# Procedures To Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A2012-5950

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** March 15, 2012
- **Citation:** 77 FR 15460

## Text

COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 43
RIN 3038-AD08
Procedures To Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Further notice of proposed rulemaking.

SUMMARY:

The Commodity Futures Trading Commission is proposing regulations to implement certain statutory provisions enacted by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Specifically, in accordance with section 727 of the Dodd-Frank Act, the Commission is proposing regulations that would define the criteria for grouping swaps into separate swap categories and would establish methodologies for setting appropriate minimum block sizes for each swap category. In addition, the Commission is proposing further measures under the Commission's regulations to prevent the public disclosure of the identities, business transactions and market positions of swap market participants.

DATES:

Comments must be received on or before May 14, 2012.

ADDRESSES:

You may submit comments, identified by RIN number 3038-AD08, by any of the following methods:

• The agency's Web site, at
http://comments.cftc.gov.
Follow the instructions for submitting comments through the Web site.

•
Mail:
David A. Stawick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

•
Hand Delivery/Courier:
Same as mail above.

•
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.

Please submit your comments using only one method.

All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to
www.cftc.gov.
You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that you believe is exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the Commission's regulations.
1

1

See
17 CFR 145.9.

Commenters to this further notice of proposed rulemaking are requested to refrain from providing comments with respect to the provisions in part 43 of the Commission's regulations that are beyond the scope of this proposed rulemaking. The Commission only plans to address those comments that are responsive to the policies, merits and substance of the proposed provisions set forth in this further notice of proposed rulemaking.

Throughout this further notice of proposed rulemaking, the Commission requests comment in response to several specific questions. For convenience, the Commission has numbered each of these requests for comment. The Commission asks that, in submitting comments, commenters kindly identify the specific number of each request to which their comments are responsive.

The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse or remove any or all of your submission from
www.cftc.gov
that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act.

FOR FURTHER INFORMATION CONTACT:

Carl E. Kennedy, Counsel, Office of the General Counsel, 202-418-6625,
c_kennedy@cftc.gov;
or George Pullen, Economist, Division of Market Oversight, 202-418-6709,
gpullen@cftc.gov;
Commodity Futures Trading Commission, Three Lafayette Center, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. The Dodd-Frank Act

B. The Initial Proposal

C. Public Comments in Response to the Initial Proposal

1. Public Comments Regarding the Proposed Determination of Appropriate Minimum Block Sizes

2. Public Comments Regarding the Proposed Anonymity Protections

3. Public Comments Regarding Implementation

D. Analysis of Swap Market Data; Issuance of the Adopting Release

II. Further Proposal—Block Trades

A. Policy Goals

B. Summary of the Proposed Approach

C. Proposing Criteria for Distinguishing Among Swap Categories in Each Asset Class

1. Interest Rate and Credit Asset Classes

a. Background

b. Interest Rate Swap Categories

i. Interest Rate Swap Data Summary

ii. Interest Rate Swap Data Analysis

c. Credit Swap Categories

i. Credit Swap Data Summary

ii. Credit Swap Data Analysis

2. Swap Category in the Equity Asset Class

3. Swap Categories in the FX Asset Class

4. Swap Categories in the Other Commodity Asset Class

D. Proposed Appropriate Minimum Block Size Methodologies for the Initial and Post-Initial Periods

1. Methodology for Determining the Appropriate Minimum Block Sizes in the Interest Rate and Credit Asset Classes

2. Treatment of Swaps Within the Equity Asset Class

3. Methodologies for Determining the Appropriate Minimum Block Sizes in the FX Asset Class

a. Initial Period Methodology for Determining Appropriate Minimum Block Sizes in the FX Asset Class

b. Post-Initial Period Methodology for Determining Appropriate Minimum Block Sizes in the FX Asset Class

4. Methodologies for Determining Appropriate Minimum Block Sizes in the Other Commodity Asset Class

a. Initial Period Methodology for Determining Appropriate Minimum Block Sizes in the Other Commodity Asset Class (Other Than Natural Gas and Electricity Swaps Proposed To Be Listed in Appendix B to Part 43)

b. Initial Period Methodology for Natural Gas and Electricity Swaps in the Other Commodity Asset Class Proposed To Be Listed in Appendix B to Part 43

c. Post-Initial Period Methodology for Determining Appropriate Minimum Block Sizes in the Other Commodity Asset Class

5. Special Provisions for the Determination of Appropriate Minimum Block Sizes for Certain Types of Swaps

a. Swaps With Optionality

b. Swaps With Composite Reference Prices

c. Physical Commodity Swaps

d. Currency Conversion

e. Successor Currencies

E. Procedural Provisions

1. Proposed § 43.6(a) Commission Determination

2. Proposed § 43.6(f)(3) and(4) Publication and Effective Date of Post-Initial Appropriate Minimum Block Sizes

3. Proposed § 43.6(g) Notification of Election

4. Proposed § 43.7 Delegation of Authority

III. Further Proposal—Anonymity Protections for the Public Dissemination of Swap Transaction and Pricing Data

A. Policy Goals

B. Establishing Notional Cap Sizes for Swap Transaction and Pricing Data To Be Publicly Disseminated in Real-Time

1. Policy Goals for Establishing Notional Cap Sizes

2. Proposed Amendments Related to Cap Sizes—§ 43.2 Definitions and § 43.4 Swap Transaction and Pricing Data To Be Publicly Disseminated in Real-Time

a. Initial Cap Sizes

b. Post-Initial Cap Sizes and the 75-Percent Notional Amount Calculation

c. Alternative Cap Size Calculations

C. Masking the Geographic Detail of Swaps in the Other Commodity Asset Class

1. Policy Goals for Masking the Geographic Detail for Swaps in the Other Commodity Asset Class

2. Proposed Amendments to § 43.4

3. Application of Proposed § 43.4(d)(4)(iii) and Proposed Appendix E to Part 43—Geographic Detail for Delivery or Pricing Points

a. U.S. Delivery of Pricing Points

i. Natural Gas and Related Products

ii. Petroleum and Products

iii. Electricity and Sources

iv. All Remaining Other Commodities

b. Non-U.S. Delivery or Pricing Points

c. Basis Swaps

4. Further Revisions to Part 43

a. Additional Contracts Added to Appendix B to Part 43

b. Technical Revisions to Part 43

IV. Regulatory Flexibility Act

A. Potential Economic Impact—Proposed § 43.6(g)—Notification of Election

B. Identification of Duplicative, Overlapping or Conflicting Federal Rules

C. Alternatives to Proposed Rules That Will Have an Impact

D. Certification

V. Paperwork Reduction Act

A. Background

B. Description of the Collection

1. Proposed § 43.6(g)—Notification of Election

2. Proposed Amendments to §§ 43.4(d)(4) and 43.4(h)

C. Request for Comments on Collection

VI. Cost-Benefit Considerations

A. Introduction

B. The Requirements of Section 15(a)

C. Structure of the Commission's Analysis; Cost Estimation Methodology

D. Background; Objectives of This Further Proposal

E. Costs and Benefits Relevant to the Block Trade Rules Section of the Further Proposal (§§ 43.6(a)-(f) and (h))

1. Costs and Benefits Relevant to the Proposed Criteria and Methodology

a. Proposed § 43.6(a) Commission Determination

b. Proposed § 43.6(b) Swap Category

c. Proposed §§ 43.6(c)-(f) and (h) Methods for Determining Appropriate Minimum Block Sizes

d. Proposed §§ 43.6(a)-(f) and (h) Costs Relevant to the Proposed Criteria and Methodology

e. Benefits Relevant to Proposed §§ 43.6(a)-(f) and (h)

f. Application of the Section 15(a) Factors to Proposed §§ 43.6(a)-(f) and (h)

i. Protection of Market Participants and the Public

ii. Efficiency, Competitiveness and Financial Integrity of Markets

iii. Price Discovery

iv. Sound Risk Management Practices

v. Other Public Interest Considerations

g. Specific Questions Regarding the Proposed Criteria and Methodology

2. Cost-Benefit Considerations Relevant to the Proposed Block Trade/Large Notional Off-Facility Swap Election Process (Proposed § 43.6(g))

a. Costs Relevant to the Proposed Election Process (Proposed § 43.6(g))

i. Incremental, Non-Recurring Expenditure to a Non-Financial End-user, SEF or DCM To Update Existing Technology

ii. Incremental, Non-Recurring Expenditure to a Non-Financial End-User, SEF or DCM To Provide Training to Existing personnel and Update Written Policies and Procedures

iii. Incremental, Recurring Expenses to a Non-Financial End-User, DCM or SEF Associated With Incremental Compliance, Maintenance and Operational Support in Connection With the Proposed Election Process

iv. Incremental, Non-Recurring Expenditure to an SDR To Update Existing Technology To Capture and Publicly Disseminate Swap Data for Block Trades and Large Notional Off-Facility Swaps

b. Benefits Relevant to the Proposed Election Process (Proposed § 43.6(g))

c. Application of the Section 15(a) Factors to Proposed § 43.6(g)

i. Protection of Market Participants and the Public

ii. Efficiency, Competitiveness and Financial Integrity

iii. Price Discovery

iv. Sound Risk Management Practices

v. Other Public Interest Considerations

d. Specific Questions Regarding the Proposed Election Process

F. Costs and Benefits Relevant to Proposed Anonymity Protections (Amendments to §§ 43.4(d)(4) and (h))

1. Proposed Amendments to § 43.4(d)(4)

2. Proposed Amendments to § 43.4(h)

3. Costs Relevant to the Proposed Amendments to §§ 43.4(d)(4) and (h)

4. Benefits Relevant to the Proposed Amendments to § 43.4

5. Application of the Section 15(a) Factors to the Proposed Amendments to § 43.4

a. Protection of Market Participants and the Public

b. Efficiency, Competitiveness and Financial Integrity

c. Price Discovery

d. Sound Risk Management Practices

e. Other Public Interest Considerations

6. Specific Questions Regarding the Proposed Amendments to § 43.4

VII. Example of a Post-Initial Appropriate Minimum Block Size Determination Using the 50-Percent Notional Amount Calculation

VIII. List of Commenters Who Responded to the Initial Proposal

I. Background

A. The Dodd-Frank Act

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).
2

Title VII of the Dodd-Frank Act
3

amended the Commodity Exchange Act (“CEA”)
4

to establish a comprehensive, new regulatory framework for swaps and security-based swaps. This legislation was enacted to reduce risk, increase transparency and promote market integrity within the financial system by,
inter alia:
(1) Providing for the registration and comprehensive regulation of swap dealers (“SDs”) and major swap participants (“MSPs”); (2) imposing mandatory clearing and trade execution requirements on standardized derivative products; (3) creating robust recordkeeping and real-time reporting regimes; and (4) enhancing the Commission's rulemaking and enforcement authorities with respect to, among others, all registered entities and intermediaries subject to the Commission's oversight.

2

See
Public Law 111-203, 124 Stat. 1376 (2010).

3
The short title of Title VII of the Dodd-Frank Act is the “Wall Street Transparency and Accountability Act of 2010.”

4

See
7 U.S.C. 1
et seq.

Section 727 of the Dodd-Frank Act created section 2(a)(13) of the CEA, which authorizes and requires the Commission to promulgate regulations for the real-time public reporting of swap transaction and pricing data.
5

Section 2(a)(13)(A) provides that the definition of “real-time public reporting” means reporting “data relating to a swap transaction, including price and volume, as soon as technologically practicable after the time at which the swap transaction has been executed.”
6

Section 2(a)(13)(B) states that the purpose of section 2(a)(13) is “to authorize the Commission to make swap transaction and pricing data available to the public in such form and at such times as the Commission determines appropriate to enhance price discovery.”

5

See

generally
CEA section 2(a)(13), 7 U.S.C. 2(a)(13).

6
CEA section 2(a)(13)(A).

In general, section 2(a)(13) of the CEA directs the Commission to prescribe regulations “providing for the public availability of transaction and pricing data” for certain swaps. Section 2(a)(13) also places two other statutory requirements on the Commission that are relevant to this further notice of proposed rulemaking (“Further Proposal”). First, sections 2(a)(13)(E)(ii) and (iii) of the CEA respectively require the Commission to prescribe regulations specifying “the criteria for determining what constitutes a large notional swap transaction (block trade) for particular markets and contracts” and “the appropriate time delay for reporting

large notional swap transactions (block trades) to the public.”
7

In promulgating regulations under section 2(a)(13), section 2(a)(13)(E)(iv) directs the Commission to take into account whether public disclosure of swap transaction and pricing data will “materially reduce market liquidity.”
8

7

See
CEA sections 2(a)(13)(E)(ii) and (iii). Section 2(a)(13)(E) explicitly refers to the swaps described only in sections 2(a)(13)(C)(i) and 2(a)(13)(C)(ii) of the CEA (
i.e.,
clearable swaps, including swaps that are exempt from clearing). As noted in the Commission's Initial Proposal (as defined below) and its Adopting Release (as defined below), the Commission interprets the provisions in section 2(a)(13)(E) to apply to all categories of swaps described in section 2(a)(13)(C) of the CEA.

8
CEA section 2(a)(13)(E)(iv). Similarly, section 5h(f)(2)(C) of the CEA directs a registered swap execution facility (“SEF”) to set forth rules for block trades for swap execution purposes.

The second statutory requirement relevant to this Further Proposal is found in sections 2(a)(13)(E)(i) and 2(a)(13)(C)(iii) of the CEA. Section 2(a)(13)(E)(i) requires the Commission to protect the identities of counterparties to mandatorily-cleared swaps, swaps excepted from the mandatory clearing requirement and voluntarily-cleared swaps. Section 2(a)(13)(C)(iii) of the CEA requires the Commission to prescribe rules that maintain the anonymity of business transactions and market positions of the counterparties to an uncleared swap.
9

Indeed, Congress sought to “ensure that the public reporting of swap transaction and pricing data [would] not disclose the names or identities of the parties to [swap] transactions.”
10

9
This provision does not cover swaps that are “determined to be required to be cleared but are not cleared.”
See
CEA section 2(a)(13)(C)(iv).

10
156 Cong. Rec. S5921 (daily ed. July 15, 2010) (Statement of Sen. Blanche Lincoln).

In carrying out these two statutory requirements under section 2(a)(13), the Commission issued a notice of proposed rulemaking. A discussion of that notice is described immediately below.

B. The Initial Proposal

On December 7, 2010, the Commission published in the
Federal Register
a notice of proposed rulemaking to implement section 2(a)(13) of the CEA (the “Initial Proposal”), which included, among others, specific provisions pursuant to sections 2(a)(13)(E)(i)-(iv) and 2(a)(13)(C)(iii).
11

In the Initial Proposal, the Commission set out proposed provisions to satisfy the statutory requirements discussed above. With respect to the first statutory requirement, the Commission proposed: (1) Definitions for the terms “large notional off-facility swap” and “block trade”
12
;

(2) a method for determining the appropriate minimum block sizes for large notional off-facility swaps and block trades;
13

and (3) a framework for timely reporting of such transactions and trades.
14

Proposed § 43.5(g) provided that registered swap data repositories (“SDRs”) shall be responsible for calculating the appropriate minimum block size for each “swap instrument” using the greater result of the distribution test
15

and the multiple test.
16

Proposed § 43.2(y) broadly defined “swap instrument” as “a grouping of swaps in the same asset class with the same or similar characteristics.”
17

Proposed § 43.5(h) provided that for any swap listed on a SEF or DCM, the SEF or DCM must set the appropriate minimum block trade size.
18

11

See
Real-Time Public Reporting of Swap Transaction Data, 75 FR 76,139, Dec. 7, 2010, as corrected in Real-Time Public Reporting of Swap Transaction Data Correction, 75 FR 76,930, Dec. 10, 2010. Interested persons are directed to the Initial Proposal for a full discussion of each of the proposed part 43 rules.

12
The Initial Proposal defined the term “large notional swap.”
See
proposed § 43.2(l), 75 FR 76,171. The Adopting Release finalized the term as “large notional off-facility swap,” to denote, in relevant part, that the swap is not executed pursuant to a SEF or designated contract market's (“DCM”) rules and procedures.
See
§ 43.2, 77 FR 1,182, 1,244, Jan. 9, 2012 (“Adopting Release”). Specifically, the Adopting Release defined the term as an “off-facility swap that has a notional or principal amount at or above the appropriate minimum block size applicable to such publicly reportable swap transaction and is not a block trade as defined in § 43.2 of the Commission's regulations.”
Id.
Throughout this Further Proposal, the Commission uses the term “large notional off-facility swap” as adopted in the Adopting Release.

The Initial Proposal's definition of “block trade” was similar to the final definition in the Adopting Release.
See
proposed § 43.2(f), 75 FR 76,171. The Adopting Release defines the term “block trade” as a publicly reportable swap transaction that: “(1) [i]nvolves a swap that is listed on a SEF or DCM; (2) [o]ccurs away from the [SEF's or DCM's] trading system or platform and is executed pursuant to the [SEF's or DCM's] rules and procedures; (3) has a notional or principal amount at or above the appropriate minimum block applicable to such swap; and (4) [i]s reported subject to the rules and procedures of the [SEF or DCM] and the rules described in [part 43], including the appropriate time delay requirements set forth in § 43.5.”
See
§ 43.2, 77 FR 1,243.

13

See
proposed § 43.5, 75 FR 76,174-76.

14
Proposed § 43.5(k)(1) in the Initial Proposal provided that the time delay for the public dissemination of data for a block trade or large notional off-facility swap shall commence at the time of execution of such trade or swap.
See
75 FR 76,176. Proposed § 43.5(k)(2) provided that the time delay for standardized block trades and large notional off-facility swaps (
i.e.,
swaps that fall under CEA Section 2(a)(13)(C)(i) and (iv)) would be 15 minutes from the time of execution.
Id.
The Initial Proposal did not provide specific time delays for large notional off-facility swaps (
i.e.,
swaps that fall under Section 2(a)(13)(C)(ii) and (iii)). Instead, proposed § 43.5(k)(3) provided that the time delay for such swaps shall be reported subject to a time delay that may be prescribed by the Commission.
Id.

The Adopting Release established time delays for the public dissemination of block trades and large notional off-facility swaps in § 43.5.
See
77 FR 1,247-49.

15
The distribution test, described in proposed § 43.5(g)(1)(i) of the Initial Proposal, required that an SDR take the rounded transaction sizes of all trades executed over a period of time for a particular swap instrument and create a distribution of those trades. An SDR would then determine the minimum threshold amount as an amount that is greater than 95 percent of the notional or principal transaction sizes for the swap instrument for an applicable period of time.
See
75 FR 76,175.

16
The multiple test, described in proposed § 43.5(g)(1)(ii) in the Initial Proposal, required that an SDR multiply the block trade multiple by the “social size” of a particular swap instrument. Proposed § 43.2(x) defined “social size” as the greatest of the mean, median or mode for a particular swap instrument. The Commission proposed a block trade multiple of five.
Id.

17

See
proposed § 43.2(y), 75 FR 76,172. For the reasons described in section II.B. infra, the Commission is proposing to use the term “swap category” instead of “swap instrument.” The Commission is of the view that the term swap category is a more descriptive term to convey the concept of a grouping of swap contracts that would be subject to the same appropriate minimum block size.

18

See
75 FR 76,176.

With respect to the second statutory requirement relevant to this Further Proposal, the Initial Proposal set forth several provisions to address issues pertinent to protecting the identities of parties to a swap. Essentially, these proposed provisions sought to protect the identities of parties to a swap through the limited disclosure of information and data relevant to the swap. In particular, proposed § 43.4(e)(1) in the Initial Proposal provided that an SDR could not publicly report swap transaction and pricing data in a manner that discloses or otherwise facilitates the identification of a party to a swap. Proposed § 43.4(e)(2) would have placed a requirement on SEFs, DCMs and reporting parties to provide an SDR with a specific description of the underlying asset and tenor of a swap. This proposed section also included a qualification with respect to the reporting of the specific description. In particular, this section provided that “[the] description must be general enough to provide anonymity but specific enough to provide for a meaningful understanding of the economic characteristics of the swap.”
19

This qualification would have applied to all swaps.

19
See 75 FR 76,174.

In the Initial Proposal, the Commission acknowledged that swaps that are executed on or pursuant to the rules of a SEF or DCM do not raise the same level of concerns in protecting the identities, business transactions or market positions of swap counterparties since these swaps generally lack

customization.
20

As a result, the Commission provided that SEFs and DCMs should tailor the description required by proposed section 43.2(e) depending on the asset class and place of execution of each swap.

20

See
75 FR 76,151 (“In contrast, for those swaps that are executed on a swap market, the Commission believes that since such contracts will be listed on a particular trading platform or facility, it will be unlikely that a party to a swap could be inferred based on the reporting of the underlying asset and therefore parties to swaps executed on swap markets must report the specific underlying assets and tenor of the swap.”).

In contrast, the Commission acknowledged that the public dissemination of a description of the specific underlying asset and tenor of swaps that are not executed on or pursuant to the rules of a SEF or DCM (
i.e.,
swaps that are executed bilaterally) may result in the unintended disclosure of the identities, business transactions or market positions of swap counterparties, particularly for swaps in the other commodity asset class.
21

To address this issue, the Commission proposed in § 43.4(e)(2) that an SDR publicly disseminate a more general description of the specific underlying asset and tenor.
22

In the Initial Proposal, the Commission provided a hypothetical example of how an SDR could mask or otherwise protect the underlying asset from public disclosure in a manner too specific so as to divulge the identity of a swap counterparty. The Commission, however, did not set forth a specific manner in which SDRs should carry out this requirement.
23

21

See
75 FR 76,150-51.

22

See
75 FR 76,174
.

23

See
75 FR 76,150. The Initial Proposal further provided that the requirement in proposed § 43.4(e)(2) was separate from the requirement that a reporting party report swap data to an SDR pursuant to section 2(a)(13)(G) of the CEA. See 75 FR 76,174.

To further protect the identities, business transactions or market positions of swap counterparties, proposed § 43.4(i) of the Initial Proposal included a rounding convention for all swaps, which included a “notional cap” provision. The proposed notional cap provision provided, for example, that if the notional size of a swap is greater than $250 million, then an SDR only would publicly disseminate a notation of “$250+” to reflect the notional size of the swap.
24

24

See
75 FR 76,152.

The Commission issued the Initial Proposal for public comment for a period of 60 days, but later reopened the comment period for an additional 45 days.
25

The comments that were submitted in response to the Initial Proposal are discussed in the section that follows.

25
The initial comment period for the Initial Proposal closed on February 7, 2011. The comment periods for most proposed rulemakings implementing the Dodd-Frank Act—including the proposed part 43 rules—subsequently were reopened for the period of April 27 through June 2, 2011.

C. Public Comments in Response to the Initial Proposal

After issuing the Initial Proposal, the Commission received 105 comment letters and held 40 meetings with interested parties regarding the proposed provisions.
26

The commenters provided general and specific comments relating to the proposed provisions regarding the determination of appropriate minimum block sizes and anonymity protections for the identities, business transactions and market positions of swap counterparties.
27

Subsection 1 below sets out a discussion of the comments submitted in response to the Initial Proposal regarding the provisions that pertain to the determination of appropriate minimum block sizes. Subsection 2 below sets out a discussion of the comments submitted in response to the Initial Proposal regarding the proposed provisions that provide anonymity protections for the identities, business transactions or market positions of swap counterparties. Subsection 3 below sets out a discussion of the comments submitted in response to the Initial Proposal regarding the implementation of proposed part 43.

26
The interested parties who either submitted comment letters or met with Commission staff included end-users, potential swap dealers, asset managers, industry groups/associations, potential SDRs, a potential SEF, multiple law firms on behalf of their clients and a DCM. Of the 105 comment letters submitted in response to the Initial Proposal, 42 letters focused on various issues relating to block trades and large notional off-facility swaps. Of the 40 meetings, five meetings focused on various issues relating to block trades and large notional off-facility swaps. All comment letters received in response to the Initial Proposal may be found on the Commission's Web site at:
http://comments.cftc.gov/PublicComments/CommentList.aspx?id=919.

27
A list of the full names and abbreviations of commenters who responded to the Initial Proposal and who the Commission refers to in this Further Proposal is included in section VI below. As noted above, letters from these commenters and others submitted in response to the Initial Proposal are available through the Commission's Web site at
http://comments.cftc.gov/PublicComments/CommentList.aspx?id=919.

1. Public Comments Regarding the Proposed Determination of Appropriate Minimum Block Sizes

In terms of general comments, many commenters argued that the potential effects of the large notional off-facility swap and block trade provisions (including the provisions regarding the appropriate time delay) would adversely affect market liquidity.
28

Several commenters generally argued that the Commission's proposed methodology was not supported by actual swap market data.
29

In support of these comments, a few commenters also argued that the Commission should examine swap markets over a sufficient period of time to obtain a comprehensive view of market liquidity.
30

Other commenters also contended that the proposed methodology to determine appropriate minimum block sizes would increase transaction costs if the appropriate minimum block sizes are set too large or if time delays are not long enough.
31

28

See, e.g.,
Freddie Mac CL at 2; ICI CL at 2; ABC/CIEBA CL at 1-2; ISDA/SIFMA CL at 2-4; Cleary Gottlieb CL at 6; JP Morgan CL at 2; WMBAA CL at 3.

29

See, e.g.,
Cleary Gottlieb CL at 4-5; SIFMA/AFME/ASIFMA CL at 12; AII CL at 3-5. In their joint comment letter, for example, ISDA and SIFMA urged the Commission to conduct an empirical study on the impact of post-trade transparency on the over-the-counter (“OTC”) markets prior to finalizing the rulemaking.
See
ISDA/SIFMA CL at 4-5. In addition, ISDA and SIFMA argued that the Commission should conduct a three-month study, during which time the Commission should prescribe interim block trade rules.
Id.

30
Commenters did not agree on what constitutes a sufficient period of time to obtain a comprehensive view of liquidity.
See, e.g.,
ISDA/SIFMA CL at 4 (three months);
but see
AII CL at 4 (one year); ABC/CIEBA CL at 5-6 (at least one year); UBS (six month consultation period).

31

See, e.g.,
UBS CL at 1; AII CL at 4; SIFMA/AFME/ASIFMA CL at 11-13; BlackRock CL at 3-4; Hunton & Williams CL at 20; Cleary Gottlieb CL at 4-6; CCMR CL at 4; Coalition of Derivatives End-Users CL at 4-7; MFA CL at 3-4; MetLife CL at 2-3.

Some commenters made specific recommendations regarding the Commission's proposed method for determining appropriate minimum block sizes for large notional off-facility swaps and block trades.
32

For example, four commenters proffered alternative methods in which to group or categorize swaps for the purposes of the appropriate minimum block size determination.
33

Ten commenters recommended ways to modify the multiple test.
34

Specifically, four commenters suggested that the Commission remove the mean from the calculation of social size.
35

Several of

these commenters also suggested that the Commission use a multiple of less than five, with a multiple of two as the most often suggested alternative.
36

32

See, e.g.,
BlackRock CL at attachment 3; Coalition of Derivatives End-Users CL at 2-4.

33

See, e.g.,
UBS CL at 1; Coalition of Derivatives End-Users CL at 2-4; Cleary Gottlieb CL at 5-6; SIFMA AMG CL at 5; Goldman CL at 3-4; ICI CL at 3.

34

See e.g.,
JP Morgan CL at 9; BlackRock CL at 4; Goldman CL at 5.

35

See, e.g.,
Goldman CL at 5 (“[W]e encourage the [Commission] to modify the multiple test by eliminating the mean prong. Defining the social size of a swap category with reference to the mean of transaction sizes would make the calculation susceptible to skewing * * *.”).
See also
JPM CL

at 8, UBS CL at 2, Federal National Mortgage Association CL at 2.

36

See, e.g.,
UBS CL at 2 (multiple of 2); JP Morgan CL at 9 (multiple of 2).
But see
MetLife CL at 5 (multiple of 1.5).

Ten commenters also recommended that the Commission alter the distribution test in a way that they would support it as a test, which should be used individually or used in combination with the multiple test.
37

The majority of these commenters suggested that the Commission use a lower percentage than the proposed 95th percentile.
38

Specifically, these commenters suggested a percentile between the 50th and 80th percentile.
39

37

See e.g.,
PIMCO CL at 4; SIFMA AMG CL at 4; UBS CL at 2.

38

See, e.g.,
BlackRock CL at 4; SIFMA AMG CL at 5; Vanguard CL at 5 .
See also
UBS CL at 2.

39

See, e.g.,
BlackRock CL at 4 (use 75th percentile); SIFMA AMG CL at 5 (recommending “somewhere in the range of the 66th to 80th percentiles”); Vanguard CL at 5 (80th percentile); JP Morgan CL at 9 (50th percentile).
See also
UBS CL at 2.

A few commenters focused their recommendations on the methodologies that an SDR would use to calculate the appropriate minimum block sizes for specific asset classes. For example, three commenters made specific recommendations regarding the calculation and criteria of large notional off-facility swaps and block trades in the interest rate swap market.
40

A third commenter made specific recommendations regarding the calculation and criteria of large notional off-facility swaps and block trades in the credit default swap market.
41

40

See
PIMCO CL at 3 (for interest rate swaps, “$250 million for swaps of 0-2 years, $200 million for swaps of 2-5 years, $100 million for swaps of 6-10 years, $75 million for swaps of 11-20 years, and $50 million for swaps over 20 years.”); AII CL at 5 (“For interest rate swaps 0-5 year interest rate swaps, it may be appropriate to set the limit at approximately $100 million. For 5-10 year interest rate swaps, the threshold might be approximately $50 million and for 10-30 year interest rate swaps, the appropriate threshold could be approximately $25 million.”); BlackRock CL at attachment 3 (for interest rate swaps, “$300K DV01 (approximately $350 million 10 year equivalent)”).

41

See
BlackRock CL at attachment 3.
See also
SIFMA/AFME/ASIFMA CL at 12 (recommending criteria for swaps and other instruments in the FX asset class).

One commenter shared its view regarding whether the block trade rules that are applied in the futures markets are an appropriate analogy for determining appropriate minimum block sizes in related swaps markets. In its comment letter to the Initial Proposal, this commenter argued that the appropriate minimum block sizes in place for the futures market should be used as a comparison for determining appropriate minimum block sizes in the swaps market.
42

The commenter stated that where an economically-equivalent futures contract is listed on a DCM, then the rules establishing appropriate minimum block sizes for a swap should be comparable to such futures contracts.
43

The commenter also suggested that the Commission use comparable futures contracts in determining, inter alia, appropriate minimum block sizes and reporting and recordkeeping requirements.
44

The commenter warned otherwise that, if the Commission was to adopt a different approach, then such action would unintentionally “[tilt] the playing field in favor of one class of instruments.”
45

The commenter further argued that this consequence would not be consistent with Congress's intent when it enacted the Dodd-Frank Act.

42

See
CME CL at 12.

43

See id.

44

See id.

45

Id.
at 13.

In contrast, other commenters suggested that the appropriate minimum block sizes in place for futures contracts would be an inappropriate comparative measure for the swaps market.
46

Some of these commenters, for example, argued that the futures market is not an appropriate basis for setting appropriate minimum block sizes for block trades and large notional off-facility swaps because the swap market is significantly different than the futures market.
47

46

See, e.g.,
Freddie Mac CL at 2; Barclays CL at 2; ICI CL at 2-3; ISDA/SIFMA CL at 3-4; Vanguard CL at 4; TriOptima CL at 5; CCMR CL at 3.

47

See
ISDA/SIFMA CL at 3-4; Vanguard CL at 4; TriOptima CL at 5; Freddie Mac CL at 2; Barclays CL at 2; ICI CL at 2-3; CCMR CL at 3.

Many commenters to the Initial Proposal contended that the Commission should determine appropriate minimum block sizes based on the liquidity of a “swap instrument.”
48

Two commenters suggested that markets with differing levels of liquidity should be subject to different block size methodologies.
49

Another commenter suggested that a volume of less than five transactions per day be used to classify certain swap categories as illiquid and therefore subject to lower relative block size thresholds.
50

Yet another commenter suggested utilizing a benchmark volume level to classify swaps within an asset class for the purpose of determining appropriate block sizes.
51

One commenter suggested considering the turnover in a market to determine appropriate block sizes and time delays.
52

Finally, another commenter recommended that the Commission review historical swap transaction data and consult with market participants in determining a liquidity spectrum for each swap category, with liquidity determined based on the average number of transactions per day (based on true risk transfer) over the preceding six months and the number of market makers regularly trading the instrument.
53

48

See
note 17 supra for the Commission's proposal to use the term “swap category” instead of “swap instrument.”

49

See
ISDA/SIFMA CL at 4; Coalition of Derivatives End-Users CL at 4.

50

See
Morgan Stanley CL at 11.

51

See
Vanguard CL at 5.

52

See
TriOptima CL at 5.

53

See
UBS CL at 2.

2. Public Comments Regarding the Proposed Anonymity Protections

Several commenters expressed concerns that the Initial Proposal did not address possible disclosure of the identities, business transactions and market positions of swap counterparties.
54

Many commenters stated that the failure to adequately protect the identities and business transactions of the counterparties in connection with transacting block trades or large notional off-facility swaps would result in harm to the market.
55

These commenters argued that the proposal would increase the risk that sophisticated market participants or some counterparties would be able to detect either the asset being offset or the identity of the end-user doing the offsetting, notwithstanding the anonymity protections proposed in the Initial Proposal.
56

According to these commenters, this issue is of particular concern when a swap market participant enters into multiple swap transactions to place a large offsetting position and some or all of those transactions involve thinly-traded products or illiquid markets.
57

Under

those circumstances, the commenters asserted that the parties to a swap would face an increased risk that their identities or transactions would be revealed to the public in violation of sections 2(a)(13)(E)(i) and 2(a)(13)(C)(iv) of the CEA.
58

The commenters concluded that, as a result, swap counterparties could experience difficulty in offsetting their positions at a competitive price.
59

54

See e.g.,
Sutherland CL at 4-5; PIMCO CL at 3; Cleary Gottlieb CL at 5; Bracewell & Giuliani CL at 2-7; DTCC CL at 12; FINRA CL at 5; Dominion CL at 6-9; Commission staff meeting with Argus Media, Inc. on Feb. 3, 2011.
See also
ISDA and SIFMA, Block trade reporting over-the-counter derivatives markets, 6 (Jan. 2011), available at
http://www.isda.org/speeches/pdf/Block-Trade-Reporting.pdf.

55

See, e.g.,
Dominion CL at 5-6; PIMCO CL at 3; ABC/CEIBA CL at 16; WMBAA CL at 10; MFA CL at 2-3; Coalition for Derivatives End-Users CL at 10; Sutherland CL at 5; Argus CL at 3-4; ATA CL at 5; Sadis Goldberg CL at 2-4.

56

See, e.g.,
Sutherland CL at 5; Coalition for Derivatives End-Users CL at 10; ATA CL at 5.

57

See, e.g.,
Argus CL at 3-4 (“In situations where only a few entities trade a certain type of underlying asset, real-time reporting may inadvertently reveal the identity of the swap participants, particularly where the underlying

asset is a commodity.”);
see also
Dominion CL at 5-6; Sutherland CL at 5; Coalition for Derivatives End-Users CL at 10.

58

See, e.g.,
Argus CL at 3-4; ATA CL at 5; Dominion CL at 5-6; Sadis Goldberg CL at 2-4.

59

Id. See
note 58
supra.

To address concerns regarding limited disclosure, several commenters recommended that the Commission establish a “masking rule.”
60

For example, one commenter suggested that the Commission set masking thresholds at or near the level that represents the dividing line between retail and institutional trades.
61

Another commenter suggested that the Commission develop a masking rule for the swaps market that is similar to the one established by the Financial Industry Regulatory Authority (“FINRA”) for the bond market.
62

These commenters suggested, however, that the Commission establish alternative methodologies to ensure limited public disclosure of swap transaction and pricing data.
63

60
JP Morgan CL at 12-14 (“The masking rule is similar in concept to the so-called `5+ rule' in TRACE. Under TRACE, transactions involving bonds in excess of $5 [m]illion are reported as `5+' * * *.”);
see also
WMBAA CL at 10; ABC/CIEBA CL at 8-9.

61

See
JP Morgan CL at 12-13.

62

See
WMBAA CL at 10.

63

See, e.g.,
ABC/CIEBA CL at 9 (“We ask the Commission adopt a rule * * * which will require that the volume of those swaps which are not block trades be disseminated in the form of ranges.”).

Some commenters expressed general concerns regarding anonymity as well as specific concerns with respect to swaps in the other commodity asset class. One commenter provided specific examples of how the identities of the counterparties could be revealed by publicly disseminating information relating to energy products.
64

Another commenter suggested the use of broad geographic regions when publicly disseminating data for commodity swaps with very specific underlying assets or delivery points (
e.g.,
natural gas) in order to protect the anonymity of the parties to these swaps.
65

In commenting on the hypothetical example provided in the Initial Proposal,
66

the commenter suggested that instead of reporting Lake Charles, Louisiana as the delivery point, an SDR could publicly disseminate “Louisiana” or “Gulf Coast.”
67

64

See
MS CL at 3.

65

See
Argus CL at 1-3.

66

See
75 FR 76,150-76,151.

67

See
Argus CL at 1-3.

Six commenters argued that the proposed anonymity provisions are not sufficient for certain swaps or certain markets (
e.g.,
large, bespoke trades offsetting energy assets; illiquid contracts entered into by non-financial end-users; etc.). These commenters further argued that the public dissemination requirement in the Initial Proposal may result in undue harm to the swap market by increasing the risk of public disclosure of the identities, business transactions and market positions of swap counterparties.
68

68

See
Argus CL at 1-3; Coalition for Derivatives End-Users CL at 8-9; Dominion CL at 6-9; Cleary Gottlieb CL at 5; MS CL at 3; Bracewell & Giuliani CL at 2-7.
See also
Commission staff meeting with NFPEEU, June 11, 2011.

3. Public Comments Regarding Implementation

In the Initial Proposal, the Commission solicited comments in response to specific questions regarding the implementation of real-time public reporting, including, inter alia, the timetable in which the Commission would require the public dissemination of swap transaction and pricing data for block trades and large notional off-facility swaps. In response to the Initial Proposal, several commenters suggested that the Commission phase-in the block trade thresholds and time delays, starting with lower thresholds and longer time delays.
69

These commenters further suggested that the Commission phase-in stricter methodologies and time delays over time.
70

For example, one commenter stated in its comment letter that the Commission should specify appropriate minimum block sizes in advance and readjust those sizes over time in order to provide certainty to the market.
71

In contrast, another commenter argued that the Commission should use data that is currently available to set appropriate minimum block sizes without any delay.
72

69

See, e.g.,
Barclays Capital CL at 5; World Federation of Exchanges CL at 2; ISDA/SIFMA CL at 11-12; and Cleary Gottlieb CL at 18-19.

70

See, e.g.,
Freddie Mac CL at 2-3; Barclays Capital CL at 5.

71

See
CCMR CL at 2-4.
Accord
Freddie Mac CL at 2-3 (“As the Commission collects data about the liquidity of the swaps market and the effects of the Commission's reporting rules, it may be appropriate to revisit the initial parameters for block trade reporting in order to further increase transparency.”).

72

See
SDMA CL at 3.

Following the close of the comment period, the Commission took several actions in consideration of the comments received regarding the proposed methodology to determine appropriate minimum block sizes, the proposed anonymity protections and the proposed implementation approach.
73

A discussion of the Commission's actions and their impact on this Further Proposal is set out immediately below.

73
Commission staff also consulted with the staffs of several other federal financial regulators in connection with the issuance of this Further Proposal.

D. Analysis of Swap Market Data; Issuance of the Adopting Release

In consideration of the public comments submitted in response to the Initial Proposal, the Commission obtained and analyzed swap data in order to better understand the trading activity of swaps in certain asset classes.
74

The Commission also reviewed additional information, including a recent study pertaining to the mandatory execution requirements and post-trade transparency concerns that arose out of two of the Commission's proposed rulemakings,
75

as well as a report issued by two industry trade associations on block trade reporting in the swaps market.
76

In addition, the Commission and the Securities and Exchange Commission, held a two-day public roundtable on Dodd-Frank Act implementation on May 2 and 3, 2011 (“Public Roundtable”).
77

During the Public Roundtable and in comment letters submitted in support thereof, interested parties recommended that the Commission adopt a phased-in approach with respect to the establishment of block trade rules.

74
A detailed discussion of the Commission staff's review and analysis process is set out below in section II.B.1.a. of this Further Proposal.

75

See
ISDA, Costs and Benefits of Mandatory Electronic Execution Requirements for Interest Rate Products, 24 (ISDA Discussion Paper No. 2, Nov. 2011), available at
http://www2.isda.org/attachment/Mzc0NA==/ISDA%20Mandatory%20Electronic%20Execution%20Discussion%20Paper.pdf.
This paper cited the Commission's notice of proposed rulemaking with respect to SEFs (Core Principles and Other Requirements for Swap Execution Facilities, 76 FR 1,214, 1,220, Jan. 7, 2011) and the Initial Proposal.

76

See
Block trade reporting for over-the-counter derivatives markets, note 54 supra.

77

See
Joint Public Roundtable on Issues Related to the Schedule for Implementing Final Rules for Swaps and Security-Based Swaps Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, 76 FR 23,211, Apr. 26, 2011. A copy of the transcript is accessible at:
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/csjac_transcript050211.pdf.

Recently, the Commission issued the Adopting Release that finalized several provisions that were proposed in the Initial Proposal.
78

Those provisions,

once effective, will implement, among other things: (1) Several definitions proposed in the Initial Proposal relevant to this Further Proposal
79
;

(2) the scope of part 43; (3) the reporting responsibilities of the parties to each swap; (4) the requirement that SDRs publicly disseminate swap transaction and pricing data; (5) the data fields that SDRs will publicly disseminate; (6) the time-stamping and recordkeeping requirements of SDRs, SEFs, DCMs and the “reporting party” to each swap
80
;

(7) the interim time delays for public dissemination and the time delays for public dissemination of large notional off-facility swaps and block trades; and (8) interim notional cap sizes for all swaps that are publicly disseminated.
81

78

See
77 FR 1,182.

79
The Adopting Release includes final definitions for the following terms: (1) Block trade; (2) large notional off-facility swap; (3) appropriate minimum block size; and (4) asset class. As noted above, the Adopting Release did not define the term swap instrument. This Further Proposal puts forth a new term swap category, which groups swaps for the purpose of determining whether a swap transaction qualifies as a large notional off-facility swap or block trade.
See
note 17
supra.

80

See
§ 43.2 of the Commission's regulations. 77 FR 1,244. The Adopting Release finalized the definition of “reporting party” as a “party to a swap with the duty to report a publicly reportable swap transaction in accordance with this part [43] and section 2(a)(13)(F) of the [CEA].” 77 FR 1,244.

81

See
77 FR 1,244.

Based on the public comments received in response to the Initial Proposal, and in order to successfully implement the real-time public reporting regulatory framework established in the Adopting Release, the Commission has decided to further propose provisions that: (1) Specify the criteria for determining swap categories and methodologies for determining the appropriate minimum block sizes for large notional off-facility swaps and block trades; and (2) provide increased protections to the identities of swap counterparties to large swap transactions and certain other commodity swaps, which were not fully addressed in the Adopting Release.
82

82
In several places in the Adopting Release, the Commission stated that it plans to address these requirements in a separate, forthcoming release.
See, e.g.,
77 FR 1,185, 1,191, 1,193 and 1,217. This Further Proposal is that release.

Commenters to this Further Proposal are requested to refrain from providing comments with respect to the provisions adopted in the Adopting Release. Those provisions are not the subject of this Further Proposal. The Commission will not address the policy merits or substance of those provisions in its final rulemaking to this Further Proposal.

In section II of this Further Proposal, the Commission sets out its proposal with respect to the criteria for determining swap categories and the methodologies for determining appropriate minimum block sizes for block trades and large notional off-facility swaps. In section III of this Further Proposal, the Commission sets out its proposal with respect to methodologies that provide anonymity to the swap counterparties to large swap transactions and certain other commodity swaps.

II. Further Proposal—Block Trades

A. Policy Goals

In section 2(a)(13) of the CEA, Congress intended that the Commission consider both the benefits of enhanced market transparency and the effects such transparency would have on market liquidity.
83

The Commission anticipates that the public dissemination of swap transaction and pricing data will generally reduce costs associated with price discovery and prevent information asymmetries between market makers and end users.
84

The Commission is of the view that the benefits of enhanced market transparency are not boundless, particularly in swap markets with limited liquidity. As noted above, section 2(a)(13)(E)(iv) of the CEA places constraints on the requirements for the real-time public reporting of swap transaction and pricing data. Specifically, this section provides that the Commission shall “take into account whether the public disclosure [of swap transaction and pricing data] will materially reduce market liquidity.”
85

83
In considering the benefits and effects of enhanced market transparency, the Commission notes that the “guiding principle in setting appropriate block trade levels [is that] the vast majority of swap transactions should be exposed to the public market through exchange trading.” Congressional Record—Senate, S5902, S5922 (July 15, 2010).

84

See e.g.,
CEA section 2(a)(13)(B) (“The purpose of this section is to authorize the Commission to make swap transaction and pricing data available to the public in such form and at such times as the Commission determines appropriate to enhance price discovery.”).

85
CEA section 2(a)(13)(E)(iv).
See also
CEA section 5h(f)(2)(C) (concerning the treatment of block trades for execution purposes).

The Commission believes that the publication of detailed information regarding “outsize swap transactions”
86

could expose swap counterparties to higher trading costs.
87

In this regard, the publication of detailed information about an outsize swap transaction may alert the market to the possibility that the original liquidity provider to the outsize swap transaction will be re-entering the market to offset that transaction.
88

Other market participants might be alerted to the liquidity provider's need to offset risk and therefore would have a strong incentive to exact a premium from the liquidity provider. As a result, liquidity providers possibly could be deterred from becoming counterparties to outsize swap transactions if swap transaction and pricing data is publicly disseminated before liquidity providers can offset their positions. The Commission anticipates that, in turn, this result could negatively affect market liquidity in the swaps market. In consideration of these potential outcomes, this Further Proposal seeks to provide maximum transparency while taking into account reductions in market liquidity through more detailed criteria to establish: (1) Swap categories (relative to the definition of swap instrument in the Initial Proposal); and (2) a phased-in approach to determining appropriate minimum block sizes for block trades and large notional off-facility swaps. A summary of the Commission's proposed approach is described below.

86
As used in this Further Proposal, an “outsize swap transaction” is a transaction that, as a function of its size and the depth of the liquidity of the relevant market (and equivalent markets), leaves one or both parties to such transaction unlikely to transact at a competitive price.

87
The Commission's proposed SEF rulemaking, would require pre-trade transparency for swap transactions that: (1) Are subject to the mandatory clearing requirement; (2) involves a swap that a SEF makes available to trade; and (3) are not block trades.
See
proposed § 37.9(a)(2)(v), 76 FR 1,220. This Further Proposal also would require SEFs to utilize the Commission's rules for block trades (
i.e.,
the subject matter of this Further Proposal) in determining the trading procedures that apply to swap transactions. Therefore, swap transactions exceeding an appropriate minimum block size would therefore be exempt from the mandatory trading requirements.

88
The price of such a transaction would reflect market conditions for the underlying commodity or reference index and the liquidity premium for executing the swap transaction. The time delays in part 43 of the Commission's regulations will protect end-users and liquidity providers from the expected price impact of the disclosure of publicly reportable swap transactions. Trading that exploits the need of traders to reduce or offset their positions has been defined in financial economics literature as “predatory trading.”
See e.g.,
Markus Brunnermeier and Lasse Heje Pedersen, Predatory Trading, Journal of Finance LX 4, Aug. 2005, available at
http://pages.stern.nyu.edu/~lpederse/papers/predatory_trading.pdf.

B. Summary of the Proposed Approach

The Commission is proposing a two-period, phased-in approach to implement of regulations for determining appropriate minimum block sizes.
89

That is, the Commission is

proposing to phase-in its regulations during an initial period and thereafter on an ongoing basis (
i.e.,
the post-initial period) so that market participants can better adjust their swap trading strategies to manage risk, secure new technologies and make necessary arrangements in order to comply with part 43. The Commission is proposing two provisions relating to the Commission's determination of appropriate minimum block sizes: (1) Initial appropriate minimum block sizes under proposed § 43.6(e); and (2) post-initial appropriate minimum block sizes under proposed § 43.6(f).

89
The Commission is proposing the same phased-in approach for determining cap sizes. For a more detailed discussion of the Commission's proposed approach with respect to cap sizes,
see
section III of this Further Proposal infra.

The two-period, phased-in approach would become effective after the implementation of the part 43 provisions in the Adopting Release. Until the date on which the proposed provisions in this Further Proposal become effective, all swaps would be subject to a time delay pursuant to the provisions in part 43.

In proposed § 43.6(e), the Commission is establishing initial appropriate minimum block sizes for each category of swaps within the interest rate, credit, foreign exchange (“FX”) and other commodity asset classes.
90

The Commission has listed the prescribed initial appropriate minimum block sizes in proposed appendix F to part 43 based on these swap categories.
91

For interest rate and credit swaps, the Commission reviewed actual market data and has prescribed initial appropriate minimum block sizes for swap categories in these asset classes based on that data. For the other asset classes, the Commission did not have access to relevant market data. As such, during the initial period, the Commission is proposing to use a methodology based on whether a swap or swap category is “economically related” to a futures contract.
92

Swaps and swap categories that are not economically related to a futures contract would remain subject to a time delay (
i.e.,
treated as block trades or large notional off-facility swaps, as applicable, regardless of notional amount). All initial appropriate minimum block sizes in proposed appendix F to part 43 would become effective 60 days following the publication in the
Federal Register
of a final rule adopting the provisions set forth in this Further Proposal.

90
The Commission is proposing that swaps in the equity asset class do not qualify as block trades and large notional off-facility swaps.
See
proposed § 43.6(d). Otherwise, the Commission is prescribing swap categories for each asset class as set forth in proposed § 43.6(b). These swap categories would remain the same during the initial and post-initial periods.

91
The Commission notes SEFs and DCMs would not be prohibited under this Further Proposal from setting block sizes for swaps at levels that are higher than the appropriate minimum block sizes as determined by the Commission.

92
A discussion of the term “economically related” is set forth below in section II.C.4 of this Further Proposal.

In proposed § 43.6(f)(1), the Commission provides that the duration of this initial period would be no less than one year after an SDR has collected reliable data for a particular asset class as determined by the Commission. During the initial period, the Commission would review reliable data for each asset class. For the purposes of this proposed provision, reliable data would include all data collected by an SDR for each asset class in accordance with the compliance chart in the adopting release to part 45 of the Commission's regulations.
93

The proposed initial period would expire following the publication of a Commission determination of post-initial appropriate minimum block sizes in accordance with the publication process set forth in proposed §§ 43.6(f)(3) and (4). Thereafter, the Commission would set post-initial appropriate minimum block sizes for swap categories no less than once each calendar year using the calculation methodology set forth in proposed § 43.6(c)(1).
94

93

See
Swap Data Recordkeeping and Reporting Requirements, 77 FR 2,136, 2,196, Jan. 13, 2012. The Commission is currently of the view, however, that data is per se reliable if it is collected by an SDR for an asset class after the respective compliance date for such asset class as set forth in part 45 of the Commission's regulations.

94
In particular, the Commission is proposing a 67-percent notional amount calculation, which is discussed in more detail infra in section II.D.1 of this Further Proposal.

The Commission is also proposing special rules for determining appropriate minimum block sizes in certain instances. In particular, in proposed § 43.6(d), the Commission prescribes special rules for swaps in the equity asset class. In proposed § 43.6(h), the Commission is establishing special rules for determining appropriate minimum block sizes in certain circumstances including, for example, rules for converting currencies and rules for determining whether a swap with optionality qualifies for block trade or large notional off-facility swap treatment.

Section C below describes the Commission's proposed approach to establish swap categories across the five asset classes. A discussion of the Commission's proposed methodologies to determine appropriate minimum block sizes follows in section D.

C. Proposing Criteria for Distinguishing Among Swap Categories in Each Asset Class

The Commission is proposing to use the term “swap category” to convey the concept of a grouping of swap contracts that would be subject to a common appropriate minimum block size.
95

Specifically, the Commission is proposing specific criteria for defining swap categories in each asset class. These proposed criteria are intended to address the following two policy objectives: (1) Categorizing together swaps with similar quantitative or qualitative characteristics that warrant being subject to the same appropriate minimum block size; and (2) minimizing the number of the swap categories within an asset class in order to avoid unnecessary complexity in the determination process.
96

In the Commission's view, balancing these policy objectives and considering the characteristics of different types of swaps within an asset class are necessary in establishing appropriate criteria for determining swap categories within each asset class. The five asset classes established by the Commission in the Adopting Release are discussed briefly in the paragraph below, followed by a discussion of the proposed swap category criteria for each asset class.

95
Proposed § 43.6(b) does not set out a definition for the term “swap category.” Instead, proposed § 43.6(b) sets out the provisions that group swaps within each asset class with common risk and liquidity profiles, as determined by the Commission.

96
These objectives are specific to the determination of appropriate swap category criteria and are intended to promote the general policy goals described above in section II.A.of this Further Proposal.

Section 43.2 of the Commission's regulations currently defines “asset class” as “a broad category of commodities, including without limitation, any `excluded commodity' as defined in section 1a(19) of the [CEA], with common characteristics underlying a swap.”
97

Section 43.2 also identifies the following five swap asset classes: interest rates;
98
equity; credit; FX;
99
and other commodities.
100

97

See
§ 43.2, 77 FR 1,243.

98
In the Adopting Release, the Commission determined that cross-currency swaps are a part of the interest rate asset class.
See
77 FR 1,193. The Commission noted that this determination is consistent with industry practice.
See id.

In this Further Proposal, the Commission is proposing to breakdown each asset class further into separate swap categories for the purpose of determining appropriate minimum block sizes for such categories. During the initial and post-initial periods, the Commission would group swaps in the five asset classes into the prescribed swap categories as set forth in proposed § 43.6(b). In the subsections that follow, the Commission discusses in detail the proposed criteria for further delineating groups of swaps in the interest rate, credit, equity, FX, and other commodity

asset classes into separate swap

categories.

99
To the extent that FX swaps or forwards, or both, are excluded from the definition of “swap” pursuant to a determination by United States Department of the Treasury (“Treasury”), the requirements of section 2(a)(13) of the CEA would not apply to those transactions, and such transactions would not be subject to part 43 of the Commission's regulations. Treasury issued a proposed determination on April 29, 2011, in which it stated that FX swaps and forwards would be excluded from the definition of “swap,” and thereby exempt from certain requirements established in the Dodd-Frank Act, including registration and clearing.
See
Determination of Foreign Exchange Swaps and Foreign Exchange Forwards Under the Commodity Exchange Act, 76 FR 25,774, May 5, 2011. Treasury's proposed determination may also be found at
http://www.treasury.gov/initiatives/wsr/Documents/FX%20Swaps%20and%20Forwards%20NPD.pdf.

The CEA provides, however, that, even if Treasury determines that FX swaps and forwards may be excluded from the definition of “swap”, these transactions still are not excluded from regulatory reporting requirements to an SDR. Nonetheless, as stated, such transactions would not be subject to part 43 of the Commission's regulations.
See
77 FR 1,188. Treasury has proposed to act pursuant to the authority in section 721 of the Dodd-Frank Act that permits a determination that certain FX swaps and forwards should not be regulated as swaps and are not structured to evade the Dodd-Frank Act. The Commission has noted that, as proposed, Treasury's determination would exclude FX swaps and forwards, as defined in CEA section 1a, but would not apply to FX options or non-deliverable forwards. FX instruments that are not covered by Treasury's final determination would still be subject to part 43 of the Commission's regulations.

100
The Adopting Release defines the term “other commodity” to mean any commodity that is not categorized in the other asset classes as may be determined by the Commission.
See
77 FR 1,244. The definition of asset class in § 43.2 also provides that the Commission may later determine that there are other asset classes not identified currently in that section.
See
77 FR 1,243.

Request for Comment

Q1. Should the Commission provide for special swap categories and appropriate minimum block size methodologies for bilateral versus cleared swap transactions? If so, why?

1. Interest Rate and Credit Asset Classes

a. Background

The Commission was able to obtain and review non-public swap data to make inferences about patterns of trading activity, price impact and liquidity in the market for swaps in the interest rate and credit asset classes. Based on that review, the Commission is proposing criteria for determining swap categories in these two asset classes. Specifically, the Commission is proposing to define swap categories for: (1) Interest rate swaps based on unique combinations of tenor
101

and currency; and (2) credit default swaps (“CDS”) based on unique combinations of tenor and conventional spreads.
102

101
As used in the Further Proposal, the tenor of a swap refers to the amount of time from the effective or start date of a swap to the end date of such swap. In circumstances where the effective or start date of the swap was different from the trade date of the swap, the Commission used the later occurring of the two dates to determine tenor.

102
As generally used in the industry, the term “conventional spread” represents the equivalent of a swap dealer's quoted spread (
i.e.,
an upfront fee based on a fixed coupon and using standard assumptions such as auctions and recovery rates. More information regarding the use of this term can be found at Markit, The CDS Big Bang: Understanding the Changes to the Global CDS Contract and North American Conventions, at
http://www.markit.com/cds/announcements/resource/cds_big_bang.pdf,
(Mar. 2009), at 19.

The Commission obtained transaction-level data for these asset classes from two third-party service providers with the assistance of the Over-the-Counter Derivatives Supervisors Group (“ODSG”).
103

The ODSG was established in 2005 and is chaired by the Federal Reserve Bank of New York. The ODSG is comprised of domestic and international supervisors of representatives from major OTC derivatives market participants.
104

In particular, the ODSG coordinated with the “G-14 banks” in order to gain written permission to access the non-public swap data.
105

103
Section 8(a) of the CEA protects non-public, transaction-level data from public disclosure. Section 8(a)(1) provides, in relevant part, that “the Commission may not publish data and information that would separately disclose the business transactions or market positions of any person and trade secrets or names of customers * * *.” To assist commenters, this Further Release includes various tables and summary statistics depicting the ODSG data in aggregate forms. In the discussion that follows, the Commission additionally has described the methodology it employed in reviewing, analyzing and drawing conclusions based on the ODSG data.

104

See
OTC Derivatives Supervisors Group—Federal Reserve Bank of New York,
http://www.ny.frb.org/markets/otc_derivatives_supervisors_group.html (last visited Jan. 15, 2012).
The ODSG was formed “in order to address the emerging risks of inadequate infrastructure for the rapidly growing market in the credit derivatives * * *.” The ODSG works directly with market participants to plan, monitor and coordinate industry progress toward collective commitments made by firms.

105
The G-14 banks are: Bank of America-Merrill Lynch; Barclays Capital; BNP Paribas; Citigroup; Credit Suisse; Deutsche Bank AG; Goldman Sachs & Co.; HSBC Group; J.P. Morgan; Morgan Stanley; The Royal Bank of Scotland Group; Societe Generale; UBS AG; and Wells Fargo Bank, N.A.

MarkitSERV, a post-trade processing company jointly owned by Markit and The Depository Trust & Clearing Corporation (“DTCC”), provided the interest rate swap data set. The interest rate swap data set covered transactions confirmed on the MarkitWire platform between June 1, 2010 and August 31, 2010 where at least one party was a G-14 Bank.
106

106
The interest rate swap data was limited to transactions and events submitted to the MarkitWire platform. MarkitWire is a trade confirmation service offered by MarkitSERV.

The Warehouse Trust Company LLC (“The Warehouse Trust”) provided the CDS data set.
107

The CDS data set covered CDS transactions for a three-month period beginning on May 1, 2010 and ending on July 31, 2010.
108

107
The Warehouse Trust, a subsidiary of DTCC DerivSERV LLC, is regulated as a member of the U.S. Federal Reserve System and as a limited purpose trust company by the New York State Banking Department. The Warehouse Trust provides the market with a trade database and centralized electronic infrastructure for post-trade processing of OTC credit derivatives contracts over their entire lifecycle. See DTCC, The Warehouse Trust Company, About the Warehouse Trust Company,
http://www.dtcc.com/about/subs/derivserv/warehousetrustco.php.
(last visited Jan. 31, 2012).

108
The Warehouse Trust data contained “allocation-level data,” which refers to refers to transactional data that does not distinguish between isolated transactions and transactions that, although documented separately, comprise part of a larger transaction.

The Commission notes the work of other regulators in aggregating observations believed to be part of a single transaction.
See
Kathryn Chen, et al., Federal Reserve Bank of New York Staff Report, An Analysis of CDS Transactions: Implications for Public Reporting, (Sept. 2011), at 25,
http://www.newyorkfed.org/research/staff_reports/sr517.html.
The Commission notes that this allocation-level information could produce a downward bias in the notional amounts of the swap transactions in the data sets provided by the ODSG. In turn, this downward bias would produce smaller appropriate minimum block trade sizes relative to a data set that, if available with appropriate execution time stamps, would reflect the aggregate notional amount of swaps completed in a single transaction.

b. The Commission filtered both data sets in order to analyze only transaction-level data corresponding to “publicly reportable swap transactions,” as defined in § 43.2 of the Adopting Release.
109

As such, the Commission excluded from its analysis duplicate and non-price forming transactions.
110

The

Commission also converted the notional amount of each swap transaction into a common currency denominator the U.S. dollar.
111

Interest Rate Swap Categories.

109
“Publicly reportable swap transaction” means, unless otherwise provided in this part: (1) Any executed swap that is an arm's-length transaction between two parties that results in a corresponding change in the market risk position between the two parties; or (2) any termination, assignment, novation, exchange, transfer, amendment, conveyance, or extinguishing of rights or obligations of a swap that changes the pricing of the swap. Examples of an executed swap that does not fall within the definition of publicly reportable swap transaction may include: (1) Certain internal swaps between 100-percent-owned subsidiaries of the same parent entity; and (2) portfolio compression exercises. These examples represent swaps that are not at arm's length, but that do result in a corresponding change in the market risk position between two parties.
See
77 FR 1,244.

110
The excluded records represented activities such as option exercises or assignments for physical, risk optimization or compression transactions, and amendments or cancellations that were assumed to be mis-confirmed. A transaction was assumed to be mis-confirmed when it was canceled without a fee, which the Commission has inferred was the result of a confirmation correction. The Commission also excluded interest rate transactions that were indicated as assignments,

terminations, and structurally excluded records since the Commission was unable to determine if these records were price-forming. The Commission also excluded CDS transactions that were notated as single name transactions. The data sets also included transaction records created for workflow purposes (and therefore redundant), duplicates and transaction records resulting from name changes or mergers.

111
The Commission calculated the average daily exchange rates between relevant currencies and the U.S. dollar for the relevant three-month period covered by the data. This average daily exchange rate was then applied to the notional amounts for non-U.S. dollar denominated swap transactions.

i. Interest Rate Swap Data Summary

The filtered transaction records in the interest rate swap data set contained 166,874 transactions with a combined notional value of approximately $45.4 trillion dollars.
112

These transactions included trades with a wide range of notional amounts, 28 different currencies, eight product types, 57 different floating rate indexes and tenors ranging from under one week to 55 years. Summary statistics of the filtered interest rate swap data set are presented in Table 1.
113

112
The Commission only reviewed relevant transaction records in the interest rate swap data set. As noted above, the Commission excluded duplicate and non-price forming transactions from its review.
See
note 110 supra for a list of excluded transaction records.

113

See
the
International Organization for Standardization
(ISO) standard
ISO 4217
for information on the currency codes used by the Commission. For information on floating rate indexes,
see also
ISDA, 2006 Definitions (2006), and supplements.

114
In producing Table 1, the Commission counted tenors for swaps with an end date within four calendar days of a complete month relative to the swap's start date as ending on the nearest complete month.

Table 1—Summary Statistics for the Interest Rate Swap Data Set by Product Type, Currency, Floating Index and Tenor
114

Number of
transactions

Percentage of total
transactions

Notional amount
(billions of USD)

Percentage of total notional
amount
(%)

Product Type:

Single Currency Interest Rate Swap
128,658
77
16,276
36

Over Night Index Swap (OIS)
12,816
8
16,878
37

Forward Rate Agreement (FRA)
5,936
4
7,071
16

Swaption
11,042
7
2,256
5

Other
8,395
5
2,909
6

Currency:

European Union Euro Area euro (EUR)
46,412
28
18,648
41

United States dollar (USD)
50,917
31
11,377
25

United Kingdom pound sterling (GBP)
16,715
10
7,560
17

Japan yen (JPY)
19,502
12
4,253
9

Other
33,301
20
3,553
8

Floating Index:

USD-LIBOR-BBA
48,651
29
9,411
21

EUR-EURIBOR-Reuters
39,446
24
9,495
21

EUR-EONIA-OIS-COMPOUND
6,517
4
9,122
20

JPY-LIBOR-BBA
19,194
12
4,010
9

GBP-LIBOR-BBA
12,835
8
2,419
5

GBP-WMBA-SONIA-COMPOUND
2,014
1
5,123
11

Other
38,190
23
5,809
13

Tenor:

1 Month
3,171
2
11,859
26

3 Month
10,229
6
11,660
26

6 Month
2,822
2
1,701
4

1 Year
9,522
6
3,484
8

2 Year
16,450
10
3,347
7

3 Year
9,628
6
1,488
3

5 Year
26,139
16
2,712
6

7 Year
6,599
4
661
1

10 Year
34,000
20
2,746
6

30 Year
9,616
6
448
1

Other
38,671
23
5,284
12

Sample Totals
166,847
100
45,390
100

Table 2 below sets out the notional amounts of the interest rate swap data set organized by product type, currency, floating index and tenor. The table also includes the notional amounts in each percentile of a distribution of the data set.

Table 2—Notional Amounts of Interest Rate Swap Data Set Organized by Product Type, Currency, Floating Index and Tenor
[In millions of USD]

Mean
notional
amount

Percentiles
5th
10th
25th
50th
75th
90th
95th

Product Type:

Single Currency Interest Rate Swap
127
4
9
23
52
117
252
438

OIS
1,293
6
13
63
341
1,261
3,784
5,282

FRA
1,168
90
133
266
631
1,039
2,000
3,018

Swaption
204
3
20
50
100
226
500
642

Other
346
*
1
23
89
250
631
1,132

Currency:

EUR
400
6
15
38
91
249
631
1,617

USD
221
5
12
31
89
200
500
1,000

GBP
435
1
1
15
57
167
755
1,698

JPY
221
11
13
28
57
124
339
790

Other
108
4
6
13
30
78
175
308

Floating Index:

USD-LIBOR-BBA
192
5
12
30
76
180
500
803

EUR-EURIBOR-Reuters
241
8
17
38
79
189
416
757

EUR-EONIA-OIS-COMPOUND
1,385
4
10
61
315
1,261
3,784
6,306

JPY-LIBOR-BBA
211
11
12
28
57
113
339
658

GBP-LIBOR-BBA
181
1
4
23
54
151
377
755

GBP-WMBA-SONIA-COMPOUND
2,450
75
113
283
1,509
3,018
6,037
9,055

Other
152
2
4
12
31
88
264
500

Tenor:

1 Month
3,523
37
252
1,251
2,522
3,784
7,546
12,074

3 Month
1,081
11
38
208
604
1,250
2,000
3,018

6 Month
581
19
49
150
377
747
1,261
1,892

1 Year
348
20
31
70
151
341
755
1,261

2 Year
205
10
16
39
111
243
453
631

3 Year
154
10
16
44
95
169
315
500

5 Year
107
5
9
25
63
113
226
316

7 Year
105
7
13
29
57
113
221
315

10 Year
83
5
10
23
50
95
175
252

30 Year
47
4
7
18
26
50
95
132

Other
249
2
4
15
50
126
340
883

The Commission also analyzed the interest rate swap data set to classify the counterparties into broad groups.
115

The Commission's analysis of the interest rate swap data set revealed that approximately 50 percent of transactions were between buyers and sellers who were both identified as G-14 banks and that these transactions represented a combined notional amount of approximately $22.85 trillion or 50 percent of the relevant IRS data set's total combined notional amount.

115
MarkitSERV anonymized the identities of the counterparties and indicated whether a G-14 bank was a party to the swap transaction. Summary statistics relating to these anonymous numbers included: (1) Total count of unique counterparties was equal to approximately 300; (2) the average notional size of transactions involving two G-14 banks was equal to approximately $280 million; (3) the average notional size of transactions involving both a G-14 bank and a non G-14 bank (which traded at least 100 swap transactions) was equal to approximately $260 million.

ii. Interest Rate Swap Data Analysis

As noted above, the Commission is proposing swap categories in the interest rate asset class based on tenor and underlying currency. The Commission is of the view that these criteria would meet the objectives of grouping swaps with economic similarity and reducing unnecessary complexity for market participants in determining whether their swaps are classified within a particular swap category. Tenors were associated with concentrations of liquidity at commonly recognized points along the yield curve. In general, the Commission observed that transactions in the data set (and related market liquidity) tended to cluster at certain tenors.
116

116
The Commission alternatively considered using tenor solely to determine interest rate swap categories. While this alternative approach would result in fewer swap categories (and would be based on the strongest single variable indicator of notional size in statistical regressions performed by the Commission on the interest rate swap data set), it may result in overbroad swap categories treating, for example, interest rate swaps denominated in U.S. dollars the same as those denominated in Polish zlotys, despite relative liquidity differences. As a result, this alternative approach may result in the super-major currency-denominated interest rate swaps setting the block size for all other currencies because of the super-major currency's relatively higher trading frequency.
See
note 123 infra for the Commission's definition of “super-majority currency.”

The Commission is proposing interest rate swap tenor groupings based on two observations regarding the data in the interest rate swap data set.
117

First, the Commission observed that price-notation conventions and points of concentrated transaction activity correspond with specific tenors (
e.g.,
three months, six months, one year, two years, etc.). Second, the Commission observed a similarity in the transaction amounts within a given tenor grouping (
e.g.,
longer-dated tenors in the data set generally had lower average notional sizes). Based on these observations, table 3 below details the proposed tenor groups for the interest rate asset

class.

117
Through the performance of statistical regressions on the interest rate swap data set, the Commission found that tenor was the single strongest indicator of variations in notional amounts.

118
The Commission chose to extend the tenor groups about one-half month beyond the commonly observed tenors to group similar tenors together and capture variations in day counts. The Commission added an additional 15 days beyond a multiple of one year to the number of days in each group to avoid ending each group on specific years.

Table 3—Proposed Tenor Groups for Interest Rates Asset Class
118

Tenor group
Tenor greater than
And tenor less than or equal to

1

Three months (107 days).

2
Three months (107 days)
Six months (198 days).

3
Six months (198 days)
One year (381 days).

4
One year (381 days)
Two years (746 days).

5
Two years (746 days)
Five years (1,842 days).

6
Five years (1,842 days)
Ten years (3,668 days).

7
Ten years (3,668 days)
30 years (10,973 days).

8
30 years (10,973 days)

Similarly, through its analysis of the interest rate swap data set, the Commission found that the currency referenced in a swap explains a significant amount of variation in notional size and, hence, can be used to categorize interest rate swaps given this relationship.
119

The Commission is proposing currency groupings after considering: (1) Price-notation conventions; (2) the relative development of currency groups in the interest rate and FX futures markets; (3) the relative swap transaction total notional amounts and transaction volumes of each currency group; and (4) the relative average transaction notional amounts and lack of evidence of large transacted notional amounts or substantial volume of each currency group.
120

After considering these factors, the Commission is proposing three currency categories for the interest rate asset class: (1) Super-major currencies, which are currencies with large volume and total notional amounts;
121

(2) major currencies, which generally exhibit moderate volume and total notional amounts;
122

and (3) non-major currencies, which generally exhibit moderate to very low volume and notional amounts.

119
The Commission considered alternative approaches of using the individual floating rate indexes or currencies to determine swap categories in the interest rate asset class. These alternative approaches would have the benefit of being more correlated to an underlying curve than the recommended currency and tenor groupings. The data contained 57 floating rate indexes and 28 currencies, which would result in 456 and 224 categories respectively, after sorting by the eight identified tenor groups. The Commission anticipates, however, that grouping swaps using individual rates or currencies would not substantially increase the explanation of variations in notional amounts, while it could result in cells with relatively few observations in some currency-tenor categories. Hence, the Commission does not believe there would be a significant benefit to offset the additional compliance burden that a more granular approach would impose on market participants.

120
Non-major currencies represent less than two percent of the total notional and about 10 percent of the transactions. These currencies typically do not have corresponding futures markets.

121
Super-major currencies represent over 92 percent of the total notional amounts and 80 percent of the total transactions in the data set. It is noteworthy that these currencies have well-developed futures markets for general interest rates and exchange rates.

122
Major currencies represent about six percent of the total notional amount and about 10 percent of the transactions. Some of these currencies host liquid futures markets for interest rates, and all exhibit liquid foreign exchange markets.

Table 4 below summarizes the Commission's three proposed currency swap

categories.

123
The Commission selected these currencies for inclusion in the definition of major currencies based on the relative liquidity of these currencies in the interest rate and FX futures markets. The Commission is of the view that this list of currencies is consistent, in part, with the Commission's existing regulations in § 15.03(a), which defines “major foreign currency as “the currency, and the cross-rates between the currencies, of Japan, the United Kingdom, Canada, Australia, Switzerland, Sweden and the European Monetary Union.” 17 CFR 15.03(a).

Table 4—Proposed Currency Categories for Interest Rates Asset Class

Currency category
Component currencies

Super-Major Currencies
United States dollar (USD), European Union Euro Area euro (EUR), United Kingdom pound sterling (GBP), and Japan yen (JPY).

Major Currencies
123

Australia dollar (AUD), Switzerland franc (CHF), Canada dollar (CAD), Republic of South Africa rand (ZAR), Republic of Korea won (KRW), Kingdom of Sweden krona (SEK), New Zealand dollar (NZD), Kingdom of Norway krone (NOK) and Denmark krone (DKK).

Non-Major Currencies
All other currencies.

Table 5 below presents details on the sample characteristics of the interest rate swap data set organized by currency and tenor swap

categories.

124
Table 5 does not include swap categories with less than 200 transactions in order to preserve the anonymity of the parties to these transactions.

Table 5—Sample Characteristics of Proposed Interest Rate Swap Categories
124

Currency category
Tenor group
Number of transactions
Percent of transactions (%)

Notional
(billions of
USD)

Percent of total notional (%)

Super-major
1
11,394
7
22,347
50

Super-major
2
2,563
2
1,813
4

Super-major
3
6,277
4
3,302
7

Super-major
4
12,395
7
3,420
8

Super-major
5
32,148
19
4,818
11

Super-major
6
42,675
26
4,220
9

Super-major
7
24,237
15
1,433
3

Super-major
8
1,857
1
56
0

Major
1
2,305
1
1,818
4

Major
2
445
0
124
0

Major
3
2,113
1
302
1

Major
4
2,639
2
226
1

Major
5
5,380
3
293
1

Major
6
3,707
2
129
0

Major
7
704
0
19
0

Major
8
<200

Non-Major
1
403
0
64
0

Non-Major
2
247
0
26
0

Non-Major
3
2,073
1
165
0

Non-Major
4
3,354
2
256
1

Non-Major
5
5,873
4
116
0

Non-Major
6
3,935
2
41
0

Non-Major
7
<200

Non-Major
8
<200

Table 6 below sets out the notional amounts of the interest rate swap data set organized by currency and tenor categories. The table includes the mean notional amount of each currency and tenor category, as well as the notional amounts in each percentile of a distribution of the data set.

Table 6—Notional Amounts of Interest Rate Swap Data Set Organized by the Proposed Interest Rate Swap Categories
[In millions of USD]

Currency group
Tenor group
Mean
Transactions percentiles
5th
10th
25th
50th
75th
90th
95th

Super-major
1
1,961
10
36
500
1,000
2,260
4,000
6,306

Super-major
2
708
13
41
200
500
883
1,500
2,260

Super-major
3
526
47
75
150
272
565
1,179
1,809

Super-major
4
276
19
43
100
176
304
565
848

Super-major
5
150
9
21
50
100
158
301
482

Super-major
6
99
6
12
30
54
100
204
305

Super-major
7
59
1
5
14
31
63
126
200

Super-major
8
30
0
0
1
13
37
65
118

Major
1
789
80
133
175
312
573
921
1,313

Major
2
279
50
70
120
210
350
480
921

Major
3
143
13
26
52
97
175
264
438

Major
4
86
9
16
33
66
104
184
240

Major
5
54
4
8
19
44
72
109
145

Major
6
35
4
7
13
23
46
72
96

Major
7
27
5
7
11
20
31
49
75

Major
8
<200

Non-major
1
160
19
37
64
129
225
315
450

Non-major
2
106
16
23
39
72
145
233
311

Non-major
3
79
8
22
31
56
102
157
224

Non-major
4
76
6
9
16
27
50
78
108

Non-major
5
20
2
4
8
14
23
39
54

Non-major
6
10
2
2
4
8
13
21
29

Non-major
7
<200

Non-major
8
<200

Request for Comment

Q2. Please provide comments regarding the Commission's proposed two criteria (tenor and underlying currency type) for determining swap categories in the interest rate asset class.

Q3. As a variation of the proposed approach, should specific currencies as proposed to be assigned be moved to other proposed currency categories?

Q4. As a second variation to the proposed approach, the Commission is considering, for super-major currency interest rate swaps, bifurcating the less than three month tenor category into two separate swap categories: (1) A swap category composed of super-major currency interest rate swaps with a less than 21 day tenor; and (2) a swap category composed of super-major currency interest rate swaps with a greater than 21 day tenor, but less than three month tenor (107 days). The Commission requests comment on the appropriateness of this variation.
125

125
This approach would yield an appropriate minimum block size for super-major currency interest rate swaps with a less than 21 day tenor of $13 billion based on the 67-percent notional amount calculation proposed in § 43.6(c)(1). The appropriate minimum block size for interest rate

swaps with a tenor of 21 days to three months would remain at $6.4 billion in the super-major currency swap category.
See
proposed appendix F to part 43 of the Commission's regulations
infra.

Q5. As a third variation to the proposed approach, the Commission considered floating rate index, product type, duration equivalents, tenor, individual currencies,
126

and currency categories in determining the economic similarities among the swaps in the interest rate asset class before settling on tenor and currency groupings as the sole criteria. Should the Commission use one or more of these other characteristics in addition to, or instead of, the proposed swap categories in the interest rate asset class?

126
The Commission found that the precision of an approach utilizing the above-mentioned tenor groupings along with individual currencies was only marginally improved.

Q6. The proposed interest rate swap categories generally resulted in the grouping of swaps characterized by similar market activity—
i.e.,
high, medium, and low volumes and notional sizes. The Commission requests comment as to whether other measures of market activity or swap characteristics should be used to group or validate the grouping of swaps.

Q7. What considerations should the Commission take into account related to the approach for calculating the tenor of back-dated swaps (
i.e.,
those swaps in which the start date is prior to the execution date)? How should back-dated swaps be categorized for the purposes of determining the tenor?

Q8. Should the Commission consider expanding or contracting the number of currency categories, and, if so, which currencies should be placed in each category? The Commission asks commenters to describe any specific recommendations and include market data in support of such recommendations.

c. Credit Swap Categories

i. Credit Swap Data Summary

The CDS data set contained 98,931 CDS index records that would fall within the definition of publicly reportable swap transaction,
127

with a combined notional value of approximately $4.6 trillion dollars.
128

The CDS data set contained transactions based on 26 broad credit indexes.
129

Of those indexes, each of the iTraxx Europe Series and the Dow Jones North America investment grade CDS indexes (“CDX.NA.IG”) served as the basis for over 20 percent of the total number of transactions and over 33 percent of the total notional value in the relevant CDS data set. Table 7 sets out summary statistics of the CDS data set and includes those CDS indexes with greater than five transactions per day on average.

127

See
note 109
supra.

128
The CDS index transactions in the data set made up approximately 33 percent of the total filtered records and 75 percent of the CDS markets' notional amount for the three months of data provided. The data set contained over 250 different reference indexes; 400 reference index and tenor combinations; and 450 reference index, tenor, and tranche combinations. The data set also contained three different currencies: USD (53%), EUR (46%), and JPY (1%). The Commission notes that in all but a handful of records, each reference index transaction was denoted in a single currency.

129
Those indexes were: (1) ABX.HE; (2) CDX.EM; (3) CDX.NA.HY; (4) CDX.NA.IG; (5) CDX.NA.IG.HVOL; (6) CDX.NA.XO; (7) CMBX.NA; (8) IOS.FN30; (9) iTRAXX Asia ex-Japan HY; (10) iTRAXX Asia ex-Japan IG; (11) iTRAXX Australia; (12) iTRAXX Europe Series; (13) iTRAXX Europe Subs; (14) iTRAXX Japan 80; (15) iTRAXX Japan HiVol; (16) iTRAXX Japan Series; (17) iTRAXX LEVX Senior; (18) iTRAXX SOVX Asia; (19) iTRAXX SOVX CEEMA; (20) iTRAXX Western Europe; (21) LCDX.NA; (22) MCDX.NA; (23) PO.FN30; (24) PRIMEX.ARM; (25) PRIMEX.FRM; and (26) TRX.NA.

Table 7—Summary Statistics by CDS Index Name

Names
Number of transactions

Percentage of
total
transactions
(%)

Notional amount
(in millions of USD)

Percentage of total notional amount
(%)

ITRAXX EUROPE SERIES 13 V1
18,287
18.48
1,138,362
24.83

CDX.NA.IG.14
12,611
12.75
1,083,974
23.64

ITRAXX EUROPE XO SERIES 13 V1
8,713
8.81
153,365
3.34

CDX.NA.HY.14
7,984
8.07
172,599
3.76

ITRAXX EUROPE SENIOR FINANCIALS SERIES 13 V1
4,774
4.83
187,978
4.10

CDX.NA.IG.9
4,134
4.18
388,650
8.48

ITRAXX EUROPE XO SERIES 13 V2
3,959
4.00
66,894
1.46

CDX.NA.IG.9 TRANCHE
3,357
3.39
112,411
2.45

ITRAXX SOVX CEEMEA SERIES 3 V1
3,252
3.29
32,291
0.70

CDX.EM.13
3,052
3.08
34,952
0.76

ITRAXX SOVX WESTERN EUROPE SERIES 3 V1
2,377
2.40
74,068
1.62

ITRAXX AUSTRALIA SERIES NUMBER 13 V1
2,138
2.16
31,540
0.69

ITRAXX EUROPE SERIES 9 V1
1,893
1.91
188,364
4.11

ITRAXX EUROPE SUB FINANCIALS SERIES 13 V1
1,779
1.80
50,241
1.10

ITRAXX EUROPE SERIES 9 V1 TRANCHE
1,577
1.59
50,269
1.10

ITRAXX JAPAN SERIES NUMBER 13 V1
1,406
1.42
19,100
0.42

ITRAXX ASIA EX-JAPAN IG SERIES NUMBER 13 V1
1,319
1.33
15,856
0.35

ITRAXX SOVX ASIA PACIFIC SERIES 3 V1
1,001
1.01
11,666
0.25

ITRAXX EUROPE HIVOL SERIES 13 V1
788
0.80
30,585
0.67

CMBX.NA.AAA.1
463
0.47
13,384
0.29

ITRAXX EUROPE SERIES 12 V1
452
0.46
71,161
1.55

CMBX.NA.AJ.3
392
0.40
6,332
0.14

CMBX.NA.AAA.2
381
0.39
8,433
0.18

LCDX.NA.14
380
0.38
7,063
0.15

MCDX.NA.14
350
0.35
2,798
0.06

CMBX.NA.AAA.4
337
0.34
6,024
0.13

CMBX.NA.A.1
332
0.34
3,834
0.08

IOS.FN30.500.09
317
0.32
7,836
0.17

Total
87,805
88.75
3,970,029
86.59

The Commission identified the following seven terms as the most relevant for the purposes of the Commission's analysis:
130

(1) Notional amount; (2) notional currency; (3) tranche indicator; (4) fixed rate; (5) tenor; (6) spread; and (7) RED code.
131

Summary statistics for the relevant CDS data set included: Average notional amount of approximately $46 million; median notional amount of approximately $24 million; mode notional amount of approximately $32 million; and skewness of 13 and kurtosis over 450, indicating that the sample's notional amounts were not normally distributed.
132

After rounding,
133

the smallest 25 percent of transactions had notional values of $9 million or less and the largest five percent of trades had notional values greater than $150 million. The swaps with the top ten most frequently traded notional sizes accounted for nearly 65 percent of all transactions and 40 percent of the total notional value.
134

130
Each transaction record contained up to 75 fields identifying information such as the anonymized counterparty identifier, trade date, submit date, transaction type, RED code (
i.e.,
the particular index series, version, or vintage), notional amount, notional currency, fixed rate, confirm date, spread, points upfront and several other variables.

131
The RED code is the industry standard identifier for CDS contracts. RED codes are nine character codes (similar to CUSIP codes for securities) where the first six characters refer to the reference entity (or index) when the last three characters refer to the reference obligation, that is, the version or series of an index, and where the first five characters refer to the reference entity (or index) when the last four refer to the vintage of an index. RED codes are used by DTCC to confirm CDS trades on the DTCC Deriv/SERV platform.
See also
Markit Credit Indices, A Primer, Nov. 2008, 30, available at
https://www.markit.com/news/Credit%20Indices%20Primer.pdf.

132
Two times the “social size”
see
note 16 supra, for the relevant CDS data set was $93 million, covered 87 percent of the number of transactions, and 49 percent of the cumulative notional amount. Five times the social size, or $230 million, covered 97 percent of transactions and 75 percent of the cumulative notional amount.

133
The Commission used the rounding convention set forth in § 43.4(g) of the Commission's regulations.

134
In descending order and in millions of dollars, the ten most frequently traded rounded notional amounts included: 32 (the mode); 10; 25; 13; 50; 63; 5; 100; 6; and 20.

The Commission also analyzed the CDS data set to classify the counterparties into broad groups.
135

The Commission's analysis of the CDS data set revealed that approximately 55 percent of transactions were between buyers and sellers who were both identified as G-14 banks and that these transactions represented a combined notional amount of approximately $3.1 trillion, or 66 percent of the relevant CDS data set's total combined notional amount.
136

135
The Commission notes that the CDS data set was anonymized by The Warehouse Trust, but counterparties were identified by a number value and an account number in one of the following eleven groups: Asset managers, bank, custodian, dealer, financial services, G14 dealer, hedge fund, insurance, non-financial, other, and pension plan. Summary statistics relating to these identifiers included: (1) Total count of buyer account identifiers equal to approximately 1,900; (2) total count of seller account identifiers equal to approximately 1,700; (3) total count of unique buyer and seller account identifiers equal to approximately 2,600; (4) total count of buyers equal to approximately 600; (5) total count of sellers equal to approximately 500; and (6) total count of unique buyers and sellers equal to approximately 700. The CDS data set identified counterparties as belonging to one of the eleven groups, and the average notional size of transactions in the eight tenor groups which contained more than 100 transactions ranging from approximately $19 million to $92 million.

136
The Commission notes that the CDS data set only included transaction records where a G-14 bank was one of the counterparties, and did not include transaction records with two buy-side counterparties. A natural bias was present in the percentage of market share that G-14 banks have in the CDS market.

ii. Credit Swap Data Analysis

As noted above, the Commission is proposing to use tenor and conventional spread criteria to define swap categories for CDS indexes. The Commission anticipates that these proposed criteria would provide an appropriate way to group swaps with economic similarities and to reduce unnecessary complexity for market participants in determining whether their swaps are classified within a particular swap category. The Commission is proposing the following six broad tenor groups in the credit asset class: (1) Zero to two years (0-746 days); (2) over two to four years (747-1,476 days); (3) over four to six years (1,477-2,207 days) (which include the five-year tenor); (4) over six to eight-and-a-half years (2,208-3,120 days); (5) over eight-and-a-half to 12.5 years (3,121-4,581 days) and (6) greater than 12.5 years (4,581 days).
137

The Commission added an additional 15 days to each tenor group beyond a multiple of one year in order to avoid ending each group on specific years.

137
The Commission assessed the possibility of applying the tenor categories proposed for swaps in the interest rate asset class to the distribution of notional sizes in the CDS indexes and anticipates the level of granularity proposed to categorize swaps in the interest rate asset class by tenor would be inappropriate for the CDS index market. The Commission anticipates that this level of granularity would be inappropriate because the vast majority of CDS index transactions in the data set were for five years (or approximately 1,825 days). Based on the concentration of CDS index transactions in five-year tenors, the Commission is proposing a six tenor bands for CDS indexes.

The Commission is proposing these swap categories based on the way transactions in the CDS data set clustered towards the center of each tenor band. While the majority of transactions in the CDS data set consisted of corporate credit default index swaps with a five-year tenor, the Commission found that trading of corporate credit default index swaps also occurred in other tenor ranges.
138

The Commission believes that its proposed approach is appropriate since CDS on indexes other than corporate indexes (
e.g.,
asset backed indexes, municipal indexes, sovereign indexes) may also trade at tenors other than five years.
139

138
For example, based on the observed CDS data set, off-the-run swaps (
i.e.,
previous five-year tenor swaps for corporate credit default index swaps) have less than five years to maturity and displayed different trading patterns than the five-year, on-the-run swaps.

139
For example, based on the observed CDS data set, the majority of municipal credit default index swaps traded with tenors of around 10 years.

With respect to the conventional spread criterion, the Commission is proposing ranges of spread values based on the Commission's review of the distribution of spreads in the entire CDS data set.
140

In particular, the Commission observed that the relevant CDS data set partitioned at the 175 basis points (“bps”) and 350 bps levels.
141

The Commission found that significant differences existed in the CDS data set between CDS indexes with spread values under 175 bps and those in the other two swap categories. Table 8 shows the summary statistics of the proposed criteria to determine swap categories for swaps in the credit asset class.
142

140

See
note 102
supra
for a definition of conventional spread.

141
The Commission is proposing partition levels by a qualitative examination of multiple histogram distributions of the traded and fixed spreads from the CDS data set. This qualitative examination was confirmed through a partition test (using JMP software), including both before and after controlling for the effects of tenor on the distribution. The Commission observed that 175 bps explained the greatest difference in means of the two data sets resulting from a single partition of the data. The Commission also observed that 350 bps was an appropriate partition for CDS index transactions with spreads over 175 bps.

142
Table 8 uses tenor and spread criteria discussed above, in a standardized, least squared regression utilizing observed log notional amounts.

Table 8—CDS Index Sample Statistics by Proposed Swap Category Criteria

Spread
Sum of notional amounts (in billions of USD)
Number of trades

<175
3,761
59,887

175-to-350
233
11,045

350>
577
27,998

Tenor (in calendar days):

0-746
146
1,421

747-1,476
569
6,774

1,477-2,207
3,490
79,357

2,208-3,120
159
2,724

3,121-4,581
18
497

4,582+
190
8,157

Request for Comment

Q9. The Commission seeks comment on all aspects of its proposed approach to define swap categories for the credit asset class for the purpose of setting appropriate minimum block sizes. More specifically, the Commission seeks comment as to whether the proposed grouping, alternatives or some other combination of alternatives offer the best means to identify swap categories.

Q10. As an alternative to the proposed criteria, should the Commission use other criteria?
143

The Commission considered the following alternative criteria: (1) The underlying reference CDS index or the more specific RED code (of which there were hundreds);
144

(2) the tranche level;
145

(3) on-the-run versus off-the-run version or series;
146

and (4) the difference in the average notional amounts of transactions by groupings of counterparties.
147

143
The Commission notes that the investment grade of an underlying asset is a material economic term of each CDS contract. When reviewing the CDS data set, the Commission considered using investment grade as an alternative criterion through which to group CDS into separate swap categories. The Commission, however, is of the view that using this alternative criterion would be inappropriate in light of the statutory prohibition against references to credit ratings in federal regulations. This prohibition is set forth in section 939 of the Dodd-Frank Act.

Section 939A(a) of the Dodd-Frank Act provides, in relevant part, that “each Federal agency shall, to the extent applicable, review—(1) any regulation issued by such agency that requires the use of an assessment of the creditworthiness of a security or money market instrument; and (2) any references to or requirement in such regulations regarding credit ratings.” In addition, section 939A(b) further provides that “[e]ach such agency shall modify any such regulations identified by the review * * * to remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations such standard of credit-worthiness as each respective agency shall determine as appropriate for such regulations.” 15 U.S.C. 78o-7 note.

Pursuant to the directive set forth in section 939A of the Dodd-Frank Act, the Commission has issued final rules removing all references to credit ratings in the Commission's regulations.
See
76 FR 78,776, Dec. 19, 2011; 76 FR 44,262, July 25, 2011.

144
While the underlying indexes and the RED codes helped explain average notional size in the CDS data set, the Commission is of the view—based on the large number of currently offered indexes, the frequency with which new indexes may be created, and the large number of RED codes—that such an approach may not be practicable and may impose unnecessary complexity on market participants trying to determine what appropriate minimum block sizes apply to what transactions.

145
In the CDS market, a “tranche” means a particular segment of the loss distribution of the underlying CDS index. For example, tranches may be specified by the loss distribution for equity, mezzanine (junior) debt, and senior debt on the referenced entities. The Commission found that the tranche-level data was even more granular than index-level data. Similarly, the Commission anticipates that grouping the relevant CDS data set in tranche criterion may not be practicable because it may produce too many swap categories and as a result would impose unnecessary complexity on market participants.

146
An on-the-run CDS index represents the most recently issued version of an index. For example, every six months, Dow Jones selects 125 investment grade entities domiciled in North America to make up the Dow Jones North American investment grade index (“CDX.NA.IG”). Each new CDX.NA.IG index is given a new series number while market participants continue to trade the old or “off-the-run” CDX.NA.IG series. The Commission observed that an on-the-run index series was more actively traded than off-the-run index series. Each version or series of an index had a distinct group of tenors and, in most cases, the five year tenor was most active. The index provider determines the composition of each index though a defined list of reference entities. The index provider has discretion to change the composition of the list of reference entities for each new version or series of an index. In its analysis of the CDS data set, the Commission generally observed either no change or a small change (ranging from one percent to ten percent) of existing composition in the reference entities underlying a new version or series of an index. Because of these two dynamics (tenor and index composition), the CDS data set contained transactions within a given index with different versions and series that were in some instances identical and in others not identical across varying tenors. While the off-the-run transactions were generally larger on average than the on-the-run transactions, trading activity in the on-the-run indexes was more active than in the off-the-run indexes.

The Commission decided not to use this level of detail for grouping CDS indexes into categories because: (i) The underlying components of swaps with differing versions or series based on the same named index are broadly similar, if not the same, indicative of economic substitutability across versions or series; (ii) differences in the average notional amount across differing versions or series were explained by differences in tenor; and (iii) and using versions or series as the criterion for defining CDS swap categories may result in an unnecessary level of complexity.

147
Although the Commission was not able to examine non-anonymized data, the Commission did observe differences of approximately 50 percent from the average notional amount for transactions involving different groups based on the counterparty identifiers provided by The Warehouse Trust. The Commission, however, believes that it would be neither practical nor equitable to base a swap category and related appropriate minimum block size based on the predominant business activity of a counterparty.

Q11. As another alternative, the Commission seeks comment on the possibility of establishing two swap categories in the credit asset class based on “activity groupings” of notional amounts of transactions: A “more active group”; and a “less active group.” The more active group would be calculated by ordering, from most to least, the sum of non-rounded notional amounts of all swaps reported to SDRs by a CDS index (
e.g.,
CDX.NA.IG) and then selecting the CDS indexes represented in the first 50 percent of aggregate notional amount. If only one index accounted for the first 50 percent of aggregate notional amount, then the next largest index also would be included in the more active group. The less active group would be comprised of the remainder of all credit index transactions that are not within the more active group. Should the Commission use this activity grouping approach to categorize CDS indexes? If so, how should the Commission determine appropriate minimum block sizes and cap sizes?

Q12. As a third alternative, the Commission seeks comment on the possibility of establishing swap categories in the credit asset class based on sector groupings of the underlying reference entities. Under this alternative approach, the Commission would group the CDS index market into the following four sectors: Corporate; sovereign; municipal; and mortgage-backed security. An index with a mix of sectors represented in the reference entities

would be categorized by the sector representing the majority of entities. The Commission is of the view that in addition to these four distinct sectors, a fifth catch-all group (other) would be necessary to categorize any new swap index that either does not fall into any of these four enumerated sectors or is in mixed sectors not predominated by a single sector.

Q13. As a fourth alternative, should the Commission consider basing swap categories for the credit asset class on individual CDS indexes? For example, CDX.NA.IG would constitute its own swap category.

Q14. Should the Commission combine aspects of the above alternatives? For example, should the Commission distinguish between on-the-run and off-the-run series under an index grouping approach? The Commission seeks comment on whether distinguishing between on-the-run and off-the-run series and tenor would be appropriate under this approach, given the underlying economic similarity of swaps utilizing the same underlying CDS index.

2. Swap Category in the Equity Asset Class

The Commission is proposing a single swap category for swaps in the equity asset class. The Commission is proposing this approach based on: (1) The existence of a highly liquid underlying cash market; (2) the absence of time delays for reporting block trades in the underlying equity cash market; (3) the small relative size of the equity index swaps market relative to the futures, options, and cash equity index markets; and (4) the Commission's goal to protect the price discovery function of the underlying equity cash market and futures market by ensuring that the Commission does not create an incentive to engage in regulatory arbitrage among the cash, swaps, and futures markets.
148

148
As used in this Further Proposal, the term “regulatory arbitrage” means engaging in financial structuring or a series of transactions without economic substance in order to avoid unwelcome regulation or to exploit inconsistencies in regulations.

Request for Comment

Q15. Please provide specific comments regarding the Commission's proposed approach with respect to having one swap category in the equity asset class.

Q16. As an alternative to the proposed approach, should the Commission establish one or more swap categories for swaps in the equity asset class based on any of the following criteria or a combination of such criteria: (1) Tenor; (2) publicly-listed equity indexes and custom equity indexes;
149

(3) market capitalization of the underlying index components;
150

and/or (4) whether a swap is based on an “open market” versus a “closed market”?
151

149
Under this alternative approach, “publicly-listed” equity indexes would be defined as equity swaps with reference prices economically related to equity indexes with publicly available index weightings. “Custom equity index swaps,” in contrast, would be defined as equity swaps that utilize reference prices that are not economically related to equity indexes with publicly known index weightings. This alternative approach would be based on the premise that a custom equity index swap would have a higher probability of being subject to liquidity risk.

150
For example, if an equity index is composed of the weighted average of ten equity components, A Corp., B Corp., C Corp., D Corp., E Corp., F Corp., G Corp., H Corp., I Corp., and J Corp. corresponding to a market capitalization on the day prior to the related swap transaction of $100 million, $200 million, $300 million, $400 million, $500 million, $200 million, $100 million, $200 million, $300 million, and $500 million, respectively, then it would result in an average market capitalization of $280 million. This alternative approach is premised on market capitalization serving as indicia of cash market liquidity for derivatives on the index.

151
Under ISDA's Master Confirmation Templates, “open market” references ISDA annexes with underlying shares or indices in Australia, Hong Kong, New Zealand or Singapore. “Closed market” references ISDA annexes with underlying shares or indices in India, Indonesia, Korea, Malaysia, Taiwan and Thailand. For more information,
see
ISDA, ISDA Equity Derivatives, ISDA Master Confirmation Templates (by region),
http://www.isda.org/c_and_a/equity_der.html#defs.

Under this alternative, other countries outside of Asia could be added to the list in a similar fashion.

Q16.a. If the Commission follows the alternative approach to use tenor as a criterion to distinguish between swap categories, how should the Commission address the practice of long-tenured swaps that are terminated prior to maturity?

3. Swap Categories in the FX Asset Class

The Commission proposes to establish swap categories for the FX asset class based on unique currency combinations. The Commission bases this approach on the observation that FX swaps and instruments with identical currency combinations draw upon the same liquidity pools. The Commission proposes in §§ 43.6(b)(4)(i) and (b)(4)(ii) to distinguish between FX swaps and instruments based on the existence of a related futures contract. Accordingly, the Commission would establish swap categories under proposed § 43.6(b)(4)(i) based on the unique currency combinations of super-major currencies, major currencies and the currencies of Brazil, China, Czech Republic, Hungary, Israel, Mexico, New Zealand, Poland, Russia, and Turkey (
e.g.,
euro (EUR) and Canadian dollar (CAD) combination would be a separate swap category; Swedish kronor (SEK) and U.S. dollar (USD) combination would be a separate swap category; etc.). These currency combinations currently have sufficient liquidity in the underlying futures market, which may suggest that there may be sufficient liquidity in the swaps market for these currency combinations. In proposed § 43.6(b)(4)(ii), the Commission would establish swap categories based on unique currency combinations not included in proposed § 43.6(b)(4)(i).

Request for Comment

Q17. The Commission requests specific comments, data and analysis in respect of its proposed approach to determining swap categories for the FX asset class.

Q18. As an alternative to the proposal, should the Commission establish swap categories based on currency class pairings? In other words, swap categories that correspond to: (i) Super-major-to-super-major; (ii) super-major-to-major; (iii) super-major-to-non-major; (iv) major-to-major; (v) major-to-non-

[Text truncated at 120,000 characters. The full text is on the page linked above.]

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2012-5950. Public record. Not legal advice.