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

Federal RegisterDec 13, 2012

Ask Donna

What actually matters in this document.

Text

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 39 and 50

RIN 3038-AD86

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

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule.

SUMMARY:

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

DATES:

The rules will become effective February 11, 2013. Specific compliance dates are discussed in the supplementary information.

FOR FURTHER INFORMATION CONTACT:

Sarah E. Josephson, Deputy Director, 202-418-5684,

sjosephson@cftc.gov;

Brian O'Keefe, Associate Director, 202-418-5658,

bokeefe@cftc.gov;

or Erik Remmler, Associate Director, 202-418-7630,

eremmler@cftc.gov,

Division of Clearing and Risk, Camden Nunery, Economist, 202-418-5723,

cnunery@cftc.gov,

Office of the Chief Economist, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Clearing Requirement Proposal

B. Financial Crisis

C. Central Role of Clearing in the Dodd-Frank Act

D. G-20 and International Commitments on Clearing

E. Overview of Section 2(h) and § 39.5

F. Submissions From DCOs

II. Comments on the Notice of Proposed Rulemaking

A. Overview of Comments Received

B. Generally Applicable Comments

C. Credit Default Swaps

D. Determination Analysis for Credit Default Swaps

E. Interest Rate Swaps

F. Determination Analysis for Interest Rate Swaps

III. Final Rule

A. Regulation 50.1: Definitions

B. Regulation 50.2: Treatment of Swaps Subject to a Clearing Requirement

C. Regulation 50.3: Notice to the Public

D. Regulation 50.4: Classes of Swaps Required To Be Cleared

E. Regulation 50.5: Clearing Transition Rules

F. Regulation 50.6: Delegation of Authority

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

IV. Implementation

V. Cost Benefit Considerations

A. Statutory and Regulatory Background

B. Overview of Swap Clearing

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

D. Consideration of Alternative Swap Classes for Clearing Determination

E. Section 15(a) Factors

VI. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

I. Background

A. Clearing Requirement Proposal

On August 7, 2012, the Commission published a notice of proposed rulemaking (NPRM) to establish a clearing requirement under new section 2(h)(1)(A) of the CEA, as provided for under section 723 of Title VII of the Dodd-Frank Act.

The Commission proposed that swaps meeting the specifications identified in two classes of CDS and four classes of interest rate swaps, and available for clearing by an eligible DCO, would be required to be cleared. The Commission also proposed rules related to the prevention of evasion of the clearing requirement and prevention of abuse of an exception or exemption to the clearing requirement. The Commission is hereby adopting §§ 50.1-50.6 and § 50.10, subject to the changes discussed below.

Clearing Requirement Determination Under Section 2(h) of the CEA; Proposed Rule, 77 FR 47170 (Aug. 7, 2012).

B. Financial Crisis

In the fall of 2008, a series of large financial institution failures triggered a financial and economic crisis that threatened to freeze U.S. and global credit markets. As a result of these failures, unprecedented governmental intervention was required to ensure the stability of the U.S. financial system.

These failures revealed the vulnerability of the U.S. financial system and economy to widespread systemic risk resulting from, among other things, poor risk management practices of financial firms and the lack of supervisory oversight for a financial institution as a whole.

On October 3, 2008, President Bush signed the Emergency Economic Stabilization Act of 2008, which was principally designed to allow the U.S. Department of the Treasury and other government agencies to take action to restore liquidity and stability to the U.S. financial system (

e.g.,

the Troubled Asset Relief Program—also known as TARP—under which the U.S. Department of the Treasury was authorized to purchase up to $700 billion of troubled assets that weighed down the balance sheets of U.S. financial institutions).

See

Public Law 110-343, 122 Stat. 3765 (2008).

See

Financial Crisis Inquiry Commission, “The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States,” Jan. 2011, at xxviii, available at

http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.

The financial crisis also illustrated the significant risks that an uncleared, over-the-counter (OTC) derivatives market can pose to the financial system. As the Financial Crisis Inquiry Commission explained:

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

See id.

at 386.

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

In particular, AIG reportedly issued uncleared CDS transactions covering more than $440 billion in bonds, leaving it with obligations that it could not cover as a result of changed market conditions.

As a result of AIG's CDS exposure, the Federal government bailed out the firm with over $180 billion of taxpayer money in order to prevent AIG's failure and a possible contagion event in the broader economy.

Financial Regulatory Reform: A New Foundation,

June 2009, available at

http://www.treasury.gov/initiatives/Documents/FinalReport_web.pdf

and cited in S. Rep. 111-176 at 29-30 (Apr. 30, 2010).

Adam Davidson, “How AIG fell apart,” Reuters, Sept. 18, 2008, available at

http://www.reuters.com/article/2008/09/18/us-how-aig-fell-apart-idUSMAR85972720080918.

Hugh Son, “AIG's Trustees Shun `Shadow Board,' Seek Directors,” Bloomberg, May 13, 2009, available at

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aaog3i4yUopo&refer=us.

More broadly, the President's Working Group (PWG) on Financial Markets noted shortcomings in the OTC

derivative markets as a whole during the crisis. The PWG identified the need for an improved integrated operational structure supporting OTC derivatives, specifically highlighting the need for an enhanced ability to manage counterparty risk through “netting and collateral agreements by promoting portfolio reconciliation and accurate valuation of trades.”

These issues were exposed in part by the surge in collateral required between counterparties during 2008, when the International Swaps and Derivatives Association (ISDA) reported an 86% increase in the collateral in use for OTC derivatives, indicating not only the increase in risk, but also circumstances in which positions may not have been collateralized.

The President's Working Group on Financial Markets, “Policy Statements on Financial Market Developments,” Mar. 2008, available at

http://www.treasury.gov/resource-center/fin-mkts/Documents/pwgpolicystatemktturmoil_03122008.pdf.

ISDA, ISDA Margin Survey, 2009, available at

http://www.isda.org/c_and_a/pdf/ISDA-Margin-Survey-2009.pdf.

With only limited checks on the amount of risk that a market participant could incur, great uncertainty was created among market participants. A market participant did not know the extent of its counterparty's exposure, whether its counterparty was appropriately hedged, or if its counterparty was dangerously exposed to adverse market movements. Without central clearing, a market participant bore the risk that its counterparty would not fulfill its payment obligations pursuant to a swap's terms (counterparty credit risk). As the financial crisis deepened, this risk made market participants wary of trading with each other. As a result, markets quickly became illiquid and trading volumes plummeted. The dramatic increase in “TED spreads” evidenced this mistrust.

These spreads increased from a long-term average of approximately 30 basis points to 464 basis points.

The TED spread measures the difference in yield between three-month Eurodollars as represented by London Interbank Offered Rate (LIBOR), and three-month Treasury Bills. LIBOR contains credit risk while T-bills do not. As the spread got larger, it meant that lenders demanded more return to compensate for credit risk than they would need if they loaned the money to the U.S. Department of the Treasury without any credit risk.

The U.S. Financial Crisis: Credit Crunch and Yield Spreads, by James R. Barth et al., page 5, available at

http://apeaweb.org/confer/bei08/papers/blp.pdf.

The failure to adequately collateralize the risk exposures posed by OTC derivatives, along with the contagion effects of the vast web of counterparty credit risk, led many to conclude that OTC derivatives should be centrally cleared. For instance, in 2008, the Federal Reserve Bank of New York (FRBNY) began encouraging market participants to establish a central counterparty to clear CDS.

For several years prior, the FRBNY had led a targeted effort to enhance operational efficiency and performance in the OTC derivatives market by increasing automation in processing and by promoting sound back office practices, such as timely confirmation of trades and portfolio reconciliation. Beginning with CDS in 2008, the FRBNY and other primary supervisors of OTC derivatives dealers increasingly focused on central clearing as a means of mitigating counterparty credit risk and lowering systemic risk to the markets as a whole. Both regulators and market participants alike recognized that risk exposures would have been monitored, measured, and collateralized through the process of central clearing.

See

Federal Reserve Bank of New York, Press Release, “New York Fed Welcomes Further Industry Commitments on Over-the-Counter Derivatives,” Oct. 31, 2008, available at

http://www.newyorkfed.org/newsevents/news/markets/2008/an081031.html,

which references documents prepared by market participants describing the importance of clearing.

See also

Letter from Senators Christopher Dodd and Blanche Lincoln to Congressmen Barney Frank and Collin Peterson (June 30, 2010) (“Congress determined that clearing is at the heart of reform—bringing transactions and counterparties into a robust, conservative, and transparent risk management framework.”).

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

The Commission believes that a clearing requirement will reduce counterparty credit risk and provide an organized mechanism for collateralizing the risk exposures posed by swaps. According to the Senate Report:

S. Rep. 111-176, at 33.

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

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

D. G-20 and International Commitments on Clearing

The financial crisis generated international consensus on the need to strengthen financial regulation by improving transparency, mitigating systemic risk, and protecting against market abuse. As a result of the widespread recognition that transactions in the OTC derivatives market increased risk and uncertainty in the global economy and became a significant contributor to the financial crisis, a series of policy initiatives were undertaken to better regulate the financial markets.

In September 2009, leaders of the Group of 20 (G-20)—whose membership includes the United States, the European Union, and 18 other countries—agreed that: (1) OTC derivatives contracts should be reported to trade repositories; (2) all standardized OTC derivatives contracts should be cleared through central counterparties and traded on exchanges or electronic trading platforms, where appropriate, by the end of 2012; and (3) non-centrally cleared contracts should be subject to higher capital requirements.

In June 2010, the G-20 leaders reaffirmed their commitment to achieve these goals. In its October 2010 report on Implementing OTC Derivatives Market Reforms (the October 2010 Report), the Financial Stability Board (FSB) made 21 recommendations addressing practical issues that authorities may encounter in implementing the G-20 leaders' commitments.

The G-20 leaders again reaffirmed their commitments at the November 2011 Summit, including the end-2012 deadline. The FSB has issued three implementation progress reports. The most recent report urged jurisdictions to push forward aggressively to meet the G-20 end-2012 deadline in as many reform areas as possible. On mandatory clearing, the report observed that “[j]urisdictions now have much of the information they requested in order to make informed decisions on the appropriate legislation and regulations to achieve the end-2012 commitment to centrally clear all standardised OTC derivatives.”

See

“Implementing OTC Derivatives Market Reforms,” Financial Stability Board, Oct. 25, 2010, available at

http://www.financialstabilityboard.org/publications/r_101025.pdf.

OTC Derivatives Working Group, “OTC Derivatives Market Reforms: Third Progress Report on Implementation,” Financial Stability Board, June 15, 2012, available at

http://www.financialstabilityboard.org/publications/r_120615.pdf.

Specifically with regard to required clearing, the Technical Committee of the International Organization of Securities Commissions (IOSCO) has published a final report,

Requirements for Mandatory Clearing,

outlining recommendations that regulators should follow to carry out the G-20's goal of requiring standardized swaps to be cleared.

IOSCO's report, published in February 2012, is available at

https://www.iosco.org/library/pubdocs/pdf/IOSCOPD374.pdf.

Nations around the world have been preparing for the move to mandatory clearing. For example, the Japanese Financial Services Authority (JFSA) has proposed requiring certain financial institutions to clear yen-denominated interest rate swaps that reference LIBOR and CDS that reference the Japanese iTraxx indices by the end of 2012. After that, the requirement will be expanded to other entities engaging in these swaps. In addition, the JFSA is considering expanding its mandatory clearing coverage to include U.S. dollar- and euro-denominated interest rate swaps, as well as yen-denominated interest rate swaps referencing TIBOR. The JFSA also will consider mandating single-name CDS referencing Japanese reference entities, and index and single-name CDS on North American and European reference entities.

The Monetary Authority of Singapore (MAS) released a consultation paper addressing mandatory clearing on February 13, 2012. Based on a preliminary review MAS expects Singapore dollar interest rate swaps, U.S. dollar interest rate swaps, and Asian currency non-deliverable forwards to meet its proposed mandatory clearing criteria. Additional swaps will be considered for mandatory clearing via clearinghouse submission or upon the review of MAS.

The Securities and Futures Commission and Hong Kong Monetary Authority jointly released a consultation paper addressing mandatory clearing on October 17, 2011. This consultation plan described a phased implementation approach where clearing requirements will initially cover standardized interest rate swaps and non-deliverable forwards. Hong Kong regulators have said they will consider extending the mandatory clearing requirements in subsequent phases. In July, the Hong Kong regulators published consultation conclusions and stated that the precise mandatory clearing obligations would be set out in subsidiary legislation which they will be consulting on in the fourth quarter of 2012.

On April 18, 2012, the Australian Council of Financial Regulators published a consultation on a number of OTC derivatives, including mandatory clearing. The Council of Financial Regulators is developing advice for the government which is expected to adopt legislation by end-2012.

Finally, in the European Union, specific clearing determinations have yet to be made. However, the European Markets Infrastructure Regulation (EMIR) provides that contracts become subject to the clearing obligation through either a “bottom up” approach or a “top down” approach. The “bottom up” approach is where a national authority authorizes a central counterparty (CCP) to clear certain classes of OTC derivatives. The “top down” approach is where the European Securities and Markets Authority (ESMA) identifies classes of OTC derivatives which should be subject to the clearing obligation but for which no CCP is authorized to clear. Based on this framework, ESMA has the authority to make clearing determinations for classes of OTC derivative contracts.

With the adoption of these final rules, the Commission is taking a critical step toward meeting the G-20 commitment and fulfilling the requirements of the Dodd-Frank Act. The Commission has consulted with authorities from around the globe to ensure that our efforts are as coordinated as possible.

E. Overview of Section 2(h) and § 39.5

The Commission promulgated § 39.5 of its regulations to implement procedural aspects of section 2(h) of the CEA.

Regulation 39.5 establishes procedures for: (1) Determining the eligibility of a DCO to clear swaps; (2) the submission of swaps by a DCO to the Commission for a clearing requirement determination; (3) Commission initiated reviews of swaps; and (4) the staying of a clearing requirement.

See

76 FR 44464 (July 26, 2011); 17 CFR 39.5.

The determinations and rules adopted in this release implement the clearing requirement under section 2(h) of the CEA for certain swaps and require that those swaps must be submitted for clearing to Commission-registered DCOs. Under section 2(h)(1)(A), “it shall be unlawful for any person to engage in a swap unless that person submits such swap for clearing to a [DCO] that is registered under [the CEA] or a [DCO] that is exempt from registration under [the CEA] if the swap is required to be cleared.”

See

section 2(h) of the CEA. The Commission also may conduct a Commission-initiated review of swaps for required clearing. Section 2(h)(2)(A)(i) of the CEA requires the Commission on an ongoing basis to “review each swap, or any group, category, type, or class of swaps to make a determination as to whether the swap, category, type or class of swaps should be required to be cleared.”

A clearing requirement determination may be initiated by a swap submission. Section 2(h)(2)(B)(i) of the CEA requires a DCO to “submit to the Commission each swap, or any group, category, type or class of swaps that it plans to accept for clearing, and provide notice to its members of the submission.” In addition under section 2(h)(2)(B)(ii) of the CEA, “[a]ny swap or group, category, type, or class of swaps listed for clearing by a [DCO] as of the date of enactment shall be considered submitted to the Commission.”

F. Submissions from DCOs

On February 1, 2012, Commission staff sent a letter requesting that DCOs submit all swaps that they were accepting for clearing as of that date, pursuant to § 39.5 of the Commission's regulations.

The Commission received submissions relating to CDS and interest rate swaps from: The International Derivatives Clearinghouse Group (IDCH)

on February 17, 2012; the CME Group (CME), ICE Clear Credit, and ICE Clear Europe, each dated February 22, 2012; and a submission from LCH.Clearnet Limited (LCH) on February 24, 2012.

The letter made it clear that DCOs should submit both pre-enactment swaps and swaps for which DCOs have initiated clearing since enactment of the Dodd-Frank Act. Pre-enactment swaps refer to those swaps that DCOs were accepting for clearing as of July 21, 2010, the date of enactment of the Dodd-Frank Act.

As discussed in detail below, IDCH has been purchased by LCH.Clearnet Group.

Other swaps submissions were received from Kansas City Board of Trade (KCBT) and the Natural Gas Exchange (NGX). KCBT and NGX do not accept any CDS or interest rate swaps for clearing.

The clearing requirement determinations and rules adopted in this release cover certain CDS and interest rate swaps currently being cleared by a DCO. The Commission intends subsequently to consider other swaps submitted by DCOs, such as agricultural, energy, and equity indices.

As stated in the NPRM, the decision to focus on CDS and interest rate swaps in the initial clearing requirement determinations is a function of both the market importance of these swaps and the fact that they already are widely cleared. In order to move the largest number of swaps to required clearing in its initial determinations, the Commission believes that it is prudent to focus on those swaps that have the highest market shares and, accordingly, the biggest market impact. Further, for these swaps there is already a blueprint for clearing and appropriate risk management. CDS and interest rate swaps fit these considerations and therefore are well suited for required clearing consideration.

The Commission will consider all other swaps submitted under § 39.5(b) as soon as possible after this determination is published. These other swaps include certain CDS that were submitted to the Commission after the initial February 2012 submissions discussed above. If the Commission determines that additional swaps should be required to be cleared, such determination likely will be proposed as a new class under § 50.4.

Notably, market participants recommended that the Commission take this approach, and comments received on the NPRM supported this approach as well.

In addition, interest rate swaps account for about $500 trillion of the $650 trillion global OTC swaps market, in notional dollars—the highest market share of any class of swaps.

LCH claims to clear about $302 trillion of those—meaning that, in notional terms, LCH clears approximately 60% of the interest rate swap market.

While CDS indices do not have as prominent a market share as interest rate swaps, CDS indices are capable of having a sizeable market impact, as they did during the 2008 financial crisis. Overall, the CDS marketplace has almost $29 trillion in notional outstanding across both single and multi-name products.

CDS on standardized indices accounts for about $10 trillion of the global OTC market in notional dollar amount outstanding.

Since March 2009, the ICE Clear Credit and ICE Clear Europe have combined to clear over $30 trillion in gross notional for all CDS.

Because of the market shares and market impacts of these swaps, and because these swaps are currently being cleared, the Commission decided to review CDS and interest rate swaps in its initial clearing requirement determinations. The Commission recognizes that while this is an appropriate basis for the initial determinations, swap clearing is likely to evolve and clearing requirement determinations made at later times may be based on a variety of other factors beyond the extent to which the swaps in question are already being cleared.

See, e.g.,

letters from the CME Group (CME), the Futures Industry Association (FIA), the Managed Funds Association (MFA), and Americans for Financial Reform (AFR).

Bank of International Settlements (BIS) data, December 2011, available at

http://www.bis.org/statistics/otcder/dt1920a.pdf.

Id.;

LCH data.

BIS data, December 2011, available at

http://www.bis.org/statistics/otcder/dt1920a.pdf.

Id.

ICE Clear Credit data, as of the April 26, 2012 clearing cycle.

II. Comments on the Notice of Proposed Rulemaking

The Commission received 29 comments during the 30-day public comment period following publication of the NPRM, and four additional comments after the comment period closed. The Commission considered each of these 33 comments in formulating the final regulations.

Comment letters received in response to the NPRM may be found on the Commission's Web site at

http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1252.

The Chairman and Commissioners, as well as Commission staff, participated in numerous meetings with clearinghouses, market participants, trade associations, public interest groups, and other interested parties. In addition, the Commission has consulted with other U.S. financial regulators including: (i) The Securities and Exchange Commission (SEC); (ii) the Board of Governors of the Federal Reserve System; (iii) the Office of the Comptroller of the Currency; and (iv) the Federal Deposit Insurance Corporation (FDIC). Staff from each of these agencies has had the opportunity to provide oral and/or written comments to this adopting release, and the final regulations incorporate elements of the comments provided.

The Commission is mindful of the benefits of harmonizing its regulatory framework with that of its counterparts in foreign countries. The Commission has therefore monitored global advisory, legislative, and regulatory proposals, and has consulted with foreign regulators in developing the final regulations.

A. Overview of Comments Received

None of the 33 comments received expressed outright opposition to the Commission's clearing requirement proposal.

Indeed, 22 of the comment letters strongly supported the Commission's proposal and urged the Commission to finalize its proposal promptly.

These comments also supported the Commission's analysis under the five-factor statutory test, and agreed with the Commission's conclusion that swaps within the four proposed classes of interest rate swaps and the two proposed classes of CDS were appropriate for required clearing.

All three DCOs clearing the swaps subject to the final rules expressed strong support for the proposal and agreed with the overall approach taken by the Commission.

An unsigned comment submitted on September 4, 2012, questioned the need for additional regulation as a general matter.

See

letters from Futures Industry Association Principle Traders Group (FIA PTG), Arbor Research and Trading, LLC, R.J. O'Brien & Associates, Svenokur, LLC, Chris Barnard, CRT Capital Group (Robert Gorham), LLC, DRW Trading Group, Javelin, The Swaps and Derivatives Market Association (SDMA), Knight Capital Americas LLC, Bart Sokol (CRT Capital Group), Jefferies & Company, Inc., MarketAxess, Eris Exchange, Coherence Capital Partners LLC, Citadel, Americans for Financial Reform (AFR), D.E. Shaw Group, AllianceBernstein, LCH.Clearnet Group Limited (LCH), CME Group Inc. (CME), and IntercontinentalExchange, Inc. (ICE).

See, e.g.,

letter from Citadel (reviewing each of the five statutory factors and supporting the Commission's analysis).

CME applauded the Commission's decision to require classes of swaps be cleared rather than take a product-by-product approach. CME also commended the decision not to propose classes of swaps on a DCO-by-DCO basis.

However, a number of commenters requested that the Commission make specific modifications to the proposed

rules,

and, in several instances, commenters requested clarification of various points.

A number of commenters requested that the Commission delay implementation of the clearing requirement until certain milestones are met.

Each of these comments is discussed in detail below.

See, e.g.,

letter from ISDA (requesting changes to the delegation provisions of proposed § 50.6).

See, e.g.,

letter from The Financial Services Roundtable (FSR) (requesting that the Commission clarify the meaning of “conditional notional amount”).

See, e.g.,

letter from ISDA (requesting that no determination take effect until there is “a further determination that a product has an adequate clearing history to support a finding of operational readiness to clear by DCOs and market participants”), and letter from Vanguard (requesting that the Commission delay mandatory clearing until new rules for segregation of customer funds and swap positions are fully operational and capable of being tested for three months).

The Futures Industry Association (FIA) expressed concern about the 30-day comment period providing sufficient time to comment on the proposal, and recommended that the Commission provide a longer comment period for future proposals.

The Commission is cognizant of the importance of affording the public sufficient time to comment on important proposals. However, given the CEA's requirement that the Commission make its clearing requirement determinations within 90 days, in most instances, providing a 30-day comment period will be appropriate. In fact, some commenters stressed the importance of completing the determination process in an efficient manner. As R.J. O'Brien noted in its comment letter, implementing the clearing mandate as soon as possible “will improve the financial industry's credibility and show the rest of the world we are serious about improving the financial safety of our markets.” Providing for a longer comment period likely would impede the Commission's ability to meet the 90-day statutory deadline for completing the determination process.

FIA specifically mentioned its inability to respond to questions asked in the NPRM with regard to competitiveness, which it viewed as important to the Commission's analysis of competitiveness under one of the five statutory factions.

See

Sections II.D and II.F below.

Lastly, two commenters encouraged the Commission to issue proposed determinations for energy, agricultural, and equity swaps as soon as possible.

As required under the CEA, the Commission will continue to review swap submissions received from DCOs for purposes of the clearing requirement in as timely a manner as possible.

See

letters from AFR and Chris Barnard.

B. Generally Applicable Comments

A number of comments are equally applicable to both the CDS and interest rate swap proposals. While most of these issues are discussed in Section III below, certain threshold comments are addressed at the outset.

i. Submission of Swaps Required To Be Cleared and Failures to Clear

CME sought clarification that market participants do not have to clear those swaps that fall within a class of swaps under § 50.4, but for which no DCO provides clearing or for which the DCO provides clearing to only a limited number of market participants. Other commenters expressed similar concerns about not requiring clearing where no DCO offers customer clearing.

Freddie Mac requested clarification regarding the legal status of a swap that is submitted for clearing to a DCO, but fails to clear.

See

Section II.D for a discussion of iTraxx and the availability of client clearing.

The Commission confirms that if no DCO clears a swap that falls within a class of swaps under § 50.4, then the clearing requirement does not apply to that swap. In essence, it is a two-step process to determine whether the clearing requirement applies to a particular swap. First, a market participant must determine whether its swap falls within one of the classes under § 50.4. Then, if the swap falls within one of the classes, the market participant must determine if any of the eligible DCOs clear that swap. The second step requires market participants to determine if all the product specifications required under the DCO's rules are met. If no eligible DCO will accept the swap for clearing because there is a different product specification, then the swap is not required to be cleared. Market participants need not submit swaps to a DCO if they know that the DCO does not clear that particular swap.

The rule text of § 50.2(a) has been modified to clarify this two-step process.

In response to Freddie Mac's request for clarification, if counterparties submit their swap to a DCO for clearing and the swap fails to clear because it contains a term or terms that prevent any eligible DCO from clearing the swap, then the swap is not subject to the Commission's clearing requirement. On the other hand, if the swap fails to clear because one or both of the counterparties have not met the DCO's or their clearing members' credit requirements,

then the swap remains subject to the clearing requirement and must be cleared as soon as technologically practicable after the counterparties learn of the credit issue. The Commission notes that section 739 of the Dodd-Frank Act amended section 22(a)(4)(B) of the CEA to provide that, regarding contract enforcement between two eligible counterparties, “[n]o agreement, contract, or transaction between eligible contract participants or persons reasonably believed to be eligible contract participants shall be void, voidable, or unenforceable * * * under this section or any other provision of Federal or State law, based solely on the failure of the agreement, contract, or transaction * * * to be cleared in accordance with section 2(h)(1).” Accordingly, a swap that fails to clear because of credit issues may not be voided by either eligible counterparty solely for the failure of the swap to be cleared in accordance with section 2(h)(1), but the basis for the failure to clear must be addressed by the counterparties and they must promptly resubmit the swap for clearing.

It is the Commission's understanding that clearing failures generally arise under two circumstances: (1) Failure of the swap to meet the product specifications required by the DCO; or (2) a credit issue with one or both of the counterparties to the swap. Generally speaking, identification of a product specification problem can be identified extremely quickly.

With regard to clearing that is not available to all market participants, the Commission will not require a swap to be cleared unless clearing is generally available to all types of market participants.

See

Section II.D for a discussion of iTraxx and the availability of client clearing.

ii. Adequacy of DCO Clearing History and Commission Review

ISDA raised a general issue regarding whether the clearing requirement determination for CDS and interest rate swaps properly differentiates between swaps that a DCO currently clears and those that are not currently cleared by a DCO. ISDA expressed concern about delegating to the Director of the Division of Clearing and Risk the authority to determine whether newly-cleared swaps fall within a previously-established class. ISDA's specific comments and recommendations are discussed, and in part adopted, in Section III below. However, ISDA's general recommendation is that the Commission not impose a clearing requirement until there is “a further determination that a product has an adequate clearing history to support a finding of operational readiness to clear by DCOs and market participants.” Specifically, ISDA requests that each product have been actually cleared by a DCO and exhibit

non-zero open interest (for both inter-dealer and customer clearing) on each day during a six-month period prior to the effective date of the clearing requirement determination.

In contrast with ISDA's comments, the three DCOs eligible to clear swaps within the classes under proposed § 50.4 praised the Commission for taking the class-based approach rather than a product-by-product approach.

In addition, CME and ICE both endorsed the Commission's decision not to limit applicability of the clearing requirement to individual DCOs.

Many other commenters also agreed with this approach.

See, e.g.,

TriOptima and Citadel.

The Commission observes that ISDA's recommendation that each DCO demonstrate non-zero open interest for six months may be inconsistent with section 2(h)(2) of the CEA, which requires each DCO to submit to the Commission all swaps that “it plans to accept for clearing.” The use of the phrase “plans to accept” indicates that Congress intended for the Commission to review swap submissions prior to a DCO's commencing clearing operations for those swaps. Under these circumstances, the DCO would not be able to demonstrate open interest. In addition, adopting ISDA's suggestion could pose a significant deterrent to competition among DCOs insofar as DCOs seeking to offer swaps for required clearing would have to wait until they attract open interest and retain it for six months before they would be on a level playing field with incumbent DCOs.

The Commission believes that it can address ISDA's concerns about DCO product expansion and risk management through its ongoing supervision and risk surveillance programs.

In addition, under § 39.5(a)(1) the Commission can review the presumption of eligibility for any DCO offering new swaps falling into a class that it is already clearing, and under § 39.5(a)(2), the Commission must review the eligibility of any DCO that wishes to clear a swap that is not within a class already being cleared by that DCO.

The many benefits of a class-based approach are discussed with regard to both CDS and interest rate swaps below.

See

discussion of the Commission's DCO examination and risk surveillance programs in the NPRM, 77 FR at 47173-74.

In its comment letter, Freddie Mac questioned how the Commission would review a proposal from a DCO to clear swaps that are required to be cleared under § 50.4. In addition to its general authority to ensure compliance with the core principles, the Commission has authority to review a DCO's eligibility to clear swaps subject to a clearing requirement at any time under § 39.5(a).

iii. Customer Segregation for Swaps

Under section 2(h)(2)(D)(ii)(V) of the CEA, in making a clearing requirement determination, the Commission must take into account the existence of reasonable legal certainty in the event of the insolvency of the relevant DCO or one or more of its clearing members with regard to the treatment of customer and swap counterparty positions, funds, and property.

Several commenters raised general concerns about customer segregation for cleared swaps.

This factor is discussed further in Sections II.D and II.F below.

Vanguard recommended that the Commission should not implement mandatory clearing for any swaps until the Commission's final swap customer segregation rules under the legally segregated, operationally commingled (LSOC) model are fully operational and capable of being tested for at least three months prior to mandatory clearing.

The Securities Industry and Financial Markets Association's Asset Management Group (SIFMA AMG) expressed similar concerns about unresolved issues concerning LSOC rules and the operational readiness of futures commission merchants (FCMs) and DCOs to comply with those rules. SIFMA AMG requested clarification of certain matters related to the LSOC model and requests that the Commission issue new rules to require FCMs to issue reports as frequently as technologically feasible, require DCOs to take all steps necessary to ensure reported information is accurate, and require DCOs to complete margin calculations as frequently as technologically feasible. SIFMA AMG recommended that the Commission implement a three-month testing period for LSOC rule implementation after the Commission and the market have completed their ongoing rule clarification efforts.

Both Vanguard and SIFMA AMG requested that all customer margin, including excess margin above the amount required by the DCO, be protected from fellow-customer risk.

ISDA noted that the commodity broker liquidation provisions under the U.S. bankruptcy code and the Commission's Part 190 regulations have never been applied to a DCO. In addition, ISDA stated that the Orderly Liquidation Authority under Title II of the Dodd-Frank Act has never been applied to any entity. For clearinghouses located in the United Kingdom, ISDA observed that the Commission is relying on legal opinions, noting the lack of practical experience with DCO insolvency in the United Kingdom. In light of the absence of practical experience with DCO insolvency, ISDA recommended that the Commission study the issue with the goal of documenting uncertainties and proposing solutions.

In response to these comments, the Commission observes that the compliance date for LSOC was November 13, 2012. The Commission worked with market participants to ensure that compliance by that date was accomplished

For reasons discussed below, the compliance schedule for this first clearing requirement will commence on March 11, 2013.

Accordingly, as requested by SIFMA AMG, parties in the first compliance category

will have more than 3 months of experience under the LSOC rules prior to required clearing taking effect. Those parties in the second and third categories will have over 6 and 9 months of testing prior to required clearing, respectively.

During this time, the Commission will continue to work with market participants to resolve matters that require clarification regarding LSOC.

The Commission notes that under § 22.13 a DCO may, subject to certain conditions contained therein, accept cleared swaps customer collateral in excess of the amount required by the DCO. Acceptance of this excess collateral is entirely at the election of the DCO. Thus, the timing of resolution of any issues that may arise as a result of the optional acceptance of such collateral is separate and apart from the November 13th compliance date for implementation of the regulatory requirements set forth in the Part 22 rules.

See

Section IV for a complete discussion of compliance dates.

Under the compliance schedule for required clearing, § 50.25, Category 1 Entities are swap dealers, security-based swap dealers, major swap participants, major security-based swap participants, and active funds. This category must come in compliance with the clearing requirement by March 11, 2013.

Category 2 Entities are commodity pools, private funds, and persons predominantly engaged in activities that are in the business of banking, or in activities that are financial in nature according to section 4(k) of the Bank Holding Company Act, provided that such participants are not third-party subaccounts. Category 2 Entities must comply with the clearing requirement by June 10, 2013, for all swaps entered into on or after that date. Category 3 Entities are all other counterparties not electing an exception for a swap under section 2(h)(7), including third-party subaccounts and ERISA plans. Category 3 Entities must comply with the clearing requirement by September 9, 2013, for all swaps entered into on or after that date.

Moreover, in response to requests for enhanced LSOC protections, the Commission understands that the industry is working toward a February implementation date for DCO rules regarding acceptance of excess collateral. The Commission recognizes

that this issue is of particular concern to third-party subaccounts that will be required to begin clearing swaps executed on or after September 9, 2013. Given the industry's February goal, the Commission believes that issues regarding the acceptance of excess collateral will be resolved before the beginning of September.

In response to ISDA's request that the Commission conduct a study regarding insolvencies of DCOs and clearing members, the Commission observes that its staff have actively participated in, and taken leading roles in, a number of international efforts related to clearinghouse and clearing member insolvency, including an important cross-border study regarding insolvency regimes.

In addition, the Commission and other U.S. authorities, including the FDIC, have been engaged, and continue to engage, in regulatory coordination and cooperation, related to insolvencies under Title II.

See, e.g.,

“Survey of Regimes for the Protection, Distribution, and/or Transfer of Client Assets” (Technical Committee of the International Organization of Securities Commissions, March, 2011); “Consultative Report on the Recovery and Resolution of Financial Market Infrastructures” (Committee on Payment and Settlement Systems and the International Organization of Securities Commissions, July, 2012). Staff are also actively participating in further efforts in these contexts by the International Organization of Securities Commissions and the Resolution Steering Group of the Financial Stability Board.

C. Credit Default Swaps

i. DCO Submissions

Pursuant to § 39.5, the Commission received filings with respect to CDS cleared by CME, ICE Clear Credit, and ICE Clear Europe, each a registered DCO.

The CME and ICE Clear Credit submissions included the CDS that each clears on North American corporate indices, covering various tenors and series.

The ICE Clear Europe submission included, among other swaps, the CDS contracts on European corporate indices that they clear, with information on each of the different tenors and series. Each of the submissions contained information relating to the five statutory factors set forth in section 2(h)(2)(D) of the CEA and other information required under § 39.5.

In the case of CME and ICE Clear Europe, the submissions also included other swaps beyond those in the CDS and interest rate swap categories. These submissions, including a description of the specific swaps covered, are available on the Commission's Web site at:

http://sirt.cftc.gov/sirt/sirt.aspx?Topic=ClearingOrganizationProducts.

The Commission has received subsequent submissions from CME and ICE Clear Credit relating to CDS. In particular, CME submitted a filing with regard to the current series of each of the CDX.NA.IG and CDX.NA.HY (Series 19). ICE Clear Credit made filings with regard to the clearing of the 3-year tenor of the CDX.HY Series 15 and the clearing of the CDX.EM indices. With the exception of the CDX.EM submission, upon which the Commission has not yet begun the determination process, the substance of each of the other submissions was addressed in both the proposed clearing determination and the final clearing determination set forth herein.

CME, ICE Clear Credit, and ICE Clear Europe provided notice of their § 39.5 swap submissions to their members by posting their submissions on their respective Web sites.

The submissions also are published on the Commission's Web site.

Available at

http://www.cmegroup.com/market-regulation/rule-filings.html

and

https://www.theice.com/publicdocs/regulatory_filings/ICEClearCredit_022212.pdf.

ICE Clear Europe did not provide a link to its relevant Web page.

See http://sirt.cftc.gov/sirt/sirt.aspx?Topic=ClearingOrganizationProducts.

Regulation 39.5(b)(3)(viii) also directs a DCO's submission to include a summary of any views on the submission expressed by members. CME's submission did not address this. In their submissions, ICE Clear Credit and ICE Clear Europe stated that neither has solicited nor received any comments to date and will notify the Commission of any such comments. The Commission did not receive any additional feedback from DCOs beyond the information included in comment letters posted on the Commission's Web site.

The CDS cleared by CME, ICE Clear Credit, and ICE Clear Europe that were submitted to the Commission are standardized contracts providing credit protection on an untranched basis, meaning that settlement is not limited to a specific range of losses upon the occurrence of credit events among the reference entities included within an index. Besides single-name CDS, untranched CDS on indices are the only type of CDS being cleared by these DCOs. Other swaps, such as credit index tranches, options, and first- or Nth-to-default baskets on these indices, are not currently cleared.

CME and ICE Clear Credit each clear CDS on indices administered by Markit. The Markit CDX family of indices is the standard North American credit default swap family of indices, with the primary corporate indices being the CDX North American Investment Grade (consisting of 125 investment grade corporate reference entities) (CDX.NA.IG) and the CDX North American High Yield (consisting of 100 high yield corporate reference entities) (CDX.NA.HY). The standard currency for CDS on these indices is the U.S. dollar.

CME offers the CDX.NA.IG at the 3-, 5-, 7- and 10-year tenors for Series 9 and each subsequent series, to the extent that those contracts that have not reached their termination date.

CME also offers the CDX.NA.HY at the 5-year tenor for Series 11, and each subsequent series. ICE Clear Credit offers the CDX.NA.IG Series 8, and each subsequent series of that index that is still outstanding, at the 3-, 5-, 7- and 10-year tenors.

ICE Clear Credit also offers the CDX.NA.IG. Series 8 to Series 10, at the 7-year tenor. For the high yield index, ICE Clear Credit clears all series from the current series through the CDX.NA.HY Series 9 at the 5-year tenor.

Each of these cleared CDX.NA contracts is denominated in U.S. dollars.

As administrator of these indices, Markit reviews the composition of underlying reference entities in the indices every six months. Once Markit establishes the constituents to be included within the indices, a new series of the respective index is created. The most recent series is identified as the “on-the-run” series, with all older series being identified as “off-the-run.” Additionally, each time one of the reference entities within an index suffers a credit event, a new version of an existing series of the index is created. In addition to the series and version variations that may exist on the index, the parties can choose the tenor of the CDS on a given index. While the 5-year tenor is the most common, and therefore most liquid, other standard tenors may include the 1-, 2-, 3-, 7-, and 10-year.

ICE Clear Credit began clearing the 3- and 7-year tenors on the CDX.NA.IG after its initial § 39.5 submission of February 22, 2012.

ICE Clear Credit also made a § 39.5 submission with regard to the 3-year tenor of CDX.NA.HY, Series 15. The Commission is not including this contract within the clearing determination at this time.

ICE Clear Europe made a submission covering the index CDS that it clears. As with CME's and ICE Clear Credit's submissions, the contracts that ICE Clear Europe clears are based on Markit indices with corporate reference entities, though in this case, the entities are based in Europe. ICE Clear Europe clears euro-denominated contracts referencing the three primary indices: iTraxx Europe (covering 125 European investment grade corporate reference entities); the iTraxx Europe Crossover (covering 50 European high yield reference entities); and the iTraxx Europe High Volatility (a 30-entity subset of the European investment grade index).

For the iTraxx Europe and Crossover, ICE Clear Europe clears outstanding contracts in the Series 7 and 8, respectively, through the current series. For the High Volatility index, ICE Clear Europe clears outstanding contracts in the Series 9 through the current series. In terms of tenors, ICE Clear Europe clears the 5-year tenor for all swaps, as well as the 10-year tenor for the iTraxx Europe index.

Based upon those portions of the CME, ICE Clear Credit, and ICE Clear Europe swap submissions relating to the CDS contracts discussed above, as well as the analysis conducted by the Commission pursuant to § 39.5(b) and set forth below, the Commission has reviewed the following classes of swaps for purposes of the clearing requirement determination.

ii. Identification of CDS Specifications

Under § 39.5, the decision of the Commission to require that a group, category, type, or class of swaps be required to be cleared is informed by a number of factors. As an initial matter, the Commission has looked to the DCOs' submissions with regard to the swaps they currently clear. After analyzing the key attributes of the swaps submitted, the Commission proposed establishing two classes of CDS to be subject to the clearing requirement and, pursuant to this final rulemaking, is finalizing those classes as proposed. The first class is based on the untranched indices covering North American corporate credits, the CDX.NA.IG and the CDX.NA.HY. The second class is based on the untranched indices covering European corporate credits, the iTraxx Europe, the iTraxx Europe Crossover, and the iTraxx Europe High Volatility. Given the different markets that the CDS indices cover, the different standard currencies, and other logistical differences in how the CDS markets and documentation work, the Commission believes this is an appropriate basis for creating these two classes.

The following table sets forth the specific specifications of each class:

Table 1

Specification

North American Untranched CDS Indices Class

1. Reference Entities

Corporate.

2. Region

North America.

3. Indices

CDX.NA.IG.

CDX.NA.HY.

4. Tenor

CDX.NA.IG: 3Y, 5Y, 7Y, 10Y.

CDX.NA.HY: 5Y.

5. Applicable Series

CDX.NA.IG 3Y: Series 15 and all subsequent Series, up to and including the current Series.

CDX.NA.IG 5Y: Series 11 and all subsequent Series, up to and including the current Series.

CDX.NA.IG 7Y: Series 8 and all subsequent Series, up to and including the current Series.

CDX.NA.IG 10Y: Series 8 and all subsequent Series, up to and including the current Series.

CDX.NA.HY 5Y: Series 11 and all subsequent Series, up to and including the current Series.

6. Tranched

No.

Specification

European Untranched CDS Indices Class

1. Reference Entities

Corporate.

2. Region

Europe.

3. Indices

iTraxx Europe.

iTraxx Europe Crossover.

iTraxx Europe HiVol.

4. Tenor

iTraxx Europe: 5Y, 10Y.

iTraxx Europe Crossover: 5Y.

iTraxx Europe HiVol: 5Y.

5. Applicable Series

iTraxx Europe 5Y: Series 10 and all subsequent Series, up to and including the current Series.

iTraxx Europe 10Y: Series 7 and all subsequent Series, up to and including the current Series.

iTraxx Europe Crossover 5Y: Series 10 and all subsequent Series, up to and including the current Series.

iTraxx Europe HiVol 5Y: Series 10 and all subsequent Series, up to and including the current Series.

6. Tranched

No.

The Commission believes that indices based on other types of entities would be viewed as a separate class and would be subject to a separate determination by the Commission. For example, given the differences that exist with regard to volumes and risk management of indices based on sovereign issuers, as opposed to corporate issuers, it is likely that such CDS would represent their own class of swaps. Similarly, to the extent indices from other regions were submitted by a DCO, it is likely that the Commission would take the view that they are part of their own class of swaps as well.

The Commission believes it appropriate to define the classes of swaps as untranched CDS contracts referencing Markit's broad-based corporate indices. These corporate indices have the most net notional outstanding, the most trading volumes, and the best available pricing. The risk management frameworks for the corporate index swaps are the most well-established, and have the most available data in terms of CDS spreads and corporate default studies for analysis of the underlying constituents of the indices. Agreements based on these indices also are widely accepted and use standardized terms.

To the extent other vendors successfully develop similar indices, the Commission would conduct the analysis required by § 39.5, either on its own initiative or based on a DCO submission. If based on that analysis the Commission issued a clearing requirement determination, it is likely that such indices would be considered to be part of an existing class of CDS that are required to be cleared.

Both of the CDS classes presented herein assume that the relevant CDS agreement will use the standardized terms established by Markit/ISDA with regard to the specific index and be denominated in a currency that is accepted for clearing by DCOs. To the extent that a CDS agreement on an index listed within the classification is not accepted for clearing by any DCO because it uses non-standard terms or is denominated in a currency that makes it ineligible for clearing, that CDS is not subject to the requirement that it be cleared, notwithstanding that the CDS is based on such index.

Also as proposed, this clearing determination is limited to only those series of the referenced indices that are currently being cleared.

Further, to the

extent that any swap on a CDS index is of a tenor such that it is scheduled to terminate prior to July 1, 2013, such a swap is not part of this clearing determination. Given the implementation periods provided for under § 50.25, discussed below in Section IV, the Commission does not want to create a situation where certain market participants will be required to clear a contract based upon their status under the implementation provisions, but other parties will never be required to clear that same contract before its scheduled termination.

As discussed in further detail below, the clearing requirement does not require existing

swaps in the older series to be cleared. The requirement is prospective, only requiring newly executed swaps in these older series to be cleared.

Similarly, the classes only include those tenors of contracts which are currently being cleared. AFR commented that both the 1- and 2-year tenors of the CDX.NA.IG should be included in the clearing requirement determination, citing concerns that if market participants shift to these shorter tenors, that shift would undermine a clearing requirement that included only longer tenors. Because no DCO clears the 1- or 2-year tenor of CDX.NA.IG, the Commission has decided to include within today's clearing determination only those tenors of the CDX.NA.IG that were proposed. The Commission will monitor the market's use of shorter tenors. To the extent that the market generates significant volumes of such shorter tenors of CDX.NA.IG, the Commission would expect that one or more DCOs will begin offering those tenors for clearing.

If no DCO were to offer these swaps for clearing, the Commission has the authority to commence a Commission-initiated review under section 2(h)(2)(A)(i) of the CEA to determine whether the swaps should be required to be cleared. Under section 2(h)(4), to the extent that the Commission finds that a particular swap or group, category, type, or class of swaps would otherwise be subject to mandatory clearing but no DCO has listed the swap, group, category, type, or class of swaps for clearing, the Commission shall (i) investigate the relevant facts and circumstances; (ii) issue a public report containing the results of the investigation within 30 days; and (iii) take such actions as the Commissions determines to be necessary and in the public interest, which may include requiring the retaining of adequate margin or capital by parties to the swap.

The clearing requirement determination will also cover each new series of these indices that is created every six months. The Commission believes this will provide certainty to the market, as opposed to awaiting a new determination for each new series.

Recognizing that there may be changes to indices and their constituents,

the Commission will analyze each new series to ensure that the indices should continue to be included within the existing class of swaps subject to a clearing determination. To the extent that the new series raises issues, such as a DCO's ability to risk manage the contracts, the Commission can issue a stay of the clearing requirement for that series under § 39.5(d). No commenter raised any questions regarding new series.

The timing of announcement of index constituents would make it impossible for the Commission to analyze the index and issue a clearing determination on the roll date, given the timeframes imposed on the Commission by § 39.5.

See

Financial Times, “CDS Market—Markit's Weird Selection,” September 27, 2012, discussing the inclusion of constituents (CIT, Calpine, and Charter Communications) in the latest series of the CDX.NA.HY that do not have actively traded CDS contracts.

As proposed, the Commission has decided that the classes be limited to untranched CDS on the aforementioned indices. With these untranched CDS, the contract covers the entire index loss distribution of the index, and settlement is not linked to a specified number of defaults. Tranched swaps, first- or “Nth” to-default, options, or any other product variations on these indices are excluded from these classes. These other swaps based on the indices, such as tranches, have very different profiles in terms of the § 39.5 analysis. Besides very different notional and trading volumes, the risk management processes and operations may be significantly different. The Commission believes it appropriate to exclude tranched swaps, and other variations on the indices, from the classes of swaps set forth herein. Such swaps, if accepted by DCOs and submitted for Commission review, likely would be viewed as a separate class or as separate classes.

AFR notes that market participants can use tranched CDS on the indices to replicate contracts and portfolios that would otherwise be subject to a clearing requirement. The Commission recognizes this concern and will continue to monitor activity in tranched CDS indices, as well as how the development of risk management processes at DCOs could allow for the clearing of those products. Today's clearing determination does not foreclose the possibility that tranched products may be subject to another clearing determination in the future.

D. Determination Analysis for Credit Default Swaps

Section 2(h)(2)(D)(i) of the CEA requires the Commission to review whether a swap submission under section 2(h)(2)(B) is consistent with section 5b(c)(2) of the CEA (DCO core principles). Section 2(h)(2)(D)(ii) of the CEA also requires the Commission to consider five factors in a determination based on swap submission: (1) The existence of significant outstanding notional exposures, trading liquidity, and adequate pricing data; (2) the availability of rule framework, capacity, operational expertise and resources, and credit support infrastructure to clear the contract on terms that are consistent with the material terms and trading conventions on which the contract is then traded; (3) the effect on the mitigation of systemic risk, taking into account the size of the market for such contract and the resources of the DCO available to clear the contract; (4) the effect on competition, including appropriate fees and charges applied to clearing; and (5) the existence of reasonable legal certainty in the event of the insolvency of the relevant DCO or one or more of its clearing members with regard to the treatment of customer and swap counterparty positions, funds, and property.

ISDA highlighted the possibility that a CDS index subject to a clearing requirement determination could undergo such significant changes to its underlying constituents during its lifecycle that such an index would no longer be considered a broad-based index, subject to the Commission's jurisdiction. The Commission notes that the indices subject to the clearing requirement determinations discussed herein contain a minimum of 30 constituents of equal weighting, limiting the likelihood of such scenario. Nonetheless, in the event of such a scenario, the Commission could review the determination, and if appropriate, stay the determination under § 39.5(d) with regard to the index and/or series so impacted.

i. Consistency With Core Principles for Derivatives Clearing Organizations

Section 2(h)(2)(D)(i) of the CEA requires the Commission to review whether a submission is consistent with the core principles for DCOs. Each of the DCO submissions relating to CDS provided data to support the Commission's analysis of the five factors under section 2(h)(2)(D) of the CEA. The Commission also was able to call upon independent analysis conducted with regard to the CDS market, as well as its knowledge and reviews of the registered DCOs' operations and risk management processes, covering topics such as product selection criteria, pricing sources, participant eligibility, and other relevant rules. The discussion of all of these factors is set forth below.

The swaps submitted by CME, ICE Clear Credit, and ICE Clear Europe pursuant to § 39.5(b) are currently being cleared by those organizations. As discussed above, the risk management, rules, and operations used by each DCO to clear these swaps are subject to review by the Commission's risk management, legal, and examinations staff on an on-going basis.

Additionally, each of the DCOs has established procedures to review any new swaps it may consider offering for clearing. Before the indices referenced herein were accepted for clearing by any of the DCOs, they were subject to review by the risk management functions of those organizations. Such analysis generally focuses on the DCO's ability to risk manage positions in the prospective swaps and on any specific operational issues that may arise from the clearing of such swaps. In the case of the former, this involves ensuring that adequate pricing data is available, both historically and on a “going forward” basis, such that a margining methodology could be established, back-tested, and used on an on-going basis. Operational issues may include analysis of additional contract terms for new swaps that may require different settlement procedures. Each of the contracts submitted by CME, ICE Clear Credit, and ICE Clear Europe and discussed herein has undergone an internal review process by the respective DCO and found to be within their product eligibility standards.

In their submissions, CME and ICE Clear Credit enclosed their risk management procedures. In its submission, ICE Clear Europe references its risk management procedures, which it had previously submitted to the Commission in connection with its application to register as a DCO. As part of its risk management and examination functions, the Commission reviews each DCO's risk management procedures, including its margining methodologies.

ICE Clear Credit uses a multi-factor model to margin the CDX.NA.IG and CDX.NA.HY indices, as well as the single-name CDS it clears. The margining methodology is designed to capture the risk of movements in credit spreads, liquidation costs, jump-to-default risk for those names on which credit protection has been sold, large position concentration risks, interest rate sensitivity, and basis risk associated with offsetting index derived single names and opposite “outright” single names. These factors are similarly used by ICE Clear Europe to calculate the margining requirements for their iTraxx swap listings and the underlying single-name constituents.

CME's CDS model also weighs a number of factors to calculate the initial margin for a portfolio of CDS positions. These include macro-economic risk factors, such as movements associated with systematic risk resulting in large shifts in credit spreads across a portfolio, shifts in credit spreads based on tenors, and changes in relative spreads between investment grade and high yield spreads. Additional factors include specific sector risks, the idiosyncratic risk of extreme moves in particular reference entities, and the liquidity risk associated with unwinding the portfolio. In all cases, the methodologies are designed to protect against any 5-day move in the value of the given CDS portfolio, with a 99% confidence level.

In addition to initial margin, each of the DCOs collects variation margin on a daily basis to capture changes in the mark-to-market value of the positions. To do this, the DCOs calculate end-of-day settlement prices using clearing members' price submissions for cleared swaps. Each of the DCOs maintains processes for ensuring the quality of clearing member price submissions, including the ability to compel trades at quoted prices on a random basis and to enforce fines on incomplete or incorrect submissions. ICE Clear Credit and ICE Clear Europe also use Markit services for CDX and iTraxx price submissions. CME uses other third-party data providers for pricing support as necessary on its cleared CDS products.

As part of their rule frameworks, each of these three DCOs also maintains participant eligibility requirements. On April 20, 2012, CME filed its amended rule concerning CDS Clearing Member Obligations and Qualifications (Rule 8H04). Pursuant to the amended rule, published to comply with Commission Regulation 39.12(a)(2), a CDS clearing member would have to maintain at least $50 million of capital. The amended rule would also require a CDS clearing member's minimum capital requirement to be “scalable” to the risks it poses. Furthermore, CME already has client clearing available for its CDS index contracts.

Similarly, on March 23, 2012, ICE Clear Credit filed its amended Rule 201(b) to incorporate the $50 million minimum capital requirement for clearing members. ICE Clear Europe has adopted similar rules to comply with § 39.12(a)(2). ICE Clear Credit also has client clearing available for its CDX index contracts.

In addition to the CDS indices discussed above, ICE Clear Credit and ICE Clear Europe offer single-name CDS for clearing.

As part of their margining methodology, they are seeking approval to offer portfolio margining for the single-name CDS and the CDS indices co-mingled as a single portfolio.

Given that the single-name reference entities will likely also be constituents of a given index within a portfolio, the Commission generally believes that such portfolio margining initiatives are consistent with the sound risk management policies for DCOs that are required under § 39.13(g)(4). Moreover, DCOs such as ICE Clear Credit already use margining methodologies that provide for appropriate portfolio margining treatment with regard to clearing members' proprietary positions.

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

Specifically, the Commission anticipates addressing ICE's portfolio margining petitions for CDS in the near term.

Such single-name CDS are defined as “security-based swaps” under section 721(a) of the Dodd-Frank Act.

See

ICE Clear Credit's petitions to the Commission and SEC, dated October 4, 2011. The petition to the Commission is available at

http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/iceclearcredit100411public.pdf. See also

ICE Clear Europe's petition available at

http://www.cftc.gov/stellent/groups/public/@requestsandactions/documents/ifdocs/icecleareurope4dfrequest.pdf.

See

ICE Clear Credit's certification to the Commission, dated as of November 25, 2011. The certification is available at

http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/rul112511icecc001.pdf.

A discussion of comments concerning portfolio margining is included below.

Based upon the Commission's on-going reviews of DCOs' risk management frameworks and clearing rules, and its annual examinations of the DCOs, the Commission believes that the submissions of CME, ICE Clear Credit, and ICE Clear Europe are consistent with section 5b(c)(2) of the CEA and the related Commission regulations. In analyzing the CDS products submissions discussed herein, the Commission does not believe that a clearing determination with regard to the specified CDS products would be inconsistent with CME, ICE Clear Credit, or ICE Clear Europe's continued ability to maintain such compliance with the DCO core principles set forth in Part 39 of the Commission's regulations.

ii. Consideration of the Five Statutory Factors for Clearing Requirement Determinations

a. Outstanding Notional Exposures, Trading Liquidity, and Adequate Pricing Data

Section 2(h)(2)(D)(ii)(I) of the CEA requires the Commission to take into account the existence of outstanding notional exposures, trading liquidity, and adequate pricing data.

The most recent BIS study

found that, as of December 2011, the size of the overall CDS marketplace exceeded $28.6 trillion in notional amount outstanding. Of that amount, $11.8 trillion was in multi-name CDS agreements. Within this sub-category of CDS, CDS on indices accounted for more than 89% of the total notional amount outstanding, with over $10 trillion in notional outstanding. Overall, CDS on index products account for 37% of all notional amounts of CDS contracts outstanding.

See

BIS data, available at

http://www.bis.org/statistics/otcder/dt1920a.pdf.

The predominant provider of CDS indices is Markit. Markit offers indices covering corporate and sovereign entities, among others, in the United States, Europe, and Asia. Recent Markit data shows daily transaction volumes of 1,559 transactions using its licensed family of CDX indices, and 1,828 daily transactions in its European iTraxx indices.

Further, it shows a rolling month gross notional amount of $745 billion in gross notional amount for the CDX family of indices and €680 billion for the iTraxx family. Nearly all of the CDX contracts and volumes come from indices that are subject to the clearing requirement determination. With regard to the European iTraxx, more than 80% of those daily contract volumes and 84% of the daily gross notional volumes come from the iTraxx investment grade and high yield indices contemplated by the clearing requirement determination.

Based on data published on

www.markit.com

as of September 27, 2012.

One point highlighted by this data, however, is the declining trading liquidity in the off-the-run series that can occur. Of the volumes noted by Markit, nearly 60% was in the current on-the-run series, as compared to all other outstanding series combined.

The submissions of ICE Clear Credit, ICE Clear Europe, and CME also note the decline in average weekly gross notional amounts and contracts for benchmark tenors for off-the-run indices. The decline however can be more precipitous among older off-the-run indices. While many market factors can contribute to the actual volumes for a specific off-the-run contract, subject to certain exceptions, the trend is generally toward lower volumes.

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

The current “on-the-run” series tend to have the most liquidity, while the older “off-the-run” series tend to have less liquidity, as many investors exit positions in an existing series and enter new positions in the new series when it becomes available (

i.e.,

they “roll” their positions to the new series) thereby increasing liquidity in the “on-the-run” series.

Set forth below is a table of data taken from DTCC as of November 7, 2012, highlighting the net notional amounts and outstanding CDS index contracts, across all tenors, for each index and series included in this clearing determination.

Data from November 7, 2012, available at

www.dtcc.com.

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

ER13DE12.000

Notwithstanding the declining volumes that occur when an index is no longer on-the-run, the Commission does not believe that is sufficient reason to exclude the older series from the classes of CDS that are subject to the clearing requirement. As the DTCC data indicates, there are still significant volumes and outstanding notional amounts in each of these series.

From the perspective of the DCO, the risk management of the older series of swaps should not provide significant additional challenges. With the significant notional and contract volumes still outstanding according to DTCC, many clearing members already have these positions on their books and are meeting their risk management requirements, even in the face of declining trading volumes. While the volumes may decline, the data included in the submissions indicates that volume still does exist, and parties should be able to trade these CDS indices as necessary. Additionally, as discussed further below, the clearing requirement would apply only to new swaps executed in the off-the-run indices.

The Commission is monitoring volumes in the on-the-run iTraxx Europe HiVol. With the newest roll of the indices occurring on September 20, 2012, this index has yet to show significant volumes in the latest series based on DTCC data. The Commission will continue to monitor these volumes and take action as appropriate.

Both AFR and ISDA specifically supported the inclusion of “off-the-run” CDS indices in the clearing determination. AFR noted that without including those indices, the market might enter into such swaps so as to avoid the clearing requirement. In addition, ISDA expressed concern about the potential negative impact on the relative liquidity between cleared and uncleared CDS swaps should a clearing requirement cease to apply during the lifecycle of the CDS.

Given the contract and notional volumes listed above, there is adequate data available on pricing. The pricing for the CDS on these indices is fairly consistent across clearinghouses. The DCOs generally require a clearing member with open interest in a particular index to provide a price on that index for end-of-day settlement purposes. After applying a process to remove clear outliers, a composite price is calculated using the remaining prices. To ensure the integrity of the submissions, clearing members' prices may be “actionable,” meaning that they may form the basis of an actual trade that the member will be forced to enter. DCOs also have compliance programs that may result in fines for clearing members that fail to submit accurate pricing data.

Beyond clearing member submissions, there are a number of third-party vendors that provide pricing services on these swaps. Third-party vendors typically source their data from a broader range of dealers. The data includes both direct contributions as well as feeds to automated trading

systems. This data is reviewed for outliers and aggregated for distribution.

b. Availability of Rule Framework, Capacity, Operational Expertise and Resources, and Credit Support Infrastructure

Section 2(h)(2)(D)(ii)(II) of the CEA requires the Commission to take into account the availability of rule framework, capacity, operational expertise and resources, and credit support infrastructure to clear the contract on terms that are consistent with the material terms and trading conventions on which the contract is then traded. The Commission has determined that this factor is satisfied by each of CME, ICE Clear Credit, and ICE Clear Europe.

CME, ICE Clear Credit, and ICE Clear Europe, respectively, currently are clearing the swaps each submitted under § 39.5. They have developed respective rule frameworks, capacity, operational expertise and resources, and credit support infrastructure to clear the contracts on terms that are consistent with the material terms and trading conventions on which the contracts currently are trading. The Commission believes that these are scalable and that CME, ICE Clear Credit, and ICE Clear Europe would be able to risk manage the additional swaps that might be submitted due to the clearing requirement determination.

Following the financial crisis, the major market participants committed in 2009 to the substantial reforms to the OTC derivatives markets.

Among the commitments from CDS dealers and buy side participants was to actively engage with central counterparties to broaden the range of cleared swaps and market participants. These changes were in addition to those generated through organizations like ISDA and their protocols standardizing CDS. For broadly traded swaps like the CDS indices, the ultimate impact of these initiatives was operational platforms,

rule frameworks, and other infrastructure initiatives that replicated the uncleared market and supported the move of these CDS to a centrally cleared environment. In this way, the CDS clearing services offered by DCOs, including CME, ICE Clear Credit, and ICE Clear Europe, were designed to be cleared in a manner that is consistent with the material terms and trading conventions of a bilateral, uncleared market.

See

the June 2, 2009 letter to The Honorable William C. Dudley, President of the Federal Reserve Bank of New York, available at

http://www.newyorkfed.org/newsevents/news/markets/2009/060209letter.pdf.

In its comment letter supporting the NPRM, MarketAxess Holdings Inc. (MarketAxess) noted that the electronic trading platform it operates supports the trading of CDX and iTraxx products. MarketAxess stated that it intends to apply for registration as a SEF once the Commission issues related final rules.

In addition, CME, ICE Clear Credit, and ICE Clear Europe are registered DCOs. To be registered as such, CME, ICE Clear Credit, and ICE Clear Europe have, on an on-going basis, demonstrated to the Commission that they are each in compliance with the DCO core principles set forth in the CEA and Commission regulations, as discussed above. As a general matter, any DCO that does not have the rule framework, capacity, operational expertise and resources, and credit support infrastructure to clear the swaps that are subject to required clearing is not in compliance with the core principles or the Commission regulations promulgating these principles.

Commenters raised issues with regard to the operational capabilities of clearinghouses to manage the clearing of iTraxx for customers. Commenters such as ISDA, FIA, MFA, and D.E. Shaw all highlighted the fact that no registered DCO currently offers customer clearing for iTraxx. Besides the lack of approved customer clearing of the iTraxx indices at any DCO, the commenters noted substantive concerns about the ability of clearinghouses to manage the “restructuring” credit event applicable to iTraxx (and certain other CDS indices) in the context of customer clearing. For the CDX.NA.IG and CDX.NA.HY indices, credit events are limited to a “failure to pay” or the bankruptcy of the companies included in the index. A credit event results in the removal of the defaulted constitute from the index, with the protection seller settling the amounts owed to the protection buyer with regard to that individual constituent. The standardized terms of the iTraxx, however, also include “restructuring” as a credit event. When a restructuring event occurs with regard to an index constituent, the impacted company is removed from the index by the creation of a single-name CDS referencing that entity. The protection buyer and seller have the option to continue that single-name CDS or to settle the contract with regard to the restructured credit.

ISDA, MFA, and FIA note that this process raises issues for DCOs. Specifically highlighted were those situations where a DCO does not, in fact, already offer clearing of the single-name CDS that is subject to the restructuring event. To the extent that the SEC or foreign regulator prohibits the DCO from clearing a particular single-name CDS, a process would need to be developed to address such circumstances. Similarly, the customer account in which the new single-name CDS would be held, in the absence of portfolio margining, would need to be addressed. MFA comments that the approval of portfolio margining petitions would remove much of the complexity of the “spin-off” of the single-name CDS from the iTraxx indices. Given the inclusion of the iTraxx within the clearing determination, MFA states that the petitions need to be approved so that the new single-name CDS can be held within the cleared swap account and margined with the iTraxx index CDS. Finally, the commenters believe that DCOs need to demonstrate that their customer clearing platforms are technologically viable and sufficiently tested before a clearing determination with regard to the iTraxx indices is finalized. For these reasons, these commenters believe a delay in the implementation of a clearing requirement for the iTraxx indices would be appropriate until such time as customer clearing platforms have been established, the necessary regulatory approvals have been granted and operational testing has been conducted for an appropriate period of time. In MFA's view the delay should be 60 to 90 days, and in ISDA's view, the testing period should consist of voluntary client clearing for at least 90 days.

On the other hand, ICE supports the Commission's inclusion of iTraxx CDS indices within its clearing requirement determination. ICE states that ICE Clear Europe has already begun the process of pursuing regulatory approval for client clearing of iTraxx, and indicates that ICE Clear Credit will do the same.

While recognizing that the standard credit events under the iTraxx add some complexity relative to the CDX indices, ICE notes that it has worked with market participants and DTCC to develop industry-wide solutions to the “restructuring” event. Further, ICE states that ICE Clear Credit has already implemented applicable parts of this solution with regard to the clearing of the CDX.EM CDS index of emerging market sovereign constituents.

ICE claims that any additional processes necessary with regard to clearing iTraxx index CDS are being addressed currently by the industry, and will not present any insurmountable challenges.

ICE Clear Europe's submission, pursuant to Commission Regulation 40.6, amending its rulebook to accommodate client clearing is available on the Commission's Web site at:

http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/rul091312iclreu001.pdf.

ICE Clear Europe is registered as a recognized clearing house with the United Kingdom's Financial Services Authority (U.K. FSA) and requires approval from the U.K. FSA to offer iTraxx clearing to customers. ICE Clear Credit's submission with regard to iTraxx clearing for both proprietary and customer accounts is available on the Commission's Web site at

http://www.cftc.gov/stellent/groups/public/@rulesandproducts/documents/ifdocs/rul092812icc001.pdf.

To the extent that ICE Clear Credit successfully launches iTraxx clearing, it would address ISDA's concern with regard to the Commission issuing a clearing determination for swaps that cannot be cleared at a U.S.-based DCO. It should be noted, however, that the Commission does not believe a DCO clearing a particular swap needs to be based in the U.S. for the Commission to find a swap subject to a clearing determination, to the extent that swap satisfies the factors required

by statute and regulation to be included in the Commission's analysis.

It is not clear, however, the extent to which clearing members are in fact offering customer clearing of the CDX.EM indices cleared by ICE Clear Credit.

Citadel also commented that they did not believe that there were any substantive reasons why the iTraxx index CDS should not be required to be cleared. The “restructuring” credit event and the spinning out of a newly cleared single-name CDS do not, in Citadel's view, present any new issues to market participants. Further, because DCOs already offer clearing on the iTraxx on a dealer-to-dealer basis, they have the necessary processes upon which to build out the client clearing platform. Citadel also states that even if the ICE Clear Credit's and ICE Clear Europe's petitions to the SEC for portfolio margining were not approved generally,

limited exemptions may be available for the single names associated with the spun-off single name. Citadel does agree with other commenters that to the extent that client clearing cannot be offered with sufficient lead time to allow for proper operational testing, a delay may be appropriate in implementing a clearing requirement for the iTraxx indices. Citadel believes 60 days voluntary customer clearing should be sufficient for such testing.

It should be noted that the Commission strongly supports the petitions for the portfolio margining of single-name CDS and CDS indices. The Commission believes that all customers should be able to benefit from the reasonable application of portfolio margining, and that the benefits thereof should not just be available to the proprietary positions in the house accounts of clearing members.

The Commission believes that the introduction of client clearing must occur before any clearing determination could become effective with regard to the iTraxx indices, or any other CDS indices that the Commission may consider.

The Commission agrees with all commenters that subject to resolution of all operational issues surrounding client clearing of the iTraxx indices, specifically the iTraxx Europe, Crossover, and High Volatility, these indices are appropriate for inclusion in a clearing requirement. The Commission is encouraged by the work currently being done by the DCOs, by other regulators, and by the market as a whole, to establish client clearing in the near term. The Commission recognizes that additional time may be necessary to allow for the DCOs to obtain the necessary regulatory approvals and design a workable framework for dealing with the issues presented by the client clearing of the iTraxx indices, before the clearing of this class of indices can be required of market participants.

The Commission agrees with the comments of MFA that the availability of client clearing should be considered when making clearing determinations. Consequently, DCOs accepting, or planning to accept, swaps for clearing should make client clearing available in compliance with Commission regulations. In the absence of such client clearing, the Commission will delay compliance with required clearing of iTraxx indices.

As part of this clearing requirement determination, the Commission is including the iTraxx class of CDS, as proposed. The Commission believes that the compliance schedule outlined in Section IV below should provide adequate time for market participants to resolve the outstanding issues with regard to client clearing of the iTraxx indices. Under this schedule, the requirement for market participants to begin clearing would commence on March 11, 2013, for swaps entered into on or after that date between Category 1 Entities. Category 2 Entities would be required to clear swaps beginning on June 10, 2013, for swaps entered into on or after that date, and Category 3 Entities would be required to clear swaps beginning on September 9, 2013, for swaps entered into on or after that date. However, if no DCO has begun offering client clearing for iTraxx by February 11, 2013, then compliance with the required clearing of iTraxx will commence sixty days after the date on which iTraxx is first offered for client clearing by an eligible DCO.

If an eligible DCO offers client clearing for iTraxx on or before September 9, 2013, the following phased implementation schedule will apply: Category 1 Entities would be required to clear iTraxx indices entered into on or after the date 60 days after the date on which iTraxx is first offered for client clearing by an eligible DCO; Category 2 Entities would be required to clear iTraxx entered into on or after the date 150 days after the date on which iTraxx is first offered for client clearing by an eligible DCO; and Category 3 Entities would be required to clear iTraxx entered into on or after the date 240 days after the date on which iTraxx is first offered for client clearing by an eligible DCO. There will be no phasing of compliance if an eligible DCO offers client clearing for iTraxx after September 9, 2013. Rather, all three categories of market participants will be expected to come into compliance by 60 days after the date on which iTraxx is first offered for client clearing by an eligible DCO.

c. Effect on the Mitigation of Systemic Risk

Section 2(h)(2)(D)(ii)(III) of the CEA requires the Commission to take into account a clearing requirement's effect on the mitigation of systemic risk, taking into account the size of the market for the contract subject to the clearing requirement and the resources of the DCOs clearing the contract. The Commission agrees with the § 39.5 swap submissions of CME, ICE Clear Credit, and ICE Clear Europe that requiring certain classes of CDS to be cleared would reduce systemic risk in this sector of the swaps market. As CME noted, the 2008 financial crisis demonstrated the potential for systemic risk arising from the interconnectedness of OTC derivatives market participants and the limited transparency of bilateral,

i.e.,

uncleared, counterparty relationships. According to the Quarterly Report (Second Quarter 2012) on Bank Trading and Derivatives Activities of the Office of the Comptroller of the Currency (OCC Report),

CDS index products account for a significant percentage of the notional value of swaps positions held by financial institutions. According to ICE Clear Credit, the CDS indices it offers for clearing are among the most actively traded swaps with the largest pre-clearing outstanding positions, and ICE Clear Credit's clearing members are among the most active market participants. ICE Clear Credit also noted that its clearing members clear a significant portion of their clearing-eligible portfolio.

Available at

http://occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq212.pdf.

Clearing the CDS indices subject to this determination will reduce systemic risk in the following ways: mitigating counterparty credit risk because the DCO would become the buyer to every seller of CDS indices subject to this determination and vice-versa; providing counterparties with daily mark-to-market valuations and exchange of

variation margin pursuant to a risk management framework set by the DCO and reviewed by the Commission's Division of Clearing and Risk; posting initial margin with the DCO in order to cover potential future exposures in the event of a default; achieving multilateral netting, which substantially reduces the number and notional amount of outstanding bilateral positions; reducing swap counterparties' operational burden by consolidating collateral management and cash flows; and eliminating the need for novations or tear-ups because clearing members may offset opposing positions.

As discussed in the NPRM, the DCOs collect substantial amounts of collateral in the form of initial margin and guaranty fund contributions to cover potential losses on CDS portfolios. The methodologies for calculating these amounts are based on covering 5-day price movements on a portfolio with a 99% confidence level for initial margin, and longer liquidation periods and higher confidence levels under “extreme but plausible” conditions in the case of guaranty fund requirements. Beyond these financial resources, the clearinghouses have in place established risk monitoring processes, system safeguards, and default management procedures, which are subject to testing and review, to address potential systemic shocks to the financial markets.

AFR specifically supported the Commission's analysis on the mitigation of systemic risk with regard to the CDS clearing determination.

ISDA commented generally that the Commission's analysis of this factor should have addressed the centralization of risk at DCOs as a result of the determinations, and the new capital, collateral, and disclosure requirements that have decreased risk in uncleared swaps.

The Commission believes its analysis of other factors did in fact focus on the management of risk at DCOs and their ability to manage the risks associated with the untranched CDS indices included within the determination. In connection with future determinations, the Commission will continue to take those issues raised by ISDA into consideration.

Other commenters such as Citadel generally agreed with the Commission's analysis of the reduction of systemic risk for both the interest rates and CDS determinations.

See

Section II.F for further discussion of this comment.

d. Effect on Competition

Section 2(h)(2)(D)(ii)(IV) of the CEA requires the Commission to take into account the effect on competition, including appropriate fees and charges applied to clearing. Of particular concern to the Commission is whether this determination would harm competition by creating, enhancing, or entrenching market power in an affected product or service market, or facilitating the exercise of market power.

Under U.S. Department of Justice guidelines, market power is viewed as the ability “to raise price [including clearing fees and charges], reduce output, diminish innovation, or otherwise harm customers as a result of diminished competitive constraints or incentives.”

See

U.S. Department of Justice and the Federal Trade Commission, Horizontal Merger Guidelines [hereinafter “Horizontal Merger Guidelines”] at § 1 (Aug. 19, 2010), available at

http://www.justice.gov/atr/public/guidelines/hmg-2010.pdf.

Id.; see also

U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC), Antitrust Guidelines for Collaborations Among Competitors at § 1.2 (April 2000), available at

http://www.ftc.gov/os/2000/04/ftcdojguidelines.pdf

(“The central question is whether the relevant agreement likely harms competition by increasing the ability or incentive profitably to raise price above or reduce output, quality, service, or innovation below what likely would prevail in the absence of the relevant agreement”).

In the NPRM, the Commission identified the following putative product and service markets as potentially affected by this clearing determination: a DCO service market encompassing those clearinghouses that currently (or with relative ease in the future could) clear the CDS subject to this determination, and a CDS product market or markets encompassing the CDS that are subject to this determination.

Without defining the precise contours of these markets at this time,

the Commission recognizes that, depending on the interplay of several factors, this clearing determination potentially could impact competition within the affected markets. Of particular importance to whether any impact is, overall, positive or negative, is: (1) Whether the demand for these clearing services and swaps is sufficiently elastic that a small but significant increase above competitive levels would prove unprofitable because users of the CDS products and DCO clearing services would substitute other products/clearing services co-existing in the same market(s), and (2) the potential for new entry into these markets. The availability of substitute products/clearing services to compete with those encompassed by this determination, and the likelihood of timely, sufficient new entry in the event prices do increase above competitive levels, each operate independently to constrain anticompetitive behavior.

Included among these could be a separate product market for CDS indices licensing. AFR stated that this factor should not focus on Markit as an index provider, but rather on clearing entities. For purposes of its consideration of this factor, the Commission believes its analysis appropriately covers competition as it relates to clearinghouses, as well as to other market participants.

The federal antitrust agencies, the DOJ and FTC, use the “hypothetical monopolist test” as a tool for defining antitrust markets for competition analysis purposes. The test “identif[ies] a set of products that are reasonably interchangeable with a product,” and thus deemed to reside in the same relevant antitrust product or service market. “[T]he test requires that a hypothetical profit-maximizing firm, not subject to price regulation, that was the only present and future seller of those products (`hypothetical monopolist') likely would impose at least a small but significant and non-transitory increase in price (`SSNIP') on at least one product in the market.” In most cases, a SSNIP of five percent is posited. If consumers would respond to the hypothesized SSNIP by substituting alternatives to a significant degree to render it unprofitable, those alternative products/services are included within the relevant market. This methodological exercise is repeated until it has been determined that consumers have no further interchangeable products/services available to them. Horizontal Merger Guidelines at § 4.1.

The Commission recognized in the NPRM that, depending on the interplay of several factors, the clearing requirement potentially could impact competition within the affected market and discussed various factors that could impact that market.

In response to the Commission's recognition of the fact that currently no DCO clears CDS indices licensed by any provider other than Markit, Markit commented that it did not believe the determination would foreclose or materially impact competition in the CDS products, including licensing. Markit noted that its open licensing policy encourages competition among DCOs, SEFs, market makers, and others. Markit further commented that, given the costs associated with clearing, CDS indices that are not subject to a determination may be at a competitive advantage, including those that may be established by other index providers.

In support of the NPRM, Citadel stated that the clearing requirement will have a strong positive impact on competition in the swap market and the market for clearing services. Citadel noted that central clearing will remove a significant barrier to entry for alternative swap market liquidity providers and will enable smaller entities to compete on more equal terms because central clearing eliminates the consideration of counterparty credit risk from the selection of execution counterparties. Citadel further commented that buy-side market participants will benefit from a wider range of potential execution counterparties and asserted that this increased competition yields benefits to market participants including narrower bid-ask spreads, improved access to best

execution, and increased market depth and liquidity, all of which facilitate the emergence of an all-to-all market with electronic and/or anonymous execution. Citadel also commented that substitution of the DCO for the bilateral counterparty decouples execution from post-trade processing and settlement.

Finally, Citadel commented that the certainty as to when the first clearing requirement will begin gives DCOs and FCMs the confidence to invest in their client clearing offerings, and to compete actively for buy-side business both on the quality and efficiency of their services as well as on price.

The Commission observes that issues regarding the bundling of clearing services and execution are beyond the scope of this rulemaking.

See generally

Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 77 FR 20128, 20154-55 (Apr. 3, 2012) (discussing the application of § 1.71(d)(2)).

While FIA commented that the NPRM included a full discussion of the potential competitive impact of the clearing proposal, as discussed above, FIA indicated that it was unable to conduct the analysis it believes would be necessary to respond to the Commission's questions in the NPRM within the 30-day comment period provided.

In response to FIA's comment, as discussed above, the Commission notes that the 30-day public comment period was necessary for the Commission to adhere to the CEA's 90-day determination process. Moreover, while FIA indicated that it would like more time to conduct further analysis of competitive issues for future determinations, FIA did not identify any specific concerns about the competitiveness issue analysis that could materially change the Commission's determination if such additional information were made available to the Commission. The comments provided by Markit and Citadel are consistent with the NPRM's conclusion that the clearing requirement potentially could impact competition within the affected market, but both commenters go on to assert that such an impact would not be negative. Accordingly, the Commission believes that its consideration of competitiveness as described in the NPRM is sufficient for purposes of finalizing the clearing requirement rule.

e. Legal Certainty in the Event of the Insolvency

Section 2(h)(2)(D)(ii)(V) of the CEA requires the Commission to take into account the existence of reasonable legal certainty in the event of the insolvency of the relevant DCO or one or more of its clearing members with regard to the treatment of customer and swap counterparty positions, funds, and property. The Commission proposed this clearing requirement based on its view that there is reasonable legal certainty with regard to the treatment of customer and swap counterparty positions, funds, and property in connection with cleared swaps, namely the CDS indices subject to this determination, in the event of the insolvency of the relevant DCO (CME, ICE Clear Credit, or ICE Clear Europe) or one or more of the DCO's clearing members.

In the case of a clearing member insolvency at CME or ICE Clear Credit, subchapter IV of Chapter 7 of the U.S. Bankruptcy Code (11 U.S.C. 761-767) and Part 190 of the Commission's regulations would govern the treatment of customer positions.

Pursuant to section 4d(f) of the CEA, a clearing member accepting funds from a customer to margin a cleared swap, must be a registered FCM. Pursuant to 11 U.S.C. 761-767 and Part 190 of the Commission's regulations, the customer's CDS positions, carried by the insolvent FCM, would be deemed “commodity contracts.”

As a result, neither a clearing member's bankruptcy nor any order of a bankruptcy court could prevent either CME or ICE Clear Credit from closing out/liquidating such positions.

However, customers of clearing members would have priority over all other claimants with respect to customer funds that had been held by the defaulting clearing member to margin swaps, such as the customers' positions in CDS indices subject to this determination.

Customer funds would be distributed to swaps customers, including CDS customers, in accordance with Commission regulations and section 766(h) of the Bankruptcy Code. Moreover, the Bankruptcy Code and the Commission's rules thereunder (in particular 11 U.S.C. 764(b) and 17 CFR 190.06) permit the transfer of customer positions and collateral to solvent clearing members.

The Commission observes that an FCM or DCO also may be subject to resolution under Title II of the Dodd-Frank Act to the extent it would qualify as covered financial company (as defined in section 201(a)(8) of the Dodd-Frank Act).

If an FCM is also registered as a broker-dealer, certain issues related to its insolvency proceeding would also be governed by the Securities Investor Protection Act.

See

11 U.S.C. 556 (“The contractual right of a commodity broker [which term would include a DCO or FCM] * * * to cause the liquidation, termination or acceleration of a commodity contract * * * shall not be stayed, avoided, or otherwise limited by operation of any provision of [the Bankruptcy Code] or by order of a court in any proceeding under [the Bankruptcy Code].”).

See

11 U.S.C. 766(h).

Similarly, 11 U.S.C. 761-767 and Part 190 would govern the bankruptcy of a DCO, in conjunction with DCO rules providing for the termination of outstanding contracts and/or return of remaining clearing member and customer property to clearing members.

With regard to ICE Clear Europe, the Commission understands that the default of a clearing member of ICE Clear Europe would be governed by the rules of that DCO. ICE Clear Europe, a DCO based in the United Kingdom, has represented that under English law its rules would supersede English insolvency laws. Under its rules, ICE Clear Europe would be permitted to close out and/or transfer positions of a defaulting clearing member that is an FCM pursuant to the U.S. Bankruptcy Code and Part 190 of the Commission's regulations. According to ICE Clear Europe's submission, the insolvency of ICE Clear Europe itself would be governed by both English insolvency law and Part 190.

ICE Clear Europe has obtained legal opinions that support the existence of such legal certainty in relation to the protection of customer and swap counterparty positions, funds, and property in the event of the insolvency of one or more of its clearing members. In addition, ICE Clear Europe has obtained a legal opinion from U.S. counsel regarding compliance with the protections afforded to FCM customers under New York law.

In response to the NPRM, Citadel commented that it agreed with the Commission's analysis that reasonable certainty exists in the event of an insolvency of a DCO or one or more DCO members. As discussed above, the Commission received three comments related to customer segregation. In essence, Vanguard and SIFMA AMG recommend that the Commission delay implementation of the clearing requirement until three months after the LSOC model is implemented, clarified, and perhaps supplemented with additional rulemaking. ISDA requests that the Commission further study the issue of insolvency for DCOs.

As stated above, the Commission believes that the concerns of Vanguard and SIFMA AMG are largely addressed by the delayed implementation timeframe for this determination. With regard to ISDA's request, as discussed above, the Commission is actively engaging in efforts to study and prepare for potential scenarios involving

clearinghouse and clearing member insolvency.

iii. Conclusions Regarding the Five Statutory Factors and Clearing Requirement Determination

Based on the foregoing discussion and analysis, the Commission has taken into account each of the five factors provided for under section 2(h)(2)(D)(ii) of the CEA. Based on these considerations, and having reviewed the relevant DCOs' submissions for consistency with section 5b(c)(2) of the CEA, the Commission is determining that the two classes of CDS identified in § 50.4(b) are required to be cleared.

E. Interest Rate Swaps

i. Introduction

Interest rate swaps are agreements wherein counterparties agree to exchange payments based on a series of cash flows over a specified period of time typically calculated using two different rates multiplied by a notional amount. The BIS estimated that, as of December 2011, over $500 trillion in notional amount of single currency interest rate swaps were outstanding representing 75% to 80% of the total estimated notional amount of derivatives outstanding.

Based on these factors and on the swap submissions received under § 39.5(b), the Commission believes that interest rate swaps represent a substantial portion of the swaps market and warrant consideration by the Commission for required clearing.

BIS, OTC Derivatives Market Activity as of December 2011, Table 1, available at

http://www.bis.org/statistics/otcder/dt1920a.pdf.

The BIS data provides the broadest market-wide estimates of interest rate swap activity available to the Commission.

The Commission's proposal for interest rate swaps was presented in two parts. The first part, Section II.E of the NPRM, discussed the Commission's rationale for determining how to classify and define the interest rate swaps identified in the DCO submissions (IRS submissions) to be considered for the clearing requirement. The second part, Section II.F, presented the Commission's consideration of the IRS submissions in accordance with section 2(h)(2)(D) of the CEA. This final release follows the same basic two-part structure. In each part, the discussion in the NPRM preamble for the corresponding part is summarized. Comments received from the public are summarized where appropriate together with the Commission's consideration of the comments.

ii. DCO Submissions

The Commission received submissions from three registered DCOs eligible to clear interest rate swaps: LCH.Clearnet Limited (LCH), the clearing division of the Chicago Mercantile Exchange Inc. (CME), and International Derivatives Clearinghouse, LLC (IDCH).

On August 14, 2012, LCH acquired IDCH and changed the name of IDCH to LCH.Clearnet LLC (LCH.LLC). LCH.LLC has submitted a request to the CFTC for approval of changes to its DCO rules that would result in LCH.LLC clearing the same interest rate swaps that LCH clears. As noted in the NPRM, IDCH had no cleared swap positions. Accordingly, the change in ownership of IDCH would not change the Commission's proposal in terms of swap class assessments or volume and liquidity considerations. The proposed clearing requirement rule is not DCO specific. Upon approval of LCH.LLC's application for its DCO rule changes, LCH.LLC would become a U.S.-domiciled DCO capable of accepting the full range of interest rate swap products contemplated in the proposal.

The IRS submissions received by the Commission are available at

http://www.cftc.gov/IndustryOversight/IndustryFilings/index.htm.

Submission materials marked by the submitting DCO for confidential treatment pursuant to §§ 39.5(b)(5) and 145.9(d) are not available for public review.

IDCH was eligible under § 39.5 to clear interest rate swaps. When LCH.LLC assumed IDCH's DCO license, LCH.LLC was deemed eligible to clear interest rate swaps as well.

The following table summarizes the interest rate swap classes and relevant specifications that each DCO identified in its IRS submission.

LCH.LLC (formerly IDCH) has applied to the Commission for DCO rule change approvals that would effectively implement clearing of the same interest rate swaps that LCH now clears. LCH.LLC is not accepting interest rate swaps for clearing until such time as it launches under its new clearing rules. Accordingly, IDCH's product list that was included in the NPRM has been removed from the summary.

Subsequent to its original submission, CME has added clearing of OIS for USD, EUR, GBP, and JPY.

In this final rule, currencies are identified either by their full name or by the three letter ISO currency designation for the currency.

Table 3—Interest Rate Swap Submissions Summary

LCH

CME

Swap Classes

Fixed-to-floating, basis, forward rate agreements (FRAs), overnight index swaps (OIS).

Fixed-to-floating.

Currencies

USD, EUR, GBP, JPY, AUD, CAD, CHF, SEK, CZK, DKK, HKD, HUF, NOK, NZD, PLN, SGD, ZAR

USD, EUR, GBP, JPY, CAD, and CHF.

Rate Indexes

For Fixed-to-floating, basis, FRAs:

LIBOR in seven currencies, BBR-BBSW, BA-CDOR, PRIBOR, CIBOR-DKNA13, CIBOR2-DKNA13, EURIBOR-Telerate, EURIBOR-Reuters, HIBOR-HIBOR, HIBOR-HKAB, HIBOR-ISDC, BUBOR-Reuters, NIBOR, BBR-FRA, BBR-Telerate, PLN-WIBOR, PLZ-WIBOR, STIBOR, SOR-Reuters, JIBAR

USD-LIBOR, CAD-BA, CHF-LIBOR, GBP-LIBOR, JPY-LIBOR, and EURIBOR.

For OIS:

FEDFUNDS, SONIA, EONIA, TOIS.

Maximum Stated Termination Dates

For Fixed-to-floating and basis:

USD, EUR, and GBP out to 50 years, AUD, CAD, CHF, SEK and JPY out to 30 years and the remaining nine currencies out to 10 years.

For OIS and FRAs:

USD, EUR, GBP, and CHF out to two years

USD, EUR, and GBP out to 50 years, and CAD, JPY, and CHF out to 30 years.

iii. Interest Rate Swap Market Conventions and Risk Management

The NPRM described how interest rate swaps present a wide range of variable product classes and product specifications within each class. Notwithstanding the large variety of contracts, there are commonalities that make it possible to categorize interest rate swaps for clearing, pricing, and risk purposes. Firstly, the vast majority of interest rate swaps use the ISDA definitions and contract conventions that allow market participants to agree quickly on common terms for each transaction. In fact, the DCOs clearing interest rate swaps all use ISDA definitions in their product specifications.

Secondly, counterparties enter into swaps to achieve particular economic

results. While the results desired may differ in small ways depending on each counterparty's specific circumstances and goals, there are certain common swap conventions that are used to identify and achieve commonly desired economic results when entering into interest rate swaps. For example, a party that is trying to hedge variable interest rate risk may enter into a fixed rate to floating rate swap, or a party that is seeking to fix interest rates for periods in the future may enter into a forward rate agreement.

The IRS submissions identified commonly known classes of swaps that they clear including: fixed rate to floating rate swaps, that are sometimes referred to as plain vanilla swaps (fixed-to-floating swaps); floating rate to floating rate swaps, also referred to as basis swaps (basis swaps); overnight index swaps (OIS); and forward rate agreements (FRAs).

100

These class terms are also being used in industry efforts to develop a taxonomy for interest rate swaps.

101

100

These are sometimes also referred to as “types,” “categories,” or “groups.” For purposes of the clearing requirement determination, the Commission uses the term “class,” in order to be consistent with the approach taken by the European Securities and Markets Authority (ESMA) in its Discussion Paper, “Draft Technical Standards for the Regulation on OTC Derivatives, CCPs, and Trade Repositories,” (Feb. 16, 2012), available at

http://www.esma.europa.eu/system/files/2012-95.pdf.

It is also noted that other categorizations are sometimes used for certain purposes. However, these four classes are common terms used by the DCOs and are common terms used in industry taxonomies.

101

See, e.g.,

ISDA Swap Taxonomies, available at

http://www2.isda.org/identifiers-and-otc-taxonomies/;

Financial Products Markup Language, available at

http://www.fpml.org/;

and Federal Reserve Bank of New York Staff Reports, “An Analysis of OTC Interest Rate Derivatives Transactions: Implications for Public Reporting” (March 2012) at 3, available at

http://www.newyorkfed.org/research/staff_reports/sr557.pdf.

Furthermore, within these general classes, certain specifications are essential for defining the economic result and the value of the swap. Each of the IRS submissions naturally used these common specifications when identifying the swaps that the DCO clears. Within each of those specifications, there are common terms used by the DCOs and markets, which allows for further classification of the full range of interest rate swaps that are executed. Accordingly, as described in the NPRM, while there are a wide variety of interest rate swaps when taking into account all possible contract specifications, certain specifications are commonly used by the DCOs and market participants. This allows for the identification of classes of swaps and primary specifications within each class.

The DCOs also risk manage and set margins for interest rate swaps on a portfolio basis rather than on a transaction- or product-specific basis. In other words, the DCOs analyze the cumulative risk of a party's portfolio. By looking at risk on a portfolio basis, the DCOs effectively take into account how swaps with different attributes, such as underlying currency, stated termination dates, underlying floating rate indexes, swap classes, etc., are correlated and thus can offset risk across attributes. This is possible because, although individual transactions may have unique contract terms, given the commonalities of transactions as discussed above, swap portfolios can be risk managed on a cumulative value basis taking into account correlations among the cleared swaps. Consequently, DCOs can be expected to fairly rapidly, and efficiently manage the risk of portfolios of interest rate swaps within and across classes in a default scenario through a small number of large hedging transactions that hedge large numbers of similarly correlated positions held by the defaulting party.

102

As such, liquidity for specific, individual swaps is not the focus of DCOs from a risk management perspective. Rather, liquidity is viewed as a function of whether a portfolio of swaps has common specifications that are determinative of the economics of the swaps in the portfolio such that a DCO can price and risk manage the portfolio through block hedging and auctions in a default situation.

103

102

After putting on these hedging positions, the DCO has the time needed to address any residual risk of the defaulted portfolio through auctioning off the defaulted portfolio together with the hedging transactions.

103

See

77 FR at 47188 and LCH IRS submission, at 4 (discussing LCH's management of the Lehman Brothers' bankruptcy in September 2008, where upon Lehman's default, LCH needed to risk manage a portfolio of approximately 66,000 interest rate swaps, which it hedged with approximately 100 new swap trades in less than five days and only used approximately 35% of the initial margin Lehman had posted).

iv. Interest Rate Swap Classification for Clearing Requirement Determinations

Section 2(h)(2)(A) of the CEA provides that the Commission “shall review each swap, or any group, category, type, or class of swaps to make a determination as to whether” any thereof shall be required to be cleared. In reviewing the IRS submissions, the Commission considered in the NPRM whether its clearing requirement determination should address individual swaps, or categories, types, classes, or other groups of swaps.

Based on the market conventions as discussed above, and the DCO recommendations in the IRS submissions, the Commission proposed a clearing requirement for four classes of interest rate swaps: Fixed-to-floating swaps, basis swaps, OIS, and FRAs. At the time the IRS submissions were submitted to the Commission, LCH offered all four classes for clearing, as did IDCH, and CME offered one of them for clearing. Subsequent to the publication of the NPRM, CME has added clearing of OIS, and has stated publicly that it intends to add clearing of basis swaps and FRAs in the near future. In addition, upon launch of LCH.LLC, it is expected that LCH.LLC will begin clearing the same swaps cleared by LCH that are included in the swap classes designated by the Commission.

These four classes represent a substantial portion of the interest rate swap market. The following table provides an indication of the outstanding positions in each class.

Table 4—Interest Rate Swaps Notional and Trade Count by Class

104

Swap class

Notional amount

(USD BNs)

Gross notional percent of total

Total trade count

Total trade count percent of total

Fixed-to-Floating

299,818

3,239,092

FRA

67,145

202,888

OIS

43,634

109,704

Basis

27,593

119,683

Other

105

65,689

617,637

Total

503,879

100

4,289,004

100

104

TriOptima data, as of March 16, 2012.

See

Section II.F below for a description of the TriOptima data. The TriOptima data provided information on nine other classes of swaps, none of which is included in the IRS submissions.

105

In the NPRM, the total notional amount for the “Other” category was incorrectly listed as $132,162 billion as a result of inadvertently including the FRA amounts in the “Other” category. Correcting this error also resulted in changes to the “Gross Notional Percent of Total” column. These corrections do not change the Commission's analysis in the NPRM. The fact that the four classes of interest rate swaps included in the clearing requirement represent a larger proportion of the total notional amount of interest rate swaps outstanding is consistent with Congressional intent to mitigate systemic risk by implementing clearing of swaps as discussed in the NPRM.

See

77 FR 47171.

For purposes of the clearing requirement determination, the Commission developed the following class definitions based on information provided by the submitting DCOs and market conventions.

1. “Fixed-to-floating swap”: A swap in which the payment or payments owed for one leg of the swap is calculated using a fixed rate and the payment or payments owed for the other leg are calculated using a floating rate.

2. “Floating-to-floating swap” or “basis swap”: A swap in which the payments for both legs are calculated using floating rates.

3. “Forward Rate Agreement” or “FRA”: A swap in which payments are exchanged on a pre-determined date for a single specified period and one leg of the swap is calculated using a fixed rate and the other leg is calculated using a floating rate that is set on a pre-determined date.

4. “Overnight indexed swap” or “OIS”: A swap for which one leg of the swap is calculated using a fixed rate and the other leg is calculated using a floating rate based on a daily overnight rate.

As described in the NPRM, the LCH and CME IRS submissions addressed issues of classification for purposes of the interest rate swap clearing requirement. In its submission, LCH discussed the classification of interest rate swaps and recommended establishing clearing requirements for classes of interest rate swaps. In effect, LCH recommended the use of a set of basic product specifications to identify and describe each class of swaps subject to the clearing requirement. CME recommended a clearing determination for all non-option interest rate swaps denominated in a currency cleared by any qualified DCO.

As an alternative, the Commission considered whether to establish clearing requirements on a product-by-product basis. The Commission noted in the NPRM that such a determination would need to identify the multitude of specifications of each product that would be subject to the clearing requirement. In this regard, LCH stated in its IRS submission that the clearing requirement “would be sub-optimal for the overall market if participants are forced to read pages of rules to decipher whether or not a swap is required to be cleared, or to have to make complex and time consuming decisions at the point of execution.”

106

A class-based approach would allow market participants to determine quickly as a threshold matter whether they might need to submit a swap to a DCO for clearing by checking initially whether the swap has the basic specifications that define each class subject to the clearing requirement.

107

106

LCH IRS submission, at 6.

107

In addition, as noted by LCH, in its IRS submission, a product-by-product requirement may be evaded more easily because the specifications of a particular swap contract would need to match the specifications of each product subject to a clearing requirement. The clearing requirement could be evaded by adding, deleting, or modifying one or more of the contract's specifications, including minor specifications that have little or no impact on the economics of the swap. By using a class-based approach that allows for ranges of contract specifications established by the DCOs within each class, the Commission is reducing the potential for evasion in accordance with section 2(h)(4)(A) of the CEA, which directs the Commission to prescribe rules necessary to prevent evasion of the clearing requirements.

A product-by-product designation also would be difficult to administer because the Commission would be required to consider each and every product submitted. On the other hand, designating classes of interest rate swaps for the clearing requirement provides a cost effective, workable method for the Commission to review variations in new swap products that DCOs will submit for clearing determinations on a going forward basis without undertaking a full Commission review of each and every swap to determine if those variations are consistent with the five factors the Commission is directed to consider under section 2(h)(2)(D) of the CEA. For such swaps, as described in greater detail below in Section III.F, the Commission proposed delegating to the Director of the Division of Clearing and Risk, with the consultation of the General Counsel, the authority to confirm whether the swap fits within the identified class and is therefore subject to the clearing requirement.

After consideration of the issues summarized above, the Commission proposed in the NPRM to follow the general approach recommended by LCH and CME of establishing the clearing requirement for classes of interest rate swaps, rather than for individual swap products.

v. Interest Rate Swap Specifications

In the NPRM, after consideration of the appropriateness of classifying interest rate swaps, the Commission analyzed the IRS submissions and proposed to set out the parameters of the four classes of interest rate swaps submitted by using the following affirmative specifications for each class: (i) Currency in which the notional and payment amounts are specified; (ii) rates referenced for each leg of the swap; and (iii) stated termination date of the swap. The Commission further proposed three “negative” or “limiting” specifications for each class: (i) No optionality (as specified by the DCOs); (ii) no dual currencies; and (iii) no conditional notional amounts.

108

The term “conditional notional amount” refers to notional amounts that can change over the term of a swap based on a condition established by the parties upon execution such that the notional amount of the swap is not a known number or schedule of numbers, but may change based on the occurrence of some future event. This term does not include what are commonly referred to as “amortizing” or “roller coaster” notional amounts for which the notional amount changes over the term of the swap based on a schedule of notional amounts known at the time the swap is executed. Furthermore, it would not include a swap containing early termination events or other terms that could result in an early termination of the swap if a DCO clears the swap with those terms. The Commission discusses this definition and comments received on it below.

The Commission proposed the three affirmative specifications because they are fundamental specifications used in the swap market to determine the economic result of a swap transaction. Counterparties enter into swaps to achieve particular economic results. For

example, counterparties may enter into interest rate swaps to hedge an economic risk, to facilitate a purchase, or to take a view on the future direction of an interest rate. The counterparties enter into a swap that they believe will best achieve their desired economic result at a reasonable cost.

As noted in the NPRM, the IRS submissions identified four different classes of swap contracts that are being cleared at this time: fixed-to-floating swaps, basis swaps, OIS, and FRAs. These classes of interest rate swaps reflect industry categorization and allow counterparties to achieve a particular economic result. For example, a fixed-to-floating swap may be used by a counterparty to hedge interest rate risk related to bonds it has issued or which it owns.

All three DCO submitters identified currency as a specification for distinguishing swaps that are subject to clearing. A swap that requires calculation or payment in a currency different than the currency of the related underlying purposes of the swap would introduce currency risk.

109

Thus, the currency designated for the swap is a basic factor in pricing the swap and achieving the economic results of the swap desired by each party.

109

For example, parties seeking to hedge interest rate risk in connection with bonds or to invest funds using swaps are more likely to enter into swaps that designate the same currency in which the bonds are payable or that the funds to be invested are held.

Furthermore, the swaps listed by all three DCOs in their IRS submissions all identified the interest rates used for each leg of the swap as a basic term that defines the swap. The rates are basic determinants of the economic value of each stream of payments of an interest rate swap.

Finally, the stated termination date, or maturity, of a swap is a basic specification for establishing the value of a swap transaction because interest rate swaps are based on an exchange of payments over a specified period of time ending on the stated termination date. The value of a swap at any one point in time depends in part on the value of each payment stream over the remaining life of the swap. For example, if a party wants to hedge variable interest rate risk for bonds it has issued that mature in ten years, it will generally enter into a swap with a stated termination date that matches the final maturity date of the bonds being hedged.

110

To terminate the swap prior to such date would result in only a partial hedge and to execute a swap with a stated termination date that is later than the final bond maturity date would simply create exposed rate risk during the extended period beyond the final maturity date of the bonds.

110

Although hedging an economic risk expected to remain outstanding for, say, ten years with a matching ten year swap may generally be the most efficient and precise approach, the Commission recognizes that parties may achieve a similar result by using swaps with different stated termination dates. However, such substitution generally provides a less precise hedge.

As noted above, the Commission also considered in the NPRM whether there are product specifications that the Commission should explicitly exclude from the initial clearing requirement determination. In this regard, the Commission considered swaps with optionality, multiple currency swaps, and swaps with conditional notional amounts. The Commission proposed that these three specifications should be included as so-called “negative” or “limiting” specifications.

By using the three affirmative specifications and three limiting specifications to further identify the swaps within each class that are subject to the clearing requirement, counterparties contemplating entering into a swap can determine quickly as a threshold matter whether the particular swap may be subject to a clearing requirement. If the swap is in a specified class and has the six specifications, the parties will know that they need to verify whether a DCO will clear that particular swap. This will reduce the burden on swap counterparties related to determining whether a particular swap may be subject to the clearing requirement.

The Commission also considered in the NPRM whether to define classes of swaps on the basis of other product specifications. Other potential specifications are numerous because of the nearly limitless alternative interest rate swaps that are theoretically possible. In the NPRM, the Commission summarized its consideration by breaking down alternative specifications into two general categories: Specifications that are commonly used to address mechanical issues for most swaps, and specifications that are less common and address idiosyncratic issues related to the particular needs of a counterparty. The Commission noted that certain specifications are specifically identified for most swap transactions, but asserted that many such specifications are not, generally speaking, fundamental to determining the economic result the parties are trying to achieve. For example, the day count fraction selected affects calculation periods and therefore the amounts payable for each payment period. The parties, and the DCOs, can make mechanical adjustments to period pricing at the time a swap is cleared based on the day count fraction alternative selected by the parties and the day count fraction does not drive the overall economic result the parties are trying to achieve or substantially differentiate the pricing and risk management of the swap relative to other swaps in the same class and having the same basic class defining specifications.

Furthermore, as noted in the NPRM, DCOs can provide clearing for the standard alternatives of each of these specifications without affecting risk management. Using the same day count fraction example, LCH will accept U.S. dollar-LIBOR trades for clearing with nine alternative day count fractions based on the common day count fractions used in the market.

111

While this specification, and other specifications of this kind, may affect the amounts owed on a swap, they can be accounted for mechanically in the payment amount calculations and do not change the basic substantive economic result the parties want to achieve.

111

Each DCO identifies the standard term or range of terms it will accept for each specification. Accordingly, swap counterparties can review the DCO's product specifications to determine whether a swap will satisfy the DCO's requirements for these specifications. Additionally, CME has developed, and LCH has committed to developing by the time the clearing requirement must be complied with in accordance with the Commission's implementation schedule, product screening mechanisms by which parties can determine whether the DCO will clear a particular swap. As discussed in greater detail throughout this release, if counterparties want to enter into a swap that is in a class subject to required clearing and no DCO will clear the swap because it has other specifications that no DCO will accept, then the parties can still enter into that transaction on an uncleared basis.

Regarding the latter, idiosyncratic specifications, examples include special representations added to address particular legal issues, unique termination events, special fees, and conditions tied to events specific to the parties. None of the DCOs clear interest rate swaps with terms in the second group. Accordingly, such specifications are not included in the classes of swaps subject to the clearing requirement proposed by this rule, and the Commission considered only the first group of more common specifications that are identified by the submitting DCOs in their product specifications.

In short, the Commission recognizes that these other specifications may have an effect on the economic result to be

achieved with the swap.

112

However, counterparties and DCOs may account for the effects of such specifications with adjustments to other specifications or in the price of the swap. Furthermore, DCOs account for various alternatives or range of alternatives for these terms without impairing risk management. Finally, as described above in more detail, including these specifications in the description of the swaps subject to a clearing requirement could increase the burden on counterparties when checking whether a swap may be subject to required clearing. Accordingly, the Commission has determined not to include other, non-class defining specifications in the swap class definition.

112

LCH recommended in its submission that floating rate tenor (also known as frequency) also be a class level specification and the Commission acknowledges that floating rate tenor can, in some cases, be a fundamental specification for achieving the economic benefits of an interest rate swap. However, it is the Commission's view that floating rate tenor is more akin to the other non-class specifications in that it is not fundamental to all economic results that may be considered by parties when contemplating a swap and it is a specification for which the DCOs can fairly easily offer all of the standard tenors that parties may consider.

vi. General Comments Received Regarding the Specifications Determination

Numerous commenters expressed support for including the Commission's four interest rate swap classes and six class specifications in the clearing requirement and were of the view that the classes satisfy the five statutory factors the Commission is required to consider for the clearing requirement determination.

113

CME expressed support for the class-based approach in the rulemaking rather than swap-by-swap and stated that the Commission “struck an appropriate balance for the initial slate of classes subject to the requirement.” LCH commented that the six swap specifications selected are consistent with its recommendation in its IRS submission and reaffirmed the reasons cited in the NPRM for using these specifications.

113

AllianceBernstein, R.J. O'Brien, Citadel, Eris Exchange, CME, FIA, D.E. Shaw, Arbor Research, LCH, Knight Capital, Jefferies, Coherence Capital, CRT Capital, Javelin Capital, SDMA, Chris Barnard, and Svenokur.

Citadel agreed with the Commission's class-based approach rather than a product-by-product based approach. Citadel stated that the class designation approach “reflects the risk management approach utilized across the industry, and most importantly by DCOs” to determine margin levels and other safeguards and is therefore the starting point for the approved classes. Citadel further noted that different tenors or series of the same instruments, while displaying different characteristics, can be priced both based on market activity and by reference to more liquid contracts of the same instruments and are risk managed with the same risk management frameworks. Finally, Citadel expressed concern that not including products that otherwise share essential characteristics as swaps that are otherwise required to be cleared and that can be priced with reference to cleared swaps could risk the development of separate markets that avoid the clearing requirement.

AFR noted that the interest rate swap classes selected properly reflect the risk profile of the interest rate swap market and will avoid uncertainty and complexity for the Commission and market participants. AFR also noted that details of product specifications such as slightly different tenors, are largely irrelevant, especially in the interest rate market and stated that any suggestion of a product-by-product approach should be interpreted as a tactic to delay implementation. Furthermore, AFR encouraged the Commission to designate swap classes to include low volume swaps that can be risk managed in ways that high-volume swaps in the class are risk managed. AFR's concern is that if the low-volume swaps are not included, they could be used to avoid the clearing requirement by replicating the swaps that are required to be cleared with the low-volume swaps. Citadel's and AFR's comments are consistent with the Commission's rationale for establishing the four classes of swaps and the six specifications for each class on which the Commission based its consideration of the five factors set forth in section 2(h)(2)(D)(ii) of the CEA. As noted in the NPRM, the Commission is directed under the CEA to make its determination for “each swap, or any group, category, type, or class of swaps.” The Commission first needed to establish the classes and class-defining specifications to which would then consider using the five statutory factors.

ISDA commented that the Commission should not use what ISDA characterized as a newly-articulated standard for choosing the swap class-defining specifications based on whether they are “fundamental to determining the economic result that parties are trying to achieve.” ISDA expressed concern with what it characterized as a standard that it is not grounded in the five statutory factors of section 2(h)(2)(D)(ii) of the CEA and will fail to discriminate between swaps that may differ in terms of the five factors. Furthermore, in ISDA's view, the fundamental economic result depends on facts and circumstances of each transaction and the parties.

The phrase “fundamental to determining the economic result that parties are trying to achieve” used by the Commission in the NPRM does not establish a new standard or replace the statutory five factor determination required by the CEA. Rather, the Commission used this phrase to describe one of several reasons for establishing which product specifications to use in defining each class to which the statutory five factor analysis was then applied. The phrase was used in the context of identifying the primary product specifications the submitting DCOs and the market use to value or price swaps within a class. As described at length in Section II.D of the NPRM, in establishing the swap classes to be considered, the Commission looked at how DCOs grouped the cleared interest rate swaps by certain defining types and specifications, how markets trade and view the products as classes, and how swaps that share certain common specifications can be priced and risk managed together as a class. The Commission's analysis for establishing the classes to be considered was not based on any new standard. Rather, the aforementioned phrase summarizes one element of the Commission's analysis of how to define the classes to be considered under the five factors established in the CEA.

Furthermore, the five factor statutory analysis was separately undertaken for each class. For the reasons stated in defining the classes and class specifications, the Commission believes that the swaps within each class are sufficiently similar to apply the statutory analysis to each class. As noted above, many commenters agreed with this conclusion.

Finally, regarding ISDA's view that the fundamental economic result depends on facts and circumstances of each transaction and the parties, the Commission recognizes that individual swap counterparties may have highly specific economic results they are trying to achieve with a swap and accordingly set the terms of the swap to achieve those specific results. However, the Commission's use of the phrase in the NPRM can be more clearly understood in context. The Commission was addressing whether certain specifications, other than the six specifications used to define each class, should be considered to be class-defining specifications. The Commission noted that certain specifications “affect the value of the swap in a mechanical way, they are not,

generally speaking, fundamental to determining the economic result.” The Commission provided an example of how other specifications may affect the amounts payable on a swap on each payment date, but when valuing a swap for pricing and risk management purposes, together with other swaps within a class, these other specifications can be accounted for by making price adjustments off a standard price curve and therefore do not change the basic pricing economics of the swap to an extent that would necessitate classifying the swap separately from other swaps defined by the six specifications identified by the Commission.

ISDA further commented that, although an overly intricate set of product specifications would impose burdens on the market, broad class designations impose greater burdens by creating the need for filtering products that a DCO will accept for clearing from the designated class. In ISDA's view, the Commission's statement in the NPRM that DCOs and vendors are “likely” to develop screening tools acknowledges the issue, but does not provide a solution. ISDA recommended that limiting clearing to swaps with prior clearing history supplemented by an advance DCO notice process would strike a reasonable balance.

In response, the Commission notes that the identification of the four interest rate swap classes and the parameters for the six specifications within each class provides a fairly detailed and easy to use initial screening mechanism for market participants to determine whether a particular swap needs to be submitted for clearing. If a market participant determines that a swap falls into a class under § 50.4, then the party will need to take reasonable efforts to determine whether any eligible DCO will accept the swap for clearing.

114

The Commission noted in the NPRM that the DCOs or other vendors would likely develop screening tools for this purpose. The Commission further notes that each DCO and its members and the FCMs who clear through the DCO, in effect, already have the capability through their own onboarding processes and transaction affirmation platforms to screen swap transactions nearly instantaneously to determine whether the transactions will be accepted by the DCO. While those systems alone should be able to serve as a screening mechanism sufficient to allow for compliance with the clearing requirement, the Commission encourages the DCOs to create a tool to provide all market participants with the ability to independently screen potential swap transactions quickly and easily. CME commented that it already has a tool to screen particular swaps for eligibility. LCH stated in its comments that while the current information on its Web site is designed for dealer use, LCH is committed to revising the information to be easily understandable by all counterparties.

114

See

Section III.B for a discussion of the reasonable efforts standard in this context.

Furthermore, the Commission does not agree that ISDA's proposal to limit the determination to swaps with prior clearing history would ease the screening process. DCOs, particularly LCH, already have prior clearing history for swaps with tens of thousands of different product specification combinations.

115

Accordingly, even if the Commission adopted such an approach, the result would have the problems that a product-by-product approach would have, as acknowledged by ISDA. Also, the Commission agrees that an appropriate DCO notice framework will facilitate product screening and addresses this comment in Section III below.

115

See, e.g., http://www.swapclear.com/why/

(stating that since 1999, LCH has cleared more than 2.2 million OTC interest rate swaps, $329 trillion notional, and compressed more than $145 trillion (as of September 2012)).

In addition, ISDA expressed concern that the discussion of specifications that are not included in the six class-specific specifications identified by the Commission could be read as a directive to abandon such other specifications to the extent they are not included in the swaps DCOs will accept for clearing. ISDA requested confirmation that footnote 97 of the NPRM (revised as footnote 111 in this final release) establishes that if a DCO does not accept a swap because the swap contains terms that the DCO does not clear, then entering into the swap as an uncleared transaction is permissible. ISDA further requested that the Commission state that entering into a swap that is not accepted for clearing does not raise a presumption of evasion.

Similarly, Freddie Mac also expressed concern that the discussion of fundamental specifications and “mechanical specifications” may signal the Commission's judgment that parties are required to clear swaps that have sufficiently close substitutes. Freddie Mac requested that the Commission clarify the treatment of swaps that no DCO will clear and that parties may enter into uncleared swaps within a designated class if a DCO will not accept the swap provided that the variation in specifications is for a legitimate business purpose. Freddie Mac noted that section 2(h)(1)(A) of the CEA refers to an obligation to “submit” the swap for clearing rather than requiring that a swap must be successfully cleared. Freddie Mac expressed concern that failure to clarify this issue would lead to uncertainty as to the legality of uncleared swaps and that executing swap dealers or other market participants could use that uncertainty to insist on contractual rights to have the option to terminate a swap that fails to clear.

The Commission confirms that the discussion of the class-defining swap specifications and other specifications served only to explain the Commission's differentiation between the class specifications and other specifications market participants use. The Commission is not requiring parties to take affirmative steps to substitute a clearable swap for an unclearable swap within a designated class.

116

See

Sections II and III for further discussion of this issue.

Regarding issues of what constitutes evasion of the clearing requirement when using a close substitute swap that is not cleared by a DCO and ISDA's request regarding a presumption regarding evasion of the clearing requirement, this issue, along with other evasion and abuse issues, are addressed in Section III.G of this release.

With respect to the “negative specifications,” AFR commented that some of these specifications, such as dual currency and optionality, are composites of two derivatives including a basic interest rate swap that may be subject to the clearing requirement and that market participants sho

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.