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

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:

Final rule.

SUMMARY:

The Commodity Futures Trading Commission is adopting 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 adopting regulations that define the criteria for grouping swaps into separate swap categories and establish methodologies for setting appropriate minimum block sizes for each swap category. In addition, the Commission is adopting further measures under the Commission's regulations to prevent the public disclosure of the identities, business transactions and market positions of swaps market participants.

DATES:

Effective date:

July 30, 2013.

FOR FURTHER INFORMATION CONTACT:

John W. Dunfee, Assistant General Counsel, Office of the General Counsel, 202-418-5396,

jdunfee@cftc.gov

; George Pullen, Economist, 202-418-6709,

gpullen@cftc.gov

, or Nhan Nguyen, Special Counsel, 202-418-5932,

nnguyen@cftc.gov

,

Division of Market Oversight;

Esen Onur, Economist, Office of the Chief Economist, 202-418-6146,

eonur@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

1. Overview

2. Public Comments in Response to the Initial Proposal

C. Issuance of the Real-Time Reporting Final Rule

D. Further Block Proposal

1. Policy Goals

2. Summary of Proposed Approach

3. Overview of Comments Received

4. Additional Proposal Regarding Aggregation of Blocks

II. Procedures To Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades—Final Rules

A. 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. Summary of Proposed Rule

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

5. Comments Regarding Swap Categories Across Asset Classes

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

1. Phase-in of Appropriate Minimum Block Sizes

2. Overview of Proposed Approach

3. The 67-Percent Notional Amount Calculation for Determination of Appropriate Minimum Block Sizes

4. Data for Determination of Appropriate Minimum Block Sizes in the Post-Initial Period

5. Methodology for Determining the Appropriate Minimum Block Sizes by Asset Class

a. Interest Rate and Credit Default Swaps

b. Equity

c. FX

i. Initial Period Methodology

ii. Post-Initial Period Methodology

d. Other Commodity

i. Initial Period Methodology

ii. Post-Initial Period Methodology

6. 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

C. Procedural Provisions

1. § 43.6(a) Commission Determination

2. § 43.6(f)(4) and (5) Publication and Effective Date of Post-Initial Appropriate Minimum Block Sizes

3. § 43.6(g) Notification of Election

4. § 43.7 Delegation of Authority

5. § 43.6(h)(6)—Aggregation

6. § 43.6(i) Eligible Block Trade Participants

III. 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. 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 or Pricing Points

i. Natural Gas and Related Products

ii. Petroleum and Related Products

iii. Electricity and Sources

iv. All Remaining Other Commodities

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

c. Basis Swaps

d. Comments Received and Commission Determination

4. Further Revisions to Part 43

a. Additional Contracts Added to Appendix B to Part 43

b. Technical Revisions to Part 43

IV. Paperwork Reduction Act

A. Background

B. Description of the Collection

1. § 43.6(g)—Notification of Election

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

V. Cost-Benefit Considerations

A. Background

B. The Statutory Mandate To Consider the Costs and Benefits of the Commission's Action: Section 15(a) of the CEA

C. Rules Establishing Determination Criteria and Methodology (§ 43.6(a)-(f) and (h))

1. Rule Summary

a. Rule 43.6(a) Commission Determination

b. Rule 43.6(b) Swap Category

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

2. Overview of Comments Received

3. Costs

a. Direct Costs

b. Indirect Costs

4. Benefits

5. Alternatives

a. Commission Determination of Minimum Block Sizes

b. Swap Category Alternatives

c. Block Methodology Alternatives

6. CEA Section 15(a) Factors

a. Protection of Market Participants and the Public

b. Efficiency, Competitiveness and Financial Integrity of Markets

c. Price Discovery

d. Sound Risk Management Practices

e. Other Public Interest Considerations

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

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

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

b. 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

c. 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

d. 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

2. Comments Received

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

4. Alternatives

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

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

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

1. Amendments to § 43.4(d)(4)

2. Amendments to § 43.4(h)

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

4. Benefits Relevant to the Amendments to § 43.4

5. Alternatives

6. Application of the Section 15(a) Factors to the 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

F. Costs and Benefits Relevant to § 43.6(h)(6)—Aggregation

1. Overview of Comments Received

2. Costs

3. Benefits

4. Section 15(a) Factors

a. Protection of Market Participants and the Public

b. Efficiency, Competitiveness, and Financial Integrity of the Futures Markets

c. Price Discovery

d. Sound Risk Management Practices

e. Other Public Interest Considerations

G. Costs and Benefits Relevant to § 43.6(i)—Eligible Block Trade Parties

1. Overview of Comments Received

2. Costs

3. Benefits

4. Section 15(a) Factors

a. Protection of Market Participants and the Public

b. Efficiency, Competitiveness, and Financial Integrity of the Futures Markets

c. Price Discovery

d. Sound Risk Management Practices

e. Other Public Interest Considerations

VI. Regulatory Flexibility Act

VII. Example of a Post-Initial Appropriate Minimum Block Size Determination Using the 67-Percent Notional Amount Calculation

VIII. List of Commenters Who Responded to the Further Block 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”).

1

Title VII of the Dodd-Frank Act

2

amended the Commodity Exchange Act (“CEA”)

3

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.

1

See

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

2

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

3

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.

4

Section 2(a)(13)(A) provides that “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.”

5

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.”

4

See generally

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

5

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) places two other statutory requirements on the Commission that are relevant to this final rule. 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.”

6

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.”

7

6

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), its Real-Time Reporting Final Rule (as defined below), and its Further Block Proposal (as defined below), the Commission, in exercising its authority under CEA section 2(a)(13)(B) 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,” is authorized to prescribe rules similar to those provisions in section 2(a)(13)(E) to uncleared swaps described in section 2(a)(13)(C)(iii) and (iv) of the CEA.

7

CEA section 2(a)(13)(E)(iv). Section 5h(f)(2)(C) of the CEA imposes a similar directive upon registered swap execution facilities (“SEF”) by requiring that they set forth rules for block trades for swap execution purposes.

The second statutory requirement relevant to this final rule is found in sections 2(a)(13)(E)(i) and 2(a)(13)(C)(iii) of the CEA. Through these sections, 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.”

8

Accordingly, § 2(a)(13)(E)(i) of the CEA 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

8

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

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).

In order to carry out the requirements of section 2(a)(13), including among other things the two statutory requirements regarding blocks and anonymity described above, the Commission issued a notice of proposed rulemaking on December 7, 2010 (the “Initial Proposal”). On January 9, 2012, the Commission issued a final rule regarding Real-Time Public Reporting of Swap Transaction Data adopting several provisions contained in the Initial Proposal (the “Real-Time Reporting Final Rule”). The Real-Time Reporting

Final Rule, however, did not adopt most of the provisions in the Initial Proposal pertaining to appropriate block sizes and anonymity. Instead, the Commission issued a further notice of proposed rulemaking regarding Procedures to Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades on March 15, 2012 (the “Further Block Proposal”).

10

Each of these issuances is described more fully below.

10

See

Procedures to Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades, 77 FR 15,460, Mar. 15, 2012.

B. The Initial Proposal

1. Overview

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, which included specific provisions pursuant to sections 2(a)(13)(E)(i)-(iv) and 2(a)(13)(C)(iii).

11

In this Initial Proposal, the Commission set out proposed provisions to satisfy, among other things, the statutory requirements discussed above regarding minimum block sizes and anonymity protections. 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”) would 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 swap execution facility (“SEF”) or designated contract market (“DCM”), the SEF or DCM must set the appropriate minimum block trade size at a level at or above that established by an SDR for the relevant swap instrument.

18

11

See

Real-Time Public Reporting of Swap Transaction Data, 75 FR 76139, Dec. 7, 2010, as corrected in Real-Time Public Reporting of Swap Transaction Data Correction, 75 FR 76930, 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 76171. The Real-Time Reporting Final Rule 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 1182, 1244, Jan. 9, 2012. Specifically, the Real-Time Reporting Final Rule 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 final rulemaking, the Commission uses the term “large notional off-facility swap” as adopted in the Real-Time Reporting Final Rule.

The Initial Proposal's definition of “block trade” was similar to the final definition in the Real-Time Reporting Final Rule.

See

proposed § 43.2(f), 75 FR 76171. The Real-Time Reporting Final Rule 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 1243.

13

See

proposed § 43.5, 75 FR 76174-76.

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 76176. 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 Real-Time Reporting Final Rule established time delays for the public dissemination of block trades and large notional off-facility swaps in § 43.5.

See

77 FR 1247-49.

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 76175.

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 transaction size for a particular swap instrument. The Commission proposed a block trade multiple of five.

Id.

17

See

proposed § 43.2(y), 75 FR 76172.

18

See

75 FR 76176.

With respect to anonymity, 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 76174.

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 § 43.2(e) depending on the asset class and place of execution of each swap.

20

See

75 FR 76151 (“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 76150-51.

22

See

75 FR 76174.

23

See

75 FR 76150. 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 76174.

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+” rather than the actual notional size of the swap.

24

24

See

75 FR 76152.

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

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

26

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.

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

.

2. Public Comments in Response to the Initial Proposal

The commenters to the Initial Proposal 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

The comments submitted regarding the Initial Proposal's provisions regarding appropriate minimum block sizes and anonymity protections are summarized in detail in the Further Block Proposal.

28

27

A list of the full names and abbreviations of commenters who responded to the Initial Proposal and who the Commission refers to in the Further Block 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

.

28

See

Further Block Proposal at 77 FR 15463-66.

Following the close of the comment period for the Initial Proposal, 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.

29

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

29

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

C. Issuance of the Real-Time Reporting Final Rule

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.

30

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

31

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

32

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

33

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 establishing block trade rules.

30

A detailed discussion of Commission staff's review and analysis process is set out below in sections II.A.1.b.i. and c.i.

31

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 1214, 1220, Jan. 7, 2011) and the Initial Proposal.

32

See

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

.

33

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 23211, Apr. 26, 2011. A copy of the transcript is accessible at:

http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/csjac_transcript050211.pdf

.

On January 9, 2012, the Commission issued the Real-Time Reporting Final Rule, finalizing several provisions that were proposed in the Initial Proposal.

34

Those provisions implement, among other things: (1) Several definitions proposed in the Initial Proposal relevant to this final rule, including “asset class”;

35

(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;

36

(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.

37

Based on commenters' recommendations, however, the Commission did not adopt proposed § 43.5 and stated its intent to re-propose a calculation methodology for appropriate minimum block sizes based on additional data and analysis in a separate rulemaking.

38

34

See

77 FR 1182.

35

The Real-Time Reporting Final Rule 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 Real-Time Reporting Final Rule did not define the term swap instrument. This final rule adopts 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.

36

See

§ 43.2 of the Commission's regulations. 77 FR 1244. The Real-Time Reporting Final Rule 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 1244.

37

See

77 FR 1244.

38

See

77 FR 1185.

D. Further Block Proposal

On March 15, 2012, the Commission issued for comment the Further Block Proposal.

39

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 Real-Time Reporting Final Rule, the Commission proposed provisions in the Further Block Proposal 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 Real-Time Reporting Final Rule.

40

39

See

77 FR 15460.

40

In several places in the Real-Time Reporting Final Rule, the Commission stated that it planned to address these requirements in a separate, forthcoming release.

See, e.g.,

77 FR 1185, 1191, 1193 and 1217. The Further Block Proposal was that release.

1. 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.

41

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 by mandating that the Commission shall “take into account whether the public disclosure [of swap transaction and pricing data] will materially reduce market liquidity.”

42

While 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,

43

it also believes that the benefits of enhanced market transparency are not boundless, particularly in swap markets with limited liquidity.

41

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).

42

CEA section 2(a)(13)(E)(iv).

See also

CEA section 5h(f)(2)(C) (concerning the treatment of block trades on SEFs for trade execution purposes).

43

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.”).

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

44

could expose swap counterparties to higher trading costs.

45

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.

46

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 liquidity in the swaps market.

44

As used in the Further Block Proposal and this final rule, 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.

45

Consistent with this final rule, the Commission clarified in the SEF final rule that a swap transaction qualifies as a block trade based on the size of the swap transaction, not based on whether the swap is subject to the trade execution requirement under section 2(h)(8) of the CEA.

See

Core Principles and Other Requirements for Swap Execution Facilities, p. 72 (May 16, 2013)]. In § 37.200 of the Commission's regulations, the Commission has codified the statutory text of SEF Core Principle 2 under section 5h(f)(2)(C) of the CEA, which requires a SEF to establish rules governing the operation of its trading facility, including trading procedures for block trades. 17 CFR 37.200(c). Similarly, the Commission's proposed rulemaking regarding core principles and other requirements for DCMs under § 38.504 of the Commission's regulations, the Commission requires DCMs to adopt rules that comply with all of the provisions of part 43, including the block trade provisions finalized herein. Core Principles and Other Requirements for Designated Contract Markets, 75 FR 80572, 80617 (Dec. 22, 2010).

46

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

.

In consideration of these potential outcomes, the Further Block Proposal sought to provide maximum public transparency, while taking into account the concerns of liquidity providers regarding possible reductions in market liquidity. To do so, the Further Block Proposal established the following more detailed criteria: (1) Swap categories (relative to the definition of swap instrument in the Initial Proposal); (2) a phased-in approach to determining appropriate minimum block sizes for block trades and large notional off-facility swaps; and (3) anonymity provisions for the public reporting of transaction data. A summary of the Commission's proposed approach is provided below.

2. Summary of Proposed Approach

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

47

Specifically, the Commission proposed phasing-in minimum block sizes during an initial period and setting them thereafter on an ongoing basis (

i.e.,

the post-initial period) so that market participants could better adjust their swap trading strategies to manage risk, secure new technologies and make necessary arrangements in order to comply with part 43 reporting requirements. The Commission proposed 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).

47

The Commission proposed the same phased-in approach for determining cap sizes, which help to protect the anonymity of counterparties' market positions and business transactions as required in the CEA. For a more detailed discussion of the Commission's proposed approach with respect to cap sizes,

see

section III.B.

The two-period, phased-in approach would become effective after the implementation of the part 43 provisions in the Real-Time Reporting Final Rule. Until the date on which the proposed provisions in the Further Block 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 proposed establishing initial appropriate minimum block sizes for each category of swaps within the interest rate, credit, foreign exchange (“FX”) and other commodity asset classes.

48

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

49

For interest rate and credit swaps, the Commission reviewed actual market data and 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 proposed using a methodology based on whether a swap or swap category is “economically related” to a futures contract.

50

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) during the initial period.

48

The Commission proposed 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 proposed 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.

49

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

50

See infra

notes 169-174 and accompanying text.

In proposed § 43.6(f)(1), the Commission provided that the duration of this initial period would be no less than one year after an SDR started collecting 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.

51

51

See

Swap Data Recordkeeping and Reporting Requirements, 77 FR 2136, 2196, Jan. 13, 2012.

The Commission stated in the Further Block Proposal and is currently of the view 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 or by other Commission action. The Commission notes that SDRs have been collecting data pursuant to the compliance dates for certain market participants and asset classes since December 2012. DCMs and Swap Dealers (“SDs”) began reporting swap transactions in the interest rate and credit default swap asset classes on December 31, 2012.

52

DCMs and SDs began reporting swap transactions in the FX, equity, and other commodity asset classes on February 28, 2013.

53

Major Swap Participants (“MSPs”) began reporting swap transactions in all five asset classes on February 28, 2013.

54

Financial Entities began reporting swap transactions in the interest rate and credit default swap asset classes on April 10, 2013.

55

Financial Entities begin reporting swap transactions for swaps executed starting April 10, 2013, in the FX, equity, and other commodity asset classes on May 29, 2013.

56

Non-SDs, non-MSPs, and non-Financial Entities begin reporting swap transactions for swaps executed starting April 10, 2013, in the interest rate and credit default swap asset classes on July 1, 2013.

57

Non-SDs, non-MSPs, and non-Financial Entities begin reporting swap transactions for swaps executed starting April 10, 2013, in the FX, equity, and other commodity asset classes on August 19, 2013.

58

Accordingly, the Commission and SDRs will have one year of reliable data as of April 10, 2014.

52

See

“Commission Q & A—On the Start of Swap Data Reporting” (Oct. 9, 2012).

53

See

“No-Action Relief for Swap Dealers from Certain Swap Data Reporting Requirements of Part 43, Part 45, and Part 46 of the Commission's Regulations Due to Effects of Hurricane Sandy,” Commission Letter No. 12-41 (Dec. 5, 2012).

54

See id.

55

See

“Time-Limited No-Action Relief for Swap Counterparties that are not Swap Dealers or Major Swap Participants, from Certain Swap Data Reporting Requirements of Parts 43, 45 and 46 of the Commission's Regulations,” Commission Letter No. 13-10 (Apr. 9, 2013).

56

See id.

57

See id.

58

See id.

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)(4) and (5). 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).

59

59

In particular, the Commission proposed a 67-percent notional amount calculation, which is discussed in more detail in section II.B.3.

The Commission also proposed special rules for determining appropriate minimum block sizes in certain instances. In particular, in proposed § 43.6(d), the Commission prescribed special rules for swaps in the equity asset class. In proposed § 43.6(h), the Commission proposed 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.

60

60

See infra

Section II.B.6. for a discussion of the special rules.

In the Further Block Proposal's proposed amendments to § 43.4(h) and 43.4(d)(4), the Commission also prescribed measures to fulfill the CEA's anonymity requirements in connection with the public dissemination of publicly reportable swap transactions. The Commission proposed adopting the practices used by most federal agencies when releasing to the public company-specific information—by removing obvious identifiers, limiting geographic detail (

e.g.,

disclosing general, non-specific geographical information about the delivery and pricing points) and masking high-risk variables by truncating extreme values for certain variables (

e.g.,

capping notional values).

61

61

The Commission proposed to follow the necessary procedures for releasing microdata files as outlined by the Federal Committee on Statistical Methodology: (i) Removal of all direct personal and institutional identifiers, (ii) limiting geographic detail, and (iii) top-coding high-risk variables which are continuous.

See

Federal Committee on Statistical Methodology, Report on Statistical Disclosure Limitation Methodology 94 (Statistical Policy Working Paper 22, 2d ed. 2005),

http://www.fcsm.gov/working-papers/totalreport.pdf

. The report was originally prepared by the Subcommittee on Disclosure Limitation Methodology in 1994 and was revised by the Confidentiality and Data Access Committee in 2005.

3. Overview of Comments Received

The Commission received comments from 35 interested parties representing a broad range of interests including: financial end-users, swap dealers, asset managers, industry groups/associations, potential SEFs, and a DCM.

62

Some commenters expressed general support for the Further Block Proposal's provisions regarding minimum block sizes and anonymity; others objected to particular aspects of the Further Block Proposal and/or offered recommendations for clarification or modification of specific proposed regulations.

62

A list of the full names and abbreviations of commenters who responded to the Further Block Proposal is included in section VIII 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

.

In addition to a general solicitation for comment on all aspects of the Further Block Proposal, the Commission requested comment on a number of specific, focused questions related to particular provisions. For example, commenters were asked to address issues related to: (i) The appropriate criteria for determining swap categories in the five asset classes; (ii) the appropriate methodology for determining appropriate minimum block sizes for swaps in the five asset classes; (iii) whether and how a phase-in of block thresholds should be implemented; (iv) special rules with respect to swaps with optionality, swaps with composite reference prices, physical commodity swaps, currency conversions, and successor currencies; (v) the role of SEFs and DCMs in

determining appropriate minimum block sizes for swaps that they list; (vi) the process by which the Commission would notify the public of appropriate minimum block sizes; (vii) the process through which a qualifying swap transaction would be treated as a block trade or large notional off-facility swap; (viii) the appropriate methodology for determining the maximum limit of the principal, notional amount of a swap that is publicly disseminated; (ix) appropriate anonymity protections for the public dissemination of publicly reportable swap transactions in the other commodity asset class.

The Commission also requested comment with respect to the cost-benefit considerations in the Further Block Proposal and specifically requested commenters to provide a feasible alternative approach to establishing minimum block sizes that would impose less regulatory burden on swap market participants and the general public. Commenters also were expressly invited to provide data regarding the direct and indirect quantifiable costs with the proposed criteria for establishing minimum block thresholds.

4. Additional Proposal Regarding Aggregation of Blocks

Among the requirements contained in the Initial Proposal, proposed § 43.5(b)(1) provided that eligible parties to a block trade (or large notional swap) must be Eligible Contract Participants (“ECPs”), except that a DCM may allow a Commodity Trading Advisor (“CTA”), investment advisor, or foreign person meeting certain criteria to transact block trades for customers who are not ECPs. Further, proposed § 43.5(m) prohibited aggregation of orders for different trading accounts in order to satisfy the appropriate minimum block size requirement, except if done so on a DCM by a CTA, investment adviser, or foreign person meeting certain criteria.

After it issued its Further Block Proposal, the Commission determined that the aggregation provision and the provision that specified the eligible parties to a block trade, including the proposed requirement that persons transacting block trades on behalf of customers must receive prior written consent to do so, were inadvertently omitted from the Further Block Proposal. These provisions were then the subject of a separate notice of proposed rulemaking issued on June 27, 2012 (“Proposed Aggregation Rule”).

63

63

Rules Prohibiting the Aggregation of Orders to Satisfy Minimum Block Sizes or Cap Size Requirements, and Establishing Eligibility Requirements for Parties to Block Trades, 77 FR 38229, June 27, 2012.

The Commission received a total of nine comment letters in response to the proposed rules regarding eligible parties to a block trade and aggregation of orders. Four of the letters responded to the Initial Proposal and five letters responded to the Proposed Aggregation Rule. Many of the comments received applied equally to the same provisions contained in both proposed § 43.6(h)(6) and 43.6(i), which address the aggregation of orders and the eligible parties to a block trade.

II. Procedures To Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades—Final Rules

A. Criteria for Distinguishing Among Swap Categories in Each Asset Class

In the Further Block Proposal, the Commission proposed 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.

64

Specifically, the Commission proposed specific criteria for defining swap categories in each asset class. As adopted in the Real-Time Reporting Final Rule, § 43.2 of the Commission's regulations 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.”

65

Section 43.2 also identifies the following five swap asset classes: Interest rates;

66

equity; credit; FX;

67

and other commodities.

68

64

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.

65

See

§ 43.2, 77 FR 1243.

66

In the Real-Time Reporting Final Rule, the Commission determined that cross-currency swaps are a part of the interest rate asset class.

See

77 FR 1193. The Commission noted that this determination is consistent with industry practice.

67

The U.S. Department of the Treasury (“Treasury”) has issued a Final Determination, pursuant to sections 1a(47)(E)(i) and 1b of the CEA, that exempts FX swaps and FX forwards from the definition of “swap” under the CEA. Therefore, 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.

See

Determination of Foreign Exchange Swaps and Foreign Exchange Forwards under the Commodity Exchange Act, 77 FR 69694, Nov. 20, 2012. Nevertheless, section 1a(47)(E)(iii) of the CEA provides that FX swaps and FX forwards transactions still are not excluded from regulatory reporting requirements to an SDR. Further, the Commission notes that Treasury's final determination excludes FX swaps and FX forwards, but does not apply to FX options or non-deliverable FX forwards. As such, FX instruments that are not covered by Treasury's final determination are subject to part 43 of the Commission's regulations.

68

The Real-Time Reporting Final Rule 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 1244. 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 1243.

The proposed swap category 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.

69

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 Real-Time Reporting Final Rule are discussed briefly in the paragraph below, followed by a discussion of the proposed swap category criteria for each asset class.

69

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 I.D.1.

In the Further Block Proposal, the Commission proposed breaking down each asset class into separate swap categories to determine 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).

Twenty-one commenters addressed the Further Block Proposal's use of swap categories.

70

The vast majority of the comments did not question the use of swap categories generally, and focused on the specific criteria proposed for determining swap categories within each asset class instead. Better Markets and ICI expressly supported the Commission's proposed use of swap categories.

71

Better Markets stated that “the concept of a `swap category' is useful, in that it allows greater granularity than the far broader notion of `asset class.' ”

72

ICI “support[ed] the CFTC's proposal to establish categories of swaps within different asset classes that would be subject to a common appropriate minimum block size to better calibrate the block thresholds to the relative liquidity of the swap categories in each asset class.”

73

ICAP, however, disagreed with the Commission's use of swap categories and stated that “the Commission's proposal is mistaken in its use of `swap categories' . . . as opposed to using the standard liquid tenors of swap contracts.”

74

70

See generally

CL-AFR; CL-AII; CL-Barclays; CL-Better Markets; CL-CME; CL-FIA; CL-GFMA; CL-ICAP; CL-ICAP Energy; CL-ICI; CL-ISDA/SIFMA; CL-Kinetix; CL-MFA; CL-Morgan Stanley; CL-Parascandola; CL-Parity; CL-Pierpont; CL-SDMA; CL-SIFMA; CL-WMBAA; CL-Vanguard.

71

CL-Better Markets at 5; CL-ICI at 4.

72

CL-Better Markets at 5.

73

CL-ICI at 4.

74

CL-ICAP at 8.

After consideration of the comments related to the use of swap categories, the Commission is adopting swap categories as proposed in § 43.6, with certain modifications based upon both general concerns expressed by commenters in regard to the use of swap categories, specific concerns raised in regard to the criteria for determining swap categories within each asset class, and other relevant market developments.

75

The following sections address the comments regarding specific asset classes and set out, where appropriate, the Commission's responsive modifications of the swap categories approach.

75

The Commission is using the term “swap category” instead of “swap instrument” in this final rule. Although the Commission is not adopting a definition of “swap category,” the Commission believes that this term groups swap contracts that would be subject to the same appropriate minimum block size based on asset class with common quantitative or qualitative characteristics,

i.e.,

risk and liquidity profiles.

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 markets for swaps in the interest rate and credit asset classes. Based on that review, the Commission proposed criteria for determining swap categories in these two asset classes. Specifically, the Commission proposed defining swap categories for: (1) Interest rate swaps based on unique combinations of tenor

76

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

77

76

As used in the Further Block 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.

Two commenters addressed how the Commission should determine tenor for backdated swaps. AFR stated that backdating a swap is the equivalent of a swap with a date of its inception, but with a price that includes an adjustment for the backdating feature of the transaction; AFR wrote that tenor should be determined accordingly. CL-AFR at 5-6. Similarly, ISDA/SIFMA requested that the Commission determine the tenor of a back dated swap as the time from the date of execution of the swap (as opposed to the start date) to the maturity date of the swap. CL-ISDA/SIFMA at 10. After consideration of these comments, the Commission maintains the same approach from the Further Block Proposal.

77

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”).

78

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

79

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

80

78

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, the Further Block Proposal included 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.

79

See

OTC Derivatives Supervisors Group—Federal Reserve Bank of New York,

http://www.ny.frb.org/markets/otc_derivatives_supervisors_group.html

(last visited May 6, 2013). 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.

80

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

81

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.

82

81

MarkitSERV is a post-trade processing company wholly owned by Markit. From its formation in 2009 until April 2013, MarkitSERV was jointly owned by Markit and The Depository Trust & Clearing Corporation (“DTCC”).

82

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.

83

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

84

83

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

.

84

The Warehouse Trust data contained “allocation-level data,” which 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.

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 Real-Time

Reporting Final Rule.

85

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

86

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

87

85

“Publicly reportable swap transaction” means, unless otherwise provided in part 43: (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 do 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 transacted at arm's length, but that do result in a corresponding change in the market risk position between two parties.

See

77 FR 1244.

86

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.

87

The Commission calculated the average daily exchange rates between relevant currencies and the U.S. dollar for the 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.

b. Interest Rate Swap Categories

i. Interest Rate Swap Data Summary

The filtered transaction records in the interest rate swap data set contained 166,847 transactions with a combined notional value of approximately $45.4 trillion dollars.

88

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.

89

88

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 supra

note 86 for a list of excluded transaction records.

89

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.

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

Number of transactions

Percentage of total

transactions

90

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:

91

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

90

The percentages were rounded to the nearest whole number. Due to the rounding, the total percentages for the listed categories do not add up to exactly 100%.

91

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 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:

92

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

92

In producing Table 2, 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.

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

93

The Commission's analysis of the interest rate swap data set revealed that approximately 50 percent of the 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.

93

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 the following: (1) The total count of unique counterparties was approximately 300; (2) the average notional size of transactions involving two G-14 banks was 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 approximately $260 million.

ii. Summary of Proposed Rule

Based upon the data described above, the Commission proposed § 43.6(b)(1) establishing swap categories in the interest rate asset class based on tenor and underlying currency.

The Commission proposed interest rate swap tenor groupings based on two observations regarding the data in the interest rate swap data set. First, the Commission observed that points of concentrated transaction activity along the yield curve correspond with specific tenors (

e.g.,

three months, six months, one year, two years, etc.). Second, the Commission observed a tendency for the transacted notional amounts to decrease as tenor increased (

e.g.,

longer-dated tenors in the data set generally had lower average notional sizes). Based on these observations, table 3 below details the eight proposed tenor groups for the interest rate asset class.

Table 3—Proposed Tenor Groups for Interest Rates Asset Class

94

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

95

The

Commission proposed currency groupings after considering: (1) The swap transaction total notional amounts and transaction volumes of currency groups based on the number of transactions; and (2) the average transaction notional amounts and lack of evidence of large transacted notional amounts or substantial volume of currency groups. After considering these factors, the Commission proposed three currency categories for the interest rate asset class: (1) Super-major currencies, which are currencies with large volume and total notional amounts;

96

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

97

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

98

94

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.

95

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 adopted 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.

96

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,

i.e.,

liquid futures markets for general interest rates and FX rates.

97

Major currencies represent about 6 percent of the total notional amount and about 10 percent of the total transactions in the data set. Some of these currencies host liquid futures markets for interest rates, and all exhibit liquid FX markets.

98

Non-major currencies represent less than two percent of the total notional amount and about 10 percent of the transactions in the data set. These currencies typically do not have corresponding interest rate and FX futures markets.

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

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

99

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.

99

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 5—Sample Characteristics of Proposed Interest Rate Swap Categories

100

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

100

Tables 5 and 6 do not include sample characteristics for swap categories with less than 200 transactions in order to preserve the anonymity of the parties to these transactions.

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

The Commission received twelve comments regarding the use of tenor to establish swap categories in the interest rate swap asset class. Five commenters expressed support for the Further Block Proposal's suggested tenor buckets.

101

Five other commenters recommended nine tenor buckets straddling the most liquid tenor points as follows: 0-3 months, 3-6 months, 6-18 months, 18 months-3 years, 3-7 years, 7-12 years, 12-20 years, 20-30 years, and more than 30 years.

102

These commenters suggested that these nine tenor groupings would provide greater granularity and avoid grouping together swaps with different levels of liquidity. Similarly, ICI suggested that narrower tenor groupings would provide greater granularity.

103

Kinetix also expressed concern with the proposed tenor buckets, stating that they grouped together products with sharply different trading volumes.

104

101

CL-AFR at 5; CL-Better Markets at 5; CL-MFA at 4; CL-Pierpont at 3; CL-SDMA at 8 (“The CFTC categories are . . . appropriate and accurate in terms of currency, index, and tenor.”)

102

CL-AII at 8; CL-Barclays at 7; CL-ISDA/SIFMA at 10; CL-SIFMA at 7; CL-Vanguard at 5.

103

See

CL-ICI at 5.

104

Kinetix stated that “[t]he major flaw comes from including in a bucket products with sharply different trading volumes.” Kinetix recommended bucketing products by average trade volume, product type, and tenor, but did not suggest specific tenor buckets. CL-Kinetix at 2.

In addition to the comments received regarding the Further Block Proposal, the Commission also considered the research in the Federal Reserve Bank of New York's March 2012 staff report entitled “An Analysis of OTC Interest Rate Derivatives Transactions: Implications for Public Reporting” (the “Federal Reserve Staff Analysis”). In that report, Federal Reserve staff tested for a relationship between tenor and trade size. The Federal Reserve staff identified nine tenor buckets, as opposed to the eight identified by the Commission. The tenor buckets identified by the Federal Reserve staff were the same as those proposed by the Commission in the Further Block Proposal, with a further division of the Commission's 0-3 month bucket into a 0-1 month bucket and a 1-3 month bucket.

105

105

The Federal Reserve staff specifically found that “when [they] reduced the number of buckets at the short end of the trading curve (by merging the 0-1 month and 1-3 month buckets into a 0-3 month bucket), the explanatory power of [their] regression declined 24%.” Federal Reserve Staff Analysis at 16.

After consideration of the comments received and the Federal Reserve Staff Analysis, the Commission is adopting § 43.6(b)(1) with one modification—the addition of another tenor grouping at the shorter end of the interest rate yield curve. The Commission notes, as an initial matter, that commenters generally supported the use of tenor buckets to establish swap categories in the interest rate asset class. Commenters, however, disagreed with the proposed tenor buckets.

In the Further Block Proposal, tenor buckets were proposed based on observations of the distributions of notional sizes and volume with the objectives of grouping swaps with similar characteristics while maintaining a manageable number of swap categories. The tenor buckets proposed by the Commission were associated with concentrations of liquidity at commonly recognized points along the interest rate yield curve. In general, the Commission observed that transactions in the data set (and presumed market liquidity) tended to cluster at certain tenors.

In establishing the categories, the Commission proposed groupings that placed actively traded tenors at the upper boundary of the category groupings because the calculation of the minimum block threshold in a category will be most influenced by the notional amounts of the most heavily traded swaps in a category,

i.e.,

those at the active tenor points. Hence, the minimum block thresholds for shorter dated swaps in a category will tend to be set based on the typical notional value of longer dated swaps. Since the longer dated swaps tend to trade in smaller notional amounts, establishing

the categories in this manner will tend to result in a more conservative (

i.e.,

smaller) minimum block threshold for shorter tenored swaps within the category. In addition, because the shorter-dated swaps within an established swap category may experience less liquidity, due to smaller trading volumes, these swaps may also benefit from the setting of a lower minimum block threshold.

The narrower tenor buckets recommended by commenters, in contrast, tend to straddle the liquid tenor points. If the Commission were to establish tenor buckets straddling the liquid tenor points (rather than having a liquid tenor point be the upper boundary of a tenor bucket), then the minimum block threshold for swaps within a category would be more heavily influenced by swaps centrally located in the category. Thus, longer dated swaps in a category, which tend to trade in smaller notional sizes, would be subject to higher minimum block thresholds, meaning fewer would be eligible for the block trade exemption.

To illustrate the impact of placing the liquid tenor point at the top of the category, consider the impact on a seven-year interest rate swap that is proposed to be grouped in a tenor bucket with swaps having a tenor greater than 5 years and less than or equal to 10 years. The most liquid tenor point (

i.e.,

the tenor point with the greatest number of observations) within this bucket would be the 10-year interest rate swap; thus, the 10-year interest rate swap would be the primary driver in determining the minimum block threshold for swaps in the 5 to 10-year tenor bucket. Table 7 is a subset of the information from Table 1 that illustrates this point. Specifically, there are 6,599 swaps with a tenor of seven years, yielding an average notional amount of $100 million (USD) and 34,000 swaps with a tenor of ten years yielding an average notional size of $81 million (USD). By combining these into the same category, the Commission is adopting a conservative approach in setting block sizes for the less liquid tenors.

Under the commenters' approach, however, the seven-year interest rate swap is grouped in the same tenor bucket with the 5-year tenor interest rate swaps. In this scenario, the liquid tenor point within the bucket is the 5-year interest rate swap; thus, the 5-year interest rate swap, with more than 26,000 transactions yielding an average notional amount of $104 million (USD), is the primary driver in determining the minimum block threshold for the tenor bucket and results in a larger block size for the 7-year tenor interest rate swaps than under the currently proposed swap category.

The Commission is of the view that the tenor with the most transactions in the swap category, and thus having the most weight in the block calculations, should be at the high end of the tenor grouping for the swap category. Given the tendency for average notional size to decrease as tenor increases as shown in Table 7 below, the Commission views this as a more conservative approach to setting minimum block thresholds, which results in lower block sizes for swap transactions at tenors that may experience less liquidity.

Table 7—Summary Statistics for the Interest Rate Swap Data Set by Tenor

106

Tenor

107

Number of

transactions

Notional amount

(billions of USD)

Average notional amount

(billions of USD)

1 Month

3,171

11,859

3.740

3 Month

10,229

11,660

1.140

6 Month

2,822

1,701

0.603

1 Year

9,522

3,484

0.366

2 Year

16,450

3,347

0.203

3 Year

9,628

1,488

0.155

5 Year

26,139

2,712

0.104

7 Year

6,599

661

0.100

10 Year

34,000

2,746

0.081

30 Year

9,616

448

0.047

Other

38,671

5,284

0.137

106

In producing Table 7, 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.

107

Tenor groups include swaps having tenors within 4 calendar days of a complete month, plus or minus, of the stated tenor. All other swaps are included in the “Other” category.

In response to comments generally calling for narrower tenor buckets, the Commission is adopting an additional tenor bucket in order to provide greater granularity as requested by commenters. The Commission is splitting the first tenor group in the Further Block Proposal (0-3 months) into two tenor groups (0-46 days, and greater than 46 days to less than or equal to 3 months). While the Commission did not receive any comments specifically discussing the less than 46 day tenor, the Commission received numerous comments recommending greater granularity. Based upon the comments received requesting nine tenor buckets and the Federal Reserve Staff Analysis identifying nine tenor buckets, the Commission has determined to add a less than 46 day tenor group. This would provide greater granularity and establish notional swap groupings that account more precisely for the effects of increased transparency on liquidity for swaps of a shorter tenor.

Accordingly, the Commission is adopting the following tenor buckets:

Table 8—Tenor Groups for Interest Rates Asset Class

108

Tenor group

Tenor greater than

And tenor less than or equal to

1

46 days.

2

46 days

Three months (107 days).

3

Three months (107 days)

Six months (198 days).

4

Six months (198 days)

One year (381 days).

5

One year (381 days)

Two years (746 days).

6

Two years (746 days)

Five years (1,842 days).

7

Five years (1,842 days)

Ten years (3,668 days).

8

Ten years (3,668 days)

30 years (10,973 days).

9

30 years (10,973 days)

108

As in the Further Block Proposal, 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 months or years.

The Commission received eleven comments regarding whether interest rate swaps should be categorized into the super-major, major, and non-major currency groupings as proposed. Five commenters supported the currency groupings proposed in the Further Block Proposal.

109

Four commenters urged the Commission to establish a separate swap category for each individual currency in determining block thresholds.

110

Two more commenters specifically recommended that each of the four super-major currencies should be categorized separately, rather than as a group, in determining block thresholds.

111

109

CL-AFR at 5; CL-Better Markets at 5; CL-MFA at 4; CL-Pierpont at 3; CL-SDMA at 8 (“The CFTC categories are . . . appropriate and accurate in terms of currency, index, and tenor.”)

110

CL-AII at 8; CL-ICI at 5; CL-SIFMA at 8-9; CL-Vanguard at 6.

111

CL-Barclays at 7; CL-ISDA/SIFMA at 7-8. While ISDA/SIFMA supported separate categories for super-major currencies, their comment also suggests separate categorization for each individual currency. Similarly, SIFMA's comment, while requesting separate categorization generally, states that dividing the four proposed super-major currencies is most important. CL-SIFMA at 8-9.

After consideration of the comments received, the Commission is adopting § 43.6(b)(1)(i) as proposed in regard to currency categories. The currencies were grouped into the three categories in the Further Block Proposal based upon the swap transaction total notional amounts and transaction volumes of currency groups based on the number of transactions, and the average transaction notional amounts of currency groups. The commenters who requested that all currencies be categorized by individual currency mainly focused on differences in liquidity among the four super-major currencies, particularly when comparing interest rate swaps in USD and EUR to those in JPY and GBP. Similarly, the commenters who specifically requested that the Commission establish separate swap categories for each of the super-major currencies focused on perceived differences in liquidity. While USD and EUR interest rate swaps feature the highest liquidity, the Commission is of the view that, based upon all of the criteria mentioned above, the super-major currencies are most similar to each other (and different from major

112

and non-major currencies) to warrant treatment as a group, rather than separately.

112

The Commission notes that the difference between the total notional and transactional volume of swaps referencing Japanese yen—the lowest among those swaps in the super-major currency category—and of swaps referencing the Australian Dollar—the highest among those swaps in the major currency category—is significantly larger than such differences between swaps within each adopted currency category. This observation supports adopting the Commission's approach in assigning certain swaps in the super-major currency category against the major currency category.

The Commission considered alternative approaches of using the individual currencies to determine swap categories in the interest rate asset class. While these alternative approaches would have provided greater correlation to an underlying curve than the adopted groupings, the Commission believes that this would not substantially increase the explanation of variations in notional amounts, but rather would result in categories with too few observations. Hence, the Commission does not believe that there would be a significant benefit to offset the additional compliance burden that a more granular approach would impose on market participants. The Commission notes that adoption of the proposed currency categories establishes 27 separate swap categories for interest rate swaps. Separate categorization of all currencies would result in nearly 200 separate swap categories. Separate categorization of the super-major currencies alone would result in 54 swap categories. The Commission believes that the 27 separate swap categories contained in the rule achieves the objectives of grouping swaps with similar characteristics while maintaining a manageable number of swap categories.

The Commission also received a number of comments recommending that interest rate swaps should be categorized based on criteria other than tenor and currency. Four commenters suggested a range of additional interest rate swap categories for the purposes of establishing block thresholds.

113

Two other commenters suggested grouping swaps by product type in addition to tenor and currency groupings.

114

Another commenter, Kinetix, recommended grouping products by average trade volume, as well as by product type and tenor.

115

Of the four commenters who expressed support for the proposed tenor and currency groupings,

116

two of them argued that further granularity would cause some swaps to be subject to lower block thresholds than are appropriate.

117

113

Barclays suggested unique block levels for each of the following swap categories: each super major currency, swaps against standard floating rate indices, basis swaps, inflation swaps, swaptions, caps and floors, cross-currency swaps, and structured swaps. CL-Barclays at 7-8. ISDA/SIFMA suggested the following additional swap categories: fixed versus non-benchmark floating rate indexes and basis swaps, inflation swaps (a specified inflation rate index), options (swaption and cap/floor markets); cross-currency swaps (each leg denominated by different currency), and exotics. CL-ISDA/SIFMA at 9. SIFMA and Vanguard suggested swap categorization based on optionality or other characteristics such as distinctions between “plain vanilla,” “interest rate options,” and “other,” as well as separate categories for major floating rate indices. CL-SIFMA at 8-9; CL-Vanguard at 5-6.

114

CL-ICI at 5; CL-MFA at 5.

115

CL-Kinetix at 2.

116

CL-AFR at 5; CL-Better Markets at 5; CL-Pierpont at 3; CL-SDMA at 8 (“The CFTC categories are . . . appropriate and accurate in terms of currency, index, and tenor.”)

117

CL-AFR at 5; CL-Better Markets at 5.

After consideration of the comments received, the Commission is adopting § 43.6(b)(1)(i) as proposed and § 43. 6(b)(1)(ii) with the modifications discussed above. Although some level of

categorization of swaps is useful to capture different levels of trading activity and hedging potential, where a number of different swaps could be used to hedge the same risk, the over-identification of swap categories will eventually lead to a dilution of observations within categories. Categories having small numbers of observations could be subject to highly volatile minimum block sizes over time. Over-identification also would be expected to lead to underestimations of the ability to offset risks using related swap instruments. The Commission believes that it has struck a balance between over- and under-categorizing swaps that will result in more stable minimum block sizes and allow for adequate risk offsets using instruments within a category. The modification described above in regard to tenor will provide some further granularity at the short end of the yield curve, as suggested by commenters above, while still achieving the objectives of grouping swaps with similar characteristics and reducing unnecessary complexity for market participants in determining whether their swaps are classified within a particular swap category.

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 transactions,

118

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

119

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

120

Of those indexes, both 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 9 sets out summary statistics of the CDS data set for CDS indexes with greater than five transactions per day on average.

118

See

note 85 supra.

119

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.

120

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 9—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

ii. Credit Swap Data Analysis

As noted above, the Commission proposed using tenor and conventional spread criteria to define swap categories for CDS indexes. The Commission proposed 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).

121

121

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 had a tenor of five years (or approximately 1,825 days). Based on the concentration of CDS index transactions in five-year tenors, the Commission proposed six tenor bands for CDS indexes.

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.

With respect to the conventional spread criterion, the Commission determined ranges of spread values based on a review of the distribution of spreads in the entire CDS data set.

122

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

123

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 CDS categories (spread values between 175 to 350 bps; spread values above 350 bps). Accordingly, the Commission proposed three separate conventional spread levels: (1) CDS indexes with spread values under 175 bps; (2) CDS indexes with spread values between 175 and 350 bps; and (3) CDS indexes with spread values above 350 bps. Table 9 shows the summary statistics of the proposed criteria to determine swap categories for swaps in the credit asset class.

124

122

See supra

note 77 for a definition of “conventional spread.”

123

The Commission proposed 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.

124

The Commission found that these categories were good predictors of notional size. This finding was based on an analysis which used the tenor and spread categories in Table 9 as explanatory variables in a least squares regression, where the logged value of the notional amount of the swap was the dependent variable.

Table 9—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)

Sum of notional amounts

Number of trades

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

The Commission sought comment on this proposed approach, a series of alternative criteria to be used, and alternative categories. The Commission received eight comments regarding the proposed swap categories for CDS. Five of the comments focused on the proposed tenor buckets in the Further Block Proposal. SIFMA and Vanguard suggested that the 4-6 year tenor bucket be divided into four buckets: 4 to 4.5 years, 4.5 to 5 years, 5 to 5.5 years, and 5.5 to 6 years.

125

AII and ICI also recommended narrowing the tenor categories for CDS.

126

MFA generally supported the Commission's proposed grouping by tenor.

127

125

CL-SIFMA at 7-8 (“We believe that such groupings would better approximate sets of swaps with similar liquidity characteristics”); CL-Vanguard at 5.

126

CL-AII at 8; CL-ICI at 5.

127

CL-MFA at 5.

Two of the comments focused on the proposed conventional spread criteria. ISDA/SIFMA expressed support for the proposed use of spread criteria, but also suggested that the Commission should clarify that the spread for a CDS transaction will be based on the traded spread, rather than on the fixed coupon.

128

Barclays, however, commented that traded spreads should not be used for categorizing CDS because swaps may move daily between threshold buckets as spreads can move substantially over short periods, which would create an unacceptable level of operational risk for market participants in trying to achieve compliance.

129

128

CL-ISDA/SIFMA at 6 (“swap categories should be based on the current spread of a transaction in order to reflect . . . changes in liquidity”).

129

CL-Barclays at 8.

In addition to the comments regarding the tenor and conventional spread criteria proposed, commenters also provided a number of recommendations regarding other potential swap categories for CDS. Three commenters suggested separate swap categories for individual CDX index series.

130

Better Markets, however, argued that using individual CDX index series to create swap categories would be too granular and recommended that CDS be divided into single-name and index categories, with indexes further subdivided into five groups: sovereign, corporate, municipal, mortgage-backed securities, and other.

131

Four commenters recommended that tranches of indices receive their own unique swap category.

132

Two commenters suggested grouping CDS by different product type.

133

MFA recommended separate swap categories for indexes and options (as well as tranches).

134

Finally, eight commenters suggested differentiating between on-the-run and off-the-run CDS

indices.

135

MFA specifically suggested separate minimum block sizes for the current 5-year on-the-run CDS indices for CDX.NA.IG, CDX.NA.HY, iTraxx Europe, and iTraxx Europe Crossover.

136

130

CL-AII at 8; CL-Barclays at 8; CL-ISDA/SIFMA at 6.

131

CL-Better Markets at 6.

132

CL-AII at 8; CL-Barclays at 8; CL-ISDA/SIFMA at 6; MFA at 5.

133

CL-ICI at 5; CL-ISDA/SIFMA at 6.

134

CL-MFA at 5.

135

MFA specifically suggested separate minimum block sizes for the current 5-year on-the-run CDS indices for CDX.NA.IG, CDX.NA.HY, iTraxx Europe, and iTraxx Europe Crossover. CL-MFA at 5; CL-AII at 8; CL-Barclays at 8; CL-ICAP at 7; CL-ISDA/SIFMA at 5-6; CL-SIFMA at 8; CL-Vanguard at 5.

136

CL-MFA at 5.

After consideration of the comments received, the Commission is adopting § 43.6(b)(2) as proposed. In general, the Commission believes that the proposed criteria—tenor and conventional spread—provide an appropriate way to group swaps with economic similarities and to reduce unnecessary complexity for market participants in determining whether a particular swap is classified within a particular swap category. In regard to ISDA/SIFMA's suggested clarification, the Commission clarifies that the spread for a CDS transaction will be based on the traded spread, rather than on the fixed coupon.

Specifically, the Commission believes that the proposed tenor and conventional spread categories sufficiently capture the variation in notional size that is necessary for setting appropriate minimum block sizes and that refining these categories as suggested by commenters will not improve the clustering of swaps in order to better set appropriate minimum block sizes. For example, the Commission notes that the tenor buckets contained in the adopted rule generally result in separate categorization for on-the-run and off-the-run indexes for swaps in the CDS data set. On-the-run indexes, for example, comprised the vast majority of swaps in the 4-6 year tenor bucket, while off-the-run indexes were the vast majority of swaps in the 0-2, 2-4, and 6-8.5 year tenor buckets.

The Commission determined these swap categories based on the way activity 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 on-the-run corporate credit default index swaps with a five-year tenor, the Commission found that significant trading of corporate credit default index swaps also occurred in other tenor ranges.

137

The Commission believes that its approach is appropriate since CDS on indexes other than corporate indexes (

e.g.,

asset backed indexes, municipal indexes, sovereign indexes) also trade at tenors other than five years.

138

137

For example, based on the observed CDS data set, corporate CDS indexes traded in all but the longest of the tenor groups. The vast majority of transactions outside of the 4-6 year tenor group were off-the-run series.

138

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

The Commission, however, decided not to use “on-the-run” or “off-the-run” designations for grouping CDS indexes into categories for the following reasons: (i) The underlying components of swaps with differing versions or series based on the same named index are broadly similar, if not the same, and are 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) using versions or series as the criterion for defining CDS swap categories may result in an unnecessary level of complexity.

139

Hence, the Commission believes that while on-the-run and off-the-run indexes may differ in terms of available liquidity, they nonetheless are economically related to each other within the categories proposed by the Commission; therefore, on-the-run indexes could be used to offset much of the risk associated with off-the-run indices. Moreover, while the off-the-run swaps generally had less trading activity, and presumably less liquidity, than the on-the-run swaps, off-the-run index swaps had larger notional sizes, on average, than on-the run swaps in the same category. Hence, the more liquid, on-the-run swaps will drive the block size in a category and will result in lower block sizes for the less liquid swaps in the category.

140

The Commission feels that this is a more conservative approach to setting block sizes for less liquid swaps.

139

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 index provider determines the composition of each index through 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.

140

This is similar to the example provided for the tenor groupings in interest rate swaps in Section II.A.1.

In response to the commenters that specifically requested a differentiation between on-the-run and off-the-run CDS indexes, the Commission believes that while on-the-run and off-the-run indexes may differ in terms of available liquidity, they nonetheless are economically related to each other within the categories proposed by the Commission such that on-the-run indexes could be used to offset much of the risk associated with off-the-run indexes. The Commission also notes that the tenor buckets contained in the adopted rule generally result in separate categorization for on-the-run and off-the-run indexes. For the CDS data set, the vast majority of swaps in the 4-6 year tenor bucket were on-the-run indexes, while the vast majority of swaps in the 0-2, 2-4, and 6-8.5 year tenor buckets were off-the-run.

In response to commenters that specifically recommended separate swap categorization for tranches, the Commission believes that the proposed swap categorization based upon conventional spread criteria will result in separate categorizations related to tranches where appropriate.

141

For example, tranches having significantly different levels of risk will potentially have spreads traded at levels that differ enough from the underlying index so as to be placed in categories that would receive a different block trade size. The conventional spread reflects the risk of the underlying transaction and the Commission believes that the risk associated with the transaction will be the primary determinant of how difficult a transaction is to hedge. Thus, the Commission believes that categorization of CDS by conventional spread will capture differences related to tranches where appropriate.

141

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.

The Commission notes that the adopted § 43.6(b)(2) establishes 18 separate swap categories for CDS swaps. While none of the commenters provided suggestions as to precisely how to categorize CDS by tranche, the Commission believes that creating additional swap categories for tranches would result in swap categories totaling a multiple of the proposed 18 swap categories, as each CDS index has multiple tranches. Establishing swap categories based upon tenor and

conventional spread criterion as in adopted § 43.6(b)(2) meets the objectives of grouping swaps with economic similarity and reducing confusion for market participants in determining whether their swaps are classified within a particular swap category.

The Commission believes that this approach will mitigate the administrative burden to both market participants and to the Commission by limiting the number of swap categories for which appropriate minimum block sizes need to be calculated. In regard to Barclay's concern that swaps would move between categories, the Commission believes that instances where a given swap will move daily between spread levels will be limited given the small number of spread categories and the observed distribution of trades. Additionally, the quantitative nature of the block category calculation should limit the operational risk by providing clarity and ease of notice to market participants as to what the minimum block sizes are, even if they are subject to change.

If market participants reach the conclusion that the Commission has determined specific swap categories in a way that will materially reduce market liquidity, then those participants are encouraged to submit data to support their conclusion. If, through its own surveillance of swaps market activity, the Commission becomes aware that a specific swap categorization for determination of appropriate minimum block levels would reduce market liquidity, then the Commission may exercise its legal authority to take action by rule or order to mitigate the potential effects on market liquidity with respect to swaps in that swap category.

2. Swap Category in the Equity Asset Class

The Commission proposed a single swap category for swaps in the equity asset class. The Commission proposed this approach based on: (1) The existence of a highly liquid underlying cash market for equities; (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.

The Commission received six comments regarding swap categories in the equity asset class. AFR supported the single swap category proposed for the equity asset class.

142

Five other commenters recommended that the Commission treat equity swaps similarly to the other asset classes and establish swap categories based upon a range of criteria.

143

AII recommended that equity swaps should be treated as blocks based on liquidity, and urged the Commission to consider linking equity swap categories to the liquidity of the underlying index.

144

Barclays recommended that swap categories should be established for equity swaps taking into account transaction volume by index and equity asset class type, and that broad-based indices should have separate block levels based upon futures market levels.

145

ICI recommended closer study of data on equity swap transactions due to potential differences in liquidity in the underlying equity cash market.

146

ISDA/SIFMA recommended categorizing equity swaps on the basis of underlying index or basket, product type, notional size, and tenor.

147

SIFMA stated that the Commission should establish equity swap block categories based upon liquidity of the underlying indices.

148

142

CL-AFR at 6.

143

CL-AII at 9; CL-Barclays at 9; CL-ICI at; ISDA/SIFMA at 10-11; SIFMA at 5.

144

CL-AII at 9.

145

CL-Barclays at 9.

146

CL-ICI at 5.

147

CL-ISDA/SIFMA at 10-11.

148

CL-SIFMA at 5.

After consideration of the comments received, the Commission is adopting § 43.6(b)(3) as proposed. While a number of the commenters point out differences in liquidity in the underlying equity indices to support separate swap categories within the equity asset class and establishment of block sizes in equities, these differences do not undermine the premises underlying the Commission's proposal. Even taking into account differences in liquidity, (1) there is still a highly liquid underlying cash market for equities; and (2) the equity index swaps market is small relative to the futures, options, and cash equity index markets. These characteristics, combined with the fact that there are no time delays for reporting block trades in the underlying equity cash market, makes establishment of swap categories, and therefore minimum block thresholds, for equity swaps inappropriate.

149

The Commission notes that establishing time delays for reporting block trades in the swaps market when no time delays exist could negatively impact the price discovery function of the underlying equity cash market and futures market. Accordingly, the Commission is adopting § 43.6(b)(3) as proposed.

150

149

See infra

Section II.B(5)(b). In the event that time delays are established for reporting block trades in the underlying equity cash market, the Commission may consider establishing swap categories and minimum block thresholds for equity swaps.

150

The Securities and Exchange Commission (“SEC”) has proposed general criteria that it would consider to set appropriate minimum block trade sizes for security-based swaps. The SEC, however, has not proposed specific numerical thresholds at this time, but rather intends to propose such thresholds upon the adoption of Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information. 75 FR 75208, 75228 (Dec. 2, 2010). On May 1, 2013, the SEC reopened the comment period regarding this proposed rule.

See

Reopening of Comment Periods for Certain Rulemaking Releases and Policy Statement Applicable to Security-Based Swaps Proposed Pursuant to the Securities Exchange Act of 1934 and the Dodd-Frank Wall Street Reform and Consumer Protection Act (May 1, 2013).

3. Swap Categories in the FX Asset Class

The Commission proposed establishing swap categories for the FX asset class based on unique currency combinations, with § 43.6(b)(4)(i) distinguishing futures-related swaps

151

from swaps that are not futures-related (covered under proposed § 43.6(b)(4)(ii)). Distinguishing futures-related swaps from other swaps would allow the Commission to set initial appropriate minimum block sizes for certain swaps based on DCM block sizes for FX futures contracts.

151

Under § 43.2, a futures-related swap is defined as a swap (as defined in section 1a(47) of the Act and as further defined by the Commission in implementing regulations) that is economically related to a futures contract.

See infra

notes 169-174 and accompanying text. Under § 43.6(b)(4)(i), a futures-related swap is a swap where one of the underlying currencies of the swap is the subject of a futures contract listed on a DCM.

The Commission based its approach on the assumption that FX swaps and futures contracts based upon the same currency draw upon the same liquidity pools. The Commission proposed in §§ 43.6(b)(4)(i) and (b)(4)(ii) to distinguish FX swaps and instruments based on the existence of a related futures contract. Liquidity in the underlying futures market for the currency combinations established in proposed § 43.6(b)(4)(i) suggested sufficient liquidity in the swaps market for these currency combinations.

The Commission proposed establishing swap categories for futures-related swaps under proposed § 43.6(b)(4)(i) based on the unique currency combinations between the currency of each of the following: the United States, European Union, United Kingdom, Japan, Australia, Switzerland, Canada, Republic of South Africa, Republic of Korea, Kingdom of Sweden, New Zealand, Kingdom of Norway, Denmark, Brazil, China, Czech Republic, Hungary, Israel, Mexico, New

Zealand, Poland, Russia, and Turkey.

152

Hence, proposed § 43.6(b)(4)(i) would establish a separate swap category for each of the 231 unique currency combinations between these currencies. In proposed § 43.6(b)(4)(ii), the Commission would establish an additional swap category based on unique currency combinations not included in proposed § 43.6(b)(4)(i).

153

152

For example, the euro (EUR) and the Canadian dollar (CAD) combination would be one swap category; whereas, the Swedish krona (SEK) and the Korean won (KRW) combination would be a separate swap category.

153

Under proposed § 43.6(e)(2), swaps having currency combinations described in § 43.6(b)(4)(ii) would all be eligible to be treated as a block trade or large notional off-facility swap. Only in the post-initial period would the proposed rules set an appropriate minimum block size for this category of FX swaps.

See infra

Section II.B(5)(c)(ii).

The Commission received six comments regarding the proposed swap categories for the FX asset class based on unique currency combinations. Two commenters recommended additional swap categories for the FX asset class.

154

Barclays suggested that EUR- and USD-denominated transactions should be categorized separately from less liquid transactions and that distinct block levels should apply to the following product categories: Forwards, non-deliverable forwards, non-deliverable options, vanilla options, and other more complex options.

155

GFMA recommended more granular swap categories that would group specific instruments according to similarity of liquidity profile.

156

AFR, however, commented that the governing principle in establishing swap categories should be the reasonable relationship of swaps within a category to a liquid class of swaps or futures that are potential hedges for that category and expressed concern that adding any additional granularity might violate this principle.

157

AII and ICI urged the Commission to remove block trading thresholds so that all transactions would be treated as blocks for the FX asset class during the initial period, and allow for collection and analysis of SDR data during this period to determine appropriate swap categories for the post-initial period.

158

154

CL-Barclays at 10; CL-GFMA at 2-3.

155

CL-Barclays at 10.

156

CL-GFMA at 2-3. GFMA also suggested that (1) FX swaps should be distinguished by tenor, and that (2) block size thresholds should vary based on time of day, in order to take into account liquidity across time zones.

157

CL-AFR at 6.

158

CL-AII at 3; CL-ICI at 5.

The Commission notes that, since the Further Block Proposal, Treasury has issued a Final Determination, pursuant to sections 1a(47)(E)(i) and 1b of the CEA, that exempts FX swaps and FX forwards from the definition of “swap” under the CEA. Therefore, 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.

159

Nevertheless, section 1a(47)(E)(iii) of the CEA provides that FX swaps and FX forwards transactions still are not excluded from regulatory reporting requirements to an SDR. Further, the Commission notes that Treasury's final determination excludes FX swaps and FX forwards, but does not apply to FX options or non-deliverable FX forwards. As such, FX instruments that are not covered by Treasury's final determination are subject to part 43 of the Commission's regulations.

159

See

Determination of Foreign Exchange Swaps and Foreign Exchange Forwards under the Commodity Exchange Act, 77 FR 69,694, Nov. 20, 2012.

After consideration of the comments received and the complexity of the proposed approach, the Commission is adopting § 43.6(b)(4) with modifications. The Commission is modifying proposed § 43.6(b)(4)(i) to establish swap categories based on the unique currency combinations between one super-major currency paired with one of the following: (1) Another super major currency

160

; (2) a major currency

161

; or (3) a currency of Brazil, China, Czech Republic, Hungary, Israel, Mexico, New Zealand, Poland, Russia, or Turkey. This approach differs from the proposal in that the adopted swap categories will not include the unique currency combinations between major currencies and other major currencies, between major currencies and each of the ten additional enumerated non-major currencies, and between the ten additional enumerated non-major currencies. Under § 43.6(b)(4) as adopted, all swap transactions subject to part 43

162

in these unique currency combinations may be treated as blocks.

163

160

As set out in Section II.A.1., the super-major currencies are the United States dollar (USD), European Union Euro Area euro (EUR), United Kingdom pound sterling (GBP), and Japan yen (JPY).

161

As set out in Section II.A.1., the major currencies are the 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).

162

As stated above, this section only applies to FX options and non-deliverable FX forwards. Treasury has exempted FX swaps and FX forwards from the definition of “swap” under the CEA.

See

Determination of Foreign Exchange Swaps and Foreign Exchange Forwards under the Commodity Exchange Act, 77 FR 69,694, Nov. 20, 2012.

163

See Table 10 for the enumerated swap categories established by § 43.6(b)(4)(i).

The changes to § 43.6(b)(4) will significantly reduce the number of swap categories, hence reducing complexity, but will still ensure coverage of the most liquid currency combinations.

164

164

According to the BIS Triennial Central Bank Survey: Foreign Exchange and Derivatives Market Activity in April 2010 (preliminary results, dated September 2010), the currency combinations enumerated under adopted § 43.6(b)(4)(i) comprise more than 80% of global FX market turnover.

According to the Survey of North American Foreign Exchange Volume in October 2012, the proposed categories established by § 43.6(b)(4)(i) cover more than 86% of the notional value of total monthly volume of FX swaps that are priced or facilitated by traders in North America. The Survey of North American Foreign Exchange Volume is conducted by the Foreign Exchange Committee, which includes representatives of major financial institutions engaged in foreign currency trading in the United States and is sponsored by the Federal Reserve Bank of New York. The survey is designed to measure the level of turnover in the foreign exchange market. Turnover is defined as the gross value in U.S. dollar equivalents of purchases and sales entered into during the reporting period. The data covers a one-month period in order to reduce the likelihood that very short-term variations in activity might distort the data and include all transactions that are priced or facilitated by traders in North America (United States, Canada, and Mexico). Transactions concluded by dealers outside of North America are excluded even if they are booked to an office within North America. The survey also excludes transactions between branches, subsidiaries, affiliates, and trading desks of the same firm. The October 2012 data can be located at

http://www.newyorkfed.org/fxc/2012/octfxsurvey2012.pdf

.

While not affording block treatment to all swaps in the FX asset class subject to part 43, these modifications will increase the number of currency combinations which will be eligible to be blocks, many of which have limited liquidity.

165

Yet, this modified approach still allows the Commission to set initial appropriate minimum block sizes for the most liquid categories based on the block trade size thresholds set by DCMs for economically-related futures contracts, as enumerated under adopted § 43.6(b)(4)(i). The Commission believes that the categories established by proposed § 43.6(b)(4)(i) and kept under adopted § 43.6(b)(4)(i) provide the separate classification for EUR- and USD-denominated transactions recommended by Barclays.

166

165

For example, the unique currency combination of the Australian Dollar (AUD) and the Canadian Dollar (CAD) had a minimum block threshold of 10,000,000 CAD in the Further Block Proposal. Under adopted § 43.6(b)(4), all trades in this unique currency combination will be eligible for block treatment.

166

The Commission emphasizes that the swap categories for the FX asset class are unique currency combinations between each of the super-major currencies, major currencies, and additional currencies listed. The classification of EUR and

USD as super-major currencies simply means that both currencies are individually eligible for inclusion among the unique currency combinations used for swap categorization. In the FX asset class, there is no separate bucket for super-major currencies (such as the buckets in the interest rate swap asset class described above).

The Commission will also modify § 43.6(b)(4)(ii) to establish one swap category for the currency combinations not included in § 43.6(b)(4)(i). This category will encompass the other currency combinations proposed, but not adopted, by the Commission, as well as other non-futures related currency swaps. With the modifications to § 43.6(b)(4), the euro (EUR) and the Canadian dollar (CAD) combination will still be one swap category as in the original proposal pursuant to § 43.6(b)(4)(i). However, the Swedish krona (SEK) and the Korean won (KRW) combination will be grouped with all the other swaps covered by § 43.6(b)(4)(ii) into one swap category. As a further example, a swap of the Czech koruna (CZK) and the Brazilian real (BRL) will be in the same category as the SEK-KRW swap. While the swaps grouped into one category by § 43.6(b)(4)(ii) may have different liquidity levels, these swaps will all be subject to the time delays provided to block trades and large notional off-facility swaps in both the initial and post-initial periods.

The Commission notes that the adopted § 43.6(b)(4)(i) establishes 78 unique currency combinations, covering a vast majority of the notional value of FX swaps concluded by traders in North America. Creating additional swap categories, as suggested by Barclays and GFMA,

167

would result in swap categories totaling a multiple of this already large number without drastically increasing the number of swaps that will be subject to real-time reporting without a delay. Establishing swap categories based upon unique currency combinations as in adopted § 43.6(b)(4)(i) meets the objectives of grouping swaps with economic similarity and reducing confusion for market participants in determining whether their swaps are classified within a particular swap category. The Commission believes that these changes will reduce the administrative burden to both market participants and to the Commission by reducing the number of swap categories for which appropriate minimum block sizes need to be calculated.

168

167

CL-Barclays at 10; CL-GFMA at 2-3.

168

In the Further Block Proposal, every unique currency combination would be considered a unique swap category, which means there would be hundreds of different swap categories for the FX asset class. Proposed § 43.6(b)(4)(i) alone established 231 swap categories. Many additional categories would have been established under proposed § 43.6(b)(4)(ii). The adopted § 43.6(b)(4) creates 78 categories requiring the calculation of appropriate minimum block sizes in the post-initial period.

Table 10—Swap Categories Established Under § 43.6

(b)(4)(i)

Super-major currencies

Euro

(EUR)

British pound (GBP)

Japanese yen (JPY)

U.S. dollar (USD)

British Pound (GBP)

EUR-GBP

Japanese Yen (JPY)

EUR-JPY

GBP-JPY

U.S. Dollar (USD)

EUR-USD

GBP-USD

JPY-USD

Australian Dollar (AUD)

AUD-EUR

AUD-GBP

AUD-JPY

AUD-USD

Canadian Dollar (CAD)

CAD-EUR

CAD-GBP

CAD-JPY

CAD-USD

Swiss Francs (CHF)

CHF-EUR

CHF-GBP

CHF-JPY

CHF-USD

Denmark Krone (DKK)

DKK-EUR

DKK-GBP

DKK-JPY

DKK-USD

Korean Won (KRW)

KRW-EUR

KRW-GBP

KRW-JPY

KRW-USD

Swedish Krona (SEK)

SEK-EUR

SEK-GBP

SEK-JPY

SEK-USD

Norwegian Krone (NOK)

NOK-EUR

NOK-GBP

NOK-JPY

NOK-USD

New Zealand Dollar (NZD)

NZD-EUR

NZD-GBP

NZD-JPY

NZD-USD

South African Rand (ZAR)

ZAR-EUR

ZAR-GBP

ZAR-JPY

ZAR-USD

Brazilian Real (BRL)

BRL-EUR

BRL-GBP

BRL-JPY

BRL-USD

Czech Koruna (CZK)

CZK-EUR

CZK-GBP

CZK-JPY

CZK-USD

Hungarian Forint (HUF)

HUF-EUR

HUF-GBP

HUF-JPY

HUF-USD

Israeli Shekel (ILS)

ILS-EUR

ILS-GBP

ILS-JPY

ILS-USD

Mexican Peso (MXN)

MXN-EUR

MXN-GBP

MXN-JPY

MXN-USD

Polish Zloty (PLN)

PLN-EUR

PLN-GBP

PLN-JPY

PLN-USD

Chinese Renminbi (RMB)

RMB-EUR

RMB-GBP

RMB-JPY

RMB-USD

Russian Ruble (RUB)

RUB-EUR

RUB-GBP

RUB-JPY

RUB-USD

Turkish Lira (TRY)

TRY-EUR

TRY-GBP

TRY-JPY

TRY-USD

4. Swap Categories in the Other Commodity Asset Class

The Commission proposed to determine swap categories in the other commodity asset class based on three sets of groupings. The first two sets of groupings create categories of swaps which are economically related to specific futures contracts (

i.e.,

futures-related swaps

169

) or swap contracts under proposed §§ 43.6(b)(5)(i) and (ii). The third set of groupings creates categories based on swaps sharing a common product type under proposed § 43.6(b)(5)(iii).

169

Proposed § 43.2 defines a futures-related swap as a swap (as defined in section 1a(47) of the Act and as further defined by the Commission in implementing regulations) that is economically related to a futures contract. The Commission is adopting this definition as proposed.

The Commission proposed defining “economically related”

170

in § 43.2 as a direct or indirect reference to the same commodity at the same delivery location or locations,

171

or with the

same or substantially similar cash market price series.

172

The Commission noted that this definition would (1) ensure that swap contracts with shared reference price characteristics indicating economic substitutability (

i.e.,

swaps in the category can be used to offset some or all of the risks associated with positions in the underlying commodity) are grouped together within a common swap category;

173

and (2) provide further clarity as to which swaps are described in § 43.4(d)(4)(ii)(B), which was previously finalized under the Real-Time Reporting Final Rule.

174

170

In the Real-Time Reporting Final Rule, the Commission explained: “For the purposes of part 43, swaps are economically related, as described in § 43.4(d)(4)(ii)(B), if such contract utilizes as its sole floating reference price the prices generated directly or indirectly from the price of a single contract described in appendix B to part 43.” 77 FR 1211. Further, the Commission explained that “an `indirect' price link to an Enumerated Physical Commodity Contract or an Other Contract described in appendix B to part 43 includes situations where the swap reference price is linked to prices of a cash-settled contract described in appendix B to part 43 that itself is cash-settled based on a physical-delivery settlement price to such contract.”

Id.

at n.289.

171

For example, a swap utilizing the Platts Gas Daily/Platts IFERC reference price is economically related to the Henry Hub Natural Gas (NYMEX) (futures) contract because it is based on the same commodity at the same delivery location as that underlying the latter contract.

172

For example, a swap utilizing the Standard and Poor's (“S&P”) 500 reference price is economically related to the S&P 500 Stock Index futures contract because it is based on the same cash market price series.

173

The Commission proposed to amend § 43.2 to define “reference price” as a floating price series (including derivatives contract and cash market prices or price indices) used by the parties to a swap or swaption to determine payments made, exchanged or accrued under the terms of a swap contract. The Commission proposed to use this term in connection with the establishment of a method through which parties to a swap transaction may elect to apply the lowest appropriate minimum block size applicable to one component swap category of such swap transaction.

See infra

Section II.B(6)(b). The Commission is adopting this definition as proposed.

174

The Real-Time Reporting Final Rule previously finalized § 43.4(d)(4)(ii)(B), which requires a registered SDR to publicly disseminate any publicly reportable swap transaction in the other commodity asset class that is “economically related” to one of the contracts described in appendix B to part 43, but did not define “economically related.” This definition, as proposed and to be adopted here, would apply to the use of this term throughout all of part 43 of the Commission's regulations.

The first set of swap categories, covered under proposed § 43.6(b)(5)(i), would establish separate swap categories for swaps that are economically related to one of the contracts listed in appendix B to part 43. Therefore, proposed § 43.6(b)(5)(i) would establish one swap category for each contract listed in appendix B to part 43. The Real-Time Reporting Final Rule previously finalized appendix B to part 43, which lists 29 Enumerated Physical Commodity Contracts and Other Contracts (

i.e.,

Brent Crude Oil (ICE)).

175

In the Further Block Proposal, the Commission proposed to add 13 electricity and natural gas swap contracts to appendix B to part 43.

176

Therefore, proposed § 43.6(b)(5)(i) would establish 42 swap categories such that each contract would be the basis for its own other commodity swap category, and all swaps that are economically related to that contract would be included in that swap category.

175

As noted by the Commission in the Real-Time Reporting Final Rule, the 28 Enumerated Physical Commodity Contracts are traded on U.S. DCMs, while Brent Crude Oil (ICE) futures contracts are primarily traded in Europe. 77 FR 1211 n. 288.

176

See infra

Section II.B5(d)(i). The Commission had previously issued orders deeming these contracts as “significant price discovery contracts” in connection with trading on exempt commercial markets (“ECMs”), based on, among other factors, their material liquidity and price discovery function.

See infra

Section III.C(4)(a). These contracts included: AECO Financial Basis Contract (“AEC”) traded on the IntercontinentalExchange, Inc. (“ICE”) (

See

75 FR 23697); NWP Rockies Financial Basis Contract (“NWR”) traded on ICE (

See

75 FR 23704); PG&E Citygate Financial Basis Contract (“PGE”) traded on ICE (

See

75 FR 23710); Waha Financial Basis Contract (“WAH”) traded on ICE (

See

75 FR 24655); Socal Border Financial Basis Contract (“SCL”) traded on ICE (

See

75 FR 24648); HSC Financial Basis Contract (“HXS”) traded on ICE (

See

75 FR 24641); ICE Chicago Financial Basis Contract (“DGD”) traded on ICE (

See

75 FR 24633); SP-15 Financial Day-Ahead LMP Peak Contract (“SPM”) traded on ICE (

See

75 FR 42380); SP-15 Financial Day-Ahead LMP Off-Peak Contract (“OFP”) traded on ICE (

See

75 FR 42380); PJM WH Real Time Peak Contract (“PJM”) traded on ICE (

See

75 FR 42390); PJM WH Real Time Off-Peak Contract (“OPJ”) traded on ICE (

See

75 FR 42390); Mid-C Financial Peak Contract (“MDC”) traded on ICE (

See

75 FR 38469); Mid-C Financial Off-Peak Contract (“OMC”) traded on ICE (

See

75 FR 38469).

As discussed further below, as of October 12, 2012, ICE withdrew its listing of these contracts as a result of converting its cleared OTC swap contracts and related options to futures listed at ICE Futures U.S. and ICE Futures Europe. Accordingly, ICE converted these contracts into economically equivalent futures contracts and has listed them for trading.

See

ICE—Swaps to Futures Transition,

https://www.theice.com/S2F.jhtml

(last visited May 7, 2013). Therefore, as discussed further below, the Commission has determined in this final rule to add the converted contracts to appendix B to part 43, such that each contract will serve as a basis for an other commodity swap category.

See infra

Section II.A(4).

The Commission has separately enumerated these contracts since it previously has identified these commodity contracts as: (1) Having high levels of open interest and significant cash flow; and (2) serving as a reference price for a significant number of cash market transactions. Moreover, the Commission has also previously determined that any swap that references or is economically related to these contracts (along with the Brent Crude Oil (ICE) contract or any contract that is economically related to it) has sufficient liquidity to ensure that the public dissemination of swap transaction and pricing data for swaps based on this reference asset poses little risk of disclosing identities of parties, business transactions, or market positions.

177

177

77 FR 1211.

The second set of swap categories, covered under proposed § 43.6(b)(5)(ii), would establish swap categories based on swaps in the other commodity asset class that are: (1) Not economically related to one of the futures or swap contracts listed in appendix B to part 43; and (2) economically related to a relevant futures contract that is subject to the block trade rules of a DCM. Proposed § 43.6(b)(5)(ii) listed the 18 futures contracts to which these swaps are economically related, and hence, establishes 18 swap categories.

178

These swap categories would include any swap that is economically related to such contracts. The swap categories established by proposed § 43.6(b)(5)(i) differ from the swap categories established by proposed § 43.6(b)(5)(ii) in that the former may be economically related to futures or swap contracts that are not subject to the block trade rules of a DCM, whereas the latter are economically related to futures contracts that are subject to the block trade rules of a DCM.

179

178

As proposed, these additional other commodity swap categories would be based on the following futures contracts: CME Cheese; CBOT Distillers' Dried Grain; CBOT Dow Jones-UBS Commodity Index Excess Return; CBOT Ethanol; CME Frost Index; CME Goldman Sachs Commodity Index (GSCI) (GSCI Excess Return Index); NYMEX Gulf Coast Gasoline; NYMEX Gulf Coast Sour Crude Oil; NYMEX Gulf Coast Ultra Low Sulfur Diesel; CME Hurricane Index; CME International Skimmed Milk Powder; NYMEX New York Harbor Ultra Low Sulfur Diesel; CBOT Nonfarm Payroll; CME Rainfall Index; CME Snowfall Index; CME Temperature Index; CME U.S. Dollar Cash Settled Crude Palm Oil; and CME Wood Pulp.

179

This distinction is noteworthy because proposed § 43.6(e)(3) provides that “[p]ublicly reportable swap transactions described in § 43.6(b)(5)(i) that are economically related to a futures contract in appendix B to this part [43] shall not qualify to be treated as block trades or large notional off-facility swaps (as applicable) [during the initial period], if such futures contract is not subject to a designated contract market's block trading rules.”

The third set of swap categories, covered under proposed § 43.6(b)(5)(iii), would establish swap categories for all other commodity swaps that are not categorized under proposed § 43.6(b)(5)(i) or (ii). These swaps are not economically related to any of the contracts listed in appendix B to part 43 or any of the contracts listed in proposed § 43.6(b)(5)(ii). For these other commodity swaps, the Commission would determine the appropriate swap category based on the product types described in appendix D to part 43 to which the underlying asset(s) of the swap would apply or otherwise relate. Proposed appendix D to part 43 establishes “Other Commodity Groups” and certain “Individual Other Commodities” within those groups. To the extent that there is an “Individual Other Commodity” listed, the Commission would deem the “Individual Other Commodity” as a separate swap category. For example, regardless of whether the underlying asset to an off-facility swap is “Sugar No. 14” or “Sugar No. 5,” the underlying asset would be grouped as “Sugar.” The Commission thereafter

would set the appropriate minimum block size for each of the swap categories listed in appendix D to part 43.

In circumstances where a swap does not apply or otherwise relate to a specific “Individual Other Commodity” listed under the “Other Commodity Group” in appendix D to part 43, the Commission would categorize such swap as falling under the respective “Other” swap categories. For example, an emissions swap would be categorized as “Emissions,” while a swap in which the underlying asset is aluminum would be categorized as “Base Metals—Other.” Additionally, in circumstances where the underlying asset of swap does not apply or otherwise relate to an “Individual Other Commodity” or an “Other” swap category, the Commission would categorize such swap as either “Other Agricultural” or “Other Non-Agricultural.”

Comments on the proposed swap categories in the other commodity asset class varied. CME Group agreed with the proposed approach to establishing swap categories in the other commodity asset class in the initial period because it would allow appropriate minimum block level sizes to be set based on the minimum block sizes set by DCMs.

180

ICI, however, recommended that the Commission obtain and analyze trading data from SDRs first before determining whether the proposed swap categories are appropriate.

181

180

CL-CME 3-4. Proposed § 43.6(e)(1) established appropriate minimum block sizes in the initial period for swap categories in proposed § 43.6(b)(5)(i)-(ii) based on the block sizes for related futures contracts set by DCMs, except for natural gas and electricity swaps proposed to be added to appendix B of part 43.

181

CL-ICI at 5.

Several commenters commented on the granularity of the proposed swap categories. Some commenters recommended more granular categories to account for the differences in liquidity and execution risk between shorter- and longer-dated contracts.

182

Similarly, Barclays also commented that swap categories in the other commodity asset class should consider that products typically experience a reduction in liquidity beyond the first or second year.

183

Other commenters, however, opposed the proposed categories as too narrow and recommended broadening the definition of “economically related” and reducing the number of swap categories to reflect increasing price correlation between different categories of commodities as well as existing hedging practices by market participants.

184

182

CL-ICAP Energy at 4; CL-fia at 3.

183

CL-Barclays at 9.

184

CL-Better Markets at 6-7; CL-AFR at 6-7.

Parity Energy requested that the Commission establish a separate category for swaps that are economically related to crude oil options because transactions in crude oil options are typically fewer and larger in size than transactions in crude oil futures contracts.

185

Parity Energy also agreed with the proposed distinction in swap categories between swaps that are economically related to natural gas swaps and swaps that are economically related to natural gas swap options.

186

185

CL-Parity at 4-5.

186

Id.

As proposed, the initial minimum block size for swaps that are economically related to Henry Hub Natural Gas futures was set at 1,000,000 mmBtu; the initial minimum block size for Henry Hub Natural Gas options was set at 5,500,000 mmBtu.

The Commission is adopting the definition of “economically related” as proposed. The Commission believes that broadening the definition, as suggested by some commenters, would reduce the precision with which swaps in the other commodity asset class can be properly categorized. As proposed, the definition of “economically related” is sufficient in that it (1) ensures that swap contracts with shared reference price characteristics (indicating economic substitutability) are grouped together within a common swap category and (2) provides further clarity as to which swaps are described in § 43.4(d)(4)(ii)(B).

Furthermore, the Commission believes that its general approach to establishing swap categories under § 43.6(b)(5)(i)-(iii) is appropriate and is adopting the text of § 43.6(b)(5)(i)-(iii) largely as proposed, with the exception of some proposed swap categories in § 43.6(b)(5)(ii).

187

With the conversion of the 13 electricity and natural gas swap contracts proposed to be added to appendix B to part 43 into DCM-listed, economically equivalent futures contracts,

188

the Commission is making one modification by establishing swap categ

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