Clearing Requirement Determination Under Section 2(h) of the Commodity Exchange Act for Interest Rate Swaps

Federal RegisterOct 14, 2016

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 50

RIN 3038-AE20

Clearing Requirement Determination Under Section 2(h) of the Commodity Exchange Act for Interest Rate Swaps

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule.

SUMMARY:

The Commodity Futures Trading Commission (Commission or CFTC) is adopting an amendment to the Commission's regulations to expand the existing clearing requirement for interest rate swaps pursuant to the pertinent section of the Commodity Exchange Act (CEA). The amended regulation requires that interest rate swaps denominated in certain currencies and having certain termination dates, as described herein, be submitted for clearing to a derivatives clearing organization (DCO) that is registered under the CEA (registered DCO) or a DCO that has been exempted from registration under the CEA (exempt DCO).

DATES:

The amended rule is effective December 13, 2016. Specific compliance dates are discussed in the Supplementary Information.

FOR FURTHER INFORMATION CONTACT:

Sarah E. Josephson, Deputy Director, Division of Clearing and Risk (DCR), at 202-418-5684 or

sjosephson@cftc.gov;

Peter A. Kals, Special Counsel, DCR, at 202-418-5466 or

pkals@cftc.gov;

Melissa A. D'Arcy, Special Counsel, DCR, at 202-418-5086 or

mdarcy@cftc.gov;

Meghan A. Tente, Special Counsel, DCR, at 202-418-5785 or

mtente@cftc.gov;

Michael A. Penick, Economist, Office of the Chief Economist (OCE), at 202-418-5279 or

mpenick@cftc.gov;

or Lihong McPhail, Research Economist, OCE, at 202-418-5722 or

lmcphail@cftc.gov,

in each case at the Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Clearing Requirement Proposal

B. Regulatory Background

C. Clearing Requirements in Other Jurisdictions

D. Submissions From DCOs

E. Commission Processes for Review and Surveillance of DCOs

II. Comments on the Notice of Proposed Rulemaking

A. Overview of Comments Received

B. Determination Analysis

C. Generally Applicable Comments

III. Expanded and Amended Regulation 50.4(a)

IV. Implementation Schedule

A. No Compliance Date Phase-In by Type of Market Participant

B. Compliance Date Tied to a Non-U.S. Jurisdiction Clearing Requirement

C. Clarifications to the Implementation Schedule

D. Scope of Entities Subject to the Implementation Schedule

E. Projected Compliance Dates

V. Cost Benefit Considerations

A. Statutory and Regulatory Background

B. Overview of Swap Clearing

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

D. Costs and Benefits of the Commission's Action as Compared to Alternatives

E. Section 15(a) Factors

VI. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

I. Background

A. Clearing Requirement Proposal

On June 16, 2016, the Commission published a notice of proposed rulemaking (NPRM) to establish an expanded interest rate swap clearing requirement under section 2(h)(1)(A) of the CEA and Commission regulation 50.4(a).

The Commission proposed requiring clearing of certain interest rate swaps offered for clearing at Chicago Mercantile Exchange, Inc. (CME), Eurex Clearing AG (Eurex), LCH.Clearnet Ltd. (LCH), and/or Singapore Exchange Derivatives Clearing Ltd. (SGX), each a Commission-registered DCO.

The interest rate swaps proposed in the NPRM were: Fixed-to-floating interest rate swaps denominated in Australian dollar (AUD), Canadian dollar (CAD), Hong Kong dollar (HKD), Mexican peso (MXN), Norwegian krone (NOK), Polish zloty (PLN), Singapore dollar (SGD), Swedish krona (SEK), and Swiss franc (CHF) (collectively, the nine additional currencies); basis swaps denominated in AUD; forward rate agreements (FRAs) denominated in AUD, NOK, PLN, and SEK; overnight index swaps (OIS) denominated in AUD and CAD; and OIS having termination dates of up to three years that are denominated in U.S. dollar (USD), euro (EUR), or sterling (GBP).

Clearing Requirement Determination Under Section 2(h) of the CEA for Interest Rate Swaps, 81 FR 39506 (June 16, 2016).

Two DCOs that the Commission has exempted from registration, ASX Clear (Futures) Pty Ltd. (Australia) (ASX) and OTC Clearing Hong Kong Ltd., clear some of the swaps covered by this determination (AUD- and HKD-denominated interest rate swaps, respectively). Pursuant to Commission orders, these two DCOs are permitted to clear for U.S. proprietary accounts but not for U.S. customers. However, as discussed further below, should either of these two exempt DCOs decide that they wish to offer clearing to U.S. customers, they would be eligible to apply for registration as full DCOs. Because these DCOs have not submitted filings under Commission regulation 39.5(b), this final rule addresses only those registered DCOs that have submitted swaps for consideration under that regulation.

See

Table 1 for information regarding which registered DCOs clear which interest rate swaps. Each DCO submitted information about the interest rate swaps subject to this rulemaking to the Commission pursuant to regulation 39.5(b), which is discussed further below.

For the reasons discussed below, this final rulemaking expands the existing interest rate swap clearing requirement by requiring the clearing of all of the swaps covered by the NPRM, except for AUD-denominated FRAs.

B. Regulatory Background

The Commission's first clearing requirement determination issued in 2012 applied to four classes of interest rate swaps and two classes of credit default swaps.

The Commission is adopting this clearing requirement determination to require the clearing of certain, additional interest rate swaps pursuant to section 2(h) of the CEA. Under section 2(h)(1)(A) of the CEA, it is unlawful for any person to engage in a swap unless that person submits such swap for clearing to a DCO that is registered under the CEA or a DCO that is exempt from registration under the CEA if the swap is required to be cleared. The Commission may initiate a clearing requirement determination pursuant to a swap submission from a registered DCO.

Section 2(h)(2)(B)(i) of

the CEA requires a DCO to submit to the Commission each swap, or any group, category, type, or class of swaps that it plans to accept for clearing and provide notice to its members of the submission. Commission regulation 39.5(b) implements the procedural elements of section 2(h)(2)(B)-(C) by establishing the specific process for the submission of swaps by a DCO to the Commission for a clearing requirement determination.

Clearing Requirement Determination Under Section 2(h) of the CEA, 77 FR 74284 (Dec. 13, 2012) [hereinafter the First Clearing Requirement Determination]. The four classes of interest rate swaps defined under Commission regulation 50.4(a) include fixed-to-floating, basis, FRA, and OIS. In 2012, the Commission required that, for the fixed-to-floating, basis, and FRA classes, the top four currencies as measured by total notional amount be subject to required clearing. Those top four currencies were EUR, USD, GBP, and Japanese yen (JPY). All four currencies were specified in the fixed-to-floating, basis, and FRA classes under regulation 50.4(a). For OIS swaps, all the currencies except JPY were specified under the rule.

Section 2(h)(2) of the CEA provides the Commission with authority to issue a determination that a swap is required to be cleared pursuant to two separate review processes. Section 2(h)(2)(A) of the CEA provides for a Commission-initiated review process whereby the Commission, on an ongoing basis, must review swaps (or a group, category, type or class of swaps) to make a determination as to whether a swap (or group, category, type or class of swaps) should be required to be cleared. The other process provided under section 2(h)(2)(B) of the CEA entails the Commission's review of swaps that are submitted by DCOs. Specifically, section 2(h)(2)(B)(i) of the CEA requires that each DCO submit to the Commission each swap (or group, category, type or class of swaps) that it plans to accept for clearing. The swaps subject to this rulemaking were submitted by DCOs pursuant to section 2(h)(2)(B)(i) of the CEA and Commission regulation 39.5(b).

Section 2(h)(2)(B)-(C) of the CEA describes the process by which the Commission is required to review swap submissions from DCOs to determine whether the swaps should be subject to the clearing requirement. On June 23, 2016, the Commission published on its Web site for public comment 34 submissions from DCOs submitted pursuant to section 2(h)(2)(B) of the CEA and CFTC regulation 39.5(b) over the past few years. The public comment period closed on July 25, 2016, and five letters were submitted by that date.

See

CFTC Press Release, CFTC Requests Public Comment on Swap Clearing Requirement Submissions (June 23, 2016), available at:

http://www.cftc.gov/PressRoom/PressReleases/pr7396-16.

Any future proposals for a new clearing requirement determination related to the swaps covered by those 34 submissions would be subject to a separate notice and comment rulemaking process. Market participants may offer additional comments or feedback on market developments related to those 34 submissions by contacting any of the DCR staff named above.

Accordingly, the Commission is issuing this final rulemaking to adopt an amendment to § 50.4(a) such that the following products are subject to the clearing requirement as set forth in regulation 50.4: (1) Fixed-to-floating swaps denominated in the nine additional currencies; (2) basis swaps denominated in AUD; (3) FRAs denominated in NOK, PLN, and SEK; (4) OIS denominated in AUD and CAD; and (5) OIS denominated in USD, EUR, and GBP that have termination dates of up to three years.

C. Clearing Requirements in Other Jurisdictions

The following is an updated summary of actions taken by other jurisdictions towards implementing clearing mandates for interest rate swaps. The Commission believes that it is important to harmonize its swap clearing requirement with clearing mandates promulgated in other jurisdictions. For example, if a non-U.S. jurisdiction issued a clearing requirement and a swap dealer (SD) located in the U.S. were not subject to that non-U.S. clearing requirement, then a swap market participant located in the non-U.S. jurisdiction might be able to avoid the non-U.S. clearing requirement by entering into a swap with the SD located in the U.S.

As the Commission reviewed the regulation 39.5(b) submissions from DCOs, it considered whether those products offered for clearing at DCOs were subject, or were likely to be subject, to a clearing requirement in another jurisdiction. For those products that were the subject of a clearing requirement rule or proposal outside of the U.S., the Commission reviewed the specifications of the products and the processes used by non-U.S. regulators to impose a clearing mandate. In addition, the Commission reviewed data produced and made available to the public in connection with any rule proposals or final rules implementing a clearing requirement in non-U.S. jurisdictions. Finally, the Commission considered comments submitted in response to clearing mandate rule proposals in non-U.S. jurisdictions and any subsequent changes that regulators made to final rules implementing a clearing mandate. In this manner, the Commission was informed by its review of non-U.S. jurisdictions' clearing mandates and considered those mandates in preparing this determination.

Consequently, the scope of the swaps included in this final rulemaking reflects the Commission's desire to harmonize with our counterparts abroad and is informed by the work of those regulators, as described below. In addition, the product specifications of the swaps included in this clearing requirement determination are intended to be consistent with those referenced in clearing mandates published by the Commission's counterparts abroad.

In the future, it may be appropriate to propose a clearing requirement under the CEA covering swaps that are not yet the subject of a proposed or final clearing mandate issued by a non-U.S. jurisdiction.

See generally

comment letter from the International Swaps and Derivatives Association, Inc. (ISDA), at 5, (discussing the goal of harmonizing clearing mandates, commending the Commission's independent analysis in the NPRM, and noting that “the CFTC does not have any control over the clearing mandates of its counterparts in non-U.S. jurisdictions and therefore should continue to conduct full and robust independent analysis prior to implementing any clearing mandates.”).

i. Australia

The Australian Securities and Investments Commission (ASIC) has published regulations that require certain Australian and non-Australian entities

to clear AUD-, USD-, GBP-, EUR-, and JPY-denominated fixed-to-floating interest rate swaps, basis swaps, and FRAs, as well as AUD-, USD-, GBP-, and EUR-denominated OIS. The regulations' swap classes are co-extensive with those described in existing Commission regulation 50.4(a), except for the addition of AUD-denominated swaps. The first compliance date for an Australian market participant to comply with the Australian clearing mandate for AUD-denominated fixed-to-floating interest rate swaps and basis swaps was April 4, 2016.

The first compliance date for the Australian clearing mandate for AUD-denominated OIS will be October 3, 2016 and for AUD-denominated FRAs April 2, 2018.

As defined under ASIC's final clearing rules, clearing entities subject to the Australian clearing mandate include Australian authorized deposit-taking institutions (ADIs) and Australian financial services licensee (AFS Licensees) that hold a total gross notional outstanding position of AUD 100 billion or more under specific circumstances, as measured at particular points in time. To account for non-Australian entities, ASIC's final rules also define foreign clearing entities, opt-in clearing entities, and cross-reference to Australia's Corporations Regulations 2001 definition of foreign internationally active dealers. ASIC Derivative Transaction Rules (Clearing) 2015, available at:

https://www.comlaw.gov.au/Details/F2015L01960.

ASIC Derivative Transaction Rules (Clearing) 2015, at section 1.2.7.

Id.,

at section 1.2.3.

As a result of this clearing requirement determination, the classes of swaps required to be cleared under Commission regulation 50.4(a) are expanded to include AUD-denominated fixed-to-floating interest rate swaps, basis swaps, and OIS swaps that are consistent with the AUD-denominated swaps that are, or will be, required to be cleared by ASIC.

For the reasons discussed below, the Commission is not finalizing its proposed requirement to clear AUD-denominated FRAs at this time.

ii. Canada

In 2015, Canada's provincial securities regulators

published a draft rule that would require certain derivatives to be cleared.

On February 24, 2016, the Canadian provincial securities regulators published a revised draft rule that applies to certain

Canadian market participants

and proposes subjecting the following classes of interest rate swaps to a clearing mandate: CAD-, USD-, EUR-, and GBP-denominated fixed-to-floating interest rate swaps; USD-, EUR-, and GBP-denominated basis swaps; USD-, EUR-, and GBP-denominated FRAs; and CAD-, USD-, EUR-, and GBP-denominated OIS.

Subject to ministerial approvals, the Canadian provincial securities regulators' revised rule will take effect on May 9, 2017.

Consequently, it is the Commission's understanding that May 9, 2017 is the first compliance date upon which a Canadian market participant will be required to comply with the clearing mandate.

Canada's provincial securities regulators are collectively referred to as the Canadian Securities Administrators, including representatives from: The Alberta Securities Commission; the British Columbia Securities Commission; the Manitoba Securities Commission; the Financial and Consumer Services Commission of New Brunswick; the Office of the Superintendent of Securities Service Newfoundland and Labrador; the Office of the Superintendent of Securities of the Northwest Territories; the Nova Scotia Securities Commission; the Nunavut Securities Offices; the Ontario Securities Commission; the Office of the Superintendent of Securities of Prince Edward Island; the Autorité des marchés financiers; the Financial and Consumer Affairs Authority of Saskatchewan; and the Office of the Yukon Superintendent of Securities.

See also

Securities and Futures (OTC Derivative Transactions—Clearing and Record Keeping Obligations and Designation of Central Counterparties) Rules, The Government of the Hong Kong Special Administrative Region Gazette, available at:

http://www.gld.gov.hk/egazette/pdf/20162005/es22016200528.pdf.

Id.

As a result of this clearing requirement determination, the classes of swaps required to be cleared under Commission regulation 50.4(a) are expanded to include HKD-denominated fixed-to-floating interest rate swaps that will be required to be cleared by the Hong Kong Securities and Futures Commission and the Hong Kong Monetary Authority.

v. Mexico

In 2015, Banco de México, the Mexican central bank, published a clearing mandate to require that certain Mexican financial institutions

clear MXN-denominated fixed-to-floating interest rate swaps having a termination date range of approximately two months to 30 years and that reference the Mexican “Interbank Equilibrium Interest Rate” (TIIE).

The first compliance date for a Mexican market participant to comply with the Banco de México's clearing mandate was on April 1, 2016.

Banco de México's Rules for Derivatives Transactions (Circular 4/2012) limit the clearing mandate to transactions between local banks, brokerage firms, and institutional investors. The Banco de México's Rules also contemplate an exemption for small entities with notional amounts outstanding below the specified threshold of 10 billion unidades de inversión.

Rules for Derivatives Transactions (Circular 4/2012), Banco de México, available at:

http://www.banxico.org.mx/disposiciones/circulares/%7BD7250B17-13A4-B0B7-F4E5-04AF29F37014%7D.pdf.

Id.

As a result of this clearing requirement determination, the classes of swaps required to be cleared under Commission regulation 50.4(a) are expanded to include MXN-denominated fixed-to-floating interest rate swaps that are required to be cleared by the Banco de México.

vi. Singapore

In 2015, the Monetary Authority of Singapore (MAS) published proposed regulations that would require financial institutions

to clear SGD-denominated fixed-to-floating interest rate swaps referencing the Swap Offer Rate (SOR) and USD-denominated fixed-to-floating interest rate swaps referencing LIBOR.

Under MAS' proposal, the clearing mandate applies to transactions between banks that exceed the SGD 20 billion gross notional outstanding derivatives contract threshold for each of the previous four calendar quarters.

Summary published by MAS available at:

http://www.mas.gov.sg/News-and-Publications/Media-Releases/2015/MAS-Consults-on-Proposed-Regulations-for-Mandatory-Clearing-of-OTC-Derivatives.aspx.

As a result of this clearing requirement determination, the classes of swaps required to be cleared under Commission regulation 50.4(a) are expanded to include SGD-denominated fixed-to-floating interest rate swaps that are likely to be the subject of final regulatory action by MAS establishing a clearing requirement, which will commence in 2017.

vii. Switzerland

In 2015, the Swiss parliament adopted legislation providing a framework for a swap clearing requirement. A clearing requirement for certain financial counterparties and non-financial counterparties

is expected to be phased in from 2016.

It is not yet known exactly which products such a clearing requirement would cover, but based on the criteria required to be considered by the Swiss Financial Market Supervisory Authority (Finma), Finma may determine that the CHF-denominated fixed-to-floating interest rate swaps referencing LIBOR should be included.

According to guidance from the Swiss Financial Market Supervisory Authority, derivatives transactions executed by and among financial counterparties and non-financial counterparties that meet the threshold requirements will be subject to the clearing requirement. Financial counterparties meet the threshold if their rolling averages for gross positions in outstanding derivatives transactions (over 30 working days) are at or above CHF 8 billion. Non-financial counterparties meet the threshold if their rolling averages for gross positions in outstanding derivatives transactions (over 30 working days) are at or above amounts specific to each product (

e.g.,

CHF 3.3 billion in interest rate derivatives transactions).

Financial Stability Board, OTC Derivatives Market Reforms, Eleventh Progress Report on Implementation, Appendix C (Implementation timetable: Central clearing of standardised transactions) (Aug. 26, 2016), available at:

www.fsb.org/2016/08/otc-derivatives-market-reforms-eleventh-progress-report-on-implementation/.

See

Swiss Financial Market Supervisory Authority (FINMA), Guidance 01/2016 Financial Market Infrastructure Act: FINMA's next steps (July 6, 2016), available at:

https://www.finma.ch/en/~/media/finma/dokumente/dokumentencenter/myfinma/4dokumentation/finma-aufsichtsmitteilungen/20160707-finma-aufsichtsmitteilung-01-2016.pdf?la=en.

As a result of this clearing requirement determination, the classes of swaps required to be cleared under Commission regulation 50.4(a) are expanded to include CHF-denominated fixed-to-floating interest rate swaps that may be subject to a clearing requirement in 2017.

D. Submissions From DCOs

CME and LCH provided the Commission with regulation 39.5(b) submissions relating to: Fixed-to-floating interest rate swaps denominated in the nine additional currencies; AUD-denominated basis swaps; and USD-, EUR-, and GBP-denominated OIS with termination dates of up to 30 years. CME and LCH provided § 39.5(b) submissions pertaining to the FRAs and OIS listed in Table 1, below. CME and

SGX provided submissions relating to MXN- and SGD-denominated fixed-to-floating interest rate swaps, respectively. Eurex provided a submission relating to CHF-denominated fixed-to-floating interest rate swaps and OIS denominated in USD, EUR, and GBP with terms up to 30 years plus 10 business days.

LCH will begin offering MXN-denominated fixed-to-floating interest rate swaps in early October 2016.

Based on representations made by CME to the Commission, the Commission believes that CME will begin offering AUD- and CAD-denominated OIS before the end of 2016.

The 39.5(b) submissions are available on the Commission's Web site at:

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

Submission materials that a submitting DCO marked for confidential treatment are not available for public review, pursuant to Commission regulations 39.5(b)(5) and 145.9(d).

LCH has filed a regulation 39.5(b) submission with the Commission as of September 23, 2016 for this swap.

Prior to offering these swaps for clearing, CME will need to file §§ 40.6 and 39.5(b) submissions with the Commission.

Table 1 summarizes the relevant interest rate swaps submitted by CME, Eurex, LCH, and SGX.

Based on its regulation 39.5(b) submission, LCH will offer clearing of MXN-denominated fixed-to-floating interest rate swaps in early October 2016.

CME plans to offer clearing of AUD-denominated OIS interest rate swaps before the end of 2016.

CME plans to offer clearing of CAD-denominated OIS interest rate swaps before the end of 2016.

Table 1—Summary of Interest Rate Swap Submissions Under Regulation 39.5(

)

Currency

Floating

rate index

Maximum

stated

termination

date

CME

Eurex

LCH

SGX

Fixed-to-Floating Interest Rate Swaps

AUD

BBSW

30 years

Yes

*No.

CAD

CDOR

30 years

Yes

No.

CHF

LIBOR

30 years

Yes

No.

HKD

HIBOR

10 years

Yes

No.

MXN

TIIE-BANXICO

21 years

Yes

No.

NOK

NIBOR

10 years

Yes

No.

PLN

WIBOR

10 years

Yes

No.

SGD

SOR-VWAP

10 years

Yes

Yes.

SEK

STIBOR

30 years

Yes

No.

Basis Swaps

AUD

BBSW

30 years

Yes

No.

Overnight Index Swaps

USD

FedFunds

30 years

Yes

No.

EUR

EONIA

30 years

Yes

No.

GBP

SONIA

30 years

Yes

No.

AUD

AONIA-OIS

5.5 years

Yes

No.

CAD

CORRA-OIS

2 years

Yes

No.

Forward Rate Agreements

AUD

BBSW

3 years

Yes

No.

NOK

NIBOR

2 years

Yes

No.

PLN

WIBOR

2 years

Yes

No.

SEK

STIBOR

3 years

Yes

No.

The Commission notes that these interest rate swaps are all single currency swaps without optionality, as defined by the applicable DCO.

The submissions from CME, Eurex, LCH, and SGX provided the information required by regulation 39.5(b)(3)(i)-(viii), which, along with other information, has assisted the Commission in making a quantitative and qualitative assessment that these swaps should be subject to a clearing requirement determination.

In making this clearing requirement determination, the Commission considered the ability of CME, Eurex, LCH, and SGX to clear a given swap, as well as data supplied cumulatively from each DCO for these swaps.

The Commission also reviewed the existing rule frameworks and risk management policies of each DCO.

In their submissions, CME and LCH stated that they had provided notice of the submissions to members as required by regulation 39.5(b)(3)(viii). SGX stated that its § 39.5(b) submission was published on its Web site. Eurex stated that it would forward its § 39.5(b) submission to its members so that they could comment.

CME, Eurex, LCH, and SGX are eligible to clear interest rate swaps under regulation 39.5(a).

Additionally, the Commission considered industry data

as well as other publicly available data sources, specifically data published by the Bank for International Settlements (BIS), and information that has been made publicly available pursuant to part 43 of the Commission's regulations (part 43 Data).

The Commission considered FIA SEF Tracker data and ISDA SwapsInfo data.

The Commission notes that it also has access to data pursuant to part 45 of the Commission's regulations (part 45 Data), which is used in the cost benefit considerations in section V. However, for the purposes of this determination, the Commission decided to use the part 43 Data in its determination analysis in section II.B to enable commenters to review the same data that the Commission reviewed in making the determination. In the future, the Commission may analyze part 45 Data and provide the public with aggregated and anonymized summaries of such data when considering whether other swaps should be subject to the clearing requirement. The Commission also may refer to other non-public data sources, as available.

This final rulemaking also reflects consultation with the staff of the Securities and Exchange Commission, U.S. prudential regulators, and international regulatory authorities. This consultation occurred prior to the approval of the NPRM, as well as prior to the approval of this final rulemaking by the Commission. The Commission

has benefitted from this close communication with its fellow authorities throughout this rulemaking process.

Finally, the Commission considered the ten public comments received in response to the NPRM.

E. Commission Processes for Review and Surveillance of DCOs

i. Part 39 Regulations Set Forth Standards for Compliance

Section 5b(c)(2) of the CEA sets forth 18 core principles with which DCOs must comply to be registered and to maintain registration. The core principles address numerous issues, including financial resources, participant and product eligibility, risk management, settlement procedures, default management, system safeguards, reporting, recordkeeping, public information, and legal risk.

Each of the DCOs that submitted the interest rate swaps subject to this rulemaking is registered with the Commission. The DCOs' regulation 39.5(b) submissions discussed herein identify swaps that the DCOs are currently clearing and are eligible to clear under regulation 39.5(a). Consequently, the Commission has been reviewing and monitoring compliance by the DCOs with the core principles for clearing the submitted swaps.

The primary objective of the Commission's supervisory program is to ensure compliance with applicable provisions of the CEA and implementing regulations, and, in particular, the core principles applicable to DCOs. A primary concern of the program is to monitor and mitigate potential risks that can arise in derivatives clearing activities for the DCO, its members, and entities using the DCO's services. Accordingly, the Commission's supervisory program takes a risk-based approach, and pays particular attention to the risks posed by stressed market conditions, and major market events, as well as market participants' reactions to such conditions and events.

In addition to the core principles set forth in section 5b(c)(2) of the CEA, section 5c(c) governs the procedures for review and approval of new products, new rules, and rule amendments submitted to the Commission by DCOs. Part 39 of the Commission's regulations implements sections 5b and 5c(c) of the CEA by establishing specific requirements for compliance with the core principles, as well as procedures for registration, for implementing DCO rules, and for clearing new products. Part 40 of the Commission's regulations sets forth additional provisions applicable to a DCO's submission of rule amendments and new products to the Commission.

The Commission has means to enforce compliance, including the Commission's ability to sue the DCO in federal court for civil monetary penalties,

issue a cease and desist order,

or suspend or revoke the registration of the DCO.

In addition, any deficiencies or other compliance issues observed during ongoing monitoring or an examination are frequently communicated to the DCO and various measures are used by the Commission to ensure that the DCO appropriately addresses such issues, including escalating communications within the DCO management and requiring the DCO to demonstrate, in writing, timely correction of such issues.

See

section 6c of the CEA.

See

section 6b of the CEA.

See

section 5e of the CEA.

ii. Initial Registration Application Review and Periodic In-Depth Reviews

Section 5b of the CEA requires a DCO to register with the Commission. In order to do so, an organization must submit an application demonstrating that it complies with the core principles. During the review period, the Commission generally conducts an on-site review of the prospective DCO's facilities, asks a series of questions, and reviews all documentation received. The Commission may ask the applicant to make changes to its rules to comply with the CEA and the Commission's regulations.

After registration, the Commission conducts examinations of DCOs to determine whether each DCO is in compliance with the CEA and Commission regulations. Each examination begins with a planning phase where staff reviews information the Commission has to determine whether the information raises specific issues and to develop an examination plan. The examination team participates in a series of meetings with the DCO at its facility. Commission staff also communicates with relevant DCO staff, including senior management, and reviews documentation. Data produced by the DCO is independently tested. Finally, when relevant, walk-through testing is conducted for key DCO processes.

Commission staff also reviews DCOs that are systemically important (SIDCOs) at least once a year. Of the DCOs discussed in this rulemaking, only CME has been determined to be a SIDCO.

iii. Commission Daily Risk Surveillance

Commission risk surveillance staff monitors the risks posed to and by DCOs, clearing members, and market participants, including market risk, liquidity risk, credit risk, and concentration risk. The analysis includes review of daily, large trader reporting data obtained from market participants, clearing members, and DCOs, which is available at the trader, clearing member, and DCO levels. Relevant margin and financial resources information also is included within the analysis.

Commission staff regularly conducts back testing to review margin coverage at the product level and follows up with the relevant DCO regarding any exceptional results. Independent stress testing of portfolios is conducted on a daily, weekly, and ad hoc basis. The independent stress tests may lead to individual trader reviews and/or futures commission merchant (FCM) risk reviews to gain a deeper understanding of a trading strategy, risk philosophy, risk controls and mitigants, and financial resources at the trader and/or FCM level. The traders and FCMs that have a higher risk profile are then reviewed during the Commission's on-site review of a DCO's risk management procedures.

Given the importance of DCOs within the financial system and the heightened scrutiny as more transactions are moved into central clearing, the goal of the Commission risk surveillance staff is: (1) To identify positions in cleared products subject to the Commission's jurisdiction that pose significant financial risk; and (2) to confirm that these risks are being appropriately managed. Commission risk surveillance staff undertakes these tasks at the trader level, the clearing member level, and the DCO level. That is, staff identifies both traders that pose risks to clearing members and clearing members that pose risks to the DCO. Staff then evaluates the financial resources and risk management practices of traders, clearing members, and DCOs in relation to those risks. Commission risk surveillance staff routinely monitors conditions in assigned markets throughout the day. Because of the work done in identifying accounts of interest, analysts are able to focus their efforts on those traders whose positions warrant heightened scrutiny under current market conditions.

To gain insight into how markets operate during stressed market conditions, an essential technique in

evaluating risk is the use of stress testing. Stress testing is the practice of determining the potential loss (or gain) to a position or portfolio based on a hypothetical price change or a hypothetical change in a price input such as option volatility. Commission risk surveillance staff conducts a wide array of stress tests. Some stress tests are based on the greatest price move over a specified period of time such as the last five years or the greatest historical price change. Another stress testing technique is the use of “event based” stress testing that replicates the price changes on a particular date in history, such as September 11, 2001, or the date that Lehman Brothers filed for bankruptcy in 2008. Other specific events might include Hurricane Katrina, the U.S. Board of Governors of the Federal Reserve System's implementation of the Commercial Paper Funding Facility as a liquidity backstop, or, most recently, the United Kingdom (U.K.)'s vote to exit from the European Union. Price changes can be measured as a dollar amount or a percentage change. This flexibility can be helpful when price levels have changed by a large amount over time. For example, the actual price changes in equity indices in October 1987 are not particularly large at today's market levels but the percentage changes are meaningful.

The general standard in designing stress tests is to use “extreme but plausible” market moves. After identifying accounts at risk and estimating the size of the risk, the third step is to compare that risk to the assets available to cover it. Because stress testing, by definition, involves extreme moves, hypothetical results will exceed initial margin requirements on a product basis,

i.e.,

the price moves will be in the 1% tail. Many large traders, however, carry portfolios of positions with offsetting characteristics. In addition, many traders and clearing members deposit excess initial margin in their accounts. Therefore, even under stressed conditions, in many instances the total initial margin available may exceed potential losses or the shortfall may be relatively small.

Each DCO maintains a financial resources package that protects the DCO against clearing member defaults. If a clearing member defaults on its obligations, the first layer of protection against a DCO default is the defaulting clearing member's initial margin, as well as the defaulting clearing member's guaranty fund contribution. The second layer of protection against a DCO default, after the defaulting clearing member's initial margin and guaranty fund contribution, is the DCO's capital contribution. The third layer of protection against a DCO default is the DCO's mutualized resources, which often include guaranty fund contributions of non-defaulting clearing members and assessments of non-defaulting clearing members. These layers of protection comprise the DCO's financial resources package.

Commission risk surveillance staff compares the level of risk posed by clearing members to a DCO's financial resources package on an ongoing basis. Pursuant to Commission regulation 39.11(a), a DCO must have sufficient financial resources to cover a default by the clearing member posing the largest risk to the DCO. Pursuant to Commission regulation 39.33(a), a SIDCO

must have sufficient financial resources to cover defaults by the clearing members posing the two largest risks to the DCO. Commission risk surveillance staff periodically compares stress test results with DCOs to assess their financial capacity.

DCOs that elect to be covered under subpart C of part 39 of the Commission's regulations also are subject to this requirement.

Commission risk surveillance staff frequently discusses the risks of particular accounts or positions with relevant DCOs. For example, as a follow-up to a trader review, Commission risk surveillance staff might compare its stress test results with those of the DCO. As also noted above, in the case of FCMs, there have been instances where, as a result of Commission risk surveillance staff comments or inquiries, DCOs have taken action to revise their stress tests and/or financial resources package to align with Commission risk surveillance staff's recommendations.

II. Comments on the Notice of Proposed Rulemaking

A. Overview of Comments Received

The Commission received 10 comment letters during the 30-day public comment period following publication of the NPRM.

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

http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1711.

The following organizations submitted comment letters: Asset Management Group of the Securities Industry and Financial Markets Association (SIFMA AMG); ASX Clear (Futures) Pty Limited (ASX); Better Markets Inc. (Better Markets); Citadel LLC (Citadel); CME Group Inc. (CME Group); International Swaps and Derivatives Association, Inc. (ISDA); Japanese Bankers Association (JBA); LCH Group Limited (LCH Group); the Managed Funds Association (MFA); and Scotiabank Inverlat, S.A. (Scotiabank).

i. Majority of Commenters Express Support for Proposal

Seven commenters (Better Markets, Citadel, CME Group, ISDA, LCH Group, MFA, and SIFMA AMG) voiced support for the proposed expansion of the clearing requirement and agreed with the Commission's analysis that the expanded clearing requirement would enhance financial stability by reducing systemic risk, improving market integrity, or increasing transparency in the swap market. Two commenters, Scotiabank and ASX, provided clarifying comments with respect to product specifications, but did not express explicit support for the proposal overall. One commenter, JBA, requested that the Commission reconsider its proposal to expand the interest rate swaps clearing requirement in light of the increasing number of clearing brokers withdrawing from the swaps clearing business due to rising costs.

ii. Substantive Issues Related to Product Specifications

One commenter, Scotiabank, discussed the specifications of the MXN-denominated fixed-to-floating interest rate swaps included in the Commission's proposed expanded fixed-to-floating interest rate swap class.

Another commenter, ASX, addressed the Commission's proposed inclusion of AUD-denominated FRAs in the expanded FRA class.

See

discussion of Scotiabank's comment letter in section III.

See

discussion of ASX's comment letter in sections II and III.

iii. Implementation and Harmonization

Most commenters responded to the NPRM's request for comment concerning the advantages and disadvantages of a simultaneous effective date versus a series of compliance dates that would coordinate implementation with clearing requirements issued by non-U.S. jurisdictions.

See

discussion of implementation issues and related comment letters in section IV.

Six commenters, CME Group, Citadel, ISDA, LCH Group, MFA, and SIFMA AMG all supported the Commission's goal of harmonizing its clearing requirement with those of non-U.S. jurisdictions. Citadel commented that such harmonization would lead to the benefit of eliminating regulatory arbitrage. LCH Group stated that such harmonization would promote certainty for market participants. SIFMA AMG commented that such harmonization would improve the functioning of swaps markets and reduce operational

complexity. ISDA commented that harmonization is crucial to effective and efficient implementation of all of the reforms of the derivatives markets sought by the G20. MFA commented that the Commission's approach to harmonizing its clearing requirement with those of other jurisdictions would increase transparency and market integrity. MFA also suggested that if the Commission proceeds with the expanded clearing requirement, then other jurisdictions will follow.

iv. Data Considered by the Commission

One commenter, Citadel, complimented the Commission for assessing the extent of outstanding notional exposures of the swaps covered by the NPRM using multiple sources of data.

Another commenter, ISDA, suggested that the Commission review data indicating the impact of the proposed expanded clearing requirement on market participants in particular jurisdictions.

See

section III.B.iii.a.

See

discussion of ISDA's comment letter in section II.C.ii.

v. Clarification

Two commenters, JBA and Scotiabank, requested clarification as to whether the expanded clearing requirement would only apply to new swaps entered into after the applicable compliance date and whether previously executed swaps would be required to be “backloaded” to clearing.

See

discussion of JBA's and Scotiabank's comment letters in section III.

vi. Access to DCOs and Clearing Members

One commenter, JBA, raised concerns about market participants needing to establish a clearing relationship with a new DCO in order to comply with the expanded clearing requirement.

Another commenter, CME Group, raised concerns about the ability of relatively small market participants to establish an account with a clearing member.

See

discussion of JBA's comment letter in sections II.B.iii.d and V.C.

See

discussion of CME Group's comment letter in section II.C.i and section V.C.

vii. Trade Execution Requirement

Three comment letters discussed the possibility of a trade execution requirement applying to some or all of the interest rate swaps subject to this rulemaking.

See

discussion of Citadel's, ISDA's, and SIFMA AMG's comment letters in section II.C.iii.

B. Determination Analysis

i. Background Information on Interest Rate Swaps

Interest rate swaps generally are agreements wherein counterparties agree to exchange payments based on a series of cash flows over a specified period of time, typically calculated using two different rates, multiplied by a notional amount. As of June 2015, according to an estimate by BIS, there was approximately $435 trillion in outstanding notional of interest rate swaps, which represents approximately 79% of the total outstanding notional of all derivatives.

Semi-Annual OTC Derivatives Statistics at End-June 2015, published December 2015 available at:

https://www.bis.org/statistics/d5_1.pdf.

The BIS data provides the broadest market-wide estimates of interest rate swap activity available to the Commission. The Commission receives swaps market information pursuant to parts 43 and 45 of the Commission's regulations.

See also

Swap Data Recordkeeping and Reporting Requirements, 77 FR 2136 (Jan. 13, 2012); Real-Time Public Reporting of Swap Transaction Data, 77 FR 1182 (Jan. 9, 2012). However, this data only includes swaps subject to the Commission's jurisdiction,

i.e.,

those swaps subject to the CEA. The BIS data represents the broader swaps market, some of which is not reportable to the Commission under the CEA.

Section 2(h)(2)(A)(i) of the CEA provides that the Commission shall review each swap, or any group, category, type, or class of swaps to make a determination as to whether the swap or group, category, type, or class of swaps should be required to be cleared. This final rulemaking adds to the four classes of interest rate swaps that the Commission defined in the First Clearing Requirement Determination:

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

2. Basis swaps: Swaps for which the payments for both legs are calculated using floating rates.

3. Forward rate agreements: Swaps in which payments are exchanged on a pre-determined date for a single specified period and one leg of the swap is calculated using a fixed rate and the other leg is calculated using a floating rate that is set on a pre-determined date.

4. Overnight index swaps: Swaps for which one leg of the swap is calculated using a fixed rate and the other leg is calculated using a floating rate based on a daily overnight rate.

Interest rate swaps within the classes described above are currently required to be cleared pursuant to regulation 50.4(a) if they meet certain specifications: (i) Currency in which notional and payment amounts of a swap are specified; (ii) floating rate index referenced in the swap; and (iii) stated termination date of the swap. The Commission also included the following three “negative” specifications:

(i) No optionality; (ii) no dual currencies; and (iii) no conditional notional amounts.

This clearing requirement determination analyzes the additional interest rate swaps submitted by CME, Eurex, LCH, and SGX according to these classifications and specifications.

The negative specifications are product specifications that are explicitly excluded from the clearing requirement. All specifications are listed in regulation 50.4(a).

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

See

77 FR at 74302 n. 108.

ii. Consistency With Core Principles for Derivatives Clearing Organizations

Section 2(h)(2)(D)(i) of the CEA requires the Commission to determine whether a clearing requirement determination would be consistent with the core principles for registered DCOs set forth in section 5b(c)(2) of the CEA and implemented in part 39 of the Commission's regulations.

CME, Eurex, LCH, and SGX, each a registered DCO, already clear the swaps identified in the regulation 39.5(b) submissions described above.

Accordingly, CME, Eurex, LCH, and SGX already are required to comply with the DCO core principles with respect to the interest rate swaps subject to this final rulemaking. Moreover, each of these DCOs has been, and is, subject to the

Commission's review and surveillance procedures, as discussed above, with respect to these swaps.

The core principles address numerous issues, including financial resources, participant and product eligibility, risk management, settlement procedures, default management, system safeguards, reporting, recordkeeping, public information, and legal risk.

See

sections 5b(c)(2)(A)-(R) of the CEA and 17 CFR part 39, subparts B and C.

Currently, CME is the only registered DCO offering MXN-denominated fixed-to-floating interest rate swaps for clearing. As noted above, LCH has filed a § 39.5(b) submission regarding this swap and will begin offering MXN-denominated fixed-to-floating interest rate swaps for clearing beginning in early October 2016. Similarly, LCH is the only registered DCO clearing AUD- and CAD-denominated OIS at this time. CME has confirmed that it intends to file § 39.5(b) submissions regarding these swaps before the end of 2016, and it is not likely to need to change its risk management framework to do so.

For the purposes of reviewing whether the regulation 39.5(b) submissions are consistent with the DCO core principles, the Commission has relied on both the information received in the regulation 39.5(b) submissions and, as discussed above, its ongoing review and risk surveillance programs.

The Commission concludes that CME, Eurex, LCH, and SGX are capable of maintaining compliance with the DCO core principles following the adoption of this clearing requirement determination. The Commission has not found any evidence to conclude that subjecting any of the interest rates swaps identified herein to a clearing requirement would adversely affect compliance by CME, Eurex, LCH, or SGX with the DCO core principles. In response to the NPRM, LCH Group commented on this topic, stating that it does not believe that the clearing requirement would adversely impact its ability to comply with the DCO core principles. Accordingly, the Commission believes that each of the regulation 39.5(b) submissions discussed herein is consistent with section 5b(c)(2) of the CEA.

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

Section 2(h)(2)(D)(ii)(I)-(V) of the CEA identifies five factors that the Commission must “take into account” in making a clearing requirement determination.

In regulation 39.5(b), the Commission developed a process for reviewing DCO swap submissions to determine whether such swaps should be subject to a clearing requirement determination. The following is the Commission's consideration of the five factors as they relate to: (1) Fixed-to-floating interest rate swaps denominated in the nine additional currencies; (2) AUD-denominated basis swaps; (3) NOK-, PLN-, and SEK-denominated FRAs; and (4) USD-, EUR-, and GBP-denominated OIS with termination dates of up to three years; and AUD- and CAD-denominated OIS, as submitted by CME, Eurex, LCH, and/or SGX pursuant to regulation 39.5(b).

The factors are:

(1) The existence of significant outstanding notional exposures, trading liquidity, and adequate pricing data;

(2) The availability of rule framework, capacity, operational expertise and resources, and credit support infrastructure to clear the contract on terms that are consistent with the material terms and trading conventions on which the contract is then traded;

(3) The effect on the mitigation of systemic risk, taking into account the size of the market for such contract and the resources of the DCO available to clear the contract;

(4) The effect on competition, including appropriate fees and charges applied to clearing; and

(5) The existence of reasonable legal certainty in the event of the insolvency of the relevant DCO or one or more of its clearing members with regard to the treatment of customer and swap counterparty positions, funds, and property.

As it reviewed the five statutory factors for this clearing requirement, the Commission considered the effect a new clearing mandate will have on a DCO's ability to withstand stressed market conditions. The post-financial crisis reforms that have increased the use of central clearing also have increased the importance of ensuring that central counterparties are resilient, particularly in times of market stress. The Commission has been working with other domestic and international regulators to make sure that adequate measures are taken to address the potential financial stability risks posed by central counterparties.

The Commission is focused on the financial stability of DCOs and is committed to monitoring all potential risks they face, including those related to increased clearing due to a new clearing requirement determination. Accordingly, how DCOs manage risk during times of market stress, as well as whether DCOs could manage the incremental risk in stressed market conditions that may result from the Commission requiring that these swaps be cleared, are critical factors that the Commission considered in issuing this final rulemaking.

The Commission's Market Risk Advisory Committee hosted a meeting on June 27, 2016, to discuss central counterparty coordination in default management, global systemically important bank resolution, and central counterparty resolution, webcast available at:

http://www.cftc.gov/Exit/index.htm?https:/youtu.be/fxQDh5lnh9c. See

CFTC Press Release PR7386-16, announcing the meeting agenda (June 16, 2016), available at:

http://www.cftc.gov/PressRoom/PressReleases/pr7391-16.

a. Factor (I)—Outstanding Notional Exposures, Trading Liquidity, and Adequate Pricing Data

The first of the five factors requires the Commission to consider “the existence of significant outstanding notional exposures, trading liquidity, and adequate pricing data” related to “a submission made [by a DCO].”

As explained in the proposal for the First Clearing Requirement Determination, there is no single source of data for notional exposures and trading liquidity for individual products within the global interest rate swap market.

Despite significant progress with regard to trade reporting over the years since the 2008 financial crisis, this remains true. Nonetheless, the Commission has considered multiple sources of data

on the interest rate swap market that provide the information the Commission needs to evaluate the first factor, including: (1) Publicly available real time data disseminated by DTCC Data Repository (U.S.) LLC (DDR), a provisionally-registered swap data repository (SDR),

pursuant to part 43 Data; (2) data from CME, Eurex, LCH, and SGX collected in their capacities as DCOs; (3) data from the BIS; (4) data from ISDA; and (5) data from the Futures Industry Association (FIA).

See

section 2(h)(2)(D)(ii) of the CEA.

See

77 FR 47170, 47193 and n. 100 (Aug. 7, 2012) (citing Bank of England, “Thoughts on Determining Central Clearing Eligibility of OTC Derivatives,” Financial Stability Paper No. 14, March 2012, at 11, available at:

http://www.bankofengland.co.uk/financialstability/Documents/fpc/fspapers/fs_paper14.pdf.

) As discussed above, the Commission receives data regarding swaps subject to its jurisdiction pursuant to parts 43 and 45 of the Commission's regulations. The Commission also receives regular reporting from registered DCOs, as well as its registered entities.

The Commission reviews part 43 Data, as well as data from CME, Eurex, LCH, and SGX, on an ongoing basis. Although the part 43 Data that is included in section II.B.iii is dated as of the second quarter 2015, Commission staff has not observed significant changes in the level of trading activity that would cause the Commission to change its finding that there is regular trading activity in these markets, as well as a measurable amount of data, such that there are significant outstanding notional exposures and trading liquidity in the swaps subject to this determination. In addition, although the data from DCOs presented in section II.B.iii is dated as of the second quarter 2015, Commission staff has not observed significant changes in the notional amounts outstanding or the aggregate notional values of swaps being cleared that would cause the Commission to change its finding that there are significant outstanding notional exposures and trading liquidity in the swaps subject to this final rulemaking. No commenters raised concerns about this data or offered additional data.

CME SDR and BSDR LLC, each a provisionally-registered SDR, accept data regarding interest rate swaps, but have not collected sufficient data relevant to the time periods considered by this determination. ICE Trade Vault, LLC, another provisionally-registered SDR, did not accept interest rate swap data during the time periods relevant to this final rulemaking.

In the First Clearing Requirement Determination, the Commission also considered (i) market data published weekly by TriOptima that covered swap trade information submitted voluntarily by 14 large derivatives dealers and (ii) trade-by-trade data provided voluntarily by the 14 dealers to the OTC Derivatives Supervisors Group (ODSG).

See

77 FR at 74307. The Commission is not using these sources for the determination adopted today because TriOptima no longer collects its data, and the ODSG data was a one-time exercise conducted between June and August 2010.

Outstanding Notional Exposures and Trading Liquidity: Fixed-to-Floating Interest Rate Swaps Denominated in the Nine Additional Currencies

In assessing the extent of outstanding notional exposures and trading liquidity for a particular swap, the Commission reviews various data series to ascertain whether there is an active market for the swap, including whether the swap is traded on a regular basis as reflected by trade count and whether there is a measurable amount of notional exposures, such that a DCO can adequately risk manage the swap. In particular, the Commission reviewed the aggregate notional exposure and the trade count data from a number of sources for each swap subject to this determination. While there is no defined standard for an active market,

the Commission believes the data indicates that there are sufficient outstanding notional exposures and trading liquidity for fixed-to-floating interest rate swaps denominated in the nine additional currencies to support a clearing requirement determination. The Part 43 Data presented in Table 2 generally demonstrates that there is significant activity in new fixed-to-floating interest rate swap trades denominated in each of the nine additional currencies. Table 2 presents aggregate notional values and trade counts of fixed-to-floating interest rate swaps denominated in these currencies that were executed during the three-month period from April 1 to June 30, 2015.

A line of economic research papers analyzing the impact of central clearing on liquidity in over-the-counter derivatives have used three or more alternative methods of calculating liquidity based on academic research. These transaction-based methods for measuring liquidity are informative for assessing and understanding what constitutes an active market.

See

Loon, Y. C. and Zhong, Z. K., The impact of central clearing on counterparty risk, liquidity, and trading: Evidence from the credit default swap market. Journal of Financial Economics, 112 (1), 91-115 (2014) at 98, available at:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2176561. See also

Loon, Y. C. and Zhong, Z. K., Does Dodd-Frank affect OTC transaction costs and liquidity? Evidence from real-time CDS trade reports. Journal of Financial Economics, 119 (3), 645-672 (2016) at 647, available at:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2443654.

The data on notional amounts the Commission receives for interest rate swaps pursuant to part 43 is subject to caps, which vary based on currency, reference rate, swap class (

e.g.,

FRA vs. OIS), and maturity of the underlying swap. As a result, the data in Table 2 will underestimate the amount of notional outstanding for the reported trades, as around 25% of the trades contained capped notional amounts.

See

17 CFR 43.4(h). According to the adopting release accompanying part 43, the Commission caps notional amounts to ensure the anonymity of the parties to a large swap and maintain the confidentiality of business transactions and market positions.

See

Real-Time Public Reporting of Swap Transaction Data, 77 FR 1182, 1213 (Jan. 9, 2012). The rules were amended in May 2013 as they relate to caps.

See

Procedures to Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades, 78 FR 32866 (May 31, 2013).

The Commission notes the market for any swap is global. Even if the bulk of the activity in a particular swap occurs between counterparties located in a single jurisdiction, Table 2 demonstrates that there is significant participation by U.S. persons in each of the swaps covered by this determination.

Because Table 2 is based on Part 43 Data, it should include only data related to those swaps for which at least one counterparty is a U.S. person.

See also

further discussion of this topic in response to a comment from ISDA at section II.C.ii.

Under the Commission's general policy, neither part 43 reporting nor the clearing requirement apply to a swap where neither counterparty is a U.S. person (although these requirements generally would apply, with the possibility of substituted compliance, to certain swaps involving foreign branches of U.S. SDs or major swap participants (MSPs), or non-U.S. persons that are guaranteed by or affiliate conduits of U.S. persons).

See

Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 FR 45292, 45369-70 (July 26, 2013). Therefore, part 43 reporting applies whenever at least one counterparty to a swap is a U.S. person.

This table reflects data that was publically disseminated by DDR and reported to it by the reporting counterparty, a swap execution facility (SEF), or designated contract market (DCM) pursuant to part 43. As such, the Commission did not independently verify the accuracy of the swap data. The transactions disseminated to the public were rounded pursuant to regulation 43.4(g). As a result, this table may underestimate the amount of notional outstanding for the reported trades. This table does not include cancelled and corrected swaps that counterparties reported under part 43. The Commission converted the notional amounts to USD according to the exchange rates of June 30, 2015. Three other SDRs provisionally-registered with the Commission, CME SDR, BSDR LLC, and ICE Trade Vault LLC also accept information pursuant to part 43. During the second quarter of 2015, none of those SDRs collected sufficient information regarding the interest rate swaps subject to this rulemaking.

Table 2—Part 43 Data Fixed-to-Floating Interest Rate Swaps Aggregate Notional Amounts and Trade Counts Reported Second Quarter 2015

Currency

Aggregate notional

(USD)

Trade count

MXN

$403,621,757,132

15,492

CAD

318,497,173,863

4,125

AUD

322,042,446,624

4,898

SEK

82,092,397,444

1,779

PLN

47,267,162,195

1,463

NOK

23,974,272,144

659

SGD

45,618,398,397

995

CHF

48,986,953,725

899

HKD

21,704,787,338

469

Table 3.1 demonstrates the outstanding notional amounts of fixed-to-floating interest rate swaps, denominated in each of the nine additional currencies except for MXN, cleared at LCH as of July 17, 2015.

As mentioned above, LCH will commence clearing fixed-to-floating interest rate swaps denominated in MXN in October 2016.

Table 3.1—LCH Data Fixed-to-Floating Interest Rate Swaps Outstanding Notional Amounts As of July 17, 2015

Currency

Outstanding notional

(USD)

CAD

$3,479,830,407,148

AUD

3,311,898,621,627

CHF

1,110,123,528,868

SEK

942,508,451,280

SGD

735,450,982,935

PLN

500,992,688,256

NOK

402,746,575,455

HKD

385,067,416,327

Table 3.2 describes

the aggregate notional values and trade counts of fixed-to-floating interest rate swaps denominated in these currencies that were cleared at LCH during the three-month period from April 1 to June 30, 2015.

Data includes zero coupon swaps and variable notional swaps and excludes basis swaps, FRAs, and OIS. LCH converted values to USD. All data from LCH cited in this rulemaking is “single-sided,” which means that the outstanding notional amounts correspond to the notional amounts of swaps submitted for clearing. Single-sided reporting from LCH, as well as data reported by CME and SGX, refers to the same concept insofar as all modes of reporting reflect the total notional amounts outstanding at the DCO based on the swaps submitted for clearing. When two counterparties submit a swap to the clearinghouse for clearing through novation, the clearinghouse becomes the new counterparty to each of the original counterparties. This novation process results in double-counting, and single-sided reporting reflects the actual number of trades submitted to a clearinghouse for clearing.

See

note 85 for an explanation of CME's single-sided data. LCH publishes outstanding notional amounts of the swaps it has cleared.

See

LCH's Web site, available at:

http://www.swapclear.com/what/clearing-volumes.html.

Table 3.2—LCH Data Fixed-to-Floating Interest Rate Swaps Aggregate Notional Amounts Cleared and Trade Counts

Second Quarter 2015

Currency

Aggregate notional

(USD)

Trade count

AUD

$747,580,867,222

11,675

CAD

591,935,914,049

8,097

SEK

192,434,187,521

5,827

SGD

188,573,379,738

4,872

CHF

175,203,370,522

3,659

PLN

99,184,390,887

4,249

NOK

72,569,065,080

2,855

HKD

65,655,762,520

1,868

Table 4.1 demonstrates

the outstanding notional amounts of fixed-to-floating interest rate swaps, denominated in each of the nine additional currencies, cleared at CME as of July 17, 2015.

Like the outstanding notional data, this data includes zero coupon swaps and variable notional swaps.

The aggregate notional amounts cleared at LCH will appear to be greater than that reflected in the part 43 Data because the part 43 Data captures only swap data subject to the CEA, while LCH, an entity organized in the United Kingdom, clears swaps for entities that may not be subject to the Commission's jurisdiction. The fact that LCH's notional amounts are higher supports this clearing requirement determination because it suggests that there may be greater liquidity in these swaps outside the U.S., of which DCOs could take advantage in order successfully to risk manage and price these swaps.

Table 4.1—CME Data Fixed-to-Floating Interest Rate Swaps Outstanding Notional Amounts

as of July 17, 2015

Currency

Outstanding notional

(USD)

CAD

$295,213,937,641

MXN

283,989,842,748

AUD

192,208,979,188

SEK

30,834,434,233

NOK

25,396,100,018

CHF

18,322,872,584

PLN

4,157,627,521

HKD

1,937,495,645

SGD

1,014,201,616

Table 4.2 describes the aggregate notional values and trade counts of fixed-to-floating interest rate swaps denominated in these currencies that were cleared at CME during

the three-month period from April 1 to June 30, 2015.

CME uses the term “open interest” to refer to outstanding notional amounts. Both terms—“open interest” and “outstanding notional amounts”—refer to the same concept. CME converted the values to USD. As noted above, like the LCH data cited in this rulemaking, all data from CME is “single-sided,” which means that the outstanding notional amounts correspond to the notional amounts of swaps submitted for clearing.

Data excludes basis swaps, FRAs, and OIS. CME publishes open interest amounts of the swaps it has cleared.

See

CME's Web site, available at:

http://www.cmegroup.com/trading/interest-rates/cleared-otc/#data.

Table 4.2—CME Data Fixed-to-Floating Interest Rate Swaps Aggregate Notional Amounts Cleared and Trade Counts Second Quarter 2015

Currency

Aggregate notional

(USD)

Trade count

MXN

$193,941,151,671

7,749

AUD

51,591,005,387

1,194

CAD

91,523,261,511

2,995

SEK

9,712,957,726

998

NOK

5,298,232,932

422

CHF

2,665,840,791

173

PLN

1,097,490,552

577

SGD

355,136,534

HKD

211,815,688

As of July 17, 2015, the outstanding notional amount of SGD-denominated fixed-to-floating interest rate swaps cleared at SGX was $58.5 billion.

SGX converted this value from SGD to USD. This figure is “single-sided,” which means that the outstanding notional amount corresponds to the notional amounts of swaps submitted for clearing. SGX publishes outstanding notional amounts on its Web site, available at:

http://www.sgx.com.

As another data source, the Commission looked to BIS data. BIS' 2013 triennial central bank survey for interest rate swaps describes the daily average notional values of interest rate swaps, including fixed-to-floating interest rate swaps, on a worldwide basis, denominated in each of the nine additional currencies.

Table 5—Excerpt From BIS Triennial Central Bank Survey 2013

Over-the-Counter Single Currency Interest Rate Derivatives Turnover

Currency

Daily average notional of swaps

(including fixed-to-floating), worldwide

(USD)

AUD

$62,854,000,000

CAD

26,794,000,000

SEK

14,618,000,000

MXN

9,285,000,000

CHF

5,335,000,000

SGD

3,349,000,000

NOK

2,560,000,000

PLN

2,138,000,000

HKD

1,992,000,000

More recently, BIS

has published statistics showing significant outstanding notional amounts forCAD-, CHF-, and SEK-denominated interest rate swaps: Approximately $10.3 trillion CAD-denominated, approximately $3.2 trillion CHF-denominated, and approximately $2.4 trillion SEK-denominated.

BIS Triennial Central Bank Survey, Interest Rate Derivatives Market Turnover in 2013, Tables 1 and 2.1-2.6 (December 2013), available at:

http://www.bis.org/publ/rpfxf13irt.pdf.

Data as of April 2013. BIS converted the figures to USD.

Interest rate derivatives by instrument, counterparty, and currency. Notional amounts outstanding, expressed in USD, at end June 2015, available at:

http://stats.bis.org/statx/srs/table/d7?p=20151&c=.

This report does not provide data specific to interest rate swaps denominated in all nine additional currencies.

On a daily basis, using data collected from DDR, ISDA's “SwapsInfo” report publishes the notional value and trade counts of fixed-to-floating interest rate swaps denominated in four of the nine additional currencies.

For example, Table 6 shows the aggregate notional values and trade counts of such swaps entered into on September 15, 2015.

SwapsInfo provides data from two SDRs—DDR and BSDR LLC—that is “required to be disclosed under U.S. regulatory guidelines.” SwapsInfo does not provide information specific to interest rate swaps denominated in all nine additional currencies. The SwapsInfo referenced in Table 6 only includes information from DDR.

See

SwapsInfo Web site, available at:

http://www.swapsinfo.org/charts/derivatives/price-transaction.

Table 6—Excerpt From ISDA SwapsInfo Interest Rate Derivatives—Price/Transaction Data Fixed-to-Floating Interest Rate Swaps

Currency

Approximate

aggregate notional

amount executed on

September 15, 2015

(USD)

Aggregate trade count executed on

September 15, 2015

AUD

$2,143,376,093

CAD

1,515,366,916

MXN

283,339,847

142

PLN

141,249,743

The Commission

also reviewed data published by the FIA, in its “SEF Tracker” report,

consisting of weekly aggregate notional values of interest rate swaps, including FRAs, denominated in various currencies, including five of the nine additional currencies, which have been transacted on 12 SEFs that are now registered with the Commission.

Table 7 shows the aggregate notional values of interest rate swaps denominated in AUD, CAD, MXN, PLN, and SEK executed on SEFs during the week of May 25, 2015, as well as such swaps denominated in CHF, HKD, and NOK.

The Commission converted the values to USD as of Sept. 18, 2015. ISDA SwapsInfo does not provide data for CHF-, HKD-, NOK-, SEK-, or SGD-denominated interest rate swaps.

SEF Tracker is published periodically on FIA's Web site, available at:

https://fia.org/sef-tracker.

The SEFs include: BGC Derivatives Markets, L.P.; Bloomberg SEF LLC; DW SEF LLC; GFI Swaps Exchange LLC; Javelin SEF, LLC; ICAP SEF (US) LLC; ICAP Global Derivatives Limited; LatAm SEF, LLC; Tradition SEF, Inc.; trueEx LLC; tpSEF Inc.; and TW SEF LLC. The Commission recognizes that under section 2(h)(8) of the CEA and Commission regulations 37.10 and 38.12, the Commission could in the future act to adopt a trade execution requirement for some or all of the interest rate swaps subject to the clearing requirement adopted in this rulemaking. The adoption of a clearing requirement determination is a prerequisite for any subsequent trade execution requirement.

See also

note 76.

The published report does not contain information for CHF-, HKD-, and NOK-denominated

interest rate swaps. FIA provided figures for those swaps to the Commission. According to FIA, no SGD-denominated interest rate swaps were transacted on SEFs during the week of May 25, 2015. During the week of July 26, 2015, the aggregate notional amount of SGD-denominated interest rate swaps executed on SEFs was $7,305,402.

Table 7—FIA Data Weekly Notional Volume of Interest Rate Swaps (including FRAs) by Currency

Currency

Aggregate weekly

notional executed

on SEFs week

of May 25, 2015

(USD)

AUD

$36,194,670,000

MXN

19,526,810,000

CAD

12,527,450,000

CHF

6,686,971,251

SEK

5,958,000,000

PLN

1,420,000,000

NOK

1,403,918,860

HKD

51,589,605

In summary, the

data indicates varying levels of activity, measured by outstanding notional amounts and trade counts, in fixed-to-floating interest rate swaps denominated in the nine additional currencies. The Commission acknowledges that the data comes from various, limited periods of time that do not explicitly include periods of market stress. However, the Commission concludes that the data demonstrates sufficient regular trading activity and outstanding notional exposures in the fixed-to-floating interest rate swaps denominated in the nine additional currencies to provide the liquidity necessary for DCOs to successfully risk manage these products and to support the adoption of a clearing requirement. Accordingly, the Commission concludes that there is sufficient regular trading activity and outstanding notional exposures for all fixed-to-floating swaps subject to this rulemaking.

May 2015 edition of FIA SEF Tracker, available at:

https://fia.org/articles/fia-releases-sef-tracker-report-may.

FIA converted the values to USD.

2. Outstanding Notional Exposures and Trading Liquidity: AUD-Denominated Basis Swaps

The First Clearing Requirement Determination required the clearing of certain USD-, EUR-, GBP-, and JPY-denominated basis swaps. As part of this clearing requirement determination, the Commission is expanding the basis swap class to include AUD-denominated basis swaps, as proposed.

According to part 43 Data, 366 new AUD-denominated basis swaps were executed during the three-month period from April 1 to June 30, 2015. The aggregate notional amount of these swaps was $32,559,762,900.

Also, during this period, there was no volume of AUD-denominated basis swaps cleared at CME, but the outstanding notional amount in such swaps cleared at CME as of June 30, 2015 was $69,662,645,400. During the second quarter of 2015, 786 new AUD-denominated basis swaps were cleared at LCH. The aggregate notional amount of these swaps was $74,012,261,949. As of July 17, 2015, the outstanding notional amount of AUD-denominated basis swaps cleared at CME and LCH was $183,995,548,759 and $443,819,944,145, respectively.

100

This figure comes from data that was publically disseminated by DDR and reported to it by the reporting counterparty, a SEF, or a DCM pursuant to part 43. As such, the Commission did not independently verify the accuracy of the swap data. The transactions disseminated to the public were rounded pursuant to regulation 43.4(g). As a result, this figure may underestimate the amount of notional outstanding for the reported trades. This figure does not include cancelled and corrected swaps that counterparties reported under part 43. The Commission converted the aggregate notional amount to USD according to the exchange rates of June 30, 2015.

100

CME and LCH converted these figures to USD.

While the data considered above comes from limited periods of time that do not explicitly include periods of market stress, the Commission concludes that the data demonstrates sufficient regular trading activity and outstanding notional exposures in AUD-denominated basis swaps to provide the liquidity necessary for DCOs to successfully risk manage these products and to support the adoption of a clearing requirement, as proposed. Accordingly, the Commission concludes that there is sufficient regular trading activity and outstanding notional exposures for AUD-denominated basis swaps subject to this rulemaking.

3. Outstanding Notional Exposures and Trading Liquidity: NOK-, PLN-, and SEK-Denominated FRAs

The First Clearing Requirement Determination required the clearing of certain USD-, EUR-, GBP-, and JPY-denominated FRAs. As part of the clearing requirement determination issued today, the Commission has decided to amend the FRA class to include only the NOK-, PLN-, and SEK-denominated FRAs proposed.

At this time, the Commission has decided not to include AUD-denominated FRAs as part of its expanded clearing requirement. This decision is based on several factors. First, the Australian authorities have postponed required clearing of AUD-denominated FRAs until July 2018.

101

Second, ASX commented that it would not be prudent for the Commission to finalize a clearing requirement for this product in light of the delay in the Australian clearing requirement for this product. Finally, ASX stated that it has observed a general trend in the Australian domestic market away from FRAs and towards single-period swaps instead.

102

While there is currently a date certain on which Australian authorities will require clearing in AUD-denominated FRAs, the Commission is electing not to finalize its proposal with regard to AUD-denominated FRAs, will continue to monitor the market for AUD-denominated FRAs, and may take further action with regard to this product as appropriate.

101

See

ASIC Derivative Transaction Rules (Clearing) 2015, at 9, available at

https://www.comlaw.gov.au/Details/F2015L01960.

102

See also

Aaron Woolner, “Australian clearing volumes steady despite new mandate,” Risk.net, Apr. 27, 2016,

http://www.risk.net/asia-risk/news/2456034/australian-clearing-volumes-steady-despite-new-mandate

(explaining that Australian dollar FRAs present clearinghouses with an operational challenge insofar as AUD-denominated FRAs settle and fix on the same day, which creates problems for clearinghouses because their end-of-day process will not complete until the start of the next Asia-Pacific trading day) (article on file with the Commission and available upon request).

Table 8 presents aggregate notional amounts and trade counts of NOK-, PLN-, and SEK-denominated FRAs executed during the second quarter of 2015, collected by DDR.

Table 8—Part 43 Data FRAs Aggregate Notional Amounts and Trade Counts Reported Second Quarter 2015

103

Currency

Aggregate notional

(USD)

Trade count

SEK

$183,646,587,508

514

NOK

105,087,098,253

397

PLN

14,455,487,594

103

Table 9.1

presents the outstanding notional amounts of NOK-, PLN-, and SEK-denominated FRAs cleared at LCH as of July 17, 2015.

103

This table reflects data that was publically disseminated by DDR and reported to it by the reporting counterparty, a SEF, or DCM pursuant to part 43. As such, the Commission did not independently verify the accuracy of the swap data. The transactions disseminated to the public were rounded pursuant to regulation 43.4(g). As a result, this table may underestimate the amount of notional outstanding for the reported trades. This table does not include cancelled and corrected swaps that counterparties reported under part 43. The Commission converted the notional amounts to USD according to the exchange rates of June 30, 2015.

Table 9.1—LCH Data FRAs Outstanding Notional Amounts As of July 17, 2015

Currency

Outstanding notional

(USD)

SEK

$706,370,365,302

NOK

544,670,239,925

PLN

274,120,726,256

Table 9.2 presents the aggregate notional values and trade counts of NOK-, PLN-, and SEK-denominated FRAs cleared at LCH during the second quarter of 2015.

Table 9.2—LCH Data FRAs Aggregate Notional Amounts Cleared and Trade Counts Second Quarter 2015

Currency

Aggregate notional

(USD)

Trade count

SEK

$369,900,226,814

1,600

NOK

348,764,102,890

1,874

PLN

232,246,791,831

1,029

Table 10.1 presents the outstanding notional amounts of NOK-, PLN-, and SEK-denominated FRAs cleared at CME as of July 17, 2015.

Table 10.1—CME Data FRAs Outstanding Notional Amounts As of July 17, 2015

Currency

Outstanding notional

(USD)

SEK

$1,448,168,085

PLN

360,386,524

NOK

122,512,986

Table 10.2 presents the aggregate notional amounts and trade counts of NOK-, PLN-, and SEK-denominated FRAs cleared at CME during the second quarter of 2015.

Table 10.2—CME Data FRAs Aggregate Notional Amounts Cleared and Trade Counts Second Quarter 2015

104

Currency

Aggregate notional

(USD)

Trade count

SEK

$1,504,300,488

NOK

PLN

The Commission

recognizes that the part 43 Data provided in Table 8 comes from a limited period of time that does not explicitly include periods of market stress. The Commission also notes the absence of any clearing activity at CME in NOK- or PLN-denominated FRAs during the second quarter of 2015. However, the Commission concludes that the part 43 Data provided in Table 8, together with the LCH data provided in Tables 9.1 and 9.2, demonstrate sufficient regular trading activity and outstanding notional exposures in NOK-, PLN-, and SEK-denominated FRAs to provide the liquidity necessary for DCOs to successfully risk manage these products and to support the adoption of a clearing requirement. Moreover, the Commission notes that like the other products subject to this determination, these FRAs are subject to a clearing requirement issued by another jurisdiction, in this case the European Union.

105

Accordingly, the Commission concludes that there is sufficient regular trading activity and outstanding notional exposures for all FRAs subject to this rulemaking.

104

Although there was no clearing activity in NOK- or PLN-denominated FRAs during the second quarter of 2015, CME continues to offer clearing of these products.

105

In analyzing the volume and liquidity of NOK-, PLN-, and SEK-denominated fixed-to-floating interest rate swaps and FRAs, ESMA concluded that there was greater volume and liquidity in products denominated in these three currencies than in fixed-to-floating interest rate swaps and FRAs denominated in three other currencies (Czech koruna (CZK), Danish kroner (DKK), and Hungarian forint (HUF)). Therefore, ESMA included the NOK-, PLN-, and SEK-denominated products in its clearing obligation but not the CZK-, DKK-, and HUF-denominated products. In other words, ESMA ultimately determined that three currencies should be subject to the EU clearing obligation and three currencies should not be, a decision with which the European Commission concurred.

See

ESMA Final Report—Draft technical standards on the clearing obligation—interest rate OTC derivatives in additional currencies (ESMA/2015/1629, Nov. 10, 2015), available at:

https://www.esma_europa.eu/sites/default/files/library/2015/11/esma-2015-1629_-_final_report_clearing_obligation_irs_other_currencies.pdf.

4. Outstanding Notional Exposures and Trading Liquidity: OIS With Termination Dates of Up to Three Years; and AUD- and CAD-Denominated OIS

The First Clearing Requirement Determination required the clearing of certain USD-, EUR- and GBP-denominated OIS with a stated termination date range of seven days to two years. As part of this clearing requirement determination, the Commission is amending the maximum termination date to three years for USD-, EUR- and GBP-denominated OIS that have been required to be cleared pursuant to the First Clearing Requirement Determination. This will make the Commission's OIS clearing requirement consistent with that in effect in the European Union.

106

See

discussion of the pending European Union Clearing Obligation in section I.C.

Table 11 presents aggregate notional values and trade counts of USD-, EUR-, and GBP-denominated OIS with terms of two to three years executed during the second quarter of 2015, collected by DDR.

Table 11—Part 43 Data 2-3 Year OIS Aggregate Notional Amounts and Trade Counts Reported

107

Second Quarter 2015

Currency

Aggregate notional

(USD)

Trade count

EUR

$7,582,189,400

USD

4,611,000,000

GBP

1,377,942,400

Tables

12 and 13 present the outstanding notional amounts outstanding, the aggregate notional values cleared and trade counts, of USD-, EUR-, and GBP-denominated OIS with terms of two to three years.

107

This table reflects data that was publically disseminated by DDR and reported to it by the reporting counterparty, SEF, or DCM pursuant to part 43. As such, the Commission did not independently verify the accuracy of the swaps. The transactions disseminated to the public were rounded pursuant to regulation 43.4(g). As a result, this table may underestimate the amount of notional outstanding for the reported trades. This table does not include cancelled and corrected swaps that counterparties reported under part 43. The Commission converted the notional amounts to USD according to the exchange rates of June 30, 2015.

Table 12—LCH Data 2-3 Year OIS Outstanding Notional Amounts, Aggregate Notional Amounts Cleared, and Trade Counts

108

Currency

Outstanding notional as of July 17, 2015

(USD)

Aggregate notional cleared second

quarter 2015

(USD)

Trade count

second quarter

2015

EUR

$456,729,830,424

$369,018,669,593

1,252

GBP

91,417,244,109

64,071,802,837

187

USD

90,058,657,103

46,523,581,500

120

Table 13—CME Data 2-3 Year OIS Outstanding Notional Amounts, Aggregate Notional Amounts Cleared, and Trade Counts

109

Currency

Outstanding notional as of July 17, 2015

(USD)

Aggregate notional cleared second

quarter 2015

(USD)

Trade count

second quarter

2015

EUR

$53,456,578,566

$6,888,346,279

USD

151,923,747,195

9,334,544,737

GBP

27,764,067,455

857,520,000

As part

of this clearing requirement determination, the Commission also is adding AUD- and CAD-denominated OIS to the OIS class included in regulation 50.4(a). This will make the Commission's OIS clearing requirement consistent with the requirements that will begin to take effect in Australia in October 2016 and in Canada in 2017.

110

108

LCH converted the EUR and GBP values to USD.

109

CME converted the EUR and GBP values to USD.

110

See

discussion of the Australian and Canadian swap clearing requirements in section I.C.

Table 14 presents aggregate notional amounts and trade counts of AUD- and CAD-denominated OIS executed during the second quarter of 2015 collected by DDR.

Table 14—Part 43 Data AUD- and CAD-OIS Aggregate Notional Amounts and Trade Counts Reported

111

Second Quarter 2015

Currency

Aggregate notional

(USD)

Trade count

AUD

$307,048,016,016

537

CAD

51,645,589,883

107

Tables 15.1

and 15.2 present the outstanding notional amounts outstanding, as well as aggregate notional values cleared and trade counts, of AUD- and CAD-denominated OIS cleared at LCH.

112

111

112

As discussed above, CME intends to begin offering to clear AUD- and CAD-denominated OIS before the end of 2016.

113

LCH converted the AUD values to USD.

114

LCH began clearing AUD-denominated OIS on January 4, 2016.

Table 15.1—LCH Data AUD-Denominated OIS Outstanding Notional Amount, Aggregate Notional Amount Cleared, and Trade Count

113

Currency

Outstanding notional

as of

January 15, 2016

114

(USD)

Aggregate notional

cleared

January 4-15, 2016

(USD)

Trade count

January 4-15, 2016

AUD

$25,739,497,700

$26,199,691,300

Table 15.2—LCH Data CAD-Denominated OIS Outstanding Notional Amount, Aggregate Notional Amount Cleared, and Trade Count

115

Currency

Outstanding notional

as of

July 17, 2015

(USD)

Aggregate notional

cleared second

quarter 2015

(USD)

Trade count

second quarter

2015

CAD

$506,221,411,997

$216,524,096,571

260

The fact that Australian and Canadian regulators have included AUD- and CAD-denominated OIS, respectively, in their clearing requirements demonstrates that they believe that these swaps represent an important part of the derivatives portfolios of Australian and Canadian banks. The part 43 Data cited in Table 14 demonstrates that there is also meaningful participation by U.S. swap market participants in these swaps. For example, U.S. SDs and their affiliated entities play an important role in the global swaps market, including in Australia and Canada. The Commission therefore believes that it is prudent for its clearing requirement to be consistent with those issued by other jurisdictions, even with respect to swaps that are relatively less frequently traded than other swaps.

116

115

LCH converted the CAD values to USD.

116

See

section II.C.ii for a more lengthy discussion and analysis of BIS data with regard to U.S.-based market participants' activity in global interest rate swap markets.

While the Commission recognizes that the data considered above comes from limited periods of time that do not explicitly include periods of market stress, the Commission concludes that the data demonstrates sufficient regular trading activity and outstanding notional exposures in USD-, GBP-, and EUR-denominated OIS with a termination date range of two to three years, as well as AUD- and CAD-denominated OIS, to provide the necessary liquidity for DCOs to successfully risk manage these products and to support the adoption of a clearing requirement. Accordingly, the Commission concludes that there is sufficient regular trading activity and outstanding notional exposures for all OIS subject to this rulemaking.

5. Pricing Data: Fixed-to-Floating Swaps Denominated in the Nine Additional Currencies; AUD-Denominated Basis Swaps; NOK-, PLN-, and SEK-Denominated FRAs; USD-, GBP, and EUR-OIS With Termination Dates of up to Three Years; and AUD- and CAD-OIS

The Commission regularly reviews pricing data on the interest rate swaps subject to this rulemaking and has found that these swaps are capable of being priced off of deep and liquid markets. Commission staff receives and reviews margin model information from CME, Eurex, LCH, and SGX that addresses how such DCOs would follow particular procedures to ensure that market liquidity exists in order to exit a position in a stressed market, including the products subject to this determination. In particular, Commission staff analyzes the level of liquidity in the specific product markets and assesses the time required to determine a price. Based on this information, the Commission staff has no reason to believe that there is, or will be, difficulty pricing the products subject to this determination in a stressed environment.

Because of the stability of access to pricing data from these markets, the pricing data for non-exotic interest rate swaps that are currently being cleared is generally viewed as reliable. In addition, CME, Eurex, LCH, and SGX provided information that supports the Commission's conclusion that there is adequate pricing data to warrant a clearing requirement for the swaps subject to this rulemaking. LCH and CME believe there is adequate pricing data for risk and default management. CME stated that its interest rate swap valuations are fully transparent and rely on pricing inputs obtained from wire service feeds. In its § 39.5(b) submission, SGX asserted that the valuation rate sources it uses, and the manner in which it determines mark-to-market prices, are in alignment with industry practices. CME, Eurex, LCH, and SGX obtain daily prices from third-party data providers, clearing members, and/or major banks.

As discussed above, the Commission reviews margin models and related pricing data submitted by CME, Eurex, LCH, and SGX. One source of information that they use to determine adequate pricing data is a regular survey of swap traders that asks the traders to estimate what it would cost to liquidate positions of different sizes in different currencies. The information obtained during these market participant surveys is incorporated into each of CME, Eurex, LCH, and SGX's internal margin models so that each is confident that it will be able to withstand stressed market conditions. Establishing accurate pricing data is one component of each of CME, Eurex, LCH, and SGX's ability to risk manage their interest rate swaps offered for clearing. The Commission believes that the methods used by these DCOs provide information on pricing that is accurate and demonstrates the ability to price the products subject to this determination successfully. Accordingly, the Commission concludes that there is adequate pricing data to support an extension of the clearing requirement to the swaps subject to this rulemaking.

6. Comments Received Regarding Factor (I)

In response to the NPRM, three commenters, Better Markets, Citadel, and CME Group agreed with the Commission's analysis of the first factor under section 2(h)(2)(D)(ii). That is, these commenters agreed that there is sufficient outstanding notional exposures in all of the swaps covered by the NPRM for DCOs successfully to risk manage such swaps and that this supports a clearing requirement determination. In its comment letter, Citadel complimented the Commission for assessing the extent of outstanding notional exposures using multiple sources of data. Citadel noted further that the various sources of data the Commission referenced in discussing the extent of outstanding notional exposures demonstrate the variety of sources a DCO may rely on to access price data for risk and default management purposes. In addition, Better Markets, Citadel, and MFA commented that there is sufficient trading activity and liquidity in the swaps subject to this rulemaking to support a clearing requirement. MFA highlighted the fact that, as noted in the NPRM, a significant percentage of the market already clears the swaps voluntarily at Commission-registered DCOs. Citadel commented that the clearing requirement would enhance liquidity in cleared instruments to the benefit of investors. Similarly, SIFMA AMG commented that clearing improves market liquidity.

With respect to pricing data, in their comment letters, CME Group and LCH Group agreed with the Commission that there is sufficient pricing data available for the swaps subject to this rulemaking such that CME Group and LCH Group can adequately manage the risks that would arise from the default of a clearing member. The Commission received no other comments related to the level of outstanding notional exposures and trading liquidity or adequacy of pricing data for the swaps subject to this rulemaking.

For the reasons described above and in light of the comments received, the Commission reaffirms its conclusion stated in the NPRM that there are sufficient outstanding notional exposures and trading liquidity, as well as adequate pricing data, to expand the clearing requirement to include the swaps subject to this rulemaking, which are referenced in revised regulation 50.4(a).

b. Factor (II)—Availability of Rule Framework, Capacity, Operational Expertise and Resources, and Credit Support Infrastructure

Section 2(h)(2)(D)(ii)(II) of the CEA requires the Commission to take into account the availability of rule

framework, capacity, operational expertise and resources, and credit support infrastructure to clear the swaps subject to this rulemaking on terms that are consistent with the material terms and trading conventions on which they are now traded. The Commission believes that CME, Eurex, LCH, and SGX have developed rule frameworks, capacity, operational expertise and resources, and credit support infrastructure to clear the interest rate swaps that they currently clear, including those products subject to this determination, on terms that are consistent with the material terms and trading conventions on which those swaps are being traded.

1. Background

The Commission subjects CME, Eurex, LCH, and SGX to ongoing review and risk surveillance programs to ensure compliance with the core principles for the submitted swaps.

117

As discussed above, as part of a registered DCO's initial registration review and periodic in-depth reviews thereafter, the Commission reviews the DCO's rule framework, capacity, and operational expertise and resources to clear the submitted swaps. The Commission may request that the DCO or DCO applicant change its rules to comply with the CEA and Commission regulations.

117

Section 5c(c) of the CEA governs the procedures for review and approval of new products, new rules, and rule amendments submitted to the Commission by DCOs. Parts 39 and 40 of the Commission's regulations implement section 5c(c) by: (i) Establishing specific requirements for compliance with the core principles as well as procedures for registration, implementing DCO rules, and clearing new products; and (ii) establishing provisions for a DCO's submission of rule amendments and new products to the Commission.

After registration, the Commission conducts examinations of DCOs to determine whether the DCO is in compliance with the CEA and Commission regulations. Moreover, Commission risk surveillance staff monitors the risks posed to and by the DCO, in ways that include regularly conducting back testing to review margin coverage at the product level and following up with the DCO and its clearing members regarding any exceptional results.

CME, Eurex, LCH, and SGX have procedures pursuant to which they regularly review their clearing of the interest rate swaps subject to this rulemaking in order to confirm, or make adjustments to, margins and other risk management tools. When reviewing CME, Eurex, LCH, and SGX's risk management tools, the Commission considers whether the DCO is able to manage risk during stressed market conditions to be one of the most significant considerations.

CME, Eurex, LCH, and SGX have developed detailed risk management practices, including a description of the risk factors considered when establishing margin levels such as historical volatility, intraday volatility, seasonal volatility, liquidity, open interest, market concentration, and potential moves to default, among other risks.

118

The Commission reviews and oversees CME's, Eurex's, LCH's, and SGX's risk management practices and development of margin models. Margin models are further refined by stress testing and daily back testing. When assessing whether CME, Eurex, LCH, and SGX can clear swaps safely during stressed market conditions, stress testing and back testing are key tools the Commission considers as well.

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Each of CME, Eurex, LCH, and SGX has published a document outlining its compliance with the Principles for Financial Market Infrastructures (PFMIs) published by the Committee on Payments and Market Infrastructures (CPMI formerly CPSS) and the International Organization of Securities Commissions (IOSCO).

See

CME Clearing: Principles for Financial Market Infrastructures Disclosure, available at:

http://www.cmegroup.com/clearing/risk-management/files/cme-clearing-principles-for-financial-market-infrastructures-disclosure.pdf. See

Assessment of Eurex Clearing AG's compliance against the CPSS-IOSCO Principles for financial market infrastructures (PFMI) and disclosure framework associated to the PFMIs, available at:

http://www.eurexclearing.com/blob/148684/58e6fe89e3f54ebe169e530ac2235b43/data/cpss-iosco-pfmi_assessment_2014_en.pdf. See

LCH's CPMI-IOSCO Self Assessment 2014, available at:

http://www.lchclearnet.com/documents/731485/762558/CPMI_IOSCO_Assessment_of_LCH+ClearnetLtd+2014.pdf/45876bd6-3818-4b76-a463-2952a613c326. See

SGX PFMI Disclosure Documents, available at:

http://www.sgx.com/wps/portal/sgxweb/home/clearing/derivatives/pfmi_disclosure.

CME, Eurex, LCH, and SGX design stress tests to simulate “extreme but plausible” market conditions based on historical analysis of product movements and/or based on hypothetical forward-looking scenarios that are created with the assistance of market experts and participants. Commission staff monitors and oversees the use and development of these stress tests. CME, Eurex, LCH, and SGX conduct stress tests daily. In addition, CME, Eurex, LCH, and SGX conduct reverse stress testing to ensure that their default funds are sized appropriately. Reverse stress testing uses plausible market movements that could deplete guaranty funds and cause large losses for top clearing members.

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These four DCOs analyze the results of stress tests and reverse stress tests to determine if any changes to their financial resources or margin models are necessary. Commission risk surveillance staff also monitors markets in real-time, performs stress tests against the DCOs' margin models as an additional level of oversight, and may recommend changes to a margin model.

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For example, CME, Eurex, LCH, and SGX may use scenarios for stress testing and reverse stress testing that capture, among other things, historical price volatilities, shifts in price determinants and yield curves, multiple defaults over various time horizons, and simultaneous pressures in funding and asset markets.

CME, Eurex, LCH, and SGX conduct back testing on a daily basis to ensure that the margin models capture market movements for member portfolios. Back testing serves two purposes: It tests margin models to determine whether they are performing as intended and it checks whether the margin models produce margin coverage levels that meet the DCO's established standards. CME conducts daily back testing for each major asset class, and SGX performs daily back testing on a contract level to examine margin models in more detail. LCH may call additional margin from clearing members if back testing demonstrates margin erosion. The back testing process helps CME, Eurex, LCH, and SGX determine whether their clearing members satisfy the required margin coverage levels and liquidation time frame.

Before offering a new product for clearing, such as the interest rate swaps subject to this rulemaking, CME, Eurex, LCH, and SGX take stress tests and back testing results into account to determine whether the clearinghouse has sufficient financial resources to offer new clearing services. In addition, the Commission reviews margin models and default resources to ensure that the DCOs can risk manage their portfolio of products offered for clearing. The Commission believes that this combination of stress testing and back testing in anticipation of offering new products for clearing provides CME, Eurex, LCH, and SGX with greater certainty that new product offerings will be risk-managed appropriately. The process of stress testing and back testing also gives the DCOs practice incorporating the new product into their models.

In addition to the Commission's surveillance and oversight, CME, Eurex, LCH, and SGX continue to monitor and test their margin models over time so that they can operate effectively in stressed and non-stressed market environments. CME, Eurex, LCH, and SGX review and validate their margin models regularly and in the case of CME and SGX, no less than annually. To risk manage their margin coverage levels for interest rate swaps denominated in

various currencies, CME and LCH also regularly survey traders to estimate what it would cost to liquidate positions of different sizes in different currencies and then incorporate those costs into the amount of initial margin that a clearing member is required to post, and tailor their margin models to account for several attributes specific to various currencies.

Finally, aside from margin coverage requirements, CME, Eurex, LCH, and SGX can monitor and manage credit risk exposure by asset class, clearing member, account, or even by individual customers. They manage credit risk by establishing position and concentration limits based on product type or counterparty. The Commission recognizes that these limits reduce potential market risks so that DCOs are better able to withstand stressed market conditions. CME, Eurex, LCH, and SGX monitor exposure concentrations and may require additional margin deposits for clearing members with weak credit scores, with large or concentrated positions, with positions that are illiquid or exhibit correlation with the member itself, and/or where the member has particularly large exposures under stress scenarios. The ability to call for any additional margin, on top of collecting initial and variation margin, to meet the current DCO exposure is another tool that CME, Eurex, LCH, and SGX may use to protect against stressed market conditions.

In support of its ability to clear the products subject to this rulemaking, CME's § 39.5(b) submissions cite to its rulebook to demonstrate the availability of rule framework, capacity, operational expertise and resources, and credit support infrastructure to clear interest rate swap contracts on terms that are consistent with the material terms and trading conventions on which the contracts are then traded. LCH's submissions state that LCH has the capability and expertise not only to manage the risks inherent in the current book of interest rate swaps cleared, but also to manage the increased volume that a clearing requirement for additional currently clearable products could generate. SGX's submission states that SGD-denominated fixed-to-floating interest rate swaps are cleared under an established rule framework and operational infrastructure that has been accepted by SGX's clearing members. SGX asserted further that it has the appropriate risk management, operations, and technology capabilities in place to ensure that it is able to liquidate positions in these swaps in an orderly manner should a default occur. Similarly, Eurex's submission states that it clears interest rate swaps pursuant to its well-developed rule framework and support infrastructure.

Importantly, the Commission notes that CME, Eurex, LCH, and SGX each developed their interest rate swap clearing offerings in conjunction with market participants and in response to the specific needs of the marketplace. In this manner, CME's, Eurex's, LCH's, and SGX's clearing services are designed to be consistent with the material terms and trading conventions of a bilateral, uncleared market.

When assessing whether CME, Eurex, LCH, and SGX can clear the swaps subject to this rulemaking safely during times of market stress, the Commission reviewed the public disclosures published by CME, Eurex, LCH, and SGX. In addition, the Commission reviewed the risk management practices used by these DCOs, and the Commission has determined that the application of such practices to the products subject to this clearing requirement determination should ensure that the products can be cleared safely during times of market stress. Accordingly, the Commission concludes that at each of the four DCOs discussed above, there is an available rule framework, capacity, operations expertise and resources, and credit support infrastructure to clear the swaps subject to this rulemaking on terms that are consistent with the material terms and trading conventions on which they are now traded.

2. Comments Received Regarding Factor (II)

In response to the NPRM, Citadel agreed with the Commission's conclusion that the existing DCO rule frameworks and infrastructure are satisfactory for clearing the swaps subject to the determination. Citadel commented that the already significant amount of voluntary clearing of these swaps demonstrates the suitability of the DCOs' frameworks and infrastructures. LCH Group commented that its rule framework, capacity, operational expertise, resources, and credit support structure are adequate to clear the swaps covered by the rulemaking, including during times of market stress. Similarly, CME Group commented that it is capable of offering uninterrupted clearing services of these swaps, even during times of market stress. Finally, Better Markets commented that the second factor under section 2(h)(2)(D)(ii) is satisfied because registered DCOs are already clearing the swaps subject to the NPRM in compliance with the DCO core principles. Better Markets also urged the Commission strictly to surveil DCOs' risk management procedures.

The Commission received no other comments related to the existence of satisfactory DCO rule frameworks and infrastructure to support this expanded clearing requirement determination.

For the reasons described above and in light of the comments received, the Commission reaffirms its conclusion stated in the NPRM that there are available rule frameworks, capacity, operations expertise and resources, as well as credit support infrastructures consistent with material terms and current trading conventions, to expand the clearing requirement to include the swaps subject to this rulemaking, which are referenced in revised regulation 50.4(a).

c. Factor (III)—Effect on the Mitigation of Systemic Risk

Section 2(h)(2)(D)(ii)(III) of the CEA requires the Commission to take into account the effect of the clearing requirement on the mitigation of systemic risk, taking into account the size of the market for such contract and the resources of the DCO available to clear the contract. The Commission believes that the market for the swaps covered by this determination is significant and that mitigating counterparty risk through clearing likely will reduce systemic risk in that market generally. Data collected by SDRs demonstrates that Commission-registered SDs are counterparties to an overwhelming majority of swaps reported to the Commission. Because only SDs with a significant volume of swaps activity are required to register with the Commission,

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by expanding the swap clearing requirement, a greater percentage of an SD's swap activity will be centrally cleared and risk managed. For example, central clearing reduces the interconnectedness of the swap positions of SDs, and other swap market participants, because the DCO, an independent third party that takes no market risk, guarantees the collateralization of swap counterparties' exposures. Mitigating counterparty credit risk for SDs with systemically important swap positions through clearing likely would reduce systemic risk in the swap market and the financial system as a whole.

121

120

See

definition of SD, codified in Commission regulation 1.3(ggg).

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In its regulation 39.5(b) submission, SGX asserts that central clearing reduces counterparty credit risk because the central counterparty interposes itself between the initial buyer and seller and because clearing creates efficiencies through the consolidation of collateral management.

In addition to managing counterparty credit risk, centrally clearing the swaps covered by this rulemaking through a DCO will reduce systemic risk through the following means: Providing counterparties with daily mark-to-market valuations and exchange of variation margin pursuant to a risk management framework; requiring posting of initial margin to cover potential future exposures in the event of a default; offering multilateral netting to substantially reduce the number and notional amount of outstanding bilateral positions; reducing swap counterparties' operational burden by consolidating collateral management and cash flows; eliminating the need for novations or tear-ups because clearing members may offset opposing positions; and increasing transparency.

The Commission recognizes that the new margin requirements for uncleared swaps for SDs and MSPs require some market participants to post and collect margin for those swaps not subject to the Commission's clearing requirement.

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Neither the Commission's nor the prudential regulators' uncleared margin requirement was finalized at the time the Commission issued the First Clearing Requirement Determination. As a result, the Commission considered the clearing requirement in light of existing market practice. Going forward, the requirement to margin uncleared swaps in certain instances will mitigate the accumulation of risk between counterparties in a manner similar to that of central clearing.

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Margin Requirements for Uncleared Swaps for SDs and MSPs, 81 FR 636 (Jan. 6, 2016) (codified in subpart E of part 23 of the Commission's regulations) (establishing initial and variation margin requirements for certain SDs and MSPs for which there is no prudential regulator); and Margin and Capital Requirements for Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015) (establishing minimum margin and capital requirements for certain registered SDs, MSPs, security-based swap dealers, and major security-based swap participants regulated by one of the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Farm Credit Administration or the Federal Housing Finance Agency).

See also

section V for further discussion of this issue.

However, the Commission believes that central clearing, including required clearing such as that described herein, offers greater risk mitigation than bilateral margining for swaps that are sufficiently standardized and meet the Commission's other requirements for suitability. First, absent any applicable exception or exemption,

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the clearing requirement applies to all transactions in swaps identified in regulation 50.4, whereas, generally speaking, the new uncleared margin requirements apply only to swaps executed between SDs and MSPs, and between an SD or MSP and its counterparty that is a “financial end-user.”

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Second, this clearing requirement requires all swap counterparties to post initial margin with a DCO, whereas under the uncleared swap margin regulations, for certain swaps, specifically those between an SD or MSP and a financial end-user, initial margin is required to be posted and collected only if the financial end-user (together with its affiliates) has over $8 billion in gross notional exposures for uncleared swaps.

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Third, swaps transacted through a DCO are secured by the DCO's guaranty fund and other available financial resources, which are intended to cover extraordinary losses that would not be covered by initial margin (“tail risk”), whereas swaps subject to the uncleared margin requirements are not secured by a guaranty fund or other financial resources available to the DCO but covered by unencumbered assets of the counterparty.

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The exception and exemptions to the clearing requirement are codified in subpart C to part 50 of the Commission's regulations.

124

See

Commission regulation 23.151 (defining financial end user).

See also

Margin and Capital Requirements for Covered Swap Entities, 80 FR at 74900 (defining financial end user for rules that are applicable to SDs and MSPs that have a prudential regulator).

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Commission regulation 23.152.

1. DCO Mitigation of Risk and Concentration of Risk

In their § 39.5(b) submissions, CME, Eurex, and LCH stated that subjecting interest rate swaps to central clearing helps mitigate systemic risk. According to LCH, if all clearable swaps were required to be cleared at a small number of central counterparties rather than being held bilaterally by a much larger group of swap counterparties, the robust risk management frameworks of clearinghouses, such as that operated by LCH, would serve to reduce operational and systemic risk in the interest rate swap market. CME stated that the 2008 financial crisis demonstrated the potential for systemic risk arising from the interconnectedness of over-the-counter (OTC) derivatives market participants and asserted that centralized clearing will reduce systemic risk.

While a clearing requirement removes a large portion of the interconnectedness of current OTC markets that leads to systemic risk, the Commission notes that central clearing, by its very nature, concentrates risk in a handful of entities. Similarly, SGX, in its § 39.5(b) submission, noted that the risk reducing and other benefits of central clearing must be weighed against the concentration of risk in a few clearinghouses. However, the Commission observes that central clearing was developed and designed to handle such concentration of risk. Moreover, as discussed at length above, the Commission's review and risk surveillance programs monitor and attempt to mitigate potential risks that can arise in derivatives clearing activities for the DCO, its members, and other entities using the DCO's services.

Part of a DCO's risk management framework includes procedures for responding in stressed circumstances, such as a clearing member's default on its obligations. As discussed below, each of CME, Eurex, LCH, and SGX has a procedure for closing out and/or transferring a defaulting clearing member's positions and collateral.

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Transferring customer positions to solvent clearing members in the event of a default is critical to reducing systemic risk. DCOs are designed to withstand defaulting positions and to prevent a defaulting clearing member's loss from spreading further and triggering additional defaults. If the introduction of this expanded clearing requirement for interest rate swaps increases the number of clearing members and market participants in the swap market, then DCOs may find it easier to transfer positions from defaulting clearing members to other clearing members because there may be a larger pool of potential clearing members to receive the positions. If this were to occur, then this expanded interest rate swap clearing requirement would help to reduce systemic risk by increasing the number of clearing members and market participants in these swaps, which would be expected to provide DCOs with additional recipients for defaulting clearing members' positions in the event of a default.

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For further discussion of treatment of customer and swap counterparty positions, funds and property in the event of a the insolvency of a DCO or one or more of its clearing members, please see Factor (V)—Legal certainty in the event of insolvency.

See

section II.B.iii.

Each DCO has experience risk managing interest rate swaps, and the Commission has determined that each of CME, Eurex, LCH, and SGX has the necessary resources available to clear the swaps that are the subject of its submission. Accordingly, the Commission concludes that it has considered the effect of the expanded clearing requirement on the mitigation of systemic risk and found that mitigating counterparty risk through required central clearing likely will

generally reduce systemic risk in the swaps markets for the products subject to this determination.

2. Comments Received Regarding Factor (III)

Several comment letters agreed with the Commission's conclusion that the clearing requirement would reduce systemic risk. Citadel commented that it believes that clearing reduces systemic risk by promoting open, efficient, and transparent markets and by reducing interconnectedness. In its comment letter, Citadel agreed with the Commission that central clearing does more to mitigate systemic risk than bilateral margining requirements. Citadel noted that unlike bilateral margining requirements, clearing eliminates the complex web of interconnected bilateral counterparty credit exposures. Citadel also commented that it believes that market participants benefit from the risk and default management frameworks that clearinghouses provide, including margin collection, end-of-day pricing, multilateral netting and compression, and a guaranty fund.

SIFMA AMG commented that clearing promotes market integrity. Better Markets commented that increased clearing may reduce systemic risk because of a potential increase in the number of DCO-clearing members. LCH Group commented that its risk management framework is calibrated to the particular characteristics of the swaps covered by the NPRM. LCH Group commented further that it is capable of handling any increased risk that could result from the clearing requirement, including during stressed market conditions.

The Commission received no other comments related to the effect of the expanded clearing requirement on the mitigation of systemic risk.

For the reasons described above and in light of the comments received, the Commission reaffirms its conclusion, stated in the NPRM that CME, Eurex, LCH, and SGX would be able to manage the risks posed by clearing the additional swaps that will be required to be cleared by virtue of the expanded clearing requirement. In addition, the Commission believes that the required central clearing of the interest rate swaps subject to this rulemaking will serve to mitigate counterparty credit risk, and might increase the number of clearing members and market participants in these swaps, thereby potentially reducing systemic risk. Thus, the Commission has decided to expand the clearing requirement so that it includes the swaps subject to this rulemaking, which are referenced in revised regulation 50.4(a).

d. Factor (IV)—Effect on Competition

Section 2(h)(2)(D)(ii)(IV) of the CEA requires the Commission to take into account the effect on competition, including appropriate fees and charges applied to clearing. As discussed above, of particular concern to the Commission is whether this determination would harm competition by creating, enhancing, or entrenching market power in an affected product or service market, or facilitating the exercise of market power. Market power is viewed as the ability to raise prices, including clearing fees and charges, reduce output, diminish innovation, or otherwise harm customers as a result of diminished competitive constraints or incentives.

1. Competition Analysis

In the NPRM, the Commission identified one putative service market as potentially affected by this clearing requirement determination: A DCO service market encompassing those clearinghouses that currently clear, or could reasonably be expected to clear, the types of interest rate swaps subject to this rulemaking,

i.e.,

CME, Eurex, LCH, and SGX. Without defining the precise contours of this market, the Commission recognizes that, depending on the interplay of several factors, this clearing requirement determination potentially could impact competition within the affected market.

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

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See

section II.C.ii for a further discussion of the market for interest rate swaps.

Any competitive import from this determination likely would stem from the fact that it removes the alternative of not clearing for interest rate swaps subject to this rulemaking. On the other hand, this clearing requirement determination does not change who may or may not compete to provide clearing services for the interest rate swaps subject to this rulemaking (as well as those not required to be cleared).

Removing the alternative of not clearing is not determinative of negative competitive impact. Other factors—including the availability of other substitutes within the market or potential for new entry into the market—may constrain market power. The Commission does not foresee that this determination constructs barriers that would deter or impede new entry into a clearing services market.

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Indeed, there is some basis to expect that the determination could foster an environment conducive to new entry. For example, this clearing requirement determination, and the prospect that more may follow, is likely to reinforce, if not encourage, growth in demand for clearing services. Demand growth, in turn, can enhance the sales opportunity, a condition hospitable to new entry.

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128

That said, the Commission recognizes that to the extent the clearing services market for the interest rate swaps subject to this rulemaking, after removing the alternative of not clearing such swaps, would be (1) limited to a concentrated few participants with highly aligned incentives, and (2) insulated from new competitive entry through barriers—

e.g.,

high sunk capital cost requirements; high switching costs to transition from embedded incumbents; and access restrictions—this clearing requirement determination could have a negative competitive impact by increasing market concentration. However, no commenters agreed with this specific argument as articulated in the NPRM.

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See, e.g.,

U.S. Dep't. of Justice & Fed. Trade Comm'n, Horizontal Merger Guidelines (2010) section 9.2 (entry likely if it would be profitable which is in part a function of “the output level the entrant is likely to obtain”). In addition, the Commission notes that there are clearing organizations that clear the swaps subject to this rulemaking that are not Commission-registered DCOs: (1) OTC Clearing Hong Kong, which the Commission has exempted from DCO registration and clears HKD-denominated interest rate swaps; (2) ASX, which the Commission also has exempted from DCO registration and clears AUD-denominated interest rate swaps; and (3) Asigna (Mexico), which clears MXN-denominated interest rate swaps. The Commission observes that each of these clearing organizations would be eligible to apply for registration as a DCO if the organization were interested in offering client clearing to U.S. customers. Exemptions from registration are conditioned on clearing only for U.S. proprietary accounts.

The Commission notes further, that while Eurex and SGX each clear only one of the interest rate swaps subject to this rulemaking, they are generally eligible to clear interest rate swaps under Commission regulation under § 39.5(a) and may decide to add to their interest rate swap offerings in light of this rulemaking.

2. Comments Received Regarding Factor (IV)

Better Markets, Citadel, and MFA commented that the clearing requirement would have a positive effect on competition. According to both Citadel and Better Markets, central clearing of swaps generally increases the range of execution counterparties, increases liquidity and price competition, narrows bid-ask spreads, and improves access to best execution. Similarly, MFA commented that the clearing requirement would increase competition among potential trading counterparties and liquidity providers by reducing counterparty credit and operational risk and by allowing market participants to trade with a wider range of execution counterparties. Better Markets also commented that the clearing requirement could promote competition because it could remove barriers to entry to the market and suggested that the clearing requirement could enhance the ability of relatively small SDs and other relatively small swap participants to compete with larger dealers and participants.

Citadel commented that by eliminating bilateral counterparty credit exposure and trading documentation, clearing can lead to market structure innovations such as trading solutions that allow investors to trade directly with one another instead of through intermediaries.

Citadel also commented that clearing lowers execution costs in addition to increasing liquidity. Citadel cited academic research published in 2016 indicating that the Commission's existing IRS clearing requirement, together with trading reforms, have enabled swap market participants to save as much as $20 million to $40 million per day, with between $7 million and $13 million of the savings by market participants being attributed to market participants that do not act as dealers in the swaps market.

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See

Citadel letter for further discussion of academic papers and possible cost savings.

Two commenters, JBA and Citadel, voiced contrasting views concerning the effects of only one DCO offering a swap subject to a clearing requirement. JBA stated that when only one DCO offers a swap for clearing, costs might increase for market participants to join that DCO or enter into new client clearing arrangements with clearing members of that DCO. JBA also commented that there may be lower liquidity for swaps newly offered at a particular DCO.

By contrast, Citadel commented that the possibility of only one DCO offering to clear a particular swap would not have adverse effects because swap market participants generally prefer to clear swaps at one DCO instead of at multiple DCOs in order to reduce costs by maximizing netting, compression, and margin offsets. Citadel also commented that fees charged by FCMs, rather than fees charged by DCOs, are the major source of clearing costs.

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Moreover, according to Citadel, the fees charged by FCMs depend primarily on the portfolio the customer wishes to clear rather than on the number of DCOs offering to clear a particular swap. Finally, Citadel commented that the clearing requirement could lead a DCO or FCM to expand its clearing offerings because of the increased clearing volumes that may result from the clearing requirement. As more DCOs and/or FCMs enter the market or expand clearing offerings, price competition would increase and costs for customers would be expected to decrease.

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FCMs provide their customers with access to DCOs in their capacity as DCO clearing members.

With regard to JBA's comment, in light of the fact that there are only three swaps covered by the determination that are currently offered for clearing by solely one DCO (MXN-denominated fixed-to-floating interest rate swaps, currently offered for clearing only at CME; and AUD- and CAD-denominated OIS, currently offered for clearing only at LCH), and LCH and CME have indicated that they intend to begin offering to clear each of these swaps, respectively, before the end of 2016, the Commission believes that JBA's competitive concerns about only one DCO offering a particular swap will be largely addressed.

While not explicitly addressing the fourth factor under section 2(h)(2)(D)(ii) of the CEA, ISDA expressed concern about how the clearing requirement for AUD- and HKD-denominated interest rate swaps might affect competition due to the fact that the Commission exempted ASX and OTC Clearing Hong Kong from DCO registration, meaning that they may clear these swaps for U.S. proprietary accounts but not for U.S. customer accounts.

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As stated in note 127 above, the Commission notes that these entities could apply to the Commission for DCO registration in order to clear for U.S. customer accounts should they decide to pursue that line of business at any time in the future.

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Commission regulation 1.3(y) defines proprietary account, and Commission regulation 1.3(gggg) defines customer account.

Citadel's comments suggest that extinguishing bilateral counterparty credit exposure and eliminating complex bilateral trading documentation for swaps subject to a clearing requirement enables market participants to access a wider range of execution counterparties and encourages the entry of new liquidity providers.

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In Citadel's view, competition among FCMs is more relevant to ensuring that the overall fees and charges applied to clearing are set at a reasonable level. In addition, the imposition of a clearing requirement may itself create the commercial rationale for another DCO or FCM to launch or expand its clearing offering. Under this view, price competition tends to increase, execution costs for investors and customers tend to decrease, and overall market liquidity would therefore improve for the swaps subject to the clearing requirement.

134

133

Commission regulation 39.12(b)(6) requires a DCO to establish rules providing that upon acceptance of a swap for clearing, the original swap is extinguished and replaced by an equal and opposite swap between the DCO and each clearing member acting as principal for a house trade or acting as agent for a customer trade. This process extinguishes counterparty credit risk between the original executing counterparties.

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See

section V for additional discussion on the implications of clearing fees. In the aggregate clearing fees may go up, but clearing fees as measured by per unit cost may go down after the implementation of a new clearing requirement determination.

For the reasons described above and in light of the comments received, the Commission concludes that it has considered the effect of the expanded clearing requirement on competition and found that it potentially could impact competition within the affected market, but anticompetitive behavior is likely to be constrained and demand for clearing services is expected to grow. Accordingly, the Commission reaffirms its conclusion stated in the NPRM that its consideration of competitiveness is sufficient to expand the clearing requirement to include the swaps subject to this rulemaking, which are referenced in revised regulation 50.4(a).

e. Factor (V)—Legal Certainty in the Event of Insolvency

Section 2(h)(2)(D)(ii)(V) of the CEA requires the Commission to take into account the existence of reasonable legal certainty in the event of the insolvency of the relevant DCO or one or more of its clearing members with regard to the treatment of customer and swap counterparty positions, funds, and property. The Commission is issuing this clearing requirement based on its view that, as stated in the NPRM, there is reasonable legal certainty with regard to the treatment of customer and swap counterparty positions, funds, and property in connection with cleared

swaps, namely the fixed-to-floating interest rate swaps, basis swap, OIS, and FRAs subject to this determination, in the event of the insolvency of the relevant DCO or one or more of the DCO's clearing members.

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In this case, the relevant DCOs are CME, LCH, and SGX. The Commission is not discussing Eurex in terms of this factor because Eurex's DCO registration order does not currently permit Eurex to clear for customers.

See

Eurex DCO registration order, available at:

http://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/orgdcoeurexclrorder212016.pdf.

1. Applicable Legal Regime—U.S.

The Commission concludes that, in the case of a clearing member insolvency at CME, where the clearing member is the subject of a proceeding under the U.S. Bankruptcy Code, subchapter IV of Chapter 7 of the U.S. Bankruptcy Code (11 U.S.C. 761-767) and parts 22 and 190 of the Commission's regulations would govern the treatment of customer positions.

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

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As a result, neither a clearing member's bankruptcy nor any order of a bankruptcy court could prevent CME from closing out/liquidating such positions. However, customers of clearing members would have priority over all other claimants with respect to customer funds that had been held by the defaulting clearing member to margin swaps, such as the interest rate swaps subject to this rulemaking.

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Thus, customer claims would have priority over proprietary claims and general creditor claims. Customer funds would be distributed to swap customers, including interest rate swap customers, in accordance with Commission regulations and section 766(h) of the Bankruptcy Code. Moreover, the Bankruptcy Code and the Commission's rules thereunder (in particular 11 U.S.C. 764(b) and 17 CFR 190.06) permit the transfer of customer positions and collateral to solvent clearing members.

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The Commission observes that an FCM or DCO also may be subject to resolution under Title II of the Dodd-Frank Act to the extent it would qualify as a covered financial company (as defined in section 201(a)(8) of the Dodd-Frank Act). Under Title II, different rules would apply to the resolution of an FCM or DCO. Discussion in this section relating to what might occur in the event an FCM or DCO defaults or becomes insolvent describes procedures and powers that exist in the absence of a Title II receivership.

137

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

138

Claims seeking payment for the administration of customer property would share this priority.

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

2. Applicable Legal Regime—U.K.

With regard to LCH, the Commission understands that the default of a clearing member of LCH would be governed by LCH's rules. LCH, a DCO based in the U.K., has represented that pursuant to European Union law, LCH's rules would supersede English insolvency laws.

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Under its rules, LCH would be permitted to close out and/or transfer positions of a defaulting clearing member that is an FCM pursuant to the U.S. Bankruptcy Code and part 190 of the Commission's regulations. According to LCH's submission, the insolvency of LCH itself would be governed by English insolvency law, which protects the enforceability of the default-related provisions of LCH's rulebook, including in respect of compliance with applicable provisions of the U.S. Bankruptcy Code and part 190 of the Commission's regulations. LCH has obtained, and shared with the Commission, legal opinions that support the existence of such legal certainty in relation to the protection of customer and swap counterparty positions, funds, and property in the event of the insolvency of one or more of its clearing members.

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The U.K. is bound by European Union legislation, including the Settlement Finality Directive (Council Directive 98/26/EC). The U.K.'s implementing legislation (The Financial Markets and Insolvency (Settlement Finality) Regulations 1999) acts to disapply, in certain instances, national U.K. insolvency law in favor of the rules of a designated system, and LCH has been so designated.

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Letters of counsel on file with the Commission.

The Commission also considered the implications of the U.K.'s recent referendum vote to withdraw from the European Union. The terms of any such withdrawal cannot be known at this time. Negotiations have not begun, and the U.K. has not yet given notice under Article 50 of the Treaty on the European Union to begin the withdrawal process. Thus, there is no indication at this time that there will be changes to the U.K.'s financial regulation regime that is based on European Union law. On June 24, 2016, the day after the vote, the Bank of England Governor Mark Carney indicated that the Bank of England's responsibilities for monetary and financial stability were unchanged by the referendum's result.

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In addition, the U.K.'s Financial Conduct Authority issued a statement confirming that U.K. financial regulation derived from European Union legislation would “remain applicable until any changes are made.”

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Bank of England, Governor Mark Carney's statement following EU referendum result (June 24, 2016), available at:

http://www.bankofengland.co.uk/publications/Documents/news/2016/056.pdf.

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U.K. Financial Conduct Authority, Statement on European Union referendum result (June 24, 2016), available at:

https://www.fca.org.uk/news/european-union-referendum-result-statement.

LCH has advised the Commission that it does not anticipate proposing any changes to its rulebook in light of the referendum, nor does it anticipate any changes to applicable law at this time. The Commission therefore expects LCH's legal opinions related to insolvency to remain valid until further notice and expects that a default of a clearing member of LCH will continue to be governed by LCH's rules. The Commission will continue to monitor developments related to the U.K. referendum.

3. Applicable Legal Regime—Singapore

With regard to SGX, the Commission understands that the default of an SGX clearing member, or SGX itself, would be governed by Singapore law, except for certain SGX rules relating to cleared swaps customer collateral, as part 22 of the Commission's regulations defines that term, which are governed by U.S. law. Like LCH, SGX has obtained, and shared with the Commission, a legal opinion that support the existence of such legal certainty.

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Letter of counsel on file with the Commission.

4. Comments Received

Better Markets and Citadel commented that they agree with the Commission that reasonable legal certainty exists in the event of an insolvency of a DCO or one or more of its clearing members with respect to the interest rate swaps covered by the NPRM. Citadel noted that the legal framework set forth in the CEA, the U.S. Bankruptcy Code, and Commission regulations applies equally to any swap cleared by a DCO. Citadel believes that the implementation of the Dodd-Frank Act has strengthened this legal framework. The Commission received no other comments related to legal certainty in the event of insolvency.

For the reasons described above and in light of the comments received, the Com

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