Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant”

Federal RegisterMay 23, 2012

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AD06

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-66868; File No. S7-39-10]

RIN 3235-AK65

Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant”

AGENCY:

Commodity Futures Trading Commission; Securities and Exchange Commission.

ACTION:

Joint final rule; joint interim final rule; interpretations.

SUMMARY:

In accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) (collectively, the “Commissions”), in consultation with the Board of Governors of the Federal Reserve System (“Board”), are adopting new rules and interpretive guidance under the Commodity Exchange Act (“CEA”), and the Securities Exchange Act of 1934 (“Exchange Act”), to further define the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” and “eligible contract participant.”

DATES:

Effective date.

The effective date for this joint final rule and joint interim final rule: July 23, 2012, except for CFTC regulations at 17 CFR 1.3(m)(5) and (6), which are effective December 31, 2012.

Comment date.

The comment period for the interim final rule (CFTC regulation at 17 CFR 1.3(ggg)(6)(iii)) will close July 23, 2012.

Compliance date.

Compliance with the element of the CFTC regulation at 17 CFR 1.3(m)(8)(iii) requiring that a commodity pool be formed by a registered CPO shall be required with respect to a commodity pool formed on or after December 31, 2012 for any person seeking to rely on such regulation; compliance with such element shall not be required with respect to a commodity pool formed prior to December 31, 2012.

FOR FURTHER INFORMATION CONTACT:

CFTC:

Jeffrey P. Burns, Assistant General Counsel, at 202- 418-5101,

jburns@cftc.gov

, Mark Fajfar, Assistant General Counsel, at 202-418-6636,

mfajfar@cftc.gov

, Julian E. Hammar, Assistant General Counsel, at 202-418-5118,

jhammar@cftc.gov

, or David E. Aron, Counsel, at 202-418-6621,

daron@cftc.gov

, Office of General Counsel; Gary Barnett, Director, at 202-418-5977,

gbarnett@cftc.gov

, or Frank Fisanich, Deputy Director, at 202-418-5949,

ffisanich@cftc.gov

, Division of Swap Dealer and Intermediary Oversight,Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581;

SEC:

Joshua Kans, Senior Special Counsel, Richard Grant, Special Counsel, or Richard Gabbert, Attorney Advisor, at 202-551-5550, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

I. Background

On July 21, 2010, President Obama signed the Dodd-Frank Act into law.

Title VII of the Dodd-Frank Act established a statutory framework to reduce risk, increase transparency, and promote market integrity within the financial system by, among other things: (i) providing for the registration and regulation of swap dealers and major swap participants; (ii) imposing clearing and trade execution requirements on standardized derivative products; (iii) creating recordkeeping and real-time reporting regimes; and (iv) enhancing the Commissions' rulemaking and enforcement authorities with respect to all registered entities and intermediaries subject to the Commissions' oversight.

See

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act may be accessed at

http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm

The Dodd-Frank Act particularly provides that the CFTC will regulate “swaps,” and that the SEC will regulate “security-based swaps.” The Dodd-Frank Act also adds definitions of the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant” and “eligible contract participant” to the CEA and Exchange Act.

Section 712(d)(1) of the Dodd-Frank Act further directs the CFTC and the SEC, in consultation with the Board, jointly to further define those terms, among others.

See

Dodd-Frank Act sections 721 and 761. Sections 721(b)(2) and 761(b)(2) also provide that the CFTC and SEC may by rule further define any other term included in an amendment made by Title VII to the CEA or the Exchange Act, respectively.

In addition, section 712(d)(1) directs the CFTC and SEC, in consultation with the Board, jointly to further define the terms “swap,” “security-based swap,” and “security-based swap agreement.” These further definitions are the subject of a separate rulemaking by the Commissions.

See

CFTC and SEC, Notice of Proposed Joint Rulemaking, Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 76 FR 29818 (May 23, 2011) (“Product Definitions Proposal”). Section 712(d)(2)(A), in turn, provides that the Commissions shall jointly adopt such other rules regarding the definitions set forth in section 712(d)(1) as they “determine are necessary and appropriate, in the public interest, and for the protection of investors.”

In addition, section 721(c) of the Dodd-Frank Act requires the CFTC to adopt a rule to further define the terms “swap dealer,” “major swap participant,” and “eligible contract participant” for the purpose of including transactions and entities that have been structured to evade Title VII. Also, section 761(b) of the Dodd-Frank Act permits the SEC to adopt a rule to further define the terms “security-based swap dealer,” “major security-based swap participant,” and “eligible contract participant,” with regard to security-based swaps, for the purpose of including transactions and entities that have been structured to evade Title VII.

In December 2010, the Commissions proposed rules and interpretations to further define the meaning of the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” and “eligible contract participant.”

The Commissions received approximately 968 written comments in response to the Proposing Release.

In addition, the Staffs of the Commissions participated in approximately 114 meetings with market participants and other members of the public about the Proposing Release,

and the Commissions held a

Joint Public Roundtable on the proposed dealer and major participant definitions.

After considering the comments received, the Commissions are adopting final rules and interpretations to further define these terms.

See

CFTC and SEC, Notice of Proposed Joint Rulemaking: Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant,” Securities Exchange Act Release No. 63452, 75 FR 80174 (Dec. 21, 2010) (“Proposing Release”).

Prior to issuing the Proposing Release, the Commissions issued a joint Advance Notice of Proposed Rulemaking (“ANPRM”) requesting public comment regarding the definitions of the terms “swap,” “security-based swap,” “security-based swap agreement,” “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” and “eligible contract participant.”

See

CFTC and SEC, Advance Notice of Proposed Joint Rulemaking: Definitions Contained in Title VII of Dodd-Frank Wall Street Reform and Consumer Protection Act, Securities Exchange Act Release No. 62717, 75 FR 51429 (Aug. 20, 2010). The Proposing Release and these final rules both reflect comments received in response to the ANPRM.

Comment letters received in response to the Proposing Release may be found on the Commissions' Web sites at

http://comments.cftc.gov/PublicComments/CommentList.aspx?id=933

and at

http://www.sec.gov/comments/s7-39-10/s73910.shtml

Summaries of these staff meetings may be found on the Commissions' Web sites at

http://

www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_2_Definitions/index.htm

and

http://www.sec.gov/comments/s7-39-10/s73910.shtml#meetings

A transcript of the roundtable discussion and public comments received with respect to the roundtable may be found on the CFTC's Web site at

http://www.cftc.gov/PressRoom/Events/opaevent_cftcsecstaff061611

II. Definitions of “Swap Dealer” and “Security-Based Swap Dealer”

The Dodd-Frank Act definitions of the terms “swap dealer” and “security-based swap dealer” focus on whether a person engages in particular types of activities involving swaps or security-based swaps.

Persons that meet either of those definitions are subject to statutory requirements related to, among other things, registration, margin, capital and business conduct.

See

section 721 of the Dodd-Frank Act (adding Section 1a(49) of the CEA, 7 U.S.C. 1a(49), to define “swap dealer”) and section 761 of the Dodd-Frank Act (adding Section 3(a)(71) of the Exchange Act, 15 U.S.C. 78c(a)(71), to define “security-based swap dealer”).

The Dodd-Frank Act excludes from the Exchange Act definition of “dealer” persons who engage in security-based swaps with eligible contract participants.

See

section 3(a)(5) of the Exchange Act, 15 U.S.C. 78c(a)(5), as amended by section 761(a)(1) of the Dodd-Frank Act.

The Dodd-Frank Act does not include comparable amendments for persons who act as brokers in swaps and security-based swaps. Because security-based swaps, as defined in section 3(a)(68) of the Exchange Act, are included in the Exchange Act section 3(a)(10) definition of “security,” persons who act as brokers in connection with security-based swaps must, absent an exception or exemption, register with the SEC as a broker pursuant to Exchange Act section 15(a), and comply with the Exchange Act's requirements applicable to brokers.

In mid-2011, the SEC issued temporary exemptions under the Exchange Act in connection with the revision of the “security” definition to encompass security-based swaps. Among other aspects, these temporary exemptions extended to certain broker activities involving security-based swaps.

See

“Order Granting Temporary Exemptions under the Securities Exchange Act of 1934 in Connection with the Pending Revision of the Definition of “Security” to Encompass Security-Based Swaps, and Request for Comment,” Securities Exchange Act Release No. 64795 (Jul. 1, 2011), 76 FR 39927, 39939 (Jul. 7, 2011) (addressing availability of exemption to registration requirement for securities brokers).

The CEA and Exchange Act definitions in general encompass persons that engage in any of the following types of activity:

(i) Holding oneself out as a dealer in swaps or security-based swaps,

(ii) making a market in swaps or security-based swaps,

(iii) regularly entering into swaps or security-based swaps with counterparties as an ordinary course of business for one's own account, or

(iv) engaging in any activity causing oneself to be commonly known in the trade as a dealer or market maker in swaps or security-based swaps.

See

CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A); Exchange Act section 3(a)(71)(A), 15 U.S.C. 78c(a)(71)(A).

These dealer activities are enumerated in the CEA and Exchange Act in the disjunctive, in that a person that engages in any one of these activities is a swap dealer under the CEA or security-based swap dealer under the Exchange Act, even if such person does not engage in one or more of the other identified activities.

At the same time, the statutory dealer definitions provide exceptions for a person that enters into swaps or security-based swaps for the person's own account, either individually or in a fiduciary capacity, but not as a part of a “regular business.”

The Dodd-Frank Act also instructs the Commissions to exempt from designation as a dealer a person that “engages in a

de minimis

quantity of [swap or security-based swap] dealing in connection with transactions with or on behalf of its customers.”

Moreover, the definition of “swap dealer” (but not the definition of “security-based swap dealer”) provides that an insured depository institution is not to be considered a swap dealer “to the extent it offers to enter into a swap with a customer in connection with originating a loan with that customer.”

The statutory definitions further provide that a person may be designated as a dealer for one or more types, classes or categories of swaps or security-based swaps, or activities without being designated a dealer for other types, classes or categories or activities.

See

CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C); Exchange Act section 3(a)(71)(C), 15 U.S.C. 78c(a)(71)(C).

See

CEA section 1a(49)(D), 7 U.S.C. 1a(49)(D); Exchange Act section 3(a)(71)(D), 15 U.S.C. 78c(a)(71)(D).

See

CEA section 1a(49)(A), 7 U.S.C. 1a(49)(A).

See

CEA section 1a(49)(B), 7 U.S.C. 1a(49)(B); Exchange Act section 3(a)(71)(B), 15 U.S.C. 78c(a)(71)(B).

In the Proposing Release, the Commissions proposed rules to identify the activity that would cause a person to be a dealer,

to implement the exception for

de minimis

dealing activity,

to implement the exception from the swap dealer definition in connection with the origination of loans by insured depository institutions,

and to provide for the limited purpose designation of dealers.

The release also set forth proposed interpretive guidance related to the definitions.

See

proposed CFTC Regulation § 1.3(ggg)(1); proposed Exchange Act rule 3a71-1(a), (b).

See

proposed CFTC Regulation § 1.3(ggg)(4); proposed Exchange Act rule 3a71-2.

See

proposed CFTC Regulation § 1.3(ggg)(5).

See

proposed CFTC Regulation § 1.3(ggg)(3); proposed Exchange Act rule 3a71-1(c).

After considering the comments received, the Commissions are adopting final rules and interpretations to further define the terms “swap dealer” and “security-based swap dealer.” In this Adopting Release, we particularly address: (i) The general analysis for identifying dealing activity involving swaps and security-based swaps; (ii) the exclusion from the “swap dealer” definition in connection with the origination of loans by insured depository institutions; (iii) the application of the dealer analysis to inter-affiliate swaps and security-based swaps; (iv) the application of the

de minimis

exception from the dealer definitions; and (v) the limited designation of swap dealers and security-based swap dealers.

A. General Considerations for the Dealer Analysis

1. Proposed Approach

The proposed rules to define the activities that would lead a person to be a “swap dealer” and “security-based swap dealer” were based closely on the corresponding language of the statutory definitions.

The Proposing Release further noted that the Dodd-Frank Act defined the terms “swap dealer” and “security-based swap dealer” in a functional manner, and stated that those statutory definitions should not be interpreted in a constrained, overly technical or rigid manner, particularly given the diversity of the swap and security-based swap markets. The Proposing Release also identified potential distinguishing characteristics of swap dealers and security-based swap dealers based on the functional role that dealers fulfill in the swap and security-based swap markets, such as: dealers tend to accommodate demand from other parties; dealers generally are available to enter into swaps or security-based swaps to facilitate other parties' interest; dealers tend not to request that other parties propose the terms of swaps or security-based swaps, but instead tend to enter into those instruments on their own standard terms or on terms they arrange in response to other parties' interest; and dealers tend to be able to arrange customized terms for

swaps or security-based swaps upon request, or to create new types of swaps or security-based swaps at the dealer's own initiative.

See

CFTC Regulation § 1.3(ggg); Exchange Act rule 3a71-1(a), (b).

Proposing Release, 75 FR at 80176.

The proposal recognized that the principles for identifying dealing activity involving swaps can differ from principles for identifying dealing activity involving security-based swaps, in part due to differences in how those instruments are used.

Id.

a. “Swap Dealer” Activity

Consistent with the statutory definition, the proposed rule stated that the term “swap dealer” includes a person that “regularly enters into swaps with counterparties as an ordinary course of business for its own account,” but also that “the term swap dealer does not include a person that enters into swaps for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business.” The Proposing Release stated that these two provisions should be read in combination with each other, and explained that the difference between the two provisions is whether or not the person enters into swaps as a part of, or as an ordinary course of, a “regular business.” Thus, the Proposing Release equated the phrases “ordinary course of business” and “regular business.” The Proposing Release also stated that persons who enter into swaps as a part of a “regular business” are those persons whose function is to accommodate demand for swaps from other parties and enter into swaps in response to interest expressed by other parties. Such persons would be swap dealers.

Conversely, the Proposing Release said that persons who do not fulfill this function in connection with swaps should not be deemed to enter into swaps as part of a “regular business,” and thus would not likely be swap dealers.

In addition, the Proposing Release explained that (in general, and not specifically limited to the provisions relating to entering into swaps as part of a “regular business”) the proposed swap dealer definition does not depend on whether a person's activity as a swap dealer is the person's sole or predominant business (other than through the

de minimis

exception discussed below).

See

Proposing Release, 75 FR at 80177.

In addition, the Proposing Release noted that the nature of swaps precludes importing concepts used to identify dealers in other areas. The Proposing Release explained that because swaps are typically not bought and sold, concepts such as whether a person buys and sells swaps, makes a two-sided market in swaps, or trades within a bid/offer spread cannot necessarily be used to determine if the person is a swap dealer, even if such concepts are useful in determining whether a person is a dealer in other financial instruments.

See id.

at 80176-77.

The Proposing Release further stated that swap dealers can be identified through their relationships with counterparties, explaining that swap dealers tend to enter into swaps with more counterparties than do non-dealers, and in some markets, non-dealers tend to constitute a large portion of swap dealers' counterparties. In contrast, the Proposing Release said, non-dealers tend to enter into swaps with swap dealers more often than with other non-dealers. The Proposing Release noted that it is likely that swap dealers are involved in most or all significant parts of the swap markets.

See id.

at 80177.

The Proposing Release concluded that this functional approach would identify as swap dealers those persons whose function is to serve as the points of connection in the swap markets. Thus, requiring registration and compliance with the requirements of the Dodd-Frank Act by such persons would thereby reduce risk and enhance operational standards and fair dealing in those markets.

See id.

The Proposing Release also noted that the swap markets are diverse and encompass a wide variety of situations in which parties enter into swaps with each other, and invited comment as to what aspects of the parties' activities in particular situations should, or should not, be considered swap dealing activities. Specifically, the Proposing Release invited comment regarding persons who enter into swaps: (i) As aggregators; (ii) as part of their participation in physical markets; or (iii) in connection with the generation and transmission of electricity.

See id.

at 80183-84.

First, regarding aggregators, the Proposing Release noted that some persons, including certain cooperatives, enter into swaps with other parties in order to aggregate the swap positions of the other parties into a size that would be more amenable to entering into swaps in the larger swap market. The Proposing Release explained that, for example, certain cooperatives enter into swaps with smaller businesses because the smaller business cannot establish a commodity position large enough to be traded on a swap or futures market, or large enough to be of interest to larger financial institutions. The Proposing Release said that while such persons engage in activities that are similar in many respects to those of a swap dealer, it may be that the swap dealing activities of these aggregators would not exceed the

de minimis

threshold, and therefore they would not be swap dealers. The CFTC requested comment as to how the

de minimis

threshold would apply to such persons, and in general on the application of the swap dealer definition to this activity. The Proposing Release also noted that the CFTC was engaged in a separate rulemaking pursuant to section 723(c)(3)(B) of the Dodd-Frank Act regarding swaps in agricultural commodities, and requested comment on the application of the swap dealer definition to dealers, including potentially agricultural cooperatives, that limit their dealing activity primarily to swaps in agricultural commodities.

After publication of the Proposing Release, the CFTC adopted a final rule on agricultural swaps under which swaps in agricultural commodities will be permitted to transact subject to the same rules as all other swaps.

See

Agricultural Swaps; Final Rule, 76 FR 49291 (Aug. 10, 2011).

Second, the Proposing Release noted that the markets in physical commodities such as oil, natural gas, chemicals and metals have developed highly customized transactions, some of which would be encompassed by the statutory definition of the term “swap,” and that some participants in these markets engage in swap dealing activities that are above the proposed

de minimis

threshold. The CFTC invited comment as to any different or additional factors that should be considered in applying the swap dealer definition to participants in these markets.

Third, the Proposing Release noted a number of complexities that arise when applying the swap dealer definition in connection with the generation and transmission of electricity. In particular, the Proposing Release noted that additional complexity results because electricity is generated, transmitted and used on a continuous, real-time basis, and because the number and variety of participants in the electricity market is very large, and some electricity services are provided as a public good rather than for profit. The CFTC invited comment as to any different or additional factors that should be considered in applying the swap dealer definition to participants in the generation and transmission of electricity. Specifically, the CFTC invited comment on whether there are special considerations, including without limitation special considerations arising from section

201(f) of the Federal Power Act,

related to not-for-profit power systems such as rural electric cooperatives and entities operating as political subdivisions of a state and on the applicability of the exemptive authority in section 722(f) of the Dodd-Frank Act to address those considerations.

16 U.S.C. 824(f).

b. “Security-Based Swap Dealer” Activity

The Proposing Release noted the parallels between the definition of “security-based swap dealer” and the definition of “dealer” under the Exchange Act,

as well as the fact that security-based swaps may be used to hedge risks associated with owning certain types of securities or to gain economic exposure akin to ownership of certain types of securities. As a result, the Proposing Release took the view that the same factors that are relevant to determining whether a person is a “dealer” under the Exchange Act also are generally relevant to the analysis of whether a person is a security-based swap dealer. The Proposing Release also addressed the relevance of the “dealer-trader” distinction for identifying dealing activity involving security-based swaps,

while recognizing that certain concepts associated with the dealer-trader distinction—particularly concepts involving “turnover of inventory” and “regular place of business”—appeared potentially less applicable to the security-based swap dealer definition. In addition, the Proposing Release noted that under the dealer-trader distinction, we would expect that entities that use security-based swaps to hedge business risks, absent other activities, likely would not be dealers.

See

Exchange Act sections 3(a)(5)(A), (B), 15 U.S.C. 78c(a)(5)(A), (B), as amended by Section 761(a)(1) of the Dodd-Frank Act.

The Proposing Release referred to the fact that the SEC previously has noted that the dealer-trader distinction: “recognizes that dealers normally have a regular clientele, hold themselves out as buying or selling securities at a regular place of business, have a regular turnover of inventory (or participate in the sale or distribution of new issues, such as by acting as an underwriter), and generally provide liquidity services in transactions with investors (or, in the case of dealers who are market makers, for other professionals).” Proposing Release, 75 FR at 80177 (

citing

Securities Exchange Act Release No. 47364 (Feb. 13, 2003) (footnotes omitted)). The Proposing Release further noted that other non-exclusive factors that are relevant for distinguishing between dealers and non-dealers can include receipt of customer property and the furnishing of incidental advice in connection with transactions.

See id.

See

Proposing Release, 75 FR at 80177-78.

c. Additional Principles Common to Both Definitions

i. “Hold Themselves Out” and “Commonly Known in the Trade” Tests

The Proposing Release identified the following non-exclusive list of factors as potentially indicating that a person meets the “hold themselves out” and “commonly known in the trade” tests of the statutory dealer definitions:

• Contacting potential counterparties to solicit interest in swaps or security-based swaps;

• Developing new types of swaps or security-based swaps (which may include financial products that contain swaps or security-based swaps) and informing potential counterparties of the availability of such swaps or security-based swaps and a willingness to enter into such swaps or security-based swaps with the potential counterparties;

• Membership in a swap association in a category reserved for dealers;

• Providing marketing materials (such as a Web site) that describe the types of swaps or security-based swaps that one is willing to enter into with other parties; or

• Generally expressing a willingness to offer or provide a range of financial products that would include swaps or security-based swaps.

See id.

at 80178.

The Proposing Release further stated that the test for being “commonly known in the trade” as a swap dealer or security-based swap dealer may appropriately reflect, among other factors, the perspective of persons with substantial experience with and knowledge of the swap and security-based swap markets (regardless of whether a particular entity is known as a dealer by persons without that experience or knowledge). The Proposing Release also stated that holding oneself out as a security-based swap dealer likely would encompass a person who is a dealer in another type of security entering into a security-based swap with a customer, as well as a person expressing its availability to enter into security-based swaps, regardless of the direction of the transaction or across a broad spectrum of risks.

See id.

ii. Market Making

In addressing the statutory definitions' “making a market” test, the Proposing Release noted that while continuous two-sided quotations and a willingness to buy and sell a security are important indicators of market making in the equities market, these indicia may not be appropriate in the swap and security-based swap markets. The proposal also noted that nothing in the statutory text or legislative history suggested the intent to impute a “continuous” activity requirement to the dealer definitions.

See id.

iii. No Predominance Test

The Proposing Release further addressed whether a person should be a dealer only if that activity is the person's sole or predominant business, and took the view that such an approach was not consistent with the statutory definition. The Proposing Release rejected this as an unworkable test of dealer status because many parties that commonly are acknowledged as dealers also engage in other businesses that outweigh their swap or security-based swap dealing business in terms of transaction volume or other measures.

See id.

at 80178-79.

iv. Application to New Types of Wwaps and New Activities

The Proposing Release noted that the Commissions intended to apply the dealer definitions flexibly when the development of innovative business models is accompanied by new types of dealer activity, following a facts-and-circumstances approach.

See id.

at 80179.

2. Commenters' Views

Numerous commenters addressed the proposed rules and interpretations in connection with the “swap dealer” and “security-based swap dealer” definitions. Several commenters addressed principles that are common to the two dealer definitions, while a number of commenters also addressed interpretations in the Proposing Release that were specific to the “swap dealer” definition.

a. “Hold Themselves Out” and “Commonly Known in the Trade” Tests

Some commenters expressed the view that the persons that hold themselves out as or are commonly known as dealers are easy to identify.

In addressing the “hold themselves out” and “commonly known” criteria of the dealer definitions, commenters placed particular focus on whether only dealers engage in the activities cited by the

Proposing Release, or whether those activities are common both to dealers and to other users of swaps and security-based swaps. Commenters particularly stated that end users contact potential counterparties,

develop new types of swaps or security-based swaps,

and propose terms or language for swap or security-based swap agreements.

One commenter further stated that identifying dealing activity based on whether a person develops new types of swaps or proposes swap terms would discourage innovation and the free negotiation of swaps.

Some commenters stated that merely responding to a request for proposals or quotations should not, in itself, constitute dealing.

Commenters also criticized the Proposing Release's suggestion that criteria for identifying dealing activity include membership in a dealer category of a trade association,

as well as providing marketing materials and offering a range of financial products.

Commenters also argued for more objective criteria for identifying persons “commonly known” as dealers.

See

transcript of Joint CFTC-SEC Staff Roundtable Discussion on Proposed Dealer and Major Participant Definitions Under Dodd-Frank Act, June 16, 2011 (“Roundtable Transcript”) at 22-23 (remarks of Ron Filler, New York Law School), 50-51 (remarks of Ron Oppenheimer, Working Group of Commercial Energy Firms), 215 (remarks of Bella Sanevich, NISA Investment Advisors LLC).

See

letters from the Financial Services Roundtable (“FSR”) dated February 22, 2011 (“FSR I”), the International Swap Dealers Association (“ISDA”) dated February 22, 2011 (“ISDA I”) and the Midsize Bank Coalition of America (“Midsize Banks”).

See

letters from the Committee on Capital Markets Regulation (“CCMR”) dated February 22, 2011 (“CCMR I”), FSR I, ISDA I and Midsize Banks.

See

letters from the BG Americas & Global LNG (“BG LNG”) dated February 22, 2011 (“BG LNG I”), CCMR I, EDF Trading North America, LLC (“EDF Trading”) and The Gavilon Group, LLC (“Gavilon”) dated February 21, 2011 (“Gavilon II”).

See

letter from EDF Trading.

See

meeting with American Electric Power, Calpine Corporation (“Calpine”), Constellation, DC Energy LLC (“DC Energy”), Edison International (“Edison Int'l”), Exelon Corp., GenOn, Southern Company, Edison Electric Institute (“EEI”) and Electric Power Supply Association (“ESPA”) (collectively “Electric Companies”) on April 13, 2011.

See

letter from ISDA I and joint letter from National Corn Growers Association (“NCGA”) and Natural Gas Supply Association (“NGSA”) (“NCGA/NGSA”) dated February 22, 2011 (“NCGA/NGSA I”).

See

letter from ISDA I.

See

letters from ISDA I and Peabody Energy Corporation (“Peabody”).

Conversely, one commenter said that three particular activities cited in the Proposing Release—membership in a swap association category reserved for dealers, providing marketing materials and expressing a willingness to offer a range of financial products—are indicative of holding oneself out as a dealer or being commonly known in the trade as a dealer, and should be codified in the final rule.

Another commenter suggested other factors, such as having a derivatives sales team, that should be treated as indicators of dealer activity.

Commenters also expressed the view that this aspect of the dealer definition should focus on whether a person solicits expressions of interest in swaps from a range of market participants,

and that end users of swaps can actively seek out and negotiate swaps without necessarily being swap dealers.

See

letter from FSR I.

See

meeting with Vitol, Inc. (“Vitol”) on February 16, 2011.

See

letter from Midsize Banks.

See

letter from EDF Trading.

b. Market Making

Several commenters generally requested that the Commissions provide more guidance as to which activities constitute making a market in swaps or security-based swaps.

Commenters also described various activities as indicating, or not indicating, market making activity. For example, two commenters expressed the view that market making is characterized by entering into swaps on one side of the market and then establishing offsetting positions on the other side of the market.

Other commenters equated market making to providing liquidity by regularly quoting bid and offer prices for swaps, and standing ready to enter into swaps.

One commenter stated that market making activity is indicated by a person consistently presenting itself as willing to take either side of a trade.

Two commenters said that market makers receive tangible benefits (such as reduced trading fees) in return for the obligation to transact when liquidity is required.

See

joint letter from American Benefits Council and the Committee on Investment of Employee Benefits Assets (“ABC/CIEBA”) and letters from FSR I.

See

letters from DC Energy and FSR I.

See

letters from Edison Int'l, NextEra Energy Resources, LLC (“NextEra”) dated February 22, 2011 (“NextEra I”) and Vitol, and joint letter from American Electric Power, Edison Int'l, Exelon Corp., and Southern Company (“Utility Group”).

See

letter from ISDA I.

See

joint letter from EEI and EPSA (“EEI/EPSA”) and letter from Vitol.

In contrast, one commenter said the proposal correctly did not limit market making to consistently quoting a two-sided market, because to do so would insert a loophole into the definition.

Some commenters expressed the view that mere active participation in a market or entering into swaps on both sides of a market does not necessarily constitute market making.

Others said that occasionally quoting prices on both sides of the market is not market making when done to obtain information about the market or to mask one's view of the market.

One commenter stated that futures commission merchants (“FCMs”) and broker-dealers that facilitate customers' entering into swaps are not necessarily market makers.

Other commenters urged the Commissions to reject the view that market making requires continuous activity.

See

letter from Americans for Financial Reform (“AFR”).

See

letters from ABC/CIEBA, Managed Funds Association (“MFA”) dated February 22, 2011 (“MFA I”), and Vitol.

See

letters from NextEra Iand Vitol.

See

letter from Newedge USA LLC (“Newedge”);

see also

Roundtable Transcript at 39 (remarks of Eric Chern, Chicago Trading Company).

See

letters from American Federation of State, County and Municipal Employees (“AFSCME”), and FSR I.

A number of commenters addressed the issue of how the dealer definitions should treat swaps or security-based swaps entered into on a trading platform such as a designated contract market (“DCM”), national securities exchange, swap execution facility (“SEF”), or security-based SEF (collectively referred to herein as “exchanges”).

Several stated that entering into swaps or security-based swaps on exchanges should not be considered in determining if a person is a dealer.

Some of these commenters emphasized the fact that parties would not know the identity of the counterparty to the swap executed on an exchange (

i.e.,

such swaps are “anonymous”),

while other commenters said that such swaps do not constitute “accommodating demand” for swaps or “facilitating interest” in swaps.

Another commenter said that future means of executing swaps on exchanges are likely to be diverse, and it is premature to draw conclusions

about how they should be treated in the dealer definitions.

While some of these commenters specially addressed this issue in the context of whether a person is a market maker in swaps, others more generally addressed the issue in terms of whether a person is a dealer. For clarity, all of those comments are being addressed in the market maker context.

See

letters from EEI/EPSA, International Energy Credit Association (“IECA-Credit”) dated February 22, 2011 (“IECA-Credit I”), and NextEra I, joint letter from Shell Trading (US) Company and Shell Energy North America (US), L.P. (“Shell Trading”) dated February 22, 2011 (“Shell Trading I”), and joint letter from Allston Trading, LLC, Atlantic Trading USA LLC, Bluefin Trading LLC, Chopper Trading LLC, DRW Holdings, LLC, Eagle Seven, LLC, Endeavor Trading, LLC, Geneva Trading USA, LLC, GETCO, Hard Eight Futures, LLC, HTG Capital Partners, IMC Financial Markets, Infinium Capital Management LLC, Kottke Associates, LLC, Liger Investments Limited, Marquette Partners, LP, Nico Holdings LLC, Optiver US, Quantlab Financial, LLC, RGM Advisors, LLC, Tibra Trading America LLC, Traditum Group LLC, WH Trading and XR Trading LLC (“Traders Coalition”).

See

letters from Shell Trading I and Traders Coalition.

See

letters from EEI/EPSA, IECA-Credit I, and NextEra I. For further discussion of this issue,

see

parts II.A.4 and II.A.5 below.

See

letter from Metropolitan Life Insurance Company (“MetLife”).

Two commenters asserted that firms that provide liquidity in cleared and exchange-executed swaps by actively participating in the market provide heterogeneity among liquidity providers and thereby disperse risk, and further stated that to regulate such persons as swap dealers subject to increased capital requirements would discourage their participation in the market and increase risk.

See

letters from Newedge and Traders Coalition; Roundtable Transcript at 39 (remarks of Eric Chern, Chicago Trading Company).

One commenter expressed the view that the statutory definition uses dealing and market making interchangeably, and suggested that the analysis of whether a person acts as a dealer should be subsumed within the analysis of whether it acts as a market maker.

See

letter from ISDA I.

c. Exception for Activities Not Part of a “Regular Business”

Several commenters addressed the exception from the dealer definitions for swap or security-based swap activities that are not part of a “regular business.” Some commenters supported the Commissions' proposed interpretation in the context of the “swap dealer” definition and stated that this interpretation should be codified in the text of the final rule.

See

letters from FSR I, MFA I and Midsize Banks.

Many commenters said that the activity of entering into swaps or security-based swaps should not be deemed to be a “regular business,” and thus not indicative of dealing activity, when the person's use of swaps or security-based swaps are ancillary to, or in connection with, a separate non-swap business that is the person's primary business.

Some commenters making this point said that when the person's primary business relates to physical commodities, the person's use of swaps relating to those commodities does not constitute a “regular business.”

Other commenters stated that where a person enters into swaps to serve its own business needs, as opposed to serving the business needs of the counterparty, the person's use of swaps does not constitute a “regular business.”

Other commenters said that the use of swaps to hedge the commercial risks of a business does not constitute a “regular business” of entering into swaps.

Some commenters also suggested that the “regular business” exclusion should be interpreted to mean “regular swap dealing business” or “regular security-based swap dealing business” to prevent the dealer definitions from capturing hedgers.

See

Roundtable Transcript at 88 (remarks of Steve Walton, Bank of Oklahoma).

See

letters from Atmos Energy Corporation (“Atmos Energy”), Dominion Resources, Inc. (“Dominion Resources”), EDF Trading, Edison Int'l, EEI/EPSA, Gavilon II, Hess Corporation and its affiliates (“Hess”), Mississippi Public Utility Staff, NextEra I, National Milk Producers Federation (“NMPF”), Shell Trading I, Utility Group and Working Group of Commercial Energy Firms (“WGCEF”) on the swap dealer definition dated February 22, 2011 (“WGCEF I”), and meeting with Bunge on February 23, 2011.

See

letters from BT Pension Scheme Management Limited (“BTPS”), EDF Trading, EEI/EPSA and Vitol.

See

letters from American Petroleum Institute (“API”) dated February 22, 2011 (“API I”), Calpine, Coalition of Physical Energy Companies (“COPE”) dated February 22, 2011 (“COPE I”), Dominion Resources, EDF Trading, Edison Int'l and Peabody;

see also

Roundtable Transcript at 45 (remarks of Ed Prosser, Gavilon) and letter from Church Alliance. In addition, three commenters said that the interpretation of the provisions relating to a “regular business” in the Proposing Release is correct, because it will exclude from the definition of swap dealer those persons using swaps to hedge commercial risk.

See

letters from Air Transport Association of America, Inc. (“ATAA”), IECA-Credit I and joint letter from Petroleum Marketers Association of America and New England Fuel Institute.

See

letters from Church Alliance and Peabody.

On the other hand, two commenters said that the proposed interpretation was correct in the view that the test of whether a person has a “regular business” of entering into swaps does not necessarily depend on whether a person's swap activities are a predominant activity, because such an approach would allow a person to engage in a significant level of swap dealing activity without registering as a swap dealer simply because the person also has substantial activities in a non-swap business or businesses.

See

letters from AFR and Better Markets, Inc. (“Better Markets”) dated February 22, 2011 (“Better Markets I”).

Other commenters suggested that the types of swap activities that a person engages in are relevant to determining whether the person has a “regular business” of entering into swaps. One commenter stated that a person has a “regular business” of entering into swaps when the person has a primary business of accommodating demand or facilitating interest in swaps,

while others similarly emphasized that a “regular business” of entering into swaps is characterized by financial intermediation activities.

One commenter took the view that a person that enters into swaps primarily with financial intermediaries does not have a “regular business” of entering into swaps.

See

letter from IECA-Credit I.

See

letter from NextEra I and Shell Trading I. Another commenter disagreed with this approach, however, saying that a person who enters into swaps as an intermediary between smaller customers and larger financial institutions is not entering into swaps for its “own account” and therefore is not a swap dealer, but rather would be an FCM or introducing broker.

See

letter from MFX Solutions, Inc. (“MFX”) dated February 22, 2011 (“MFX I”).

See

letter from Traders Coalition.

Some commenters said that the final rule should clarify the point at which a person's episodic or occasional swap activities become a “regular business” of entering into swaps.

Others stated that the fact that a person enters into swaps frequently or with a large number of counterparties does not necessarily mean that the person has a “regular business” of entering into swaps.

See

letters from BG LNG I and WGCEF I.

See

letters from NCGA/NGSA I and Vitol. One of these commenters asked that the final rule clarify that simply because a person engages in swap activity exceeding the thresholds for the

de minimis

exception from the swap dealer definition does not necessarily mean that the person is engaged in a “regular business” of swap dealing.

See

letter from Vitol.

Commenters proposed specific tests for determining if a person has a “regular business” of entering into swaps. One commenter said the determination should look to whether a person enters into swaps to accommodate demand from other parties and to profit from a bid/ask spread on swaps (as opposed to swaps that are substitutes for physical transactions or positions and used by at least one party to hedge commercial risk), and consider specifically the volume, revenues and profits of such activities, the person's value at risk (VaR) and exposure from such activities, and its resources devoted to such activities.

Another commenter said that the determination should be based on the nature of the person's business, the person's business purpose for using swaps, and the person's method of executing swap transactions (

e.g.,

a person whose business primarily relates to physical commodities, who uses swaps to hedge commercial risk, and who executes swaps on an exchange would be less likely to have a “regular business” of entering into swaps).

See

letter from NextEra I;

see also

letter from Hess (proposing similar criteria).

See

letter from Shell Trading I.

One commenter argued that the “regular business” exception should apply to all four of the dealer tests—not only the test for persons that regularly enters into swaps or security-based swaps as an “ordinary course of business”—and further argued that the “regular business” exception should be linked to a “two-way market” base

requirement to avoid commercial hedgers being encompassed by the dealer definitions.

See

letter from ISDA dated I.

d. Other Dealer Issues

Commenters also addressed other issues in the Proposing Release, including: (i) Whether Congress intended that there be implicit preconditions to dealer status; (ii) whether the concepts of “accommodating demand” for swaps or security-based swaps or “facilitating interest” in swaps are useful in identifying dealers; and (iii) whether the interpretation of the dealer definitions should depend on pre-defined, objective criteria.

i. Preconditions

Several commenters said that the proposal is overbroad and would encompass persons that Congress did not intend to regulate as dealers.

Comments in this vein said that the statutory definition should be interpreted to require that persons meet certain criteria or engage in certain activity, not explicitly stated in the statute, to be covered by the swap dealer definition. For instance, some commenters said that a dealer is a person who enters into swaps or security-based swaps on either side of the market and who profits from fees for doing so, or from the spread between the terms of swaps on either side of the market.

Other commenters made a similar point, saying that swap dealers are those persons that intermediate between swap users on either side of the market.

See, e.g.,

letters from BG LNG I, EDF Trading, ISDA I, NCGA/NGSA dated February 17, 2012 (“NCGA/NGSA II”) and WGCEF I, and joint letter from American Farm Bureau Federation, American Soybean Association, National Association of Wheat Growers, National Cattlemen's Beef Association, National Corn Growers Association, National Council of Farmer Cooperatives, National Grain and Feed Association, National Milk Producers Federation and National Pork Producers Council (“Farmers' Associations”).

See

letters from COPE I, Edison Int'l, Hess, ISDA I, Shell Trading I, Utility Group, Vitol and WGCEF I;

see also

Roundtable Transcript at 43-45 (remarks of Ed Prosser, Gavilon). However, other commenters questioned whether profiting from a bid/ask spread is a relevant test of dealer status, and emphasized that dealers are those persons who take risk by entering into swaps or security-based swaps on both sides of the market.

See

Roundtable Transcript at 21, 56 (remarks of Richard Ostrander, Morgan Stanley) and 43 (remarks of Russ Wasson, National Rural Electric Cooperative Association (“NRECA”)). Another commenter pointed out that it could be difficult to determine how a person is profiting from entering into swaps.

See

Roundtable Transcript at 42 (remarks of Michael Masters, Better Markets).

See

letters from API I, BG LNG I and NCGA/NGSA II.

The commenters were not all in agreement on this, however. Several commenters (including some of those that said swap dealers enter into swaps on both sides of the market) also stated that there are a variety of situations in which a person's activity of contemporaneously entering into swaps on both sides of the market is not indicative of dealing activity.

One commenter said that it would not be appropriate to require that a person enter into swaps or security-based swaps on both sides of the market as a litmus test for dealer status, because to do so would create loopholes in the definition.

Two commenters also supported rejection of any interpretation that would limit the dealer definitions to encompass only those entities that solely or predominately act as dealers.

The examples cited were: entering into swaps on either side of a market depending on a firm's commercial purpose for entering each particular swap (

see

letters from the Industrial Energy Consumers of America (“IECA-Consumers”) and WGCEF I, and letter from the Not-For-Profit Electric End User Coalition (“NFPEEU”), consisting of NRECA, American Public Power Association (“APPA”) and Large Public Power Council (“LPPC”);

see also

Roundtable Transcript at 44 (remarks of Ed Prosser, Gavilon)); entering into swaps on both sides of an illiquid market for purposes of price discovery or to elicit bids and offers from other market participants (

see

letters from Hess, Vitol and WGCEF I); and entering into swaps on both sides of the market as part of an investment strategy (

see

letter from ABC/CIEBA).

See

letter from AFR.

See

letters from AFR and Better Markets I.

In addition, commenters were particularly divided as to whether acting as an intermediary always is indicative of swap dealing, as some commenters said that a person is not a swap dealer when it simply stands between two parties by entering into offsetting swaps with each party.

See

letters from BOKF, National Association (“BOK”) dated January 13, 2012 (“BOK V”), MFX I, Newedge and Northland Energy Trading LLC (“Northland Energy”);

see also

Roundtable Transcript at 48 (remarks of John Nicholas, Newedge). One commenter queried whether the final rule should clarify whether a customer relationship between the parties to a swap is necessary in order for the swap to be relevant in determining whether either of the parties is a swap dealer.

See

letter from Representative Scott Desjarlais (“Rep. Desjarlais”).

ii. “Accommodating Demand” and “Facilitating Interest”

A number of commenters addressed the Proposing Release's view that a tendency to accommodate demand for swaps and a general availability to enter into swaps to facilitate other parties' interest in swaps (referred to here as “accommodating demand” and “facilitating interest”) are characteristic of swap dealers. Some commenters stated that accommodating demand and facilitating interest would not be effective factors to identify swap dealers, particularly in bilateral negotiations where it is difficult to say which party is accommodating demand for swaps.

Other commenters said the activities of accommodating demand or facilitating interest are indicative of swap dealing only in certain circumstances, such as when they are not related to a person's commodity business,

or when done with the purpose of serving the needs of the other party to the swap.

Some commenters argued that the statement in the Proposing Release that swap dealers are likely involved in most or all significant parts of the swap markets is incorrect in the market for energy swaps. There, the commenters said, persons can find counterparties for swaps without the intermediation of a swap dealer, and swaps entered into directly by two end users are more frequent.

See

letters from NextEra I and Peabody and meeting with Vitol on February 15, 2011.

See

letter from Shell Trading I.

See

letters from IECA-Credit I, National Association of Insurance Commissioners (“NAIC”), Vitol and WGCEF I. One of these commenters also said that entering into a bespoke swap with a registered swap dealer, in which the swap dealer lays off risk, should not be viewed as accommodating demand or facilitating interest.

See

letter from Vitol.

See

letter from BG LNG I, NCGA/NGSA I, NFPEEU, NRG Energy, Inc. (“NRG Energy”) and WGCEF I and meeting with Vitol on February 16, 2011.

Other commenters, though, said that the proposal's focus on accommodating demand and facilitating interest strikes the right balance and that the proposed approach is generally correct.

Another commenter did not object to including accommodating demand and facilitating risk as factors in the definition, but said that those factors should be applied flexibly.

See

letters from AFR and MFX I.

See

letter from National Grain and Feed Association (“NGFA”) dated February 22, 2011 (“NGFA I”).

iii. Application of Objective Criteria, and Additional Factors

Some commenters, specifically addressing the CFTC's proposed interpretive approach to the “swap dealer” definition, said that the final rule should set out objective criteria that market participants could use to determine whether or not they are covered by the definition and therefore required to register as swap dealers.

Others focused especially on statements in the Proposing Release to the effect that swap dealers are those persons who “tend to” engage in certain activities, and that persons who engage in certain activities are “likely” to be swap dealers, as being overly subjective and difficult to interpret.

See

letters from BG LNG I, EEI/EPSA, Peabody, Rep. Desjarlais and Utility Group. Some commenters said that the CFTC's interpretive approach to the swap dealer definition should be codified in the text of the final rule.

See

letters from Alternative Investment Management Association Limited (“AIMA”) dated February 22, 2011 (“AIMA I”) and COPE I.

See

letters from BG LNG I, Chesapeake Energy Corporation (“Chesapeake Energy”), COPE I, ISDA I, Vitol and WGCEF I. Some commenters focused on particular aspects of the swap dealer definition as requiring further detail, such as, for example, what it means to be “commonly known in the trade” as a swap dealer (

see

letter from Peabody) and the definition of market making (

see

letters from Midsize Banks and Peabody).

Certain commenters suggested specific objective criteria to use to identify swap dealers. One commenter said that swap dealing activity is characterized by more frequent use of swaps; having substantial staff and technological resources devoted to swaps; a larger portion of revenue and profit being derived from swap activity; and owning fewer physical assets related to the type of swaps entered into.

Another commenter said that to identify swap dealers, the CFTC should compare a person's revenue or profits generated by swap activity to its overall revenue or profits; compare a person's total business volume to the volume, VaR and exposure associated with the swap activity; compare a person's total business resources to the resources devoted to swap activity; and consider ownership or control of physical assets in the specific market or region to which the person's swap activity is tied.

See

letter from Hess.

See

letter from NextEra I.

More generally, some commenters supported codification of more concrete tests in connection with the dealer definitions.

100

However, other commenters said that the use of bright line rules to determine whether a person is a dealer would be inappropriate given the dynamic nature of the swap and security-based swap markets. These commenters supported a facts and circumstances approach to the dealer definition as a better approach.

101

One commenter also raised issues about the sources of information that may be considered as part of a dealer determination.

102

100

See, e.g.,

letters from EEI/EPSA, FSR I, ISDA I, NextEra I and WGCEF I.

101

See

letters from Better Markets I, Chris Barnard (“Barnard”) and Prof. Michael Greenberger, University of Maryland School of Law (“Greenberger”).

102

See

letter from ISDA I (stating that sources of information considered by the Commissions in determining dealer status should be revealed to the entity being evaluated).

e. Application of Exchange Act “Dealer-Trader” distinction

i. Security-Based Swap Dealer Definition

A number of commenters supported the proposed use of the dealer-trader distinction under the Exchange Act to interpret the “security-based swap dealer” definition.

103

Two commenters, however, specifically opposed use of the distinction in the context of security-based swaps, arguing that use of the distinction would create confusion or would be inconsistent with the goal of improved transparency.

104

103

See, e.g.,

letters from Coalition for Derivatives End-Users (“CDEU”), CCMR I, ISDA I and MetLife.

104

See

letters from AFR and AFSCME.

ii. Swap Dealer Definition

Some commenters said that the CFTC should apply the dealer-trader distinction as it has been interpreted with respect to the definition of “dealer” under the Exchange Act to identify swap dealers.

105

Some commenters said that the applicable interpretations under the Exchange Act mean that swaps a person uses for proprietary trading (including for speculative purposes) should not be considered in determining if the person is a swap dealer because dealers enter into transactions in order to profit from spreads or fees regardless of their view of the market for the underlying item, whereas traders enter into transactions in order to take a view on the direction of the market or to obtain exposure to movements in the price of the underlying item.

106

Two commenters said that if the CFTC applied the distinction, traders should be subject to potential registration as major swap participants, and dealers should be subject to regulation as swap dealers.

107

Commenters acknowledged differences between the market for swaps and the market for securities, but said that the Exchange Act interpretations are still relevant.

108

105

Some of these commenters said that, since some provisions in the statutory swap dealer definition are similar to the definition of a “dealer” under the Exchange Act, Congress intended that the two definitions would be applied in the same way.

See

letters from API I, BG LNG I, CDEU, IECA-Consumers and WGCEF I. Others said that the CFTC should apply these interpretations because they have been effectively applied for a long time in the context of securities.

See

letters from CCMR I and MFA I.

106

See

letters from Gavilon II, and Next Era I, and meetings with Electric Companies on April 13, 2011 and WGCEF on April 28, 2011. Another commenter said the interpretations mean that dealers and traders can be distinguished by their activities: dealers hold themselves out as buying and selling on a regular basis, derive income from providing services in the chain of distribution, and profit from price spreads, while traders do not provide services or extend credit but, rather, profit from changes in the market value of underlying items.

See

letter from API I.

107

See

letters from EDF Trading and IECA-Consumers.

108

See

letters from API I, Gavilon I and IECA-Consumers.

On the other hand, some commenters agreed with the CFTC's view not to apply Exchange Act interpretations to the definition of the term “swap dealer.” These commenters said that it is appropriate not to apply the interpretations under the Exchange Act to identify persons that meet the swap dealer definition under the CEA.

109

See

letters from AFR and AFSCME;

see also

joint meeting with AFR and Better Markets on March 17, 2011 (dealer-trader distinction not helpful in identifying swap dealers because the transparency and operational robustness of the swap market is much lower than in the securities market). One commenter said the precedents should be applied only by the SEC to identify security-based swap dealers.

See

letter from NAIC.

e. Application to Particular Swap Markets

i. Aggregators

Certain commenters addressed persons who enter into swaps as aggregators, with most of those commenters discussing agricultural cooperatives. Commenters said that agricultural cooperatives that hedge their own risks or the risks of their members regarding agricultural commodities should be excluded from the swap dealer definition because Congress did not intend to treat agricultural cooperatives as swap dealers and because agricultural cooperatives are in effect an extension of their members.

110

Some commenters said that the agricultural cooperatives' use of swaps allows their members to hedge risks when the members' transactions are too small for (or otherwise not qualified for) the futures markets.

111

110

See

letters from Dairy Farmers of America (“DFA”), Growmark, Land O'Lakes, Inc. (“Land O'Lakes”) dated February 22, 2011 (“Land O'Lakes II”), National Council of Farmer Cooperatives (“NCFC”) dated February 22, 2011 (“NCFC I”) and NMPF. One commenter also said that a subsidiary of an agricultural cooperative that enters into swaps with its parent cooperative, and the members of the parent cooperative, should be excluded from the swap dealer definition for the same reason.

See

meeting with Agrivisor. Another commenter said that an agricultural cooperative's swaps with farmers and other persons for risk management should be disregarded in determining if the cooperative is a swap dealer so long as the swaps relate to the marketing function of the cooperative, even if the swaps are not with members of the cooperative.

See

letter from NMPF.

111

See

letters from DFA and Growmark.

Some commenters said that an exclusion from the swap dealer definition also should be available to private companies that serve as aggregators for swaps in agricultural commodities or otherwise offer swaps

for agricultural risk management.

112

These commenters said that such an exclusion would reduce the costs and regulatory burdens imposed on such companies and therefore provide a broader choice of swap providers to farmers and other agricultural market participants, which they said would reduce risks.

113

112

See

letters from Farmers' Associations, NGFA I and NMPF.

113

See id.

One commenter discussed a small energy firm that aggregates demand for swaps from small energy retailers and consumers. This commenter said that such aggregators should be excluded from the swap dealer definition because imposing the swap dealer regulations (which would be promulgated with large financial firms in mind) on such firms would increase costs for the aggregators, discourage the aggregators' offering of swaps, and thereby reduce choice and efficiency in the market.

114

Another commenter said that a firm that enters into swaps with microfinance lenders and offsetting swaps with commercial banks is akin to an introducing broker or FCM, and should be excluded from the swap dealer definition on the grounds that it does not enter into swaps on its own initiative, but rather to provide access to the swap markets to smaller counterparties.

115

114

See

letter from Northland Energy. This commenter defined an “aggregator” as a person who: (i) Enters into swaps predominantly in one direction with counterparties that are using swaps to establish bona fide hedges; and (ii) offsets risks associated with such swaps using regulated futures contracts or cleared swaps.

115

See

letter from MFX dated June 3, 2011 (“MFX II”). This commenter said that the exclusion should be available to a person who operates primarily on a not-for-profit basis and limits its swap activities to offering swaps to persons in underserved markets and offsetting such swaps, and who meets other requirements to limit the scope of the exclusion.

Another commenter said that there is no need for any special treatment of aggregators in the swap dealer definition. According to this commenter, the CFTC's guidance regarding the definition and the

de minimis

exception from the definition address the relevant issues properly and completely.

116

See

letter from Better Markets I.

ii. Physical Commodity Swaps

Commenters that discussed physical commodity swaps primarily focused on swaps related to energy commodities such as oil, natural gas and electricity. The commenters said that the market for these swaps is different from the market for swaps on interest rates and other financial commodities because, among other things, the swaps are used to mitigate price and delivery risks directly linked to a commercial enterprise; less swap activity flows through intermediaries; the markets for the underlying physical commodities are separately regulated; and the failure of a commodity market participant is not likely to impact financial markets as a whole.

117

Therefore, these commenters believe, the application of the swap dealer definition to participants in these physical commodity swap markets should be different from the application to participants in the financial commodity swap markets.

118

Some commenters said that imposing the costs of swap dealer regulation on participants in the markets for physical commodity swaps would discourage participation in the market, thereby reducing liquidity and increasing market concentration.

119

117

See

letters from BG LNG I, Dominion Resources, National Energy Marketers Association (“NEM”), NFPEEU, Vitol and WGCEF I joint letter from Senator Debbie Stabenow and Representative Frank Lucas (many commercial end-users of swaps with inherent physical commodity price risk use swaps to hedge such risk and otherwise for their own trading objectives and not for the benefit of others) and meetings with Bunge on May 18, 2011 and Electric Companies on April 13, 2011.

118

See id.

119

See

letters from Dominion Resources, NEM and NFPEEU.

iii. Electricity Swaps

Commenters on the use of swaps in connection with the generation and transmission of electricity addressed a variety of issues. First, commenters said that markets related to electricity are different from markets for other physical commodities in that electricity must be generated and transmitted at the time it is needed (it cannot be stored for future use); the overall demand for electricity is inelastic but demand at any particular time is subject to external variables, such as weather; the generation, transmission and use of electricity is widely dispersed and geographically specific; the markets are overseen by regulators such as state Public Utility Commissions, regional transmission organizations (“RTOs”) and the Federal Energy Regulatory Commission (“FERC”); and government mandates require continuous supply of electricity and treat electricity as a “public good.”

120

Commenters said that because of these differences, the use of swaps related to electricity is different from the use of swaps on other physical commodities in that electricity swaps: Are more highly customized to a particular place and time; are more likely to relate to a short time period or be more frequently entered into; typically can be tied to a specific generation, transmission or use of electricity; are more likely to be entered into directly by end-users rather than through dealers; are likely to be entered into by electricity companies on both sides of the market; and in many cases were subject to regulatory oversight prior to the Dodd-Frank Act.

121

120

See

letters from Edison Int'l, the staff of the FERC (“FERC Staff”), National Association of Regulatory Utility Commissioners (“NARUC”), NEM, NextEra I, NFPEEU and National Rural Utilities Cooperative Finance Corporation (“NRU CFC”) dated February 14, 2011 (“NRU CFC I”), joint letter from NRECA, APPA, LPPC, EEI and EPSA (“Electric Trade Associations”) and meetings with Electric Companies on April 13, 2011 and NFPEEU on January 29, 2011.

121

See

letters from Edison Int'l, EEI/EPSA, Electric Trade Associations, FERC Staff, NextEra I and NFPEEU and meeting with Electric Companies on April 13, 2011.

Commenters made various points regarding how swaps related to electricity should be treated for purposes of the swap dealer definition. A coalition of not-for-profit power utilities and electric cooperatives said that electricity cooperatives should be excluded from the swap dealer definition because they are non-profit entities that enter into swaps for the benefit of their members, they do not hold themselves out as swap dealers, they do not make markets, and their swaps are not necessarily reflective of market rates.

122

Other commenters said that swaps related to transactions on tariff schedules approved by FERC or the Electric Reliability Council of Texas should be disregarded in determining if a person is a swap dealer.

123

And, some commenters said that any special treatment of swaps related to electricity should apply not only to companies that generate, transmit or distribute electricity, but also to energy marketing companies that use swaps to benefit from price changes in the underlying energy commodities or to hedge related risks.

124

122

See

letter from NFPEEU. This commenter said the exclusion from the swap dealer definition should extend to persons acting as an operating or purchasing agent for other utilities in connection with energy infrastructure products, or otherwise entering into energy commodity swaps on behalf of other end users.

123

See

letters from EDF Trading, FERC Staff and NARUC.

124

See

letters from DC Energy, EDF Trading and EEI/EPSA.

On the other hand, some commenters acknowledged that a person who makes a market in swaps related to electricity by standing ready to enter into such swaps in order to profit from a bid/ask spread would be a swap dealer, even if the person was in the business of generating, transmitting or distributing

electricity and owned physical facilities for that purpose.

125

See

letter from EEI/EPSA and meeting with Electric Companies on April 13, 2011.

f. Suggested Exlusions From the Dealer Definitions

Several commenters took the view that the swap dealer and security-based swap dealer definitions should categorically exclude, or should be interpreted in a way that would be expected to exclude, a variety of types of persons or transactions. Commenters particularly suggested that the following categories of persons should be excluded from the dealer definitions: Agricultural cooperatives and electric cooperatives (as addressed above), employee benefit plans as defined in the Employee Retirement Income Security Act of 1974 (“ERISA”),

126

farm credit system institutions,

127

Federal Home Loan Banks,

128

insured depository institutions that limit their swap dealing activity to riskless principal transactions,

129

FCMs and broker-dealers that limit their swap dealing activity to riskless principal transactions,

130

financial guaranty insurers and their affiliates that do not enter into new swaps,

131

asset managers,

132

non-financial companies offering swaps related to their physical commodity business,

133

any person who enters into swaps or security-based swaps only with registered dealers and major participants,

134

persons that do not pose systemic risk,

135

hedge funds

136

and entities that enter into swaps or security-based swaps solely in a fiduciary capacity.

137

126

See

letter from ABC/CIEBA.

127

See

letter from Farm Credit Council dated February 22, 2011 (“Farm Credit Council I”).

128

See

letters from Credit Union National Association (“CUNA”) and Federal Home Loan Banks (“FHLB”) dated February 22, 2011 (“FHLB I”).

129

See

letter from BOK dated January 31, 2011 (“BOK I”);

but see

letter from Vitol at 7 (riskless principal transactions are a “good model for true swap dealing activity”).

130

See

letter from Newedge.

131

See

letter from Association of Financial Guaranty Insurers (“AFGI”).

132

See

letter from BlackRock, Inc. (“BlackRock”) dated February 22, 2011 (“BlackRock I”).

133

Commenters making this point varied in their phrasing of potential exclusions, and particularly suggested exclusions for: Agricultural firms offering swaps as risk management tools related to physical commodities (

see

letter from NGFA I); all firms, other than financial entities whose primary business is swap dealing (

see

letter from NEM); any person that uses swaps only to reduce price volatility, enters into a volume of swaps relating to any physical commodity that is less than the volume of its trading in that commodity, and is not making a market (

see

letter from Chesapeake Energy); or any person that limit its use of swaps to hedging or speculating (

see

letters from API I).

134

See

letter from ISDA I.

135

See

letters from NARUC and NCGA/NGSA I.

136

See

letter from MFA I.

137

See

letters from FSR dated February 22, 2011 and Midsize Banks.

Commenters also suggested that the dealer definitions categorically exclude, or should be interpreted to exclude, the following types of swaps and security-based swaps: Exchange-cleared swaps and security-based swaps,

138

options to make or receive delivery of physical commodities,

139

cash forward transactions with embedded swaps and book-out transactions,

140

swaps or security-based swaps that are used for hedging or mitigating commercial risk,

141

swaps entered into to profit from future changes in the price of the underlying commodity,

142

swaps or security-based swaps entered into as a fiduciary or agent for another person,

143

swaps or security-based swaps entered into for purposes of price discovery,

144

and, as noted above, swaps related to items that are covered by a tariff approved by FERC or the Electric Reliability Council of Texas.

145

138

See

letters from Commodity Markets Council (“CMC”), EEI/EPSA, IECA-Credit I, NextEra I, Shell Trading I, Utility Group and Vitol.

139

See

letters from NextEra I and WGCEF I. The commenters acknowledged that such options may or may not be included in the definition of “swap.”

140

See

letter from CMC.

141

See, e.g.,

letters from Edison Int'l and WGCEF I and joint letter from Senator Stabenow and Representative Lucas (also saying that definition of “hedging” should be consistent with respect to the dealer and major participant definitions and the end-user exception from clearing).

142

See

letters from EEI/EPSA, NextEra I, Utility Group and WGCEF I.

143

See

letters from Midsize Banks, NFPEEU and FSR I.

144

See

letters from EEI/EPSA, Vitol and WGCEF I.

145

See

letters from EDF Trading, FERC Staff and NARUC.

In contrast, some commenters opposed providing any categorical exclusions from the dealer definitions. One commenter stated that the definitions' focus on a person's activities—as opposed to whether that person falls within a particular category—is a better means of determining whether the person is a swap dealer.

146

Another commenter described the requested exclusions as attempts to achieve carve-outs that are not provided for in the statute.

147

146

See

letter from Better Markets I.

147

See

letter from AFSCME. Additional commenters emphasized the need for transparency about swaps and swap activities.

See

letters from Jason Cropping and BJ D'Milli.

Lastly, several commenters addressed the extraterritorial application of the definitions of the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” and “eligible contract participant.” In general, the commenters addressed when and how the definitions should be applied to persons based outside the U.S. and how the definitions should take account of non-U.S. requirements that may be applicable to such persons.

148

The Commissions intend to separately address issues related to the application of these definitions to non-U.S. persons in the context of the application of Title VII to non-U.S. persons.

148

See, e.g.,

letters from FSR I, Institute of International Bankers, ISDA I, Investment Management Association, Japan Financial Services Agency, Securities Industry and Financial Markets Association (“SIFMA”) dated February 3, 2011 (“SIFMA I”), and the World Bank Group, joint letter from the Autorité de contrôle prudential and the Autorité des marches financiers, joint letter from Bank of America Merrill Lynch, Barclays Capital, BNP Paribas S.A. (“BNP Paribas”), Citi, Crédit Agricole Corporate and Investment Bank, Credit Suisse Securities (USA), Deutsche Bank AG (“Deutsche Bank”), HSBC, Morgan Stanley, Nomura Securities International, Inc. (“Nomura Securities”), Société Générale and UBS Securities LLC (“Twelve Firms”), joint letter from the Bank of Tokyo-Mitsubishi UFJ, Ltd., Mizuho Corporate Bank, Ltd. and Sumitomo Mitsui Banking Corporation, and joint letter from Barclays Bank PLC, BNP Paribas, Credit Suisse AG, Deutsche Bank, HSBC, Nomura Securities, Rabobank Nederland, Royal Bank of Canada, the Royal Bank of Scotland Group pLc, Société Générale, the Toronto-Dominion Bank and UBS AG.

g. Cost-Benefit Issues and Hedging Deterrence

Several commenters emphasized the cost of being regulated as a dealer, and emphasized that an overbroad scope of the dealer definitions would impose significant unwarranted costs on entities contrary to the goals of the Dodd-Frank Act, and would deter the use of swaps and security-based swaps for hedging.

149

Some commenters also noted that impact of the provisions of section 716 of the Dodd-Frank Act on entities that are deemed to be swap

dealers or security-based swap dealers.

150

Also, one commenter suggested that using a qualitative test for the dealer definition might increase costs due to regulatory uncertainty.

151

149

See

joint letter from Representatives Spencer Bachus and Frank Lucas at 2 (“Casting an overly-broad net in defining [dealer and major participant] could force some smaller participants to leave the marketplace as a result of increased costs, or eliminate certain types of contracts used for hedging. If either occurs, businesses will be left exposed to market volatility and the consequences will ultimately be felt by Americans in the form of increased consumer costs.”) and letters from ISDA Iat 7 (“The substantial additional burdens and costs of Dealer regulation must be reserved for those whose business it is to `make the market,' that is, those who consistently both buy and sell. This is in accord with Dodd-Frank Act's market regulatory goals, as well as the legislation's obvious intent to preserve healthy growth and innovation in the U.S. swap markets.” (footnote omitted)), Peabody at 2-3 (“Legal uncertainty over the application to end users of the significant regulatory requirements for [swap dealers] could lead end users to minimize their use of swaps in order to avoid the risk of being deemed to be [a swap dealer].”), and Church Alliance (stating that the risk of incurring the costs of dealer regulation would harm employee benefit plans by reducing their use of swaps and security-based swaps for hedging and risk mitigation).

150

See

letters from American Bankers Association (“ABA”) dated November 3, 2011 (“ABA I”), BOK I, and ISDA I. Section 716 of the Dodd-Frank Act prohibits any “swaps entity”—a term that encompasses swap dealers and security-based swap dealers—from receiving Federal assistance with respect to any swap, security-based swap, or other activity of the swaps entity.

151

See

letter from API I (stating that costs of regulatory uncertainty stem from the use of qualitative factors for identifying dealing, and from regulatory efforts to reach beyond “true” swap dealers);

see also

letter from Dominion Resources (the opportunity costs associated with regulatory uncertainty should be considered).

One commenter specifically suggested that in considering the final rules, the Commissions should consider empirical data regarding the costs and benefits flowing from the rules and issue a second analysis of the costs and benefits of the rules for public comment,

152

while other commenters said that the consideration of cost and benefits should include the cumulative cost of interrelated regulatory burdens arising from all the rules proposed under the Dodd-Frank Act.

153

Other commenters said the Commissions should consider alternatives that would impose fewer costs.

154

152

See

letter from WGCEF I.

153

See

letters from ABA I, NFPEEU and WGCEF dated December 20, 2011, enclosing a report prepared by NERA Economic Consulting (“NERA”) (“WGCEF VIII”);

see also

letter from NERA dated March 13, 2012.

154

See

letters from NextEra I (referring to alternative

de minimis

tests) and NFPEEU.

Another commenter said that the cost-benefit analyses in the Proposing Release may have understated the benefits of the proposed rules, because focusing on individual aspects of all the rules proposed under the Dodd-Frank Act prevents consideration of the full range of benefits that arise from the rules as a whole, in terms of providing greater financial stability, reducing systemic risk and avoiding the expense of assistance to financial institutions in the future.

155

This commenter said the consideration of benefits of the proposed rules should include the mitigated risk of a financial crisis.

156

155

See

letter from Better Markets dated June 3, 2011 (“Better Markets II”).

156

Better Markets cited estimates that the worldwide cost of the 2008 financial crisis in terms of lost output was between $60 trillion and $200 trillion, depending primarily on the long term persistence of the effects.

See

letter from Better Markets II.

3. Final Rules and Interpretation—General Principles

Consistent with the Proposing Release, the final rules that define the terms “swap dealer” and “security-based swap dealer” closely follow the statutory definitions' four tests and exclusion for activities that are not part of a “regular business.”

157

In addition, this Adopting Release sets forth interpretive guidance regarding various elements of the final rules.

157

See

CFTC Regulation § 1.3(ggg)(1), (2); Exchange Act rule 3a71-1(a), (b).

Because the definitions of the terms “swap dealer” in the CEA and “security-based swap dealer” in the Exchange Act are substantially similar, the rules further defining those terms and the accompanying interpretations in this Adopting Release reflect common underlying principles. At the same time, the interpretations regarding the application of the definitions differ in certain respects given the differences in the uses of and markets for swaps and security-based swaps.

158

For example, because security-based swaps may be used to hedge or gain economic exposure to underlying individual securities (while recognizing distinctions between security-based swaps and other types of securities, as discussed below), there is a basis to build upon the same principles that presently are used to identify dealers for other types of securities. These same principles, though instructive, may be inapplicable to swaps in certain circumstances or may be applied differently in the context of dealing activities involving commodity, interest rate, or other types of swaps.

158

Section 712(a)(7)(A) of the Dodd-Frank Act provides that in adopting rules and orders implementing Title VII, the Commissions shall treat functionally or economically similar products or entities in a similar manner. Section 712(a)(7)(B), though, provides that the Commissions need not act in an identical manner.

For these reasons, we separately are addressing the interpretation of the “swap dealer” and “security-based swap dealer” definitions.

Also, as discussed below, the Commissions are directing their respective staffs to report separately regarding the rules being adopted in connection with the definition and related interpretations. These staff reports will help the Commissions evaluate the “swap dealer” and “security-based swap dealer” definitions in all respects, including whether new or revised tests or approaches would be appropriate for identifying swap dealers and security-based swap dealers.

159

See

part V,

infra.

4. Final Rules and Interpretation—Definition of “Swap Dealer”

The Dodd-Frank Act contains a comprehensive definition of the term “swap dealer,” based upon types of activities. As noted above, we are adopting a final rule under the CEA that, like the proposed rule, defines the term “swap dealer” using terms from the four statutory tests and the exclusion for swap activities that are not part of “a regular business.”

160

The final rule includes modifications from the proposed rule that are described below, including provisions stating that swaps entered into for hedging physical positions as defined in the rule, swaps between majority-owned affiliates, swaps entered into by a cooperative with its members, and certain swaps entered into by registered floor traders, are excluded from the swap dealer determination.

161

The Commissions, in consideration of comments received, are also making certain modifications to the interpretive guidance set out in the Proposing Release with respect to various elements of the statutory definition of the term “swap dealer,” as described below.

160

See

CFTC Regulation § 1.3(ggg)(1), (2).

161

See

CFTC Regulation § 1.3(ggg)(6)(ii), (iii).

The determination of whether a person is covered by the statutory definition of the term “swap dealer” requires application of various provisions of the rule further defining that term, as well as the interpretive guidance in this Adopting Release, depending on the person's particular circumstances. We intend that the determination with respect to a particular person would proceed as follows.

The person would begin by applying the statutory definition, and the provisions of the rule which implement the four statutory tests and the exclusion for swap activities that are not part of “a regular business,”

162

in order to determine if the person is engaged in swap dealing activity. In that analysis, the person would apply the interpretive guidance described in this part II.A.4, which provides for consideration of the relevant facts and circumstances. As part of this consideration, the person would apply elements of the dealer-trader distinction, as appropriate, including as described in part II.A.4.a, below.

162

See

CFTC Regulation § 1.3(ggg)(1), (2).

The rule provides that certain swaps are not considered in the determination of whether a person is a swap dealer.

163

In particular, swaps entered into by an insured depository institution with a customer in connection with originating a loan with that customer,

164

swaps

between majority-owned affiliates,

165

swaps entered into by a cooperative with its members,

166

swaps entered into for hedging physical positions as defined in the rule,

167

and certain swaps entered into by registered floor traders

168

are excluded from the swap dealer determination.

163

See

CFTC Regulation § 1.3(ggg)(5), (6).

164

See

CFTC Regulation § 1.3(ggg)(5);

see also

part II.B,

infra.

165

See

CFTC Regulation § 1.3(ggg)(6)(i);

see also

part II.C,

infra.

166

See

CFTC Regulation § 1.3(ggg)(6)(ii);

see also

part II.C,

infra.

167

See

CFTC Regulation § 1.3(ggg)(6)(iii);

see also

part II.B.4.e,

infra.

168

See

CFTC Regulation § 1.3(ggg)(6)(iv);

see also

part II.B.4.f,

infra.

If, after completing this review (taking into account the applicable interpretive guidance and excluding any swaps as noted above), the person determines that it is engaged in swap dealing activity, the next step is to determine if the person is engaged in more than a

de minimis

quantity of swap dealing.

169

If so, the person is a swap dealer. When the person registers, it may apply to limit its designation as a swap dealer to specified categories of swaps or specified activities of the person in connection with swaps.

170

169

See

CFTC Regulation § 1.3(ggg)(4);

see also

part II.D,

infra.

170

See

CFTC Regulation § 1.3(ggg)(3);

see also

part II.E,

infra.

In this part II.A.4., we provide interpretive guidance on the application of the “swap dealer” definition, modified from the Proposing Release as appropriate based on comments received. This guidance separately addresses the following: application of the dealer-trader framework; the “holding out” and “commonly known” criteria; market making; the not part of “a regular business” exception; the exclusion of swaps entered into for hedging physical positions as defined in the rule; and the overall interpretive approach to the definition.

171

The Commissions note that interpretations of the applicability of the dealer-trader distinction to the “swap dealer” definition under the CEA do not affect existing, or future, interpretations of the dealer-trader distinction under the Exchange Act.

a. Use of the Dealer-Trader Distinction

We believe that the dealer-trader distinction

172

—which already forms a basis for identifying which persons fall within the longstanding Exchange Act definition of “dealer”—in general provides an appropriate framework for interpreting the statutory definition of the term “swap dealer.”

173

While there are differences in the structure of those two statutory definitions,

174

we believe that their parallels—particularly their exclusions for activities that are “not part of a regular business”—warrant analogous interpretive approaches for distinguishing dealers from non-dealers.

175

Thus, the dealer-trader distinction forms the basis for a framework that appropriately distinguishes between persons who should be regulated as swap dealers and those who should not. We also believe that the distinction affords an appropriate degree of flexibility to the analysis, and that it would not be appropriate to seek to codify the distinction in rule text.

172

See

note 31,

supra.

The principles embedded within the “dealer-trader distinction” are also applicable to distinguishing dealers from non-dealers such as hedgers or investors.

See

note 250,

infra.

173

174

For example, while the “dealer” definition encompasses certain persons in the business of “buying and selling” securities, the “swap dealer” definition does not address either “buying” or “selling.” We also note that the “dealer” definition requires the conjunctive “buying

and

selling”—which connotes a degree of offsetting two-sided activity. In contrast, the swap dealer definition (particularly the “regularly enters into” swaps language of the definition's third prong) lacks that conjunctive terminology.

175

In the Proposing Release, the CFTC did not propose to use principles from the dealer-trader distinction to interpret the definition of the term “swap dealer,” instead proposing an interpretive approach that focused on, among other things, a person's functional role in the swap markets and its relationships with swap counterparties.

See

Proposing Release, 75 FR at 80177. There was, however, some overlap in practice between the factors identified in the Proposing Release relating to a swap dealer's functional role and relationships and the principles of the dealer-trader distinction that were proposed to be applied to identify security-based swap dealers. Moreover, the changes to the interpretive approach to the swap dealer definition that we are adopting here and discussed in this part II.A.4 are in many respects similar to the principles of the dealer-trader distinction. We also acknowledge the commenters who asked for additional guidance regarding the application of the definitions.

See, e.g.,

letters from Gavilon II, Peabody and the Utility Group, and meeting with CDEU on April 7, 2011.

Thus, while the incorporation of the dealer-trader distinction in the interpretation of the term “swap dealer” constitutes a change from the Proposing Release, this is simply reflective of the other changes to the CFTC's interpretive approach that we are adopting for the final rule and the overlap between the factors relating to a swap dealer's functional role and counterparty relationships and the principles of the dealer-trader distinction.

The Commissions recognize that the dealer-trader distinction needs to be adapted to apply to swap activities in light of the special characteristics of swaps and the differences between the “dealer” definition, on the one hand, and the “swap dealer” definition, on the other. Relevant differences between the swap market and the markets for securities (other than security-based swaps) include:

•

Level of activity

—Swap markets are marked by less activity than markets involving certain types of securities (while recognizing that some debt and equity securities are not actively traded). This suggests that in the swap context, concepts of “regularity” should account for a participant's level of activity in the market relative to the total size of the market.

•

No separate issuer

—Each counterparty to a swap in essence is the “issuer” of that instrument; in contrast, dealers in cash market securities generally transact in securities issued by another party. This distinction suggests that the concept of maintaining an “inventory” of securities is inapposite in the context of swaps. Moreover, this distinction—along with the fact that the “swap dealer” definition lacks the conjunctive “buying

and

selling” language of the “dealer” definition—suggests that concepts of two-sided markets at times would be less relevant for identifying swap dealers than they would be for identifying dealers.

176

The analysis also should account for the fact that a party to a swap can use other derivatives or cash market instruments to hedge the risks associated with the swap position, meaning that two-way trading is not necessary to maintain a flat risk book.

•

Predominance of over-the-counter and non-standardized instruments

—Swaps an thus far are not significantly traded on exchanges or other trading systems, in contrast to some cash market securities (while recognizing that many cash market securities also are not significantly traded on those systems).

177

These attributes—along with the lack of “buying

and

selling” language in the swap dealer definition, as noted above—suggest that concepts of what it means to make a market need to be construed flexibly in the contexts of the swap markets.

177

Even though we expect trading of swaps on exchanges following the implementation of Title VII, we expect there to remain a significant amount of over-the-counter activity involving swaps.

•

Mutuality of obligations and significance to “customer” relationship

—In contrast to a secondary market transaction involving equity or debt securities, in which the completion of a purchase or sale transaction can be expected to terminate the mutual obligations of the parties to the transaction, the parties to a swap often will have an ongoing obligation to exchange cash flows over the life of the agreement. In light of this attribute, some market participants have expressed the view that they have “counterparties” rather than “customers” in the context of their swap activities.

In applying the dealer-trader distinction, it also is necessary to apply

the statutory provisions that will govern swap dealers in an effective and logical way. Those statutory provisions added by the Dodd-Frank Act advance financial responsibility (

e.g.,

the ability to satisfy obligations, and the maintenance of counterparties' funds and assets) associated with swap dealers' activities,

178

other counterparty protections,

179

and the promotion of market efficiency and transparency.

180

As a whole, the relevant statutory provisions suggest that we should interpret the “swap dealer” definition to identify those persons for which regulation is warranted either: (i) Due to the nature of their interactions with counterparties; or (ii) to promote market stability and transparency, in light of the role those persons occupy within the swap and security-based swap markets.

178

E.g.,

capital and margin requirements (CEA section 4s(e)), and requirements for segregation of collateral (CEA sections 4d(f), 4s(l)).

179

E.g.,

requirements with respect to business conduct when transacting with special entities (CEA sections 4s(h)(2), 4s(h)(4), 4s(h)(5)); disclosure requirements (CEA section 4s(h)(3)(B)); requirements for fair and balanced communications (CEA section 4s(h)(3)(D)); other requirements related to the public interest and investor protection (CEA section 4s(h)(3)(D)); and conflict of interest provisions (CEA section 4s(j)(5)).

180

E.g.,

reporting and recordkeeping requirements (CEA section 4s(f)); daily trading records requirements (CEA section 4s(g)); regulatory standards related to the confirmation, processing, netting, documentation and valuation of security-based swaps (CEA section 4s(i)); position limit monitoring requirements (CEA section 4s(j)(1)); risk management procedure requirements (CEA section 4s(j)(2)); and requirements related to the disclosure of information to regulators (CEA section 4s(j)(3)).

There are several aspects of our interpretive approach to the swap dealer definition that are particularly similar to the dealer-trader distinction as it will be applied to determine if a person is a security-based swap dealer. In particular, the following activities, which are indicative of dealing activity in the application of the dealer-trader distinction,

181

similarly are indicative that a person is acting as a swap dealer:

182

(i) Providing liquidity by accommodating demand for or facilitating interest in the instrument (swaps, in this case), holding oneself out as willing to enter into swaps (independent of whether another party has already expressed interest), or being known in the industry as being available to accommodate demand for swaps; (ii) advising a counterparty as to how to use swaps to meet the counterparty's hedging goals, or structuring swaps on behalf of a counterparty; (iii) having a regular clientele and actively advertising or soliciting clients in connection with swaps;

183

(iv) acting in a market maker capacity on an organized exchange or trading system for swaps;

184

and (v) helping to set the prices offered in the market (such as by acting as a market maker) rather than taking those prices, although the fact that a person regularly takes the market price for its swaps does not foreclose the possibility that the person may be a swap dealer.

181

See generally

part II.A.5,

infra.

182

To clarify, the activities listed in the text are indicative of acting as a swap dealer. Engaging in one or more of these activities is not a prerequisite to a person being covered by the swap dealer definition.

183

As with the interpretation of the dealer-trader distinction with respect to securities, a nomenclature distinction between “counterparties” and “customers” is not significant for purposes of applying the dealer-trader distinction to swap activities. Contractual provisions related to nomenclature, such as a provision stating that no “customer” relationship is present, would not be significant if the reality of the situation is different.

See

note 271,

infra,

and accompanying text.

184

As with the dealer-trader distinction as it has been interpreted under the Exchange Act with respect to securities (and as noted below in the discussion of the “makes a market in swaps” prong of the swap dealer definition), the presence of an organized exchange or trading system is not a prerequisite to being a market maker for purposes of the swap dealer definition, nor is acting as a market maker a prerequisite to being a swap dealer.

The Commissions further note that the following elements of the interpretive approach to the swap dealer definition are also generally consistent with the dealer-trader distinction as it will be applied to determine if a person is a security-based swap dealer: (i) A willingness to enter into swaps on either side of the market is not a prerequisite to swap dealer status; (ii) the swap dealer analysis does not turn on whether a person's swap dealing activity constitutes that person's sole or predominant business; (iii) a customer relationship is not a prerequisite to swap dealer status; and (iv) in general, entering into a swap for the purpose of hedging, absent other activity, is unlikely to be indicative of dealing. Last, under the interpretive approach to the definition of both the terms “swap dealer” and “security-based swap dealer,” whether a person is acting as a dealer will turn upon the relevant facts and circumstances, as informed by the interpretive guidance set forth in this Adopting Release.

At the same time, the Commissions recognize that the dealer-trader distinction is not static, but rather has evolved over time through interpretive materials. The Commissions expect the dealer-trader distinction to evolve over time with respect to swaps independently of its evolution over time with respect to securities or security-based swaps. Prior interpretations and future developments in the law regarding securities or security-based swaps may inform the interpretation of the swap dealer definition, but will not be dispositive in identifying dealers in the swap markets.

185

In interpreting the term “swap dealer,” we intend to consider, but do not formally adopt, the body of court decisions, SEC releases, and SEC staff no-action letters that have interpreted the dealer-trader distinction.

b. Indicia of Holding Oneself Out as a Dealer in Swaps or Being Commonly Known in the Trade as a Dealer in Swaps

The final rule further defining the term “swap dealer” includes the provisions in the proposed rule which incorporate the statutory requirements that the term includes a person that is holding itself out as a dealer in swaps or is engaging in any activity causing it to be commonly known in the trade as a dealer or market maker in swaps.

186

See

CFTC Regulation § 1.3(ggg)(1)(i) and (iv).

We continue to believe that the Proposing Release appropriately identifies a number of factors as indicia of “hold[ing] itself out as a dealer in swaps” and “engag[ing] in any activity causing [itself] to be commonly known in the trade as a dealer or market maker in swaps.”

187

In our view, those factors thus are relevant to determining if a person is a swap dealer. For example, regarding the proposed factor of “membership in a swap association in a category reserved for dealers,” we note that the bylaws of the International Swaps and Derivatives Association (“ISDA”) provide that any business organization that:

187

These factors are as follows: Contacting potential counterparties to solicit interest; developing new types of swaps or security-based swaps and informing potential counterparties of their availability and of the person's willingness to enter into the swap or security-based swap; membership in a swap association in a category reserved for dealers; providing marketing materials describing the type of swaps or security-based swaps the party is willing to enter into; and generally expressing a willingness to offer or provide a range of products or services that include swaps or security-based swaps.

See

Proposing Release, 75 FR at 80178.

Directly or through an affiliate, as part of its business (whether for its own account or as agent), deals in derivatives shall be eligible for election to membership in the Association as a Primary Member, provided that no person or entity shall be eligible for membership as a Primary Member if such person or entity participates in derivatives transactions solely for the purpose of risk hedging or asset or liability management.

188

See

By-laws of ISDA at 3, available at:

https://www.isdadocs.org/membership

. The Commissions note that the Primary Members of ISDA are not limited to only financial firms.

We believe that in circumstances such as this, where a category of association

membership requires that a person deal in derivatives and not limit its participation in derivative transactions to solely risk hedging, membership in the category is an indicator of swap dealer status.

189

However, while such membership is an indicator of swap dealer status, a person holding such membership could nonetheless be excluded by other provisions of the definition of the term “swap dealer.” For example, an insured depository institution that limits its activity to offering swaps in connection with the origination of loans, as discussed below in part II.B, would not be covered by the definition simply because it holds such membership.

We take note, however, of the comments that these activities may be insufficient to establish that a person is a swap dealer. In particular, we generally agree with commenters that many commercial end users of swaps do, from time to time, actively seek out and negotiate swaps. Yet, based on the applicable facts and circumstances, these end users do not necessarily fall within the definition of a swap dealer solely because they actively seek out and negotiate swaps from time to time.

The activities described in the Proposing Release as indicia of holding oneself out as a swap dealer or engaging in any activity causing oneself to be commonly known as a swap dealer should not be considered in a vacuum, but should instead be considered in the context of all the activities of the swap participant. While the activities listed in the Proposing Release are indicators that a person is holding itself out or is commonly known as a swap dealer, these are factors to be considered in the analysis. They are not

per se

conclusive, and could be countered by other factors indicating that the person is not a swap dealer.

190

Because of the flexibility—including the consideration of applicable facts and circumstances—needed for such an analysis, we do not believe that it is appropriate to codify this guidance in rule text, as suggested by some commenters.

190

The statutory definition of the term “swap dealer” contains four separate clauses, or “prongs,” joined by the disjunctive “or,” the ordinary meaning of which is that the prongs are stated as alternative types of swap dealer. Accordingly, where an assessment of all the activities of a swap participant demonstrates that the person is not holding itself out as a swap dealer or engaging in any activity that causes it to be commonly known as a swap dealer, that person may, nonetheless, be a swap dealer based on the market making or regular business prongs of the swap dealer definition, discussed below. The Commissions note, however, that as discussed below in part II.A.4.g, the CFTC's overall interpretive guidance, including guidance regarding the dealer-trader framework, applies to identify swap dealers under all four prongs of the statutory “swap dealer” definition.

c. Market Making

The final rule defining “swap dealer” includes the provision from the proposed rule which incorporates the statutory requirement that this term include a person that “makes a market in swaps.”

191

See

CFTC Regulation § 1.3(ggg)(1)(ii). Because the statutory swap dealer definition contains four disjunctive prongs, the CFTC does not agree with a commenter (

see

letter from ISDA I) who asserted that status as a market maker in swaps is a prerequisite to a person being a swap dealer.

We have considered the comments suggesting various descriptions of activities that should and should not be deemed to be market making in swaps for purposes of this rule. In consideration of these comments, we clarify that making a market in swaps is appropriately described as routinely standing ready to enter into swaps at the request or demand of a counterparty. In this regard, “routinely” means that the person must do so more frequently than occasionally, but there is no requirement that the person do so continuously.

192

A person that occasionally, or less than routinely, enters into a swap at the request of a counterparty is not a maker of a market in swaps, and therefore is not a swap dealer on that basis. However, we reiterate, as stated in the Proposing Release, that since many types of swaps are not entered into on a continuous basis, it is not necessary that a person enter into swaps at the request or demand of counterparties on a continuous basis in order for the person to be a market maker in swaps and, therefore, a swap dealer.

It is appropriate, in response to comments asking for further guidance regarding what activities constitute making a market in swaps, to describe some of the activities indicative of whether a person is routinely standing ready to enter into swaps at the request or demand of a counterparty. Such activities include routinely: (i) Quoting bid or offer prices, rates or other financial terms for swaps on an exchange; (ii) responding to requests made directly, or indirectly through an interdealer broker, by potential counterparties for bid or offer prices, rates or other similar terms for bilaterally negotiated swaps; (iii) placing limit orders for swaps; or (iv) receiving compensation for acting in a market maker capacity on an organized exchange or trading system for swaps.

193

These examples are not exhaustive, and other activities also may be indicative of making a market in swaps if the person engaging in them routinely stands ready to enter into swaps as principal at the request or demand of a counterparty.

193

In addition, section 619 of the Dodd-Frank Act (the “Volcker Rule”) generally prohibits banking entities from engaging in proprietary trading, but contains an exception for certain market making-related activities. The Commissions have proposed an approach to the Volcker Rule under which a person could seek to avoid the Volcker Rule in connection with swap activities by asserting the availability of that market making exception.

See

SEC, Board, Office of the Comptroller of the Currency (“OCC”), and Federal Deposit Insurance Corporation (“FDIC”), Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds; Proposed Rule, 76 FR 68846 (Nov. 7, 2011); CFTC, Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds; Proposed Rule, 77 FR 8332 (Feb. 14, 2012). Under this approach, such a person would likely also be required to register as a swap dealer (unless the person is excluded from the swap dealer definition, such as by the exclusion of certain swaps entered into in connection with the origination of a loan). The SEC has proposed to adopt the same approach with respect to the interplay of the Volcker Rule and the definition of the term “security-based swap dealer.”

See

note 272,

infra.

In determining whether a person's routine presence in the market constitutes market making under these four factors, the dealer-trader interpretative framework may be usefully applied.

194

Under the dealer-trader distinction, seeking to profit by providing liquidity to the market is an indication of dealer activity.

195

Thus, in applying these four factors, it is useful to consider whether the person is seeking, through presence in the market, compensation for providing liquidity, compensation through spreads or fees, or other compensation not attributable to changes in the value of the swaps it enters into.

196

If not, such activity would not be indicative of market making.

194

We recognize that routine presence in the swap market is not necessarily indicative of making a market in swaps. For example, persons may be routinely present in the market in order to engage in swaps for purposes of hedging, to advance their investment objectives, or to engage in proprietary trading.

195

See

note 265,

infra,

and accompanying text.

196

In this case, the spread from which a person profits may be between two or more swaps, or it may be between a swap and another position or financial instrument. In contrast, entering into swaps in order to obtain compensation attributable to changes in the value of the swaps is indicative of using swaps for a hedging, investment or trading purpose.

Some commenters suggested that, in order to be a market maker in swaps, a person must make a two-way market in swaps.

197

Nonetheless, it is possible for a person making a one-way market in swaps to be a maker of a market in swaps and, therefore, within the swap dealer definition. This may be true, for example, where a person routinely

stands ready to enter into swaps on a particular side of the market—say, routinely bidding for floating exposures on a swap trading platform—while entering into transactions on the other side of the market in other instruments (such as futures contracts). The relevant indicator of market maker status is the willingness of the person to routinely stand ready to enter into swaps at the request or demand of a counterparty (as opposed to entering into swaps to accommodate one's own demand or desire to participate in a particular market), be it on one or both sides of the market, and then to enter into offsetting positions, either in the swap market or in other markets.

197

See

letters cited in notes 52 to 58,

supra.

Although swaps are notional contracts requiring the performance of agreed upon terms by each party, it is possible to describe swap users in practical terms as being on either “side” of a market. For example, for many swaps the party paying a fixed amount is on one “side” of the market and the party paying a floating amount is on the other “side.”

The Commissions disagree with the commenters who said that swaps executed on an exchange should not be considered in determining if a person is a market maker in swaps and thus a swap dealer.

198

First, the statutory definition of the term “swap dealer” makes no distinction between swaps executed on an exchange and swaps that are not, suggesting that the same protections should apply regardless of the method of executing the swap. Second, from the perspective of an end user seeking to execute a swap on an exchange, the important consideration under our analysis is whether a market maker is ready to enter into swaps, not whether the market maker is aware of the counterparty's identity. A market maker in swaps routinely stands ready to enter into swaps at the request or demand of a counterparty, regardless of whether the counterparty and the market maker meet on a disclosed basis through bilateral negotiations or anonymously through an exchange.

199

Similarly, the issue of whether a person is a registered FCM or broker-dealer is not necessarily relevant to whether the person is a maker of a market in swaps, if the person is routinely standing ready to enter into swaps at the request or demand of a counterparty. Third, we believe it would be inappropriate to disregard swaps executed on exchanges in order, as some commenters suggested,

200

to encourage market participants to use, or to provide liquidity to, exchanges. Finally, variety of exchanges, markets, and other facilities for the execution of swaps are likely to evolve in response to the requirements of the Dodd-Frank Act, and there is no basis for any bright-line rule excluding swaps executed on an exchange, given the impossibility of obtaining information about how market participants will interact and execute swaps in the future, after the requirements under the Dodd-Frank Act are fully in effect. For all these reasons, we have determined that it is inappropriate to restrict the “making a market in swaps” prong of the swap dealer definition (

i.e.,

routinely standing ready to enter into swaps at the request or demand of a counterparty) to swaps that are not executed on an exchange.

201

198

See, e.g.,

letters cited in note 62,

supra.

199

As discussed above, in many cases routine presence in the swap market, without more, would not constitute market making activity. Nevertheless, the CFTC will, in connection with promulgation of final rules relating to capital requirements for swap dealers and major swap participants, consider institution of reduced capital requirements for entities or individuals that fall within the swap dealer definition and that execute swaps only on exchanges, using only proprietary funds. Similarly, the CFTC also will consider the applicability to such entities or individuals of the other requirements imposed on swap dealers (

e.g.,

internal business conduct standards, external business conduct standards with counterparties), and may adjust those swap dealer requirements as appropriate.

200

See, e.g.,

letters cited in note 66,

supra.

Since the structures of the markets on which swaps will be executed are still in development, and market obligations have not been established, there is little support for comments asserting that market makers should be defined as only those persons who receive benefits from the market (such as reduced trading fees) in return for the obligation to transact when the market requires liquidity.

201

By contrast, it may be appropriate, over time, to tailor the specific requirements imposed on swap dealers depending on the facility on which the swap dealer executes swaps. For example, the application of certain business conduct requirements may vary depending on how the swap is executed, and it may be appropriate, as the swap markets evolve, to consider adjusting certain of those requirements for swaps that are executed on an exchange or through particular modes of execution.

d. Exception for Activities Not Part of “a Regular Business”

The final rule includes the provisions in the proposed rule that incorporate the provisions of the statutory definition regarding activities that are not part of “a regular business” of entering into swaps. One provision states that the term “swap dealer” includes a person that “regularly enters into swaps with counterparties as an ordinary course of business for its own account”; the other provision states that the term “swap dealer” does not include a person that “enters into swaps for such person's own account, either individually or in a fiduciary capacity, but not as a part of a regular business.”

202

Final CFTC Regulation § 1.3(ggg)(2) is modified from the proposal to include the word “a” before the words “regular business,” to conform the text of the rule to the text of the statute.

See

CEA section 1a(49)(C), 7 U.S.C. 1a(49)(C).

As stated in the Proposing Release, we interpret the reference in the definition of the term “swap dealer” to a person entering into swaps “with counterparties * * * for its own account” to refer to a person who enters into a swap as a principal, and not as an agent. A person who enters into swaps as an agent for customers (

i.e.,

for the customers' accounts) would be required to register as either an FCM, introducing broker, commodity pool operator or commodity trading advisor, depending on the nature of the person's activity.

The Commissions continue to believe, as stated in the Proposing Release, that the phrases “ordinary course of business” and “a regular business” are, for purposes of the definition of “swap dealer” essentially synonymous. In this context, we interpret these phrases to focus on activities of a person that are usual and normal in the person's course of business and identifiable as a swap dealing business. It is not necessarily relevant whether the person conducts its swap-related activities in a dedicated subsidiary, division, department or trading desk, or whether such activities are a person's “primary” business or an “ancillary” business, so long as the person's swap dealing business is identifiable.

203

We recognize, as noted by one commenter (

see

letter from ISDA I), that the “regular business” exclusion is not limited solely to the “ordinary course of business” test of the swap dealer definition. Our interpretations of the other three tests are, and should be read to be, consistent with the exclusion of activities that are not part of a regular business.

We have taken into consideration comments seeking additional guidance regarding the types and levels of activities that constitute having “a regular business” of entering into swaps.

204

In this regard, any one of the following activities would generally constitute both entering into swaps “as an ordinary course of business” and “as a part of a regular business”:

205

(i) Entering into swaps with the purpose of satisfying the business or risk management needs of the counterparty (as opposed to entering into swaps to accommodate one's own demand or desire to participate in a particular market); (ii) maintaining a separate profit and loss statement reflecting the results of swap activity or treating swap activity as a separate profit center; or (iii) having staff and resources allocated to dealer-type activities with counterparties, including activities relating to credit analysis, customer onboarding, document negotiation, confirmation generation, requests for novations and amendments, exposure monitoring and collateral calls, covenant monitoring, and reconciliation.

206

204

See, e.g.,

letters from BG LNG I, COPE I, IECA-Credit I, Shell Trading I, WGCEF I and Vitol (stating that the proposed approach was overly subjective and requesting guidance as to the specific activities that are covered by the statutory definition).

205

These activities are inconsistent with entering into a swap to hedge a physical position as defined in § 1.3(ggg)(6)(iii). As discussed below, such hedging is not dealing activity.

206

The three indicators of being engaged in “a regular business” of entering into swaps described

here are set forth in the alternative. Any one of these indicators may be sufficient, based on a facts and circumstances analysis, to reach a conclusion that an entity is engaged in “a regular business” of entering into swaps.

The Commissions see merit in the comments saying that “a regular business” of entering into swaps can be characterized by entering into swaps to satisfy the business or risk management needs of the other party to the swap, and so incorporate this element into our interpretation of the rule.

207

Also, an objective indicator of a person being engaged in “a regular business” of entering into swaps is when the person accounts for the results of its swap activities separately, by maintaining a separate profit and loss statement for those activities or treating them as a separate profit center. Our interpretation incorporates this indicator of activity that is “a regular business” of entering into swaps.

207

This element of the interpretation reflects our agreement with those commenters who said that “a regular business” of entering into swaps is characterized by having a business of accommodating demand or facilitating interest in swaps (

see

letter from IECA-Credit I), and those commenters who said that “a regular business” does not encompass the use of swaps to serve a person's own business needs, as opposed to serving the business needs of the counterparty (

see

letters cited in note 71,

supra

Other comments suggesting specific criteria to identify “a regular business” also were helpful. We agree with commenters

208

that “a regular business” of entering into swaps can be characterized by having staff and resources allocated to the types of activities in which swap dealers must engage with their counterparties, such as those noted above (

e.g.,

credit analysis, confirmation generation, collateral calls, and covenant monitoring). However, we understand that some end users of swaps engage in some of these activities and, in certain circumstances, may have staff and resources available for these activities. Therefore, this element of the definition should be applied in a reasonable manner, taking all appropriate circumstances into account. This element does not depend on whether a specific amount or percentage of expenses or employee time are related to these swap activities. Instead, it is appropriate to objectively examine a person's use of staff and resources related to swap activities. Using staff and resources to a significant extent in conducting credit analysis, opening and monitoring accounts and the other activities noted above, is an indication that the person is engaged in “a regular business” of entering into swaps.

208

See

letters cited in note 80,

supra.

Regarding the commenters' assertion that the activity of entering into swaps in connection with a person's physical commodity business cannot constitute “a regular business” of the person, we believe that while in most cases this is not dealing activity,

209

per se

exclusion of this type is not appropriate because it is possible that in some circumstances a person might enter into swaps that are connected to a physical commodity business but also serve market functions characteristic of the functions served by swap dealers. Also, again, the statutory definition does not contain any such exclusion, but rather includes any person who “regularly enters into swaps with counterparties as an ordinary course of business for its own account,” without regard to the person's particular type of business.

209

See

CFTC Regulation § 1.3(ggg)(6)(iii) (swaps entered into for hedging physical positions as defined in the rule are not considered in the determination of whether a person is a swap dealer).

Consistent with the statutory definition, we interpret “a regular business” of entering into swaps in a manner that applies equally to all market participants that engage in the activities set forth in the statutory definition. This will ensure that all participants in the swap markets are regulated in a fair and consistent manner, regardless of whether their underlying business is primarily physical or financial in nature.

210

Regulation of firms engaged in an underlying physical business is also consistent with regulatory practices outside the U.S. For example, non-financial entities register with the Financial Services Authority in the U.K. as “Oil Market Participants” and “Energy Market Participants.”

See

Financial Services Authority Handbook EMPS and OMPS, available at

http://fsahandbook.info/FSA/html/handbook

Finally, as noted above, the manner in which persons negotiate, execute and use swaps is likely to evolve in response to the requirements of the Dodd-Frank Act and the other forces that will shape the swap markets going forward. For this reason, it would be inappropriate to craft per se exclusions from the swap dealer definition at a time when the only available information about the use of swaps relates to the period prior to implementation of the Dodd-Frank Act.

211

For the same reasons, we do not believe it would be appropriate, in determining whether a person has a “regular business” of entering into swaps, to consider whether a person engages in activities normally associated with financial institutions, as some commenters suggested.

See

letters cited in note 76,

supra.

e. Interim Final Rule Excluding Swaps Entered Into for Hedging Physical Positions

We note that some commenters said that swaps used to hedge or mitigate commercial risks should not be considered in determining whether a person is a swap dealer.

212

We understand that swaps are used to hedge risks in numerous and varied ways, and we expect that the number of persons covered by the definition will be very small in comparison to the thousands of persons that use swaps for hedging.

212

See, e.g.,

letters cited in note 72,

supra.

In terms of the statutory definition of the term “swap dealer,” the CFTC notes as an initial matter that there is no specific provision addressing hedging activity. Thus, the statutory definition leaves the treatment of hedging swaps to the CFTC's discretion; it neither precludes consideration of a swap's hedging purpose, nor does it require an absolute exclusion of all swaps used for hedging.

213

In this regard, the statutory definition of the term “swap dealer” stands in contrast to the statutory definition of the term “major swap participant” which, as discussed further below, explicitly provides that positions in swaps held for hedging or mitigating commercial risk are to be excluded in certain parts of that definition.

See

CEA section 1a(33)(A)(i)(1), 7 U.S.C. 1a(33)(A)(i)(1). The absence of any explicit requirement in the “swap dealer” definition to exclude swaps held for hedging or mitigating commercial risk does not support the view that Congress intended to categorically exclude all swaps that may serve as hedges in determining whether a person is covered by the definition.

Similarly, the absence of any limitation in the statutory definition of the term “swap dealer” to financial entities, when such limitation is included elsewhere in Title VII, indicates that no such limitation applies to the swap dealer definition. CEA section 2(h)(7), 7 U.S.C. 2(h)(7), specifically limits the application of the clearing mandate, in certain circumstances, to only “financial entities.” That section also provides a detailed definition of the term “financial entity.”

See

CEA section 2(h)(7)(C), 7 U.S.C. 2(h)(7)(C). That such a limitation is included in this section, but not in the swap dealer definition, does not support the view that the statutory definition of the term “swap dealer” should encompass only financial entities.

In general, entering into a swap for the purpose of hedging is inconsistent with swap dealing.

214

The practical

difficulty lies in determining when a person has entered into a swap for the purpose of hedging, as opposed to other purposes for entering into swaps, such as accommodating demand for swaps or as part of making a market in swaps, and in distinguishing a swap with a hedging purpose from a swap with a hedging consequence. In view of these uncertainties, the CFTC believes it is appropriate to adopt an interim final rule that draws upon the principles of bona fide hedging that the CFTC has long applied to identify when a financial instrument is used for hedging purposes, and excludes from the swap dealer analysis swaps entered into for the purpose of hedging physical positions that meet the requirements of the rule.

214

For example, under the dealer-trader distinction, the Commissions would expect persons that use security-based swaps to hedge their business risks, absent other activity, likely would not be dealers.

See

part II.A.5.b,

infra.

Under the CFTC's interpretive guidance, making a market in swaps is appropriately described as routinely standing ready to enter into swaps at the request or demand of a counterparty, and the indicia of swap dealing as a “regular business” include entering into swaps to satisfy the business or risk management needs of the counterparty. Entering into swaps for the purpose of hedging one's own risks generally would not be indicative of this form of swap activity.

see also

part II.C,

infra.

However, to the extent a person engages in dealing activities involving swaps, the presence of offsetting positions that hedge those dealing activities would not excuse the requirement that the person register as a swap dealer.

221

Thus, the CFTC's interpretation of the swap dealer definition in this regard draws upon principles in the dealer-trader distinction.

See

part II.A.4.a. Additional authority for CFTC Regulation § 1.3(ggg)(6)(iii) is provided by subparagraph (B) of the swap dealer definition. This subparagraph provides that a person “may be designated as a swap dealer for a single type or single class or category of swap or activities and considered not to be a swap dealer for other types, classes, or categories of swaps or activities.” CEA Section 1a(49)(B), 7 U.S.C. 1a(49)(B). It thereby authorizes a review of a person's various activities with respect to swaps, and a determination that some of the person's activities are covered by a designation as a swap dealer, while other of the person's activities are not. Thus, a person who enters into some swaps for hedging physical positions as defined in CFTC Regulation § 1.3(ggg)(6)(iii), and also enters into other swaps in connection with activities covered by the swap dealer definition, could be designated as a swap dealer only for the latter activities.

At the same time, however, there may be circumstances where a person's activity of entering into swaps is encompassed by the statutory definition of the term “swap dealer,” notwithstanding that the swaps have the effect of hedging or mitigating the person's commercial risk.

222

Although these swaps could, in theory, be excluded from the swap dealer analysis, we believe that a broader,

per se

exclusion for all swaps that hedge or mitigate commercial risk is

inappropriate for the swap dealer definition.

222

For example, “pay floating/receive fixed” swaps entered into by a swap dealer with long exposure to the floating side of a market would have the effect of hedging the dealer's exposure.

First, the hedging exclusion that we are adopting is in the nature of a safe harbor;

i.e.,

it describes activity that will not be considered swap dealing activity. As such, the CFTC believes that it is appropriate that the interim final rule not be cast broadly.

223

This does not mean that other types of hedging activity that do not meet the requirements of the interim final rule are necessarily swap dealing activity. Rather, such hedging activity is to be considered in light of all other relevant facts and circumstances to determine whether the person is engaging in activity (

e.g.,

accommodating demand for swaps, making a market for swaps, etc.) that makes the person a swap dealer.

223

While we recognize that a rule delineating the swap activities that do not constitute swap dealing would simplify and make more certain, at least in some contexts, the application of the swap dealer definition, there are also reasons for caution in incorporating a categorical exclusion for hedging.

Second, the usefulness of an exclusion of all swaps that hedge or mitigate commercial risk for certain aspects of the major swap participant definition

224

is not a reason to use the same exclusion in the swap dealer definition, since the swap dealer definition serves a different function. The definition of the term “major swap participant,” which applies only to persons who are not swap dealers,

225

is premised on the prior identification, by the swap dealer definition, of persons who accommodate demand for swaps, make a market in swaps, or otherwise engage in swap dealing activity. The major swap participant definition performs the subsequent function of identifying persons that are not swap dealers, but hold swap positions that create an especially high level of risk that could significantly impact the U.S. financial system.

226

Only for this subsequent function is it appropriate to apply the broader exclusion of swaps held for the purpose of hedging or mitigating commercial risk.

227

224

See

part IV.C,

infra.

225

See

CEA § 1a(33)(A)(i), 7 U.S.C. 1a(33)(A)(i).

226

See

CEA § 1a(33)(B), 7 U.S.C. 1a(33)(B).

227

We do not believe that the differences between the exclusion in the major participant definitions for swaps held for the purpose of hedging or mitigating commercial risk and the exclusion in the swap dealer definition for certain swaps entered into for the purpose of hedging risks related to physical positions mean that the Commissions, or the CFTC in particular, have implemented two different definitions of hedging. In fact, neither of these exclusions define the term “hedging.” Rather, the differences between the two exclusions reflect differences in the parameters that must be satisfied in order to ensure that hedging swaps are appropriately excluded from the two different definitions.

The CFTC believes that since the over-the-counter swap markets have operated largely without regulatory oversight and encompass swaps used for a wide variety of commercial purposes, no method has yet been developed to reliably distinguish, through a

per se

rule, between: (i) Swaps that are entered into for the purpose of hedging or mitigating commercial risk; and (ii) swaps that are entered into for the purpose of accommodating the counterparty's needs or demands or otherwise constitute swap dealing activity, but which also have a hedging consequence.

228

In contrast, the CFTC notes that it has set forth and modified standards for bona fide hedging transactions and granted exemptions in compliance with such standards for decades.

229

These historically-developed standards form the basis of the interim final rule excluding from the swap dealer analysis certain swaps that hedge the risks associated with a physical position.

228

As noted in the preceding paragraph, it is not necessary to make this distinction for purposes of the major swap participant definition.

229

See, e.g.,

42 FR 42751 (Aug. 8, 1977). Although the latest formulation of the definition of bona fide hedging—CFTC Regulation § 151.5(a)—was recently adopted,

see

CFTC, Position Limits for Futures and Swaps; Final Rule and Interim Final Rule, 76 FR 71626 (Nov. 18, 2011), the bona fide hedging test has been in use for decades.

The exclusion in CFTC Regulation § 1.3(ggg)(6)(iii) depends not on the effect or consequences of the swap, but on whether the purpose for which a person enters into a swap is to hedge a physical position as defined in the rule. If so, then the swap is excluded from the dealer analysis because using swaps for that purpose is inconsistent with, and is not, dealing activity.

230

On the other hand, if, at the time the swap is entered into, the person's purpose for entering into the swap is not as defined in CFTC regulation § 1.3(ggg)(6)(iii), or if it is unclear whether the swap is for such purpose, then the fact that the swap hedges the person's exposure in some regard does not preclude consideration of that swap in the dealer analysis.

231

In this latter case, all relevant facts and circumstances regarding the swap and the person's activity with respect to the swap would be relevant in the determination of whether the person is a swap dealer.

232

230

To be clear, the swaps a person enters into for hedging physical positions as defined in CFTC Regulation § 1.3(ggg)(6)(iii) are not indicative of dealing activity under any of the prongs of the swap dealer definition.

231

In this regard, CFTC Regulation § 1.3(ggg)(6)(iii) is different from certain of the CFTC's rules regarding bona fide hedging, where a person's purpose in entering into a swap may not be relevant.

232

We believe that, in practice, the difficulty of distinguishing, in applying the swap dealer definition, swaps entered into for the purpose of hedging from other types of swaps will be resolvable when the facts and circumstances of a person's swap activities are taken into consideration in light of our interpretive guidance.

We believe that, based on the CFTC's experience in applying bona fide hedging principles with respect to swaps hedging risks related to physical positions, the exclusion in CFTC Regulation § 1.3(ggg)(6)(iii) at this time is the best means of providing certainty to market participants regarding which swaps may be disregarded in the dealer analysis. However, commenters presented a range of views as to the exclusions from the dealer analysis that may be appropriate in this regard.

233

Accordingly, the CFTC is implementing this exclusion on an interim rule basis and is seeking comments on all aspects of the interim rule, including any adjustments that may be appropriate in the rule or accompanying interpretive guidance.

233

See, e.g.,

letters cited in note 141,

supra.

The CFTC also seeks comments on whether a different approach to swaps entered into for the purpose of hedging risk is appropriate to implement the statutory definition of the term “swap dealer.”

For example, the CFTC invites commenters to address whether any exclusion of hedging swaps from the swap dealer analysis is appropriate, and if so, how swaps that are entered into for purposes of hedging may be identified and distinguished from other swaps. Commenters are encouraged to address whether it is relevant to distinguish swaps entered into for purposes of hedging from swaps that have a consequential result of hedging, and if so, how such swaps may be distinguished. Also, commenters may address whether the exclusion should be limited to swaps hedging risks related to physical positions or extended to encompass swaps hedging financial risks or other types of risks.

Commenters should address whether the exclusion in CFTC Regulation § 1.3(ggg)(6)(iii) should be consistent with the exclusion in CFTC Regulation § 1.3(kkk). If so, why, and if not, why not? If the two exclusions should be consistent, does consistency require that that exclusions be identical, or would there be variations in application of the two exclusions? Are there market participants whose swap positions would be classified as held for the purpose of hedging or mitigating commercial risk under CFTC Regulation

§ 1.3(kkk) but would not qualify for the exclusion under CFTC Regulation § 1.3(ggg)(6)(iii)? If so, specifically identify the types of market participants and swaps. If the CFTC were to apply in the swap dealer definition the exclusion in CFTC Regulation § 1.3(kkk) in lieu of the exclusion in CFTC Regulation § 1.3(ggg)(6)(iii), would there be negative market impacts? If so, what are they? Would there be positive market impacts? If so, what are they? In particular, what type(s) of swaps that “hedge or mitigate commercial risk,” but that are not excluded under the interim rule, may constitute dealing activity in light of the rules and interpretive guidance regarding the swap dealer definition set forth in this Adopting Release?

Comments regarding the costs and benefits related to the interim final rule and any alternative approaches, including in particular the quantification of such costs and benefits, are also invited.

Commenters are encouraged, to the extent feasible, to be comprehensive and detailed in providing their approach and rationale. The comment period for the interim final rule will close July 23, 2012.

f. Swaps Entered Into by Persons Registered as Floor Traders

Commenters discussed whether the swap dealer definition encompasses the activity of entering into swaps on or subject to the rules of a DCM or SEF, and submitted for clearing to a derivatives clearing organization (“DCO”), particularly when firms engage in that activity using only proprietary funds.

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Because Title VII of the Dodd-Frank Act amended the definition of floor trader specifically to encompass activities involving swaps,

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the CFTC believes that it would lead to potentially duplicative regulation if floor traders engaging in swaps in their capacity as floor traders were also required to register as swap dealers. Accordingly, the CFTC believes that it is appropriate not to consider such swaps when determining whether a person acting as a floor trader, as defined under CEA section 1a(23),

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and registered with the CFTC under CFTC Regulation § 3.11, is a swap dealer if the floor trader meets certain conditions. Specifically, the final rule provides that, in determining whether a person is a swap dealer, each swap that the person enters into in its capacity as a floor trader as defined by CEA section 1a(23) or on a SEF shall not be considered for the purpose of determining whether the person is a swap dealer, provided that the person:

234

See

letter from Trading Coalition. One commenter specifically discussed floor traders and floor brokers and the regulatory regime that should apply to them following implementation of the Dodd Frank Act.

See

letter from Christopher K. Hehmeyer.

We note that other commenters suggested that all swaps cleared on an exchange should be excluded from the dealer definitions.

See

letters cited in note 138,

supra.

However, the discussion here is limited to persons who are registered as floor traders and meet other conditions. Also, the final rule provision discussed here does not exclude floor traders from the definition of the term “swap dealer;” rather, it provides that if the stated conditions are met, certain swaps entered into by floor traders are excluded from the swap dealer analysis.

235

See

section 721(a)(11) of the Dodd-Frank Act (amending the definition of the term “floor trader” in CEA section 1a(23)). The Exchange Act does not have an equivalent regulatory category to floor trader under the CEA, and thus Congress did not make a similar amendment to the Exchange Act.

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The definition of the term “floor trader” includes a person entering into swaps on a “contract market.”

See

CEA section 1a(23). This exclusion also encompasses swaps that a registered floor trader enters into on or subject to the rules of a SEF, in addition to on or subject to the rules of a DCM, so long as the swap meets the conditions stated in the exclusion.

(i) Is registered with the CFTC as a floor trader pursuant to CFTC Regulation § 3.11;

(ii) enters into swaps solely with proprietary funds for that trader's own account on or subject to the rules of a DCM or SEF, and submits each such swap for clearing to a DCO;

(iii) is not an affiliated person of a registered swap dealer;

(iv) does not directly, or through an affiliated person, negotiate the terms of swap agreements, other than price and quantity or to participate in a request for quote process subject to the rules of a DCM or SEF;

(v) does not directly or through an affiliated person offer or provide swap clearing se

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