# Procedures To Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2013-12133 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** May 31, 2013 - **Citation:** 78 FR 32866 ## Text COMMODITY FUTURES TRADING COMMISSION 17 CFR Part 43 RIN 3038-AD08 Procedures To Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades AGENCY: Commodity Futures Trading Commission. ACTION: 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 [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2013-12133. Public record. Not legal advice.