumes that 
additional CDS brought into clearing would have similar margin 
requirements per unit of notional to those CDS that are already 
being cleared. These assumptions, in turn, imply similar levels of 
liquidity, compression, netting, and similar tenors for the swaps 
that are currently cleared and those that are not. While the 
Commission recognizes that these factors are not likely to be 
identical among both groups of products, adequate information to 
quantify the impact of each of these possible differences between 
the two groups of swaps on the amount of additional collateral that 
would have to be posted is not available.
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    First, this analysis assumes that every IRS and index-based CDS not 
currently cleared is brought into clearing under the proposed rule. 
However, in this rule the Commission has proposed required clearing 
only for certain classes of IRS and CDS, and not for all IRS and CDS. 
Therefore, there will still be certain types of IRS, such as those 
related to the thirteen additional currencies cleared by LCH, that are 
not required to be cleared. Moreover, the clearing requirement will 
apply only to new swap transactions whereas market estimates include 
legacy transactions.
    In addition, non-financial entities entering into swaps for the 
purpose of hedging or mitigating commercial risk are not required to 
use clearing under section 2(h)(7) of the CEA. As a consequence, many 
entities will not be required to clear, even when entering into IRS or 
CDS that are otherwise required to be cleared. Third, some IRS and CDS 
involve cross-border transactions to which the Commission's clearing 
requirement will not apply.\188\ Fourth, collateral is already posted 
with respect to many non-cleared IRS and CDS. ISDA conducted a recent 
survey which reported that 93.4% of all trades involving credit 
derivatives, and 78.1% of all trades involving fixed income derivatives 
are subject to collateral agreements.\189\ Moreover, ISDA estimated 
that the aggregate amount of collateral in circulation in the non-
cleared OTC derivatives market at the end of 2011 was approximately 
$3.6 trillion.\190\
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    \188\ See Cross-Border Application of Certain Swaps Provisions 
of the Commodity Exchange Act, 77 FR 41213 (July 12, 2012).
    \189\ See ISDA Margin Survey 2012, at 15, available at: http://www2.isda.org/functional-areas/research/surveys/margin-surveys/. 
Although it is unclear exactly how many of the derivatives covered 
by this survey are swaps, it is reasonable to assume that a large 
part of them are.
    \190\ This estimate, however, does not adjust for double 
counting of collateral assets. The same survey reports that as much 
as 91.1% of cash used as collateral and 43.8% of securities used as 
collateral are being reused, and therefore are counted two or more 
times in the ISDA survey. See ISDA Margin Survey 2012, at 20 and 11, 
respectively.
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    In any case, it is reasonable to assume that the requirement to 
clear the swaps covered by the proposed rule will result in increased 
use of clearing and increased posting of collateral with respect to 
such swaps. To calculate the additional collateral cost to market 
participants, we must estimate the difference between the cost of 
capital for the additional collateral and the returns on that capital. 
In comments regarding other Commission rules, commenters have often 
taken the view that the difference between the cost and returns on 
capital for funds that are used as collateral is substantial.
    In a study commissioned by the Working Group of Commercial Energy 
Firms, for example, NERA used an estimate of 13.08% for the pre-tax 
weighted average cost of capital for the firm, and an estimate of 3.49% 
for the pre-tax yield on collateral, for a difference as 9.59% which 
NERA used as the net pre-tax cost of collateral.\191\ However, these 
estimates use the borrowing costs for the entire firm, but only 
consider the returns on capital for one part of the firm, when 
determining the spread between the two. The result is an over-stated 
difference, and therefore a higher cost associated with collateral than 
would result if the costs of capital and returns of capital were 
compared on a consistent basis.\192\
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    \191\ The NERA study is available at: http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=50037 and their comments 
defending their cost of capital are available in their letter at 
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=57015.
    \192\ This aspect of the NERA study has been described in 
greater detail by MIT professors John Parsons and Antonio Mello, 
available at: http://bettingthebusiness.com/2012/01/22/phantom-costs-to-the-swap-dealer-designation-and-otc-reform/ and http://bettingthebusiness.com/2012/03/19/nera-doubles-down/.
---------------------------------------------------------------------------

    However, the Commission notes that this cost is not only likely 
overstated, for the reasons mentioned above, but that it also may not 
be a new cost. Rather, it is a displacement of a cost that is embedded 
in uncleared, uncollateralized swaps. Entering into a swap is costly 
for any market participant because of the default risk posed by its 
counterparty, whether the counterparty is a DCO, swap dealer, or other 
market participant. When a market participant faces the DCO, the DCO 
accounts for that counterparty risk by requiring collateral to be 
posted, and the cost of capital for the collateral is part of the cost 
that is necessary in order to maintain the swap position. When a market 
participant faces a dealer or other counterparty in an uncleared swap, 
however, the uncleared swap contains an implicit line of credit upon 
which the market participant effectively draws when its swap position 
is out of

[[Page 47214]]

the money. Counterparties charge for this implicit line of credit in 
the spread they offer on uncollateralized, uncleared swaps. It can be 
shown that the cash flows of an uncollateralized swap (i.e., a swap 
with an implicit line of credit) are, over time, substantially 
equivalent to the cash flows of a collateralized swap with an explicit 
line of credit.\193\ And because the counterparty risk created by the 
implicit line of credit is the same as the counterparty risk that would 
result from an explicit line of credit provided to the same market 
participant, to a first order approximation, the charge for each should 
be the same as well.\194\ This means that the cost of capital for 
additional collateral posted as a consequence of requiring 
uncollateralized swaps to be cleared does not introduce an additional 
cost, but rather takes a cost that is implicit in an uncleared, 
uncollateralized swap and makes it explicit. This observation applies 
to capital costs associated with both initial margin and variation 
margin.
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    \193\ Mello, Antonio S., and John E. Parsons, ``Margins, 
Liquidity, and the Cost of Hedging.'' MIT Center for Energy and 
Environmental Policy Research, May 2012, available at http://dspace.mit.edu/bitstream/handle/1721.1/70896/2012-005.pdf?sequence=1.
    \194\ See id., Mello and Parsons state in their paper, ``Hedging 
is costly. But the real source of the cost is not the margin posted, 
but the underlying credit risk that motivates counterparties to 
demand that margin be posted.'' Id. at 12. They go on to demonstrate 
that, ``To a first approximation, the cost charged for the non-
margined swap must be equal to the cost of funding the margin 
account. This follows from the fact that the non-margined swap just 
includes funding of the margin account as an embedded feature of the 
package.'' Id. at 15-16.
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    The Commission invites further comment regarding the total amount 
of additional collateral that would be posted due to required clearing 
of the classes of swaps designated in this proposal. Furthermore, the 
Commission invites comment regarding the cost of capital and returns on 
capital for that collateral, as well as on the cost of the implicit 
line of credit embedded in uncleared, uncollateralized swaps. The 
Commission, in particular, welcomes any quantifiable data and analysis 
that commenters are willing to share regarding these subjects.
    Another impact of the proposed rule may be that financial 
institutions are required to hold additional capital with respect to 
their swap positions pursuant to prudential regulatory capital 
requirements. Basel III standards are designed to incentivize central 
clearing of derivatives by applying a lower capital weighting to them 
than for similar uncleared derivatives positions. Therefore, the 
Commission expects that the capital that financial institutions are 
required to hold is likely to be reduced as a consequence of their 
increased use of swap clearing. The Commission invites comment on the 
effects of required clearing on the capital requirements for financial 
institutions. To the extent possible, please quantify the relevant 
costs and benefits and explain the effect of the relevant capital 
standards.
    In addition, operational costs may result from the collateral 
requirements that apply to the proposed clearing requirement. With 
uncleared swaps, counterparties may agree not to collect variation 
margin until certain thresholds of exposure are reached, thus reducing 
or perhaps entirely eliminating the need to exchange variation margin 
as exposure changes. DCOs, on the other hand, collect and pay variation 
margin on a daily basis and sometimes more frequently. As a 
consequence, increased required clearing may increase certain 
operational costs associated with moving variation margin to and from 
the DCO. On the other hand, increased clearing is also likely to lead 
to benefits from reduced operational costs related to valuation 
disputes, as parties to cleared swaps agree to abide by the DCO's 
valuation procedures. To the extent that the requirement to clear the 
types of swaps covered by the proposed rule leads to increased use of 
clearing, these costs and benefits are likely to result. The Commission 
invites further comment regarding the costs and benefits associated 
with operational differences related to the collateralization of 
uncleared versus cleared swaps.
    Increases in clearing as a result of the proposed clearing 
requirement also may result in additional costs for clearing members in 
the form of guaranty fund contributions. However, it also may be that 
increased clearing of swaps would decrease guaranty fund contributions 
for certain clearing members. Market participants that currently 
transact swaps bilaterally and do not clear such swaps must either 
become clearing members of an appropriate DCO or submit such swaps for 
clearing through an existing clearing member, once the clearing 
requirement applies to such swaps. A party that chooses to become a 
clearing member of a DCO must make a guaranty fund contribution. A 
party that chooses to clear swaps through an existing clearing member 
may have a share of the clearing member's guaranty fund contribution 
passed along to it in the form of fees. While the addition of new 
clearing members and new customers for existing clearing members may 
result in existing clearing members experiencing an increase in their 
guaranty fund requirements, it should be noted that if (1) new clearing 
members are not among the two clearing members used to calculate the 
guaranty fund and (2) any new customers trading through a clearing 
member do not increase the size of uncollateralized risks at either of 
the two clearing members used to calculate the guaranty fund, all else 
held constant, existing clearing members may experience a decrease in 
their guaranty fund requirement.\195\
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    \195\ In order to calculate the size of their guaranty funds, 
clearinghouses for swaps generally stress their clearing members' 
portfolios under a number of extreme, but plausible, scenarios in 
order to identify the two clearing members with the largest losses. 
The resulting loss calculation of those two clearing members is used 
to size the guaranty fund. Once that amount is established, the 
clearinghouse will require contributions of all clearing members 
based on their relative ``losses'' under the stress scenarios. 
Assuming that the portfolios of new clearing members and new 
customers do not alter the overall sizing of the guaranty fund, but 
that the new clearing members are making contributions to the 
guaranty fund based on their relative potential losses, the overall 
guaranty fund contribution for existing clearing members may 
decrease.
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d. Benefits of Clearing
    As noted above, the benefits of swap clearing, in general, are 
significant. Thus, to the extent that the proposed clearing requirement 
for certain classes of IRS and CDS leads to increased use of clearing, 
these benefits are likely to result. As is the case for the costs noted 
above, it is impossible to predict the precise extent to which the use 
of clearing will increase as a result of the proposed rule, and 
therefore the benefits of the proposed rule cannot be precisely 
quantified. But the Commission believes that the benefits of increased 
clearing resulting from the proposed rule will be significant, because 
the classes of swaps required to be cleared by the proposed rule 
represent a substantial portion of the total swap markets. Currently 
outstanding IRS and CDS indices have notional amounts of about $504 
trillion and $10.4 trillion, respectively, which is a substantial part 
of the $648 trillion notional global swaps market.\196\ As noted above, 
the proposed rule requires that only certain classes of IRS and CDS 
indices be cleared, but such classes likely represent the most common 
swaps within those overall asset classes, and therefore are likely to 
constitute a relatively large portion of those asset classes. By 
requiring these particular swaps to be cleared, the benefits of 
clearing are expected to be realized across a relatively large portion 
of the

[[Page 47215]]

market. The Commission requests comment on whether such benefits will 
result from the proposed rule and, if so, the expected magnitude of 
such benefits.
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    \196\ BIS data, December 2011, available at: http://www.bis.org/statistics/derstats.htm.
---------------------------------------------------------------------------

    The proposed rule's requirement that certain classes of swaps be 
cleared is expected to increase the number of swaps in which market 
participants will face a DCO, and therefore, will face a highly 
creditworthy counterparty. DCOs are some of the most creditworthy 
counterparties in the swap market because they have at their disposal a 
number of risk management tools that enable them to manage counterparty 
risk effectively. Those tools include contractual rights that enable 
them to use margin to manage current and potential future exposure, to 
close out and transfer defaulting positions while minimizing losses 
that result from such defaults, and to protect solvency during the 
default of one or more members through a waterfall of financial 
contributions from which they can draw, as outlined above. Also, 
clearing protects swap users from the risk of having to share in loss 
mutualization among FCMs if one DCO member defaults and such measures 
are necessary.
    This proposed rule requires that classes of swaps that are required 
to be cleared must be submitted to clearing ``as soon as 
technologically practicable after execution, but in any event by the 
end of the day of execution.'' \197\ This conforms to the requirements 
established in the recently finalized rule regarding timing of 
acceptance for clearing,\198\ which is designed to promote rapid 
submission of these swaps for clearing and reduce the unnecessary 
counterparty risk that can develop between the time of execution and 
submission to clearing.\199\
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    \197\ See proposed Sec.  50.2(a).
    \198\ See Client Clearing Documentation, Timing of Acceptance 
for Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr. 
9, 2012).
    \199\ The Commission notes that if a market participant executed 
a swap that is required to be cleared on a SEF or DCM, then that 
market participant will be deemed to have met their obligation to 
submit the swap to a DCO because of the straight-through processing 
rules previously adopted by the Commission.
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    The Commission expects that the requirement for rapid submission, 
processing, and acceptance or rejection of swaps for clearing will be 
beneficial in several respects. It is important to note that when two 
parties enter into a bilateral swap with the intention of clearing it, 
each party bears counterparty risk until the swap is cleared. Once the 
swap is cleared, the clearinghouse becomes the counterparty to each of 
the original parties, which minimizes and standardizes counterparty 
risk.
    Where swaps of the type covered by the proposed rule are not 
executed on an exchange, the proposed rule should significantly reduce 
the amount of time needed to process them. Although costs associated 
with latency-period counterparty credit risk cannot be completely 
eliminated in this context, the rules will reduce the need to 
discriminate among potential counterparties in off-exchange swaps, as 
well as the potential costs associated with rejected swaps. By reducing 
the counterparty risk that could otherwise develop during the latency 
period, these rules promote a market in which all eligible market 
participants have access to counterparties willing to trade on terms 
that approximate the best available terms in the market. This may 
improve price discovery and promote market integrity.
    In addition, absent proposed Sec.  50.10 and related 
interpretations, certain risks could increase in a manner that the 
Commission would not be able to measure accurately. Proposed Sec.  
50.10 and related interpretations are expected to bring the appropriate 
scope of swaps within the requirements of section 2(h), which will 
facilitate the achievement of the benefits of swap clearing and trade 
execution, among others. Activity conducted solely for a legitimate 
business purpose, absent other indicia of evasion or abuse, would not 
constitute a violation of proposed Sec.  50.10 as described in the 
Commission's proposed interpretation.

D. Costs and Benefits of the Proposed Rule as Compared to Alternatives

    The Commission's proposal to apply the clearing requirement 
initially to certain CDS and IRS is a function of both the market 
importance of these products and the fact that they already are widely 
cleared. In order to move the largest number of swaps to required 
clearing in its initial determination, the Commission believes that it 
is prudent to focus on swaps that are widely used and for which there 
is already a blueprint for clearing and appropriate risk management. 
CDS and IRS that match these factors are therefore well suited for 
required clearing.
    As noted above, IRS with a notional amount of $504 trillion are 
currently outstanding--the highest proportion of the $648 trillion 
global swaps market of any class of swaps.\200\ CDS indices with a 
notional amount of about $10.4 trillion are currently outstanding.\201\ 
While CDS indices do not have as prominent a share of the entire swaps 
market as IRS, uncleared CDS is capable of having a sizeable market 
impact, as it did during the 2008 financial crisis. In addition, many 
of the swaps within each of the classes proposed for required clearing 
are already cleared by one or more clearinghouses. LCH claims to clear 
IRS with a notional amount of about $284 trillion--meaning that, in 
notional terms, LCH clears 51% of the interest rate swap market.\202\ 
The swap market has made a smooth transition into clearing CDS on its 
own initiative. As a result, DCOs, FCMs, and many market participants 
already have experience clearing the types of swaps that have been 
proposed for required clearing. The Commission expects, therefore, that 
DCOs and FCMs are equipped to handle the increases in volume and 
outstanding notional amount in these swaps that is likely to be cleared 
as the result of the proposed rule. Because of the wide use of these 
swaps and their importance to the market, and because these swaps are 
already cleared safely, the Commission is proposing to subject certain 
types of IRS and CDS to the initial clearing requirement.
---------------------------------------------------------------------------

    \200\ BIS data, June 2011, available at http://www.bis.org/publ/otc_hy1111.pdf.
    \201\ See id.
    \202\ See id.
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    The Commission is proposing certain key specifications for CDS and 
IRS that will inform whether a particular swaps falls within one of the 
classes of swaps that are required to be cleared. The two classes of 
CDS that are required to be cleared are (1) U.S. dollar-denominated CDS 
covering North America corporate credits and (2) euro-denominated CDS 
referencing European obligations. The four classes of IRS required to 
be cleared are (1) fixed-to-floating swaps, (2) basis swaps, (3) OIS, 
and (4) FRAs.
    Regarding CDS, the Commission has outlined three key specifications 
comprising (1) region and nature of reference entity, (2) the nature of 
the CDS itself, and (3) tenor. Each of these specifications will assist 
market participants in determining whether a swap falls within the CDS 
classes of swaps required to be cleared. For the first, a 
distinguishing characteristic is whether the reference entity is in 
North American or European and whether it is one of Markit's CDX.NA.IG, 
CDX.NA.HY, iTraxx Europe, iTraxx Europe Crossover and iTraxx Europe 
High Volatility indices. The second key specification relates to 
whether the CDS is tranched or untranched. The classes that are 
required to be cleared include only untranched CDS where the contract 
covers the entire index loss

[[Page 47216]]

distribution of the indice and settlement is not linked to a specified 
number of defaults. Tranched swaps, first- or ``Nth'' to-default, 
options, or any other product variations on these indices are excluded 
from these classes. Finally, the third key specification entails 
whether a swap falls within a tenor, specific to an index, that is 
required to be cleared. The Commission has determined that each of the 
3-, 5-, 7-, and 10-year tenors be included within the class of swaps 
subject to the clearing requirement determination for CDX.NA.IG; the 5-
year tenor be included for CDX.NA.HY; each of the 5- and 10-year for 
ITraxx Europe; the 5-year for ITraxx Europe Crossover; and, the 5-year 
for ITraxx Europe High Volatility. In addition, it should be noted that 
only certain series will be viewed as required to be cleared.
    The Commission had a number of alternatives to that proposed. 
First, the Commission could have used a narrower or broader group of 
reference entities. For example, the Commission has not included the 
CDX.NA.IG.HVOL within the North American swap class. While doing so 
would have increased the number of swaps required to be cleared, the 
Commission questions whether there is sufficient liquidity to justify 
required clearing at this time given that the recent series of 
CDX.NA.IG.HVOL have not been cleared by ICE (and are not offered at all 
by CME).
    The Commission could also have endeavored to include tranched CDS. 
The Commission recognizes that there is a significant market for 
tranched swaps using the indices. In these transactions, parties to the 
CDS contract agree to address only a certain range of losses along the 
entire loss distribution curve. Other swaps such as first or ``Nth'' to 
default baskets, and options, also exist on the indices. However, these 
swaps are not being cleared currently and were not submitted by a DCO 
for consideration under Sec.  39.5.
    Regarding tenor, the Commission could have included more of those 
offered within the classes of swaps required to be cleared. For 
example, the CDX.NA.IG has 1- and 2-year tenors and the CDX.NA.HY, has 
3-, 7-, and 10-year tenors that have not been included among the 
specified tenors. The iTraxx Europe has 3- and 7-year tenors and the 
Crossover and High Volatility each have 3-, 7-, and 10-year tenors that 
have not been included. In addition, the Commission could have included 
all series of active indices. The concern, regarding both tenors and 
series, is that certain tenors and series have lower liquidity and may 
be difficult for a DCO to adequately risk manage. While including more 
tenors and series would have increased the volume of swaps required to 
be cleared to some degree, the Commission proposes that doing so may 
have raised costs for DCOs and other market participants and been less 
desirable relative to the factors established in Sec.  39.5.
    With regard to IRS, as mentioned above, the Commission is proposing 
a clearing requirement for four classes of interest rate swaps: fixed-
to-floating swaps, basis swaps, OIS, and FRAs. Within those four 
classes, the Commission is proposing three affirmative specifications 
for each class ((i) Currency used for in which the notional and payment 
amounts are specified, (ii) rates referenced for each leg of the swap, 
and (iii) stated termination date of the swap) and three ``negative'' 
specifications for each class ((i) No optionality (as specified by the 
DCOs); (ii) no dual currencies; and (iii) no conditional notional 
amounts).
    The Commission considered whether to establish clearing 
requirements on a product-by-product basis. Such a determination would 
need to identify the multitude of legal specifications of each product 
that would be subject to the clearing requirement. Although the 
industry uses standardized definitions and conventions, the product 
descriptions would be lengthy and require counterparties to compare all 
of the legal terms of their particular swap against the terms of the 
many different swaps that would be included in a clearing requirement. 
The Commission believes that for interest rate swaps, a product-by-
product determination could be unnecessarily burdensome for market 
participants in trying to assess whether each swap transaction is 
subject to the requirement. A class-based approach would allow market 
participants to determine quickly whether they need to submit their 
swap to a DCO for clearing by checking initially whether the swap has 
the basic specifications that define each class subject to the clearing 
requirement.
    As an alternative to the classes selected, LCH recommended that the 
Commission use the following specifications to classify interest rate 
swaps for purposes of making a clearing determination: (i) Swap class 
(i.e., what the two legs of the swap are (fixed-to-floating, basis, 
OIS, etc.)), (ii) floating rate definitions used, (iii) the currency 
designated for swap calculations and payments, (iv) stated final term 
of the swap (also known as maturity), (v) notional structure over the 
life of the swap (constant, amortizing, roller coaster, etc.), (vi) 
floating rate frequency, (vii) whether optionality is included, and 
(viii) whether a single currency or more than one currency is used for 
denominating payments and notional amount. CME recommended a clearing 
determination for all non-option interest rate swaps denominated in a 
currency cleared by any qualified DCO.
    These alternative specifications fall into two general categories: 
specifications that are commonly used to address mechanical issues for 
most swaps, and specifications that are less common and address 
idiosyncratic issues related to the particular needs of a counterparty. 
Examples of the latter are special representations added to address 
particular legal issues, unique termination events, special fees, and 
conditions tied to events specific to the parties. None of the DCOs 
clear interest rate swaps with terms in the second group. As for 
mechanical specifications, while the Commission recognizes that such 
specifications may affect the value of the swap, such specifications 
are not, generally speaking, fundamental to determining the economic 
result the parties are trying to achieve.\203\ The Commission has 
proposed the three affirmative specifications described above because 
it believes that they are fundamental specifications used by 
counterparties to determine the economic result of a swap transaction 
for each party.
---------------------------------------------------------------------------

    \203\ As noted in Section II.E above, mechanical specifications 
include characteristics such as floating rate reset tenors, 
reference city for business days, business day convention, and 
others that have some small impact on valuation but that do not 
fundamentally alter the economic consequence of the swap for the 
parties that enter into it.
---------------------------------------------------------------------------

    The Commission also could have avoided the negative specifications 
for IRS, which would have had the effect of potentially including more 
IRS swaps within the universe of those required to be cleared. However, 
the Commission believes that swaps with optionality, multiple currency 
swaps, and swaps with conditional notional amounts raise concerns 
regarding adequate pricing measures and consistency across swap 
contracts. Such contingencies make them difficult for DCOs to 
effectively risk manage. Additionally, at this time, no DCO is offering 
them for clearing.
    Another alternative considered by the Commission, but not proposed, 
was that of stating the clearing requirement in terms of a particular 
type of swap, rather than using broad characteristics to describe the 
type of swaps for which clearing would be required. For example, rather 
than requiring that all IRS that meet the six specifications in 
proposed Sec.  50.4(a) be cleared, the rule could have specified that 
only certain

[[Page 47217]]

sub-types of those IRS--such as all such IRS with a term of five 
years--are required to be cleared. Such an approach might permit the 
Commission to account for variation in liquidity and outstanding 
notional values among different sub-types of swap, and thereby focus 
the clearing requirement on very particular swaps to account for these 
differences within the same general class. Also, generally speaking, 
limiting the clearing requirement to fewer swaps could reduce some 
costs associated with clearing.
    However, this advantage was weighed against an important 
disadvantage of this approach. A highly focused clearing requirement 
could increase the ability for market participants to replicate the 
economic results of a swap that is required to be cleared by 
substituting a swap not required to be cleared; this greater latitude 
for clearing avoidance, in turn, could increase systemic risk and 
dampen the beneficial effects of clearing noted above.\204\ Under the 
approach proposed by the Commission, all swaps that fall within 
identified classes are covered by the clearing requirement, which 
reduces the risk of such avoidance and the associated reduction of 
benefits. Moreover, stating the clearing requirement in more general 
terms reduces the costs associated with determining whether or not a 
particular swap is subject to the clearing requirement.
---------------------------------------------------------------------------

    \204\ For instance, in the example noted above, swaps with a 
term of five years and one day would not be required to be cleared.
---------------------------------------------------------------------------

    The Commission invites comment on the costs and benefits of 
identifying classes of swaps for clearing in a more focused or more 
general manner. If possible, please quantify costs and benefits that 
result either from the approach proposed by the Commission or from 
alternatives that you believe the Commission should consider.
    The Commission also considered proposing required clearing for all 
seventeen currencies of IRS that are currently offered for clearing, 
but decided instead to propose required clearing at this time for IRS 
in four currencies (EUR, USD, GBP, and JPY). The Commission recognizes 
that requiring IRS in all seventeen currencies submitted by LCH 
Clearnet to be cleared would provide the benefit of some incremental 
reduction in overall counterparty, and thus systemic, risk attendant to 
clearing a greater portion of IRS. However, as noted above, the 
Commission proposes that initiating the clearing requirement in a 
measured manner with respect to IRS in the four specified currencies 
familiar to many market participants is the preferable approach at this 
time because it would give market participants an opportunity to 
identify and address any operational challenges related to required 
clearing. Moreover, the currencies included in the proposed classes 
constitute approximately 93% of cleared IRS, which suggests that 
significant reductions in counterparty risk and gains in systemic 
protection will be accomplished by limiting the clearing determination 
to them.
    Similarly, the Commission considered requiring clearing of all CDS 
that are currently being cleared, but decided not to include, in the 
initial clearing requirement, certain types of CDS that have a less 
significant role in the current market.\205\
---------------------------------------------------------------------------

    \205\ For instance, the Commission decided not to include 
CDX.NA.IG.HiVOL from the proposed determination given the lack of 
volume in the current on-the-run and recent off-the-run series. In 
addition, CME currently does not clear any HiVOL contracts, and ICE 
Clear Credit no longer clears the most recent series.
---------------------------------------------------------------------------

    The Commission invites further comment on its decision-making with 
regard to the classes of IRS and CDS that would be required to be 
cleared. Commenters are also invited to submit any data or other 
information that they may have quantifying or qualifying the costs and 
benefits of the proposal with their comment letters.

E. Section 15(a) Factors

    As noted above, the requirement to clear the classes of swaps 
covered by the proposed rule is expected to result in increased use of 
clearing, although it is impossible to quantify with certainty the 
extent of that increase. Thus, this section discusses the expected 
results from an overall increase in the use of swap clearing in terms 
of the factors set forth in section 15(a) of the CEA.
i. Protection of Market Participants and the Public
    As described above, required clearing of the classes of swaps 
identified in this proposed rule is expected to reduce counterparty 
risk for market participants that clear those swaps because they will 
face the DCO rather than another market participant that lacks the full 
array of risk management tools that the DCO has at its disposal. This 
also reduces uncertainty in times of market stress because market 
participants facing a DCO are less concerned with the impact of such 
stress on the solvency of their counterparty for cleared trades.
    By proposing to require clearing of certain classes of swaps, all 
of which are already available for clearing, the Commission expects to 
encourage a smooth transition by creating an opportunity for market 
participants to work out challenges related to required clearing of 
swaps while operating in familiar terrain. More specifically, the DCOs 
will clear an increased volume of swaps that they already understand 
and have experience managing. Similarly, FCMs likely will realize 
increased customer and transaction volume as the result of the 
requirement, but will not have to simultaneously learn how to 
operationalize clearing for new types of swaps. And the experience of 
FCMs with these products is also likely to benefit customers that are 
new to clearing, as the FCM guides them through initial experiences 
with cleared swaps.\206\
---------------------------------------------------------------------------

    \206\ As discussed in Section II.C and II.E above, DCOs offering 
clearing for CDS and IRS have established extensive risk management 
practices, which focus on the protection of market participants. See 
also Sections II.D and II.F for a discussion of the effect on the 
mitigation of systemic risk in the CDS market and in the IRS market, 
as well as the protection of market participants during insolvency 
events at either the clearing member or DCO level.
---------------------------------------------------------------------------

    In addition, uncleared swaps subject to collateral agreements can 
be the subject of valuation disputes. These valuation disputes 
sometimes require several months, or longer, to resolve. 
Uncollateralized exposure can grow significantly during that time, 
leaving one of the two parties exposed to counterparty risk that was 
intended to be covered through a collateral agreement. DCOs reduce 
valuation disputes for cleared swaps as well as the risk that 
uncollateralized exposure can develop and accumulate during the time 
when such a dispute would have otherwise occurred, thus providing 
additional protection to market participants who transact in swaps that 
are required to be cleared.\207\
---------------------------------------------------------------------------

    \207\ See Sections II.D and II.F above for a further discussion 
of how DCOs obtain adequate pricing data for the CDS and IRS that 
they clear. Based on this pricing data, valuation disputes are 
minimized, if not eliminated for cleared swaps.
---------------------------------------------------------------------------

    As far as costs are concerned, market participants that do not 
currently have established clearing relationships with an FCM will have 
to set up and maintain such a relationship in order to clear swaps that 
are required to be cleared. As discussed above, market participants 
that conduct a limited number of swaps per year will likely be required 
to pay monthly or annual fees that FCM's charge to maintain both the 
relationship and outstanding swap positions belonging to the customer. 
In addition, the FCM is likely to pass along fees charged by the DCO 
for establishing and maintaining open positions.

[[Page 47218]]

ii. Efficiency, Competitiveness, and Financial Integrity of Swap 
Markets
    Swap clearing, in general, is expected to reduce uncertainty 
regarding counterparty risk in times of market stress and promote 
liquidity and efficiency during those times. Increased liquidity 
promotes the ability of market participants to limit losses by exiting 
positions effectively when necessary in order to manage risk during a 
time of market stress.
    In addition, to the extent that positions move from facing multiple 
counterparties in the bilateral market to being run through a smaller 
number of clearinghouses, clearing facilitates increased netting. This 
reduces the amount of collateral that a party must post in margin 
accounts.
    As discussed in Sections II.D and II.F above, in setting forth this 
proposal, the Commission took into account a number of specific factors 
that relate to the financial integrity of the swap markets. 
Specifically, the discussion above includes an assessment of whether 
the DCOs clearing CDS and IRS have the rule framework, capacity, 
operational expertise and resources, and credit support infrastructure 
to clear CDS and IRS on terms that are consistent with the material 
terms and trading conventions on which the contract is then traded. The 
proposal also considered the resources of DCOs to handle additional 
clearing, as well as the existence of reasonable legal certainty in the 
event of a clearing member or DCO insolvency.\208\
---------------------------------------------------------------------------

    \208\ See Section II.C and II.E.
---------------------------------------------------------------------------

    As discussed above, bilateral swaps create counterparty risk that 
may lead market participants to discriminate among potential 
counterparties based on their creditworthiness. Such discrimination is 
expensive and time consuming insofar as market participants must 
conduct due diligence in order to evaluate a potential counterparty's 
creditworthiness. Requiring certain types of swaps to be cleared 
reduces the number of transactions for which such due diligence is 
necessary, thereby contributing to the efficiency of the swap markets.
    In proposing a clearing requirement for both CDS and IRS, the 
Commission must consider the effect on competition, including 
appropriate fees and charges applied to clearing. As discussed in more 
detail in Sections II.D and II.F above, there are a number of potential 
outcomes that may result from required clearing. Some of these outcomes 
may impose costs, such as if a DCO possessed market power and exercised 
that power in an anticompetitive manner, and some of the outcomes would 
be positive, such as if the clearing requirement facilitated a stronger 
entry-opportunity for competitors.
    As far as costs are concerned, the markets for some swaps within 
the classes that are proposed to be required to be cleared may be less 
liquid than others. All other things being equal, swaps for which the 
markets are less liquid have the potential to develop larger current 
uncollateralized exposures after a default on a cleared position, and 
therefore will require posting of relatively greater amounts of initial 
margin.
iii. Price Discovery
    Clearing, in general, encourages better price discovery because it 
eliminates the importance of counterparty creditworthiness in pricing 
swaps cleared through a given DCO. That is, by making the counterparty 
creditworthiness of all swaps of a certain type essentially the same, 
prices should reflect factors related to the terms of the swap, rather 
than the idiosyncratic risk posed by the entities trading it.\209\
---------------------------------------------------------------------------

    \209\ See Chen, K., et al. ``An Analysis of CDS Transactions: 
Implications for Public Reporting,'' September 2011, Federal Reserve 
Bank of New York Staff Reports, at 14, available at http://www.newyorkfed.org/research/staff_reports/sr517.pdf.
---------------------------------------------------------------------------

    As discussed in sections II.D and II.F above, DCOs obtain adequate 
pricing data for the CDS and IRS that they clear. Each DCO establishes 
a rule framework for its pricing methodology and rigorously tests its 
pricing models to ensure that the cornerstone of its risk management 
regime is as sound as possible.
iv. Sound Risk Management Practices
    If a firm enters into swaps to hedge certain positions and then the 
counterparty to those swaps defaults unexpectedly, the firm could be 
left with large outstanding exposures. As stated above, when a swap is 
cleared the DCO becomes the counterparty facing each of the two 
original participants in the swap. This standardizes and reduces 
counterparty risk for each of the two original participants. To the 
extent that a market participant's hedges comprise swaps that are 
required to be cleared, the requirement enhances their risk management 
practices by reducing their counterparty risk.
    In addition, from systemic perspective, required clearing reduces 
the complexity of unwinding/transferring swap positions from large 
entities that default. Procedures for transfer of swap positions and 
mutualization of losses among DCO members are already in place, and the 
Commission anticipates that they are much more likely to function in a 
manner that enables rapid transfer of defaulted positions than legal 
processes that would surround the enforcement of bilateral contracts 
for uncleared swaps.\210\
---------------------------------------------------------------------------

    \210\ As discussed in Sections II.C and II.E above, sound risk 
management practices are critical for all DCOs, especially those 
offering clearing for CDS and IRS. In the discussion above, the 
Commission considered whether each DCO submission under review was 
consistent with the core principles for DCOs. In particular, the 
Commission considered the DCO submissions in light of Core Principle 
D, which relates to risk management. See also Sections II.D and II.F 
for a discussion of the effect on the mitigation of systemic risk in 
the CDS market and in the IRS market, as well as the protection of 
market participants during insolvency events at either the clearing 
member or DCO level.
---------------------------------------------------------------------------

v. Other Public Interest Considerations
    In September 2009, the President and the other leaders of the 
``G20'' nations met in Pittsburgh and committed to a program of action 
that includes, among other things, central clearing of all standardized 
swaps.\211\ Together, IRS and CDS represent more than 75% of the 
notional amount of outstanding swaps, and therefore, requiring the most 
active, standardized classes of swaps within those groups to be cleared 
represents a significant step toward the fulfillment of that 
commitment.
---------------------------------------------------------------------------

    \211\ A list of the G20 commitments made in Pittsburgh can be 
found at: http://www.g20.utoronto.ca/analysis/commitments-09-pittsburgh.html.
---------------------------------------------------------------------------

VI. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that agencies 
consider whether the rules they propose will have a significant 
economic impact on a substantial number of small entities and, if so, 
provide a regulatory flexibility analysis respecting the impact.\212\ 
The clearing requirement determinations and rules proposed by the 
Commission will affect only eligible contract participants (ECPs) 
because all persons that are not ECPs are required to execute their 
swaps on a DCM, and all contracts executed on a DCM must be cleared by 
a DCO, as required by statute and regulation; not by operation of any 
clearing requirement.\213\
---------------------------------------------------------------------------

    \212\ See 5 U.S.C. 601 et seq.
    \213\ To the extent that this rulemaking affects DCMs, DCOs, or 
FCMs, the Commission has previously determined that DCMs, DCOs, and 
FCMs are not small entities for purposes of the RFA. See, 
respectively and as indicated, 47 FR 18618, 18619, Apr. 30, 1982 
(DCMs and FCMs); and 66 FR 45604, 45609, Aug. 29, 2001 (DCOs).

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

[[Page 47219]]

    The Commission has previously determined that ECPs are not small 
entities for purposes of the RFA.\214\ However, in its proposed 
rulemaking to establish a schedule to phase in compliance with certain 
provisions of the Dodd-Frank Act, including the clearing requirement 
under section 2(h)(1)(A) of the CEA, the Commission received a joint 
comment (Electric Associations Letter) from the Edison Electric 
Institute (EEI), the National Rural Electric Cooperative Association 
(NRECA) and the Electric Power Supply Association (EPSA) asserting that 
certain members of NRECA may both be ECPs under the CEA and small 
businesses under the RFA.\215\ These members of NRECA, as the 
Commission understands, have been determined to be small entities by 
the Small Business Administration (SBA) because they are ``primarily 
engaged in the generation, transmission, and/or distribution of 
electric energy for sale and [their] total electric output for the 
preceding fiscal year did not exceed 4 million megawatt hours.''\216\ 
Although the Electric Associations Letter does not provide details on 
whether or how the NRECA members that have been determined to be small 
entities use the IRS and CDS that are the subject of this rulemaking, 
the Electric Associations Letter does state that the EEI, NRECA and 
EPSA members ``engage in swaps to hedge commercial risk.'' \217\ 
Because the NRECA members that have been determined to be small 
entities would be using swaps to hedge commercial risk, the Commission 
expects that they would be able to use the end-user exception from the 
clearing requirement and therefore would not be affected to any 
significant extent by this rulemaking.
---------------------------------------------------------------------------

    \214\ See 66 FR 20740, 20743 (Apr. 25, 2001).
    \215\ See joint letter from EEI, NRECA, and ESPA, dated Nov. 4, 
2011, (Electric Associations Letter), commenting on Swap Transaction 
Compliance and Implementation Schedule: Clearing and Trade Execution 
Requirements under Section 2(h) of the CEA, 76 FR 58186 (Sept. 20, 
2011).
    \216\ Small Business Administration, Table of Small Business 
Size Standards, Nov. 5, 2010.
    \217\ See Electric Associations Letter, at 2. The letter also 
suggests that EEI, NRECA, and EPSA members are not financial 
entities. See id., at note 5, and at 5 (the associations' members 
``are not financial companies'').
---------------------------------------------------------------------------

    Thus, because nearly all of the ECPs that may be subject to the 
proposed clearing requirement are not small entities, and because the 
few ECPs that have been determined by the SBA to be small entities are 
unlikely to be subject to the clearing requirement, the Chairman, on 
behalf of the CFTC, hereby certifies pursuant to 5 U.S.C. 605(b) that 
the rules herein will not have a significant economic impact on a 
substantial number of small entities. The Commission invites public 
comment on this determination.

B. Paperwork Reduction Act

    The Paperwork Reduction Act (PRA) \218\ imposes certain 
requirements on federal agencies (including the Commission) in 
connection with conducting or sponsoring any collection of information 
as defined by the PRA. Proposed Sec.  50.3(a), which would require each 
DCO to post on its Web site a list of all swaps that it will accept for 
clearing and clearly indicate which of those swaps the Commission has 
determined are required to be cleared, builds upon the requirements of 
Sec.  39.21(c)(1), which requires each DCO to disclose publicly 
information concerning the terms and conditions of each contract, 
agreement, and transaction cleared and settled by the DCO. Thus, this 
rulemaking will not require a new collection of information from any 
persons or entities. The Commission invites public comment on whether 
this rulemaking will require a new collection of information.
---------------------------------------------------------------------------

    \218\ 44 U.S.C. 3507(d).
---------------------------------------------------------------------------

List of Subjects in 17 CFR Part 50

    Business and industry, Clearing, Swaps.
    In consideration of the foregoing, and pursuant to the authority in 
the Commodity Exchange Act, as amended, and in particular section 2(h) 
of the Act, the Commission hereby adopts an amendment to Chapter I of 
Title 17 of the Code of Federal Regulation by proposing to amend part 
50 as follows:

PART 50--CLEARING REQUIREMENT AND RELATED RULES

    1. The authority citation for part 50 reads as follows:

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

    2. Add new part 50 to read as follows:

PART 50--CLEARING REQUIREMENT AND RELATED RULES

Subpart A--Definitions and Clearing Requirement
Sec.
Sec.  50.1 Definitions.
50.2 Treatment of swaps subject to a clearing requirement.
50.3 Notice to the public.
50.4 Classes of swaps required to be cleared.
50.5 Swaps exempt from a clearing requirement.
50.6 Delegation of Authority.
50.7-9 [Reserved]
50.10 Prevention of Evasion of the Clearing Requirement and Abuse of 
an Exception or Exemption to the Clearing Requirement.
50.11-24 [Reserved]
Subpart B--Compliance Schedule
50.25 Clearing Requirement Compliance Schedule.
50.26-49 [Reserved]
Subpart C--Exceptions to Clearing Requirement
Sec.  50.50-100 [Reserved]


Sec.  50.1  Definitions.

    For the purposes of this part,
    Business day means any day other than a Saturday, Sunday, or 
[legal] holiday.
    Day of execution means the calendar day of the party to the swap 
that ends latest, provided that if a swap is (A) entered into after 
4:00 p.m. in the location of a party, or (B) entered into on a day that 
is not a business day in the location of a party, then such swap shall 
be deemed to have been entered into by that party on the immediately 
succeeding business day of that party, and the day of execution shall 
be determined with reference to such business day.


Sec.  50.2  Treatment of swaps subject to a clearing requirement.

    (a) All persons executing a swap that (1) is not subject to an 
exception under section 2(h)(7) of the Act and Sec.  39.6, and (2) is 
included in a class of swaps identified in Sec.  50.4, shall submit 
such swap to a derivatives clearing organization for clearing as soon 
as technologically practicable after execution, but in any event by the 
end of the day of execution.
    (b) Each person subject to the requirements of paragraph (a) shall 
undertake reasonable efforts to verify whether a swap is required to be 
cleared.


Sec.  50.3  Notice to the public.

    (a) In addition to its obligations under Sec.  39.21(c)(1), each 
derivatives clearing organization shall make publicly available on its 
Web site a list of all swaps that it will accept for clearing and 
identify which swaps on the list are required to be cleared under 
section 2(h)(1) of the Act and this part.
    (b) The Commission shall maintain a current list of all swaps that 
are required to be cleared and all derivatives clearing organizations 
that are eligible to clear such swaps on its Web site.

[[Page 47220]]

Sec.  50.4  Classes of swaps required to be cleared.

    (a) Interest rate swaps. Swaps that have the following 
specifications are required to be cleared under section 2(h)(1) of the 
Act, and shall be cleared pursuant to the rules of any derivatives 
clearing organization eligible to clear such swaps under Sec.  39.5(a) 
of this chapter.

----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                          Fixed-to-Floating Swap Class
----------------------------------------------------------------------------------------------------------------
          Specification
 
1. Currency.....................  U.S. Dollar (USD).  Euro (EUR)........  Sterling (GBP)....  Yen (JPY).
2. Floating Rate Indexes........  LIBOR.............  EURIBOR...........  LIBOR.............  LIBOR.
3. Stated Termination Date Range  28 days to 50       28 days to 50       28 days to 50       28 days to 30
                                   years.              years.              years.              years.
4. Optionality..................  No................  No................  No................  No.
5. Dual Currencies..............  No................  No................  No................  No.
6. Conditional Notional Amounts.  No................  No................  No................  No.
----------------------------------------------------------------------------------------------------------------
                                                Basis Swap Class
----------------------------------------------------------------------------------------------------------------
          Specification
 
1. Currency.....................  U.S. Dollar (USD).  Euro (EUR)........  Sterling (GBP)....  Yen (JPY).
2. Floating Rate Indexes........  LIBOR.............  EURIBOR...........  LIBOR.............  LIBOR.
3. Stated Termination Date Range  28 days to 50       28 days to 50       28 days to 50       28 days to 30
                                   years.              years.              years.              years.
4. Optionality..................  No................  No................  No................  No.
5. Dual Currencies..............  No................  No................  No................  No.
6. Conditional Notional Amounts.  No................  No................  No................  No.
----------------------------------------------------------------------------------------------------------------
                                          Forward Rate Agreement Class
----------------------------------------------------------------------------------------------------------------
          Specification
 
1. Currency.....................  U.S. Dollar (USD).  Euro (EUR)........  Sterling (GBP)....  Yen (JPY).
2. Floating Rate Indexes........  LIBOR.............  EURIBOR...........  LIBOR.............  LIBOR.
3. Stated Termination Date Range  3 days to 3 years.  3 days to 3 years.  3 days to 3 years.  3 days to 3 years.
4. Optionality..................  No................  No................  No................  No.
5. Dual Currencies..............  No................  No................  No................  No.
6. Conditional Notional Amounts.  No................  No................  No................  No.
----------------------------------------------------------------------------------------------------------------
                                           Overnight Index Swap Class
----------------------------------------------------------------------------------------------------------------
          Specification
 
1. Currency.....................  U.S. Dollar (USD).  Euro (EUR)........  Sterling (GBP)....  Yen (JPY).
2. Floating Rate Indexes........  FedFunds..........  EONIA.............  SONIA.............  ..................
3. Stated Termination Date Range  7 days to 2 years.  7 days to 2 years.  7 days to 2 years.
4. Optionality..................  No................  No................  No................  ..................
5. Dual Currencies..............  No................  No................  No................  ..................
6. Conditional Notional Amounts.  No................  No................  No................  ..................
----------------------------------------------------------------------------------------------------------------

     (b) Credit default swaps. Swaps that have the following 
specifications are required to be cleared under section 2(h)(1) of the 
Act, and shall be cleared pursuant to the rules of any derivatives 
clearing organization eligible to clear such swaps under Sec.  39.5(a) 
of this chapter.

------------------------------------------------------------------------
 
------------------------------------------------------------------------
               North American Untranched CDS Indices Class
------------------------------------------------------------------------
           Specification
 
1. Reference Entities.............  Corporate.
2. Region.........................  North America.
3. Indices........................  CDX.NA.IG.
                                    CDX.NA.HY.
4. Tenor..........................  CDX.NA.IG: 3Y, 5Y, 7Y, 10Y.
                                    CDX.NA.HY: 5Y.
5. Applicable Series..............  CDX.NA.IG 3Y: Series 15 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    CDX.NA.IG 5Y: Series 11 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    CDX.NA.IG 7Y: Series 8 and all
                                     subsequent Series, up to and
                                     including the current Series.

[[Page 47221]]

 
                                    CDX.NA.IG 10Y: Series 8 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    CDX.NA.HY 5Y: Series 11 and all
                                     subsequent Series, up to and
                                     including the current Series.
6. Tranched.......................  No.
------------------------------------------------------------------------
                  European Untranched CDS Indices Class
------------------------------------------------------------------------
           Specification
 
1. Reference Entities.............  Corporate.
2. Region.........................  Europe.
3. Indices........................  iTraxx Europe.
                                    iTraxx Europe Crossover.
                                    iTraxx Europe HiVol.
4. Tenor..........................  iTraxx Europe: 5Y, 10Y
                                    iTraxx Europe Crossover: 5Y.
                                    iTraxx Europe HiVol: 5Y.
5. Applicable Series..............  iTraxx Europe 5Y: Series 10 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    iTraxx Europe 10Y: Series 7 and all
                                     subsequent Series, up to and
                                     including the current Series.
                                    iTraxx Europe Crossover 5Y: Series
                                     10 and all subsequent Series, up to
                                     and including the current Series.
                                    iTraxx Europe HiVol 5Y: Series 10
                                     and all subsequent Series, up to
                                     and including the current Series.
6. Tranched.......................  No.
------------------------------------------------------------------------

Sec.  50.5  Clearing Transition Rules.

    (a) Swaps entered into before July 21, 2010 shall be exempt from 
the clearing requirement under Sec.  50.2 if reported to a swap data 
repository pursuant to section 2(h)(5)(A) of the Act and Sec.  44.02 of 
this chapter.
    (b) Swaps entered into before the application of the clearing 
requirement for a particular class of swaps under Sec.  50.2 and Sec.  
50.4 shall be exempt from the clearing requirement if reported to a 
swap data repository pursuant to section 2(h)(5)(B) of the Act and 
Sec.  44.03 of this chapter.


Sec.  50.6  Delegation of Authority.

    (a) The Commission hereby delegates to the Director of the Division 
of Clearing and Risk or such other employee or employees as the 
Director may designate from time to time, with the consultation of the 
General Counsel or such other employee or employees as the General 
Counsel may designate from time to time, the authority:
    (1) To determine whether one or more swaps submitted by a 
derivatives clearing organization under Sec.  39.5 falls within a class 
of swaps as described in Sec.  50.4; and
    (2) To notify all relevant derivatives clearing organizations of 
that determination.
    (b) The Director of the Division of Clearing and Risk may submit to 
the Commission for its consideration any matter which has been 
delegated in this section. Nothing in this section prohibits the 
Commission, at its election, from exercising the authority delegated in 
this section.


Sec.  50.7-9  [Reserved].


Sec.  50.10  Prevention of Evasion of the Clearing Requirement and 
Abuse of an Exception or Exemption to the Clearing Requirement.

    (a) It shall be unlawful for any person to knowingly or recklessly 
evade or participate in or facilitate an evasion of the requirements of 
section 2(h) of the Act or any Commission rule or regulation 
promulgated thereunder.
    (b) It shall be unlawful for any person to abuse the exception to 
the clearing requirement as provided under section 2(h)(7) of the Act 
and Sec.  39.6 of this chapter.
    (c) It shall be unlawful for any person to abuse any exemption or 
exception to the requirements of section 2(h) of the Act, including any 
exemption or exception as the Commission may provide by rule, 
regulation, or order.

    By the Commission.
    Issued in Washington, DC, on July 24, 2012.
Sauntia S. Warfield,
Assistant Secretary of the Commission.

Appendices to Clearing Requirement Determination Under Section 2(h) of 
the CEA--Commission Voting Summary and Statements of Commissioners

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

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 proposal to require certain interest rate swaps 
and credit default swap (CDS) indices to be cleared as provided by 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act).
    For over a century, through good times and bad, central clearing 
in the futures market has lowered risk to the broader public. Dodd-
Frank financial reform brings this effective model to the swaps 
market. One of the primary benefits of swaps market reform is that 
standard swaps between financial firms will move into central 
clearing, which will significantly lower the risks of the highly 
interconnected financial system.
    The Dodd-Frank Act requires the Commission to determine whether 
a swap is required to be cleared. For purposes of this first set of 
determinations, the Commission has looked to swaps that are 
currently cleared based upon submissions from eight derivatives 
clearing organizations (DCOs).
    This first proposed clearing determination would require that 
swaps within identified classes be cleared by a DCO. This first 
determination includes interest rate swaps in four currencies, as 
well as five CDS indices. The proposal addresses swaps that five 
DCOs are already clearing, including standard interest rate swaps in 
U.S. dollars, euros, British pounds and Japanese yen, as well as a 
number of CDS indices, including North American and European 
corporate names. Subsequently, the Commission will consider other 
swaps, such as agricultural, energy and equity indices.
    I believe that the Commission's proposed determination for each 
class satisfies the five factors provided for by Congress in the 
Dodd-Frank Act, including the first factor that addresses 
outstanding exposures, liquidity and pricing data.
    Under the proposal, a DCO would be required to post on its Web 
site a list of all swaps it will accept for clearing and must

[[Page 47222]]

indicate which swaps the Commission had determined are required to 
be cleared.
    I look forward to receiving public input on this proposed rule.

Appendix 2--Statement of Commissioner Scott D. O'Malia

    I respectfully concur with the Commodity Futures Trading 
Commission's (``Commission'') proposal to establish a clearing 
requirement for certain classes of credit default swaps and interest 
rate swaps pursuant to the Commission's authority under new section 
2(h)(1)(A) of the Commodity Exchange Act (``CEA'').\1\ Centralized 
clearing is a vital part of the Dodd-Frank Act reforms and is 
expected to reduce counterparty credit risks, improve transparency 
and fairness around the setting of margin requirements, increase 
market liquidity, and reduce overall systemic risks.
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    \1\ 7 U.S.C. 2(h). Congress amended section 2(h) of the CEA 
under section 723 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-
Frank Act'').
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    I am pleased that the Commission's proposal thoughtfully 
incorporates comments received in response to my July 28, 2011 
letter \2\ to the public seeking comment on the five substantive 
criteria that the Commission is required to consider in making 
mandatory clearing determinations.\3\ The comments help provide the 
necessary clarity and guidance that the markets have sought 
regarding how the Commission will consider and weigh these criteria.
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    \2\ My letter, and comments submitted in response thereto, can 
be found on the Commission's Web site at: http://www.cftc.gov/About/Commissioners/ScottDOMalia/reviewofswaps.
    \3\ Specifically, section 2(h)(2)(D)(ii) requires the Commission 
consider the following five factors based on a Commission initiated 
review of a swap submission: (1) The existence of significant 
outstanding notional exposures, trading liquidity, and adequate 
pricing of data; (2) the availability of rule framework, capacity 
operational expertise and resources, and credit support 
infrastructure to clear the contract on terms that are consistent 
with the material terms and trading conventions on which the 
contract is then traded; (3) the effect on the mitigation of 
systemic risk, taking into account the size of the market for such 
contract and the resources of the derivatives clearing organization 
(``DCO'') available to clear the contract; (4) the effect on 
competition, including appropriate fees and charges applied to 
clearing; and (5) the existence of reasonable legal certainty in the 
event of the insolvency of the relevant DCO (or one or more of its 
clearing members) with regard to the treatment of customer and swap 
counterparty positions, funds, and property.
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    Today's proposal also (1) includes a more reasoned cost-benefit 
analysis that is based on an appropriate pre-Dodd-Frank baseline, 
(2) discusses a variety of alternatives based on public comments, 
and (3) asks a series of questions in the absence of available data. 
Once again, I am encouraged that Commission staff is working with 
technical experts from the Office of Management and Budget (``OMB'') 
to improve our cost-benefit analyses. It is my hope that the 
Commission's final rule similarly benefits from our cooperative 
relationship with OMB.
    Once this proposal is published in the Federal Register, the 90-
day clock will start. The Commission will review all comments, and 
discuss its final determination for clearing the majority of swaps 
in due course. I implore commenters to provide feedback and to 
submit data as soon as possible so that the Commission can account 
for the actual impact that today's rule will have on market 
liquidity, margining, and the reduction of risks.
[FR Doc. 2012-18382 Filed 8-6-12; 8:45 am]
BILLING CODE 6351-01-P