Exemptions From Swap Trade Execution Requirement
| Published date | 11 February 2021 |
| Citation | 86 FR 8993 |
| Record Number | 2020-28943 |
| Section | Rules and Regulations |
| Court | Commodity Futures Trading Commission |
Federal Register, Volume 86 Issue 27 (Thursday, February 11, 2021)
[Federal Register Volume 86, Number 27 (Thursday, February 11, 2021)]
[Rules and Regulations]
[Pages 8993-9003]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-28943]
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Rules and Regulations
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains regulatory documents
having general applicability and legal effect, most of which are keyed
to and codified in the Code of Federal Regulations, which is published
under 50 titles pursuant to 44 U.S.C. 1510.
The Code of Federal Regulations is sold by the Superintendent of Documents.
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Federal Register / Vol. 86, No. 27 / Thursday, February 11, 2021 /
Rules and Regulations
[[Page 8993]]
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 36
RIN 3038-AE25
Exemptions From Swap Trade Execution Requirement
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting a final rule (``Final Rule'') that establishes
two exemptions from the statutory requirement to execute certain types
of swaps on a swap execution facility (``SEF'') or a designated
contract market (``DCM'') (this requirement, the ``trade execution
requirement'').
DATES: The Final Rule is effective on March 15, 2021.
FOR FURTHER INFORMATION CONTACT: Roger Smith, Associate Chief Counsel,
Division of Market Oversight, (202) 418-5344, [email protected],
Commodity Futures Trading Commission, 525 West Monroe Street, Suite
1100, Chicago, IL 60661; or Michael Penick, Senior Economist, (202)
418-5279, [email protected], Office of the Chief Economist, Commodity
Futures Trading Commission, Three Lafayette Centre, 1151 21st Street
NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background and Introduction
A. Statutory and Regulatory History
B. Summary of the Final Rule
II. Part 36--Trade Execution Exemptions Linked to Swap Clearing
Requirement Exceptions and Exemptions
A. Background and Proposed Rule
B. Trade Execution Requirement Exemption for Swaps Eligible for
a Clearing Requirement Exception or Exemption Under Part 50
1. Summary of Comments
2. Final Rule: CEA Section 4(c) Authority and Standards
C. Trade Execution Exemption for Swaps Between Eligible
Affiliate Counterparties
1. Proposed Rule
2. Summary of Comments
3. Final Rule: CEA Section 4(c) Authority and Standard
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
1. Introduction
D. Antitrust Considerations
I. Background and Introduction
A. Statutory and Regulatory History
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act \1\ amended the Commodity Exchange Act (``CEA'' or
``Act'') \2\ to establish a comprehensive new swaps regulatory
framework that addresses, inter alia, the trading of swaps and the
registration and oversight of SEFs.\3\ CEA section 2(h)(8) provides
that swap transactions that are subject to the swap clearing
requirement under CEA section 2(h)(1)(A) \4\ must be executed on a DCM,
a registered SEF, or a SEF that is exempt from registration pursuant to
CEA section 5h(g) (``Exempt SEF''),\5\ unless (i) no DCM or SEF \6\
``makes the swap available to trade'' or (ii) the related transaction
is subject to the exception from the swap clearing requirement under
CEA section 2(h)(7). The swap clearing requirement exception under CEA
section 2(h)(7) applies to non-financial entities that are using swaps
to hedge or mitigate commercial risk and notify the Commission how they
generally meet their financial obligations related to uncleared swaps,
and has been implemented under Commission regulation 50.50.\7\
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\1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, tit. VII, 124 Stat. 1376 (2010) (codified as
amended in various sections of 7 U.S.C.), https://www.cftc.gov/sites/default/files/idc/groups/public/@lrfederalregister/documents/file/2013-12242a.pdf (``Dodd-Frank Act'').
\2\ 7 U.S.C. 1 et seq.
\3\ 7 U.S.C. 2(h)(8), 7b-3. As amended, CEA section 1a(50)
defines a SEF as a trading system or platform that allows multiple
participants to execute or trade swaps with multiple participants
through any means of interstate commerce.'' 7 U.S.C. 1a(50). CEA
section 5h(a)(1) requires an entity to register as a SEF or a DCM
prior to operating a facility for the trading or processing of
swaps. 7 U.S.C. 7b-3(a)(1). CEA section 5h(f) requires registered
SEFs to comply with fifteen core principles. 7 U.S.C. 7b-3(f).
\4\ Section 723(a)(3) of the Dodd-Frank Act added a new CEA
section 2(h) to establish the clearing requirement for swaps. 7
U.S.C. 2(h). CEA section 2(h)(1)(A) provides that it is unlawful for
any person to engage in a swap unless that person submits such swap
for clearing to a derivatives clearing organization that is
registered under the Act or a derivatives clearing organization that
is exempt from registration under the Act if the swap is required to
be cleared. 7 U.S.C. 2(h)(1)(A). CEA section 2(h)(2) specifies the
process for the Commission to review and determine whether a swap,
or a group, category, type or class of swap should be subject to the
clearing requirement. 7 U.S.C. 2(h)(2). The Commission further
implemented the clearing requirement determination process under
regulation 39.5 and part 50. Part 50 specifies the interest rate and
credit default swaps that are currently subject to the Commission's
clearing requirement. 17 CFR part 50.
\5\ The Commission notes that CEA section 2(h)(8)(A)(ii)
contains a typographical error that specifies CEA section 5h(f),
rather than CEA section 5h(g), as the provision that allows the
Commission to exempt a SEF from registration. Where appropriate, the
Commission corrects this reference in the discussion herein.
\6\ CEA sections 2(h)(8)(A)(i)-(ii) provide that with respect to
transactions involving swaps subject to the clearing requirement,
counterparties shall execute the transaction on a board of trade
designated as a contract market under section 5; or execute the
transaction on a swap execution facility registered under 5h or a
swap execution facility that is exempt from registration under
section 5h(g) of the Act. Given this reference in CEA section
2(h)(8)(A)(ii), the Commission accordingly interprets ``swap
execution facility'' in CEA section 2(h)(8)(B) to include a swap
execution facility that is exempt from registration pursuant to CEA
section 5h(g).
\7\ This regulation codifies the statutory exception to the swap
clearing requirement set forth in 7 U.S.C. 2(h)(7)(A). See infra
notes 19-20 and accompanying text. Recently, the Commission
renumbered Commission regulation 50.50(d) as a new numbered section
and heading, namely, Commission regulation 50.53. A stand-alone
exemption from the clearing requirement for certain banks, savings
associations, farm credit system institutions, and credit unions
separated this exemption from the non-financial entities' exception
provided for under CEA section 2(h)(7) and codified in regulation
50.50(a)-(c). See Swap Clearing Requirement Exemptions, 85 FR 76428
(Nov. 30, 2020).
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In 2013, pursuant to its discretionary rulemaking authority in CEA
sections 5h(f)(1) and 8a(5), the Commission issued an initial set of
rules implementing this statutory framework for swap trading and the
registration and oversight of SEFs (``2013 SEF Rules'').\8\
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\8\ Core Principles and Other Requirements for Swap Execution
Facilities, 78 FR 33476 (Jun. 4, 2013) (``SEF Core Principles Final
Rule''); Process for a Designated Contract Market or Swap Execution
Facility to Make a Swap Available to Trade, Swap Transaction
Compliance and Implementation Schedule, and Trade Execution
Requirement Under the Commodity Exchange Act, 78 FR 33606 (Jun. 4,
2013) (``MAT Final Rule'').
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In November 2018, the Commission issued a proposed rule (``Proposed
[[Page 8994]]
Rule''), again under CEA sections 5h(f)(1) and 8a(5), that set forth
comprehensive structural reforms to the SEF regulatory regime.\9\ For
example, the Proposed Rule would have removed existing limitations on
swap execution methods on SEFs,\10\ while expanding the categories of
swaps that are subject to the trade execution requirement as well as
the types of entities that must register as SEFs. In addition to these
broad reforms, the Proposed Rule also contained, among other things,
more targeted regulatory proposals to codify exemptions from the trade
execution requirement, including two such exemptions linked to
exceptions to, or exemptions from, the swap clearing requirement.\11\
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\9\ Swap Execution Facilities and Trade Execution Requirement,
83 FR 61946 (Nov. 30, 2018).
\10\ Under the CFTC's current regulations, swaps subject to the
trade execution requirement must be executed via a central limit
order book (``Order Book'') or a request for quote to no fewer than
three unaffiliated market participants in conjunction with an Order
Book (``RFQ''). 17 CFR 37.9(a).
\11\ 83 FR at 62036-62040. The Proposed Rule also included a
trade execution exemption for swap components of package
transactions that includes both a swap that is otherwise subject to
the trade execution requirement and a new bond issuance (``New
Issuance Bonds package transactions''). The Commission in a separate
proposal, that sought to codify the majority of relief currently
provided to package transactions, also proposed an exemption from
the trade execution requirement for swap components of New Issuance
Bond package transactions. See Swap Execution Facility Requirements
and Real-Time Reporting Requirements, 85 FR 9407 (Feb. 19, 2020). On
November 18, 2020, the Commission adopted that exemption in a
separate rulemaking, as Sec. 36.1(a) of its regulations. See Swap
Execution Facility Requirements, 85 FR 82313 (Dec. 18, 2020).
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Commenters provided limited and generally positive feedback
regarding these two proposed exemptions from the trade execution
requirement.\12\ By contrast, the Proposed Rule's broader market
reforms elicited a number of public comments expressing concerns with
the expansive scope of the changes and recommending that the Commission
focus on more targeted improvements to the swap trading regulatory
regime.\13\ In light of available resources and current priorities, the
Commission agrees that it is appropriate to proceed with incremental
improvements rather than a wholesale reform package at this time.\14\
Accordingly, this Final Rule addresses only the two proposed exemptions
from the trade execution requirement linked to the swap clearing
requirement's exemptions and exceptions under part 50, such as the end-
user exception under Commission regulation 50.50, the exemption for co-
operatives under Commission regulation 50.51, and the inter-affiliate
exemption under Commission regulation 50.52.\15\ Additional targeted
improvements to the swap trading regulatory framework have been and
will continue to be made via discrete rulemakings.\16\
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\12\ See Comment Letter from Japanese Bankers Association at 4
(Mar. 13, 2019) (``JBA Letter''); Comment Letter from Citadel and
Citadel Securities at 40-41 (Mar. 15, 2019) (``Citadel Letter''). As
discussed below, Citadel recommended certain limitations on the
applicability of these exemptions. While the Commission received
numerous comments on the Proposed Rule, only the JBA Letter and
Citadel Letter commented directly on the two proposed exemptions
addressed in these Final Rules.
\13\ See, e.g., Comment Letter from the Alternative Investment
Management Association at 1-2 (Feb. 25, 2019) (urging the CFTC ``to
approach any change to swap execution facilities and trade execution
in a phased and targeted manner, rather than adopt a wholesale
package of changes in a single rulemaking''); Comment Letter from
Managed Funds Association at 2-3 (Mar. 15, 2019) (expressing concern
with the breadth of the Proposed Rule and recommending targeted
rather than comprehensive changes to the swap trading framework);
Comment Letter from IATP at 3-4 (Mar. 15, 2019) (same); Comment
Letter from Securities Industry and Financial Markets Association at
1 (Mar. 15, 2019) (``SIFMA Letter'') (same); Comment Letter from
SIFMA Asset Management Group at 1 (Mar. 15, 2019) (same); Comment
Letter from Tradeweb Markets LLC at 1-2 (Mar. 14, 2019) (``Tradeweb
Letter'') (same); Comment Letter from Wellington Management Company
LLP at 1 (Mar. 15, 2019) (same); see also Comment Letter from
Futures Industry Association at 7-9 (Mar. 15, 2019) (``FIA Letter'')
(stating that proposed market reforms ``would present tall
operational challenges and impose substantial costs on all market
participants''); Comment Letter from Commodity Markets Council at 2
(Mar. 15, 2019) (same).
\14\ In addition, the Proposed Rule addressed a number of SEF
operational challenges arising from incongruities between the 2013
SEF Rules and existing technology and market practice. Proposed
solutions to these operational challenges also received broad
support from commenters. The Commission finalized certain of these
proposals in a parallel rulemaking.
\15\ See infra note 23.
\16\ For example, the Commission recently codified staff no-
action relief related to block trades, error trades, and package
transactions. See Real-Time Public Reporting Requirements, 85 FR
75422 (Nov. 25, 2020) (codifying stat no-action relief related to
block trades). The adopting release codifying staff no-action relief
related to package transactions and error trades is available on the
Commission's website at https://www.cftc.gov/media/5276/votingdraft111820b/download.
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B. Summary of the Final Rule
The Final Rule establishes two exemptions from the trade execution
requirement for swaps, both of which are linked to the Commission's
exemptions from, and exceptions to, the swap clearing requirement. The
first such trade execution requirement exemption applies to a swap that
qualifies for, and meets the associated requirements of, any exception
or exemption under part 50 of the Commission's regulations. The second
codifies relief provided under CFTC Letter No. 17-67, and prior staff
letters,\17\ and applies to a swap that is entered into by eligible
affiliate counterparties and cleared, regardless of the affiliates'
ability to claim the inter-affiliate clearing exemption under Sec.
50.52 of the Commission's regulations.
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\17\ CFTC Letter No. 17-67, Re: Extension of No-Action Relief
from Commodity Exchange Act Section 2(h)(8) for Swaps Executed
Between Certain Affiliated Entities that Are Not Exempt from
Clearing Under Commission Regulation 50.52 (Dec. 14, 2017) (``NAL
No. 17-67''); CFTC Letter No. 16-80, Re: Extension of No-Action
Relief from Commodity Exchange Act Section 2(h)(8) for Swaps
Executed Between Certain Affiliated Entities that Are Not Exempt
from Clearing Under Commission Regulation 50.52 (Nov. 28, 2016);
CFTC Letter No. 15-62, Re: Extension of No-Action Relief from
Commodity Exchange Act Section 2(h)(8) for Swaps Executed Between
Certain Affiliated Entities that Are Not Exempt from Clearing Under
Commission Regulation 50.52 (Nov. 17, 2015); CFTC Letter No. 14-136,
Re: Extension of No-Action Relief from Commodity Exchange Act
Section 2(h)(8) for Swaps Executed Between Certain Affiliated
Entities that Are Not Exempt from Clearing Under Commission
Regulation 50.52 (Nov. 7, 2014); CFTC Letter No. 14-26, Time-Limited
No-Action Relief from the Commodity Exchange Act Section 2(h)(8) for
Swaps Executed Between Certain Affiliated Entities Not Electing
Commission Regulation Sec. 50.52 (Mar. 6, 2014).
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II. Part 36--Trade Execution Exemptions Linked to Swap Clearing
Requirement Exceptions and Exemptions
A. Background and Proposed Rule
CEA section 2(h)(8) specifies that swap transactions that are
excepted from the clearing requirement pursuant to CEA section 2(h)(7)
are not subject to the trade execution requirement.\18\ CEA section
2(h)(7)(C)(i), which is codified in Commission regulation 50.50, is
known as the ``end-user exception'' and provides an exception from the
swap clearing requirement if one of the counterparties to the
transaction (i) is not a financial entity; (ii) is using the swap to
hedge or mitigate commercial risk; and (iii) notifies the Commission as
to how it generally meets its financial obligations associated with
entering into uncleared swaps.\19\ The Commission adopted requirements
under Sec. 50.50 to implement this exception.\20\ CEA section
2(h)(7)(C)(ii) provided the Commission with the authority to consider
whether to exempt from the definition of ``financial entity'' small
banks, savings associations, farm credit system institutions and credit
unions. The Commission exercised this authority at the same time it
[[Page 8995]]
promulgated the end-user exception final rule.\21\
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\18\ 7 U.S.C. 2(h)(8)(B).
\19\ 7 U.S.C. 2(h)(7).
\20\ 17 CFR 50.50. Among other things, Sec. 50.50 establishes
when a swap transaction is considered to hedge or mitigate
commercial risk; specifies how to satisfy the reporting requirement;
and exempts small financial institutions from the definition of
``financial entity.'' 17 CFR 50.50.
\21\ On May 12, 2020, the Commission proposed a non-substantive
change to Sec. 50.50(d). The Commission proposed to move the
exception from the clearing requirement for small banks, loan
associations, farm credit system institutions, and credit unions
under Sec. 50.50(d) to a stand-alone regulation, namely Sec.
50.53. Swap Clearing Requirement Exemptions, 85 FR 27955, 27962-63
(May 12, 2020). The Commission adopted this proposal on November 2,
2020. See Swap Clearing Requirement Exemptions, 85 FR 76428 (Nov.
30, 2020). Those regulations are now codified in Commission
regulation 50.53.
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In contrast to swaps that are eligible for the end-user exception,
the Commission's regulations do not specifically exempt from the trade
execution requirement swaps that are not subject to the swap clearing
requirement based on other statutory authority provisions. Pursuant to
its exemptive authority under CEA section 4(c), the Commission
promulgated additional exemptions from the clearing requirement for
swaps between certain types of entities. Commission regulation 50.51
allows an ``exempt cooperative'' to elect a clearing exemption for
swaps entered into in connection with loans to the cooperative's
members.\22\ Commission regulation 50.52 provides a clearing exemption
for swaps between eligible affiliate counterparties.\23\
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\22\ 17 CFR 50.51. The exemption permits a qualifying exempt
cooperative to elect not to clear swaps that are executed in
connection with originating a loan or loans for the members of the
cooperative, or hedging or mitigating commercial risk related to
member loans or arising from swaps related to originating loans for
members. 17 CFR 50.51(b)(1)-(2).
\23\ 17 CFR 50.52. Counterparties have ``eligible affiliate
counterparty'' status if: (i) One counterparty, directly or
indirectly, holds a majority ownership interest in the other
counterparty, and the counterparty that holds the majority interest
in the other counterparty reports its financial statements on a
consolidated basis under Generally Accepted Accounting Principles or
International Financial Reporting Standards, and such consolidated
financial statements include the financial results of the majority-
owned counterparty; or (ii) a third party, directly or indirectly,
holds a majority ownership interest in both counterparties, and the
third party reports its financial statements on a consolidated basis
under Generally Accepted Accounting Principles or International
Financial Reporting Standards, and such consolidated financial
statements include the financial results of both of the swap
counterparties. 17 CFR 50.52(a)(1)(i)-(ii). To elect the exemption,
such counterparties must also meet additional conditions, including
documentation requirements; centralized risk management
requirements; reporting requirements; and a requirement to clear
outward-facing swaps that are of a type identified in the
Commission's clearing requirement (subject to applicable exceptions,
exemptions, and alternative compliance frameworks). 17 CFR 50.52(b)-
(c).
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At the time of the drafting of the Proposed Rule, the Commission
was in the process of considering a proposal to codify certain
exemptions from the clearing requirement.\24\ The Proposed Rule applied
the Commission's section 4(c) exemptive authority to create an explicit
exemption from the trade execution requirement for any future
exceptions to, or exemptions from, the clearing requirement under part
50.\25\
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\24\ E.g., Swap Clearing Requirement Exemptions, 85 FR 27955
(May 12, 2020) (proposing to exempt from the clearing requirement
swaps entered into by central banks, sovereign entities,
international financial institutions (``IFIs), bank holding
companies, savings and loan holding companies, and community
development financial institutions); Amendments to the Clearing
Exemption for Swaps Entered into by Certain Bank Holding Companies,
Savings and Loan Holding Companies, and Community Development
Financial Institutions, 83 FR 44001 (Aug. 29, 2018). As noted above,
the Commission adopted the May 12, 2020 proposal on November 2,
2020. Swap Clearing Requirement Exemptions, 85 FR 76428 (Nov. 30,
2020). See also Proposed Rule at 62038 (discussing the proposed
exemption from the clearing requirement for swaps entered by
eligible bank holding companies, savings and loan holding companies,
and community development financial institutions).
\25\ Proposed Rule at 62038.
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Proposed Sec. 36.1(c) established an exemption to the trade
execution requirement for swap transactions for which an exception or
exemption has been elected pursuant to part 50. The Proposed Rule also
indicated that the trade execution requirement would not apply to swap
transactions for which a future exemption has been adopted by the
Commission under part 50.
Proposed Sec. 36.1(e) established a separate exemption from the
trade execution requirement that may be elected by eligible affiliate
counterparties to a swap submitted for clearing, notwithstanding the
eligible affiliate counterparties' option to elect a clearing exemption
pursuant to Sec. 50.52. Eligible affiliate counterparties may rely on
this exemption from the trade execution requirement regardless of their
decision not to elect the inter-affiliate clearing exemption and
instead clear the swap.
The Commission has determined that these two exemptions are
consistent with the objectives of CEA section 4(c). The following
sections address the exemptions in turn.
B. Trade Execution Requirement Exemption for Swaps Eligible for a
Clearing Requirement Exception or Exemption Under Part 50
1. Summary of Comments
The Commission received several comments on the proposed
regulations to codify exemptions to the trade execution requirement for
swaps that are not subject to the clearing requirement under part 50.
JBA expressed support for the proposed exemption.\26\ Citadel also
expressed support for the exemption for swap transactions that are
currently subject to a clearing exception or exemption. However,
Citadel stated that the Commission should not preemptively grant a
trade execution requirement exemption for swaps falling under future
clearing exceptions or exemptions, but rather should consider
additional future trade execution requirement exemptions on a case-by-
case basis.\27\ In addition, Citadel recommended that participants be
required to actually elect the clearing exemption in order to be
eligible for the corresponding exemption from the trade execution
requirement.
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\26\ JBA Letter at 4.
\27\ Citadel Letter at 40-41.
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In addition to the proposed exemptions for swaps not subject to the
clearing requirement, Blackrock, ISDA, SIFMA, and GFXD requested an
exemption from the trade execution requirement that would apply in
instances where a SEF outage or system disruption or limited hours of
operation prevent participants from complying with the requirement.\28\
Some commenters also requested additional exemptions from the trade
execution requirement for block trades and package transactions, such
as package transactions that include a futures component.\29\ Mercaris
separately requested exemptions from the trade execution requirement
for swaps that are based on new agricultural assets or have a notional
value not exceeding $5 billion, on the grounds that the Proposed Rule
would have an adverse impact on small swaps broking entities due to its
expansion of the types of swaps that are subject to the trade execution
requirement (to include all swaps that are required to be cleared) as
well as the types of entities that are required to register as SEFs (to
include trading platforms operated by swaps broking entities).\30\
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\28\ See Comment Letter from Blackrock at 2 (Mar. 15, 2019)
(``Blackrock Letter''); Comment Letter from International Swaps and
Derivatives Association, Inc. at 11 (Mar. 15, 2019) (``ISDA
Letter''); SIFMA Letter at 14; Comment Letter from the Global
Foreign Exchange Division of the Global Financial Markets
Association at 5 (Mar. 15, 2019) (``GFXD Letter'').
\29\ See ISDA Letter at 11, Appendix at 5; SIFMA Letter at 13-
14; GFXD Letter at 5-6; Tradeweb Letter at 6; FIA Letter at 15,
Comment Letter from Vanguard at 2 (Mar. 15, 2019).
\30\ Comment Letter from Mercaris at 1-2 (Mar. 4, 2019)
(``Mercaris Letter'').
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2. Final Rule: CEA Section 4(c) Authority and Standards
For the purposes of promoting responsible economic or financial
[[Page 8996]]
innovation and fair competition,\31\ CEA section 4(c) provides the
Commission with the authority to exempt any agreement, contract, or
transaction from any CEA provision, subject to specified factors.
Specifically, the Commission must first determine that (i) the
requirement should not be applied to the agreement, contract, or
transaction for which the exemption is sought; (ii) the exemption would
be consistent with the public interest and the purposes of [the Act];
(iii) the agreement, contract, or transaction at issue will be entered
into solely between appropriate persons; \32\ and (iv) the agreement,
contract, or transaction at issue will not have a material adverse
effect on the ability of the Commission or exchange to discharge its
regulatory or self-regulatory duties under the Act.\33\
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\31\ 7 U.S.C. 6(c)(1). CEA section 4(c)(1) is intended to allow
the Commission to ``provid[e] certainty and stability to existing
and emerging markets so that financial innovation and market
development can proceed in an effective and competitive manner.''
House Conf. Report No. 102-978, 102d Cong. 2d Sess. at 81 (Oct. 2,
1992), reprinted in 1992 U.S.C.C.A.N. 3179, 3213.
\32\ 7 U.S.C. 6(c)(3). CEA section 4(c)(3) includes a number of
specified categories of persons within ``appropriate persons'' that
are deemed as appropriate to enter into swaps exempted pursuant to
CEA section 4(c). This includes persons the Commission determines to
be appropriate in light of their financial profile or other
qualifications, or the applicability of appropriate regulatory
protections. As noted below, for purposes of the Final Rule's
section 4(c) exemptions, the Commission has determined that eligible
contract participants as defined in CEA section 1a are ``appropriate
persons.''
\33\ 7 U.S.C. 6(c)(2). Notwithstanding the adoption of
exemptions from the Act, the Commission emphasizes that their use is
subject to the Commission's anti-fraud and anti-manipulation
enforcement authority. In this connection, Sec. 50.10(a) prohibits
any person from knowingly or recklessly evading or participating in,
or facilitating, an evasion of CEA section 2(h) or any Commission
rule or regulation adopted thereunder. 17 CFR 50.10(a). Further,
Sec. 50.10(c) prohibits any person from abusing any exemption or
exception to CEA section 2(h), including any associated exemption or
exception provided by rule, regulation, or order. 17 CFR 50.10(c).
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For the reasons stated below, the Commission believes that the
trade execution requirement should not be applied to a swap transaction
that is eligible for a clearing requirement exception or exemption
under part 50, and that the exemption from the trade execution
requirement is in the public interest and consistent with the CEA in
such circumstances.
The Commission has determined to finalize the exemption largely as
proposed, renumbered as Sec. 36.1(b).\34\ As modified in this adopting
release for additional clarity and consistency, Sec. 36.1(b) will
apply to any swap transaction that qualifies for the exception under
section 2(h)(7) of the Act or an exception or exemption under part 50
of this chapter, and for which the associated requirements are met.\35\
As discussed below, applying the trade execution requirement to swaps
that are eligible for an exception to or exemption from the clearing
requirement, or are otherwise not subject to the clearing requirement,
is not consistent with section 2(h)(8) of the CEA and would impose
additional burdens on market participants that would be required to
incur the costs and burdens of SEF or DCM onboarding and execution. For
example, a counterparty that determines not to clear a swap pursuant to
a part 50 exemption, but otherwise remains subject to the trade
execution requirement, may be limited in where it may trade or execute
that swap and subsequently incur costs and operational burdens related
to SEF or DCM onboarding and trading. Therefore, the Commission
believes swaps that are excepted or exempted from the clearing
requirement should also be exempted from the trade execution
requirement.
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\34\ The Commission recently adopted a final rule which adopted
an exemption from the trade execution requirement under Sec.
36.1(a) of the Commission's regulations to establish an exemption to
the trade execution requirement for swap transactions that are
components of a ``New Issuance Bond'' package transaction. See supra
note 11.
\35\ For avoidance of doubt, the Commission makes clear that
swap transactions that qualify for a swap clearing requirement
exception or exemption under subparts C and D of part 50, and for
which the associated requirements are met, are eligible for the
exemption from the trade execution requirement under renumbered
Sec. 36.1(b).
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In response to Citadel's comment that swaps subject to future
exemptions from the clearing requirement should not automatically be
eligible for an exemption from the trade execution requirement, the
Commission notes that Congress expressly chose to link the statutory
exemption from the trade execution requirement under CEA section
2(h)(8) to the 2(h)(7) exemption from the clearing requirement.
Therefore, as explained elsewhere, the Commission considers it
appropriate to follow this statutory intent with respect to the trade
execution requirement and recognize that any swaps eligible for an
exemption from the clearing requirement should qualify for an exemption
from the trade execution requirement. The Commission notes that,
consistent with the statutory restrictions on the use of its CEA
section 4(c) authority, it has been judicious in issuing clearing
exceptions and exemptions, and will continue to be so particularly in
light of this linking of clearing exceptions and exemptions with the
trade execution exemption.
Additionally, while the Final Rule automatically makes swaps that
are eligible for future exemptions from, and exceptions to, the
clearing requirement eligible for this exemption from the trade
execution requirement, nothing in the Final Rule limits a future
Commission's ability to issue new clearing exemptions or exceptions but
still require compliance with CEA section 2(h)(8) by amending this
exemption. Given the limited nature of these part 50 exceptions and
exemptions, the Commission does not believe that this approach with
regard to the trade execution requirement will diminish swaps market
transparency or liquidity in a manner likely to implicate systemic risk
concerns.
Commenters' requests for additional exemptions from the trade
execution requirement are outside the scope of the current rulemaking.
However, the Commission will take these requests under advisement for
future rulemakings.\36\
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\36\ In addition, the Commission notes that Mercaris grounded
its exemption requests on a concern that the Proposed Rule's
expansion of the trade execution and SEF registration requirements
would adversely affect small swaps broking entities. Because the
Final Rule would not enact either of the changes that Mercaris cited
as likely to adversely affect small swaps broking entities, the
Commission assumes that Mercaris' exemption requests are
inapplicable to the Final Rule.
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In its comments, Citadel also recommended that participants be
required to elect the clearing exemption in order to be eligible for
this exemption from the trade execution requirement. The Commission
notes that as proposed, renumbered Sec. 36.1(b) required that the
appropriate swap clearing requirement exception or exemption be elected
in order to be eligible for this exemption. However, since the Proposed
Rule, the Commission has adopted exemptions from the swap clearing
requirement under part 50 that do not to need be elected, but rather
apply by virtue of the status of a counterparty to the transaction.\37\
In particular, the swap clearing requirement exemptions for swaps
entered into by central banks, sovereign entities, and IFIs apply by
virtue of a counterparty's status as such an entity.
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\37\ See supra note 24.
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Therefore, the Commission is amending Sec. 36.1(b) to state that
section 2(h)(8) of the Act does not apply to a swap transaction that
qualifies for an exception under section 2(h)(7) of the Act or one or
more of the exceptions or exemptions under part 50 of chapter I of
title 17, and for which the associated requirements are met. This
amendment will still require, as recommended by Citadel, that, where
applicable, the
[[Page 8997]]
relevant swap clearing requirement exception or exemption be elected in
order to be eligible for this exemption. In addition, the amendment
also reflects, as discussed above, that there are certain swap clearing
requirement exemptions that are not required to be elected. However,
the Commission notes that consistent with Citadel's comment, this
amendment would still require that all associated requirements of the
relevant swap clearing requirement exception or exemption be met in
order to be eligible for this exemption.
Under Sec. 36.1(b), swap transactions would still be entered into
solely between eligible contract participants (``ECPs''),\38\ whom the
Commission believes, for purposes of this Final Rule, to be appropriate
persons. The scope of this exemption is limited and applies to
transactions that are already excepted or exempted from the swap
clearing requirement. Further, transactions subject to this exemption
are still subject to the Commission's reporting requirements under
parts 43 and 45. Therefore, the Commission will still be able to
conduct oversight and surveillance of the transactions covered by the
exemption. For these reasons, the Commission believes that the
exemption would not have a material adverse effect on the ability of
the Commission or any SEF or DCM to discharge its regulatory or self-
regulatory responsibilities under the CEA and the Commission's
regulations.
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\38\ 7 U.S.C. 2(e) (providing that it shall be unlawful for any
person, other than an eligible contract participant, to enter into a
swap unless the swap is entered into on, or subject to the rules of,
a board of trade designated as a contract market).
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C. Trade Execution Exemption for Swaps Between Eligible Affiliate
Counterparties
1. Proposed Rule
The Proposed Rule proposed to create a new Sec. 36.1(e) to
establish an exemption from the trade execution requirement for swaps
between certain affiliates that are submitted for clearing.
Counterparties are eligible to elect the exemption if they meet the
conditions set forth under Sec. 50.52(a) for ``eligible affiliate
counterparty'' status.\39\
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\39\ See supra note 23 (describing requirements for meeting
``eligible affiliate counterparty'' status).
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The Commission has previously stated that transactions subject to
the inter-affiliate exemption from the swap clearing requirement are
exempt from the trade execution requirement.\40\ In accordance with
time-limited no-action relief granted by Commission staff,
counterparties that meet the ``eligible affiliate counterparty''
definition under Sec. 50.52(a), but do not claim the inter-affiliate
clearing requirement exemption may execute swaps away from a SEF or DCM
that are otherwise subject to the trade execution requirement.\41\ CFTC
staff has granted relief to address the difficulty cited by market
participants in executing inter-affiliate swap transactions through the
required methods of execution prescribed for swaps subject to the trade
execution requirement under Sec. 37.9, i.e., Order Book and RFQ, and
subpart J of part 38 of the Commission's regulations. In particular,
executing these transactions via competitive means of execution would
be difficult because inter-affiliate swaps generally are not intended
to be executed on an arm's-length basis or based on fully competitive
pricing.\42\ Rather, such swaps are used to manage risk among and
between affiliates and are subject to internal accounting processes.
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\40\ MAT Final Rule, 78 FR 33606, 33606 n. 1 (June 4, 2013).
\41\ See supra note 17.
\42\ See NAL No. 17-67 at 2.
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In the 2013 rulemaking adopting the inter-affiliate exemption from
the clearing requirement, commenters explained that corporate groups
often use a single affiliate to face the swap market on behalf of
multiple affiliates within the group, which permits the corporate group
to net affiliates' trades. This netting effectively reduces the overall
risk of the corporate group and the number of open swap positions with
external market participants, which in turn reduces operational,
market, counterparty credit, and settlement risk.\43\ Market
participants have asserted that requiring these swap transactions to be
executed through a SEF or DCM would impose unnecessary costs and
inefficiencies without any of the related benefits associated with
competitive means of execution.\44\ Accordingly, the Commission sought
through the Proposed Rule to provide permanent relief from the trade
execution requirement for eligible affiliate counterparties.
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\43\ Clearing Exemption for Swaps Between Certain Affiliated
Entities, 78 FR 21750, 21753-54 (Apr. 11, 2013).
\44\ NAL No. 17-67 at 2.
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2. Summary of Comments
JBA expressed support for the proposed exemption on the grounds
that inter-affiliate transactions ``do not necessarily seek competitive
pricing, but are generally based on intra-group risk management and
trading strategies.'' \45\ Citadel generally supported the proposed
exemption but recommended that participants be required to actually
elect the clearing exemption in order to be eligible for the
corresponding exemption from the trade execution requirement.\46\
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\45\ JBA Letter at 4.
\46\ Citadel Letter at 41.
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3. Final Rule: CEA Section 4(c) Authority and Standard
The Commission believes that exempting an inter-affiliate swap from
the trade execution requirement is consistent with the objectives of
CEA section 4(c) regardless of whether or not it has been submitted for
clearing. For the reasons discussed below, the Commission has
determined to finalize this exemption as proposed, renumbered as Sec.
36.1(c).
As noted above, these transactions are not intended to be arm's-
length, market-facing, or competitively executed under any
circumstance, irrespective of the type of swap involved. Therefore,
these transactions would not contribute to the price discovery process
if executed on a SEF or a DCM. The statutory purposes of the swaps
trading regulatory regime are ``to promote the trading of swaps on swap
execution facilities and to promote pre-trade price transparency in the
swaps market.'' \47\ The Commission does not believe that these dual
purposes are served by requiring on-SEF trading of swaps that will not
contribute to the price discovery process. The Commission therefore
agrees with commenters that subjecting these types of transactions to
the trade execution requirement confers little if any benefit to the
overall swaps market.
---------------------------------------------------------------------------
\47\ 7 U.S.C. 7b-3(e) (emphasis added).
---------------------------------------------------------------------------
The Commission recognizes the efficiency benefits associated with
entering into inter-affiliate swaps via internal processes and
acknowledges that applying the trade execution requirement to such
transactions could inhibit affiliated counterparties from efficiently
executing these types of transactions for risk management, operational,
and accounting purposes. The Commission therefore believes this trade
execution requirement exemption would promote economic and financial
innovation by allowing affiliated counterparties to efficiently utilize
the risk management approach that best suits their specific needs,
including with respect to decisions regarding whether to clear inter-
affiliate swaps, without being unduly influenced by whether that choice
would require them to execute swaps on a SEF or DCM.
In response to Citadel's comment, the Commission has determined not
to require affiliate counterparties to elect the inter-affiliate
exemption under Sec. 50.52 in order to claim the
[[Page 8998]]
concomitant trade execution exemption.\48\ Promoting central clearing
of standardized swaps is a key objective of the G-20 commitments set
out at the 2009 Pittsburgh Summit, as implemented by Section 2(h) of
the CEA.\49\ A rule requiring counterparties to elect not to clear a
swap in order to claim a trade execution requirement exemption would
frustrate this purpose. Moreover, the Commission finds this exemption
appropriate for counterparties that meet the definition of ``eligible
affiliate counterparty'' but decide to clear the swap perhaps because
they recognize a benefit from clearing or they do not want to satisfy
the other conditions of Sec. 50.52 that are required to elect that
exemption from the clearing requirement.
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\48\ As noted above, the Commission previously determined that
swaps for which the counterparties claim the inter-affiliate
clearing exemption are not subject to the trade execution
requirement. Supra note 37 and accompanying text.
\49\ See Leaders' Statement at the Pittsburgh Summit (Sept. 24-
25, 2009), available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf (stating that
standardized derivatives should be centrally cleared and should be
traded on exchanges or electronic trading platforms where
appropriate).
---------------------------------------------------------------------------
As explained previously, the Commission recognizes the benefits of
inter-affiliate swap transactions, including their contributions to
efficient risk management within corporate groups. Given that inter-
affiliate trades are not executed on a competitive basis and therefore
do not contribute to meaningful price discovery, the Commission does
not believe that subjecting such transactions to the trade execution
requirement would provide any benefit to the swaps markets that would
justify the costs and burdens of such a requirement, which may
discourage corporate groups from using these transactions as part of an
effective risk-management strategy.
For these reasons, the exemption from the trade execution
requirement for affiliated counterparties is appropriate and consistent
with the public interest and purposes of the CEA. This exemption is
limited to transactions between eligible affiliate counterparties. The
transactions subject to this exemption are still required to be
reported under the Commission's regulatory reporting requirements under
part 45. Therefore, the Commission will still be able to conduct
oversight and surveillance of the transactions covered by the
exemption. For these reasons, the Commission does not believe that it
would have a materially adverse effect on the ability of the Commission
or any SEF or DCM to discharge its regulatory or self-regulatory duties
under the CEA. Finally, under the exemption, swap transactions would
still be entered into solely between ECPs, whom the Commission
believes, for purposes of this Final Rule, to be appropriate persons.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \50\ requires Federal
agencies, in promulgating regulations, to consider the impact of those
regulations on small businesses. The regulations adopted herein will
affect SEFs, DCMs, and ECPs. The Commission has previously established
certain definitions of ``small entities'' to be used by the Commission
in evaluating the impact of its regulations on small entities in
accordance with the RFA.\51\ The Commission previously concluded that
SEFs and DCMs are not small entities for the purpose of the RFA.\52\
The Commission has also previously stated its belief that ECPs \53\ as
defined in section 1a(18) of the CEA,\54\ are not small entities for
purposes of the RFA.\55\
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\50\ 5 U.S.C. 601 et seq.
\51\ 47 FR 18618-18621 (Apr. 30, 1982).
\52\ SEF Core Principles Final Rule, 78 FR 33476, 33548 (June 4,
2013) (citing 47 FR 18618, 18621 (Apr. 30, 1982) (discussing DCMs));
66 FR 42256, 42268 (Aug. 10, 2001) (discussing derivatives
transaction execution facilities, exempt commercial markets, and
exempt boards of trade); and 66 FR 45604, 45609 (Aug. 29, 2001)
(discussing registered derivatives clearing organizations
(``DCOs''))).
\53\ 17 CFR 37.703.
\54\ 7 U.S.C. 1(a)(18).
\55\ 66 FR 20740, 20743 (Apr. 25, 2001) (stating that ECPs by
the nature of their definition in the CEA should not be considered
small entities).
---------------------------------------------------------------------------
As noted above, one commenter, Mercaris, stated that the Proposed
Rule would have an adverse impact on small swaps broking entities due
to its expansion of the types of swaps that are subject to the trade
execution requirement (to include all swaps that are required to be
cleared) as well as the types of entities that are required to register
as SEFs (to include trading platforms operated by swaps broking
entities). Mercaris accordingly requested exemptions from the trade
execution requirement for swaps that are based on new agricultural
assets or have a notional value not exceeding $5 billion, and stated
that a failure to provide such exemptions would violate the RFA.\56\
Because the Final Rule would not adopt either of the changes that
Mercaris cited as having an adverse impact on small swaps broking
entities, Mercaris's exemption requests and statements regarding the
RFA are inapplicable to the Final Rule.
---------------------------------------------------------------------------
\56\ Mercaris Letter at 1-2.
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Therefore, the Chairman, on behalf of the Commission, hereby
certifies, pursuant to 5 U.S.C. 605(b), that the regulations will not
have a significant economic impact on a substantial number of small
entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \57\ imposes certain
requirements on Federal agencies (including the Commission) in
connection with conducting or sponsoring any ``collection of
information,'' \58\ as defined by the PRA. Among its purposes, the PRA
is intended to minimize the paperwork burden to the private sector, to
ensure that any collection of information by a government agency is put
to the greatest possible use, and to minimize duplicative information
collections across the government.\59\
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\57\ 44 U.S.C. 3501 et seq.
\58\ For purposes of this PRA discussion, the terms
``information collection'' and ``collection of information'' have
the same meaning, and this section will use the terms
interchangeably.
\59\ 44 U.S.C. 3501.
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The PRA applies to all information, regardless of form or format,
whenever the government is obtaining, causing to be obtained, or
soliciting information, and includes required disclosure to third
parties or the public, of facts or opinions, when the information
collection calls for answers to identical questions posed to, or
identical reporting or recordkeeping requirements imposed on, ten or
more persons.\60\ The PRA requirements have been determined to include
not only mandatory, but also voluntary information collections, and
include both written and oral communications.\61\
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\60\ 44 U.S.C. 3502.
\61\ 5 CFR 1320.3(c)(1).
---------------------------------------------------------------------------
The Final Rule establishes two exemptions from the trade execution
requirement. The Final Rule will not create any new, or revise any
existing, collections of information under the PRA. Therefore, no
information collection request has been submitted to the Office of
Management and Budget for review.
C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\62\ Section 15(a) further
specifies that the costs and
[[Page 8999]]
benefits shall be evaluated in light of the following five broad areas
of market and public concern: (1) Protection of market participants and
the public; (2) efficiency, competitiveness, and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations.
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\62\ 7 U.S.C. 19(a).
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2. Background
The Commission is amending Sec. 36.1 to codify two exemptions from
the trade execution requirement for swaps. As noted, the trade
execution requirement applies to any swap that is subject to the swap
clearing requirement and has been ``made available to trade'' by a SEF
or DCM pursuant to Sec. 37.10 or Sec. 38.12. The first trade
execution requirement exemption applies to a swap transaction that
qualifies for an exception to, or exemption from, the clearing
requirement under part 50 of the Commission's regulations, and for
which the associated requirements are met. The second applies to a swap
that is entered into by eligible affiliate counterparties and cleared,
regardless of the affiliates' decision not to claim the inter-affiliate
clearing exemption under Sec. 50.52 of the Commission's regulations
and instead clear the swap.
The baseline against which the Commission considers the costs and
benefits of this Final Rule is the statutory and regulatory
requirements of the CEA and Commission regulations now in effect, in
particular CEA section 2(h)(8) and certain rules in part 37 of the
Commission's regulations. The Commission, however, notes that as a
practical matter certain market participants, such as eligible
affiliates and non-financial end-users, have adopted trade execution
practices consistent with this Final Rule based upon statutory
provisions or no-action relief provided by Commission staff that is
time-limited in nature.\63\ As such, to the extent that market
participants have relied on statutory provisions to provide an
exception from the trade execution requirement or relevant staff no-
action relief, the actual costs and benefits of the Final Rule may not
be as significant.
---------------------------------------------------------------------------
\63\ See NAL No. 17-67.
---------------------------------------------------------------------------
In some instances, it is not reasonably feasible to quantify the
costs and benefits with respect to certain factors, for example, price
discovery or market integrity. Notwithstanding these types of
limitations, however, the Commission otherwise identifies and considers
the costs and benefits of these rules in qualitative terms. The
Commission did not receive any comments from commenters which
quantified or attempted to quantify the costs and benefits of the
Proposed Rule.
The following consideration of costs and benefits is organized
according to the rules and rule amendments adopted in this release. For
each rule, the Commission summarizes the amendments and identifies and
discusses the costs and benefits attributable to such rule. The
Commission, where applicable, then considers the costs and benefits of
the rules in light of the five public interest considerations set out
in section 15(a) of the CEA.
The Commission notes that this consideration of costs and benefits
is based on the understanding that the swaps market functions
internationally, with many transactions involving U.S. firms taking
place across international boundaries, with some Commission registrants
being organized outside of the United States, with leading industry
members typically conducting operations both within and outside the
United States, and with industry members commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
discussion of costs and benefits below refers to the effects of the
Final Rule on all swaps activity subject to the new and amended
regulations, whether by virtue of the activity's physical location in
the United States or by virtue of the activity's connection with
activities in, or effect on, U.S. commerce under CEA section 2(i).\64\
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\64\ Section 2(i)(1) applies the swaps provisions of both the
Dodd-Frank Act and Commission regulations promulgated under those
provisions to activities outside the United States that ``have a
direct and significant connection with activities in, or effect on,
commerce of the United States[.]'' 7 U.S.C. 2(i). Section 2(i)(2)
makes them applicable to activities outside the United States that
contravene Commission rules promulgated to prevent evasion of the
Dodd-Frank Act.
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CEA section 2(h)(8) specifies that swap transactions that are
excepted from the clearing requirement pursuant to CEA section 2(h)(7)
(described in more detail above) are not subject to the trade execution
requirement.\65\ The Commission adopted requirements under Sec. 50.50
to implement the end-user exception under CEA section 2(h)(7).\66\
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\65\ 7 U.S.C. 2(h)(8)(B).
\66\ 17 CFR 50.50. Among other things, Sec. 50.50 establishes
when a swap is being used to hedge or mitigate commercial risk and
specifies how to satisfy the reporting requirement to elect such an
exception from the clearing requirement. 17 CFR 50.50.
---------------------------------------------------------------------------
The Commission is adopting Sec. 36.1(b) to expressly exempt from
the trade execution requirement swaps that are exempt from the clearing
requirement pursuant to part 50 of the Commission's regulations. Part
50 exempts from the clearing requirement swaps that have at least one
counterparty that is a certain type of entity, including ``exempt
cooperatives'', entities that qualify for the statutory end-user
exception,\67\ and eligible affiliate counterparties.\68\ In addition,
the Commission recently adopted amendments to part 50 codifying
additional clearing exemptions for swaps entered into with certain
central banks, sovereign entities, IFIs, bank holding companies,
savings and loan holding companies, and community development financial
institutions.\69\
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\67\ This includes the exemption for qualifying banks, savings
associations, farm credit system institutions, and credit unions in
Commission regulation 50.53.
\68\ See supra note 23 (describing requirements for meeting
``eligible affiliate counterparty'' status).
\69\ See Swap Clearing Requirement Exemptions, 85 FR 76428 (Nov.
30, 2020).
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3. Benefits and Costs
The Final Rule exempts from the trade execution requirement swap
transactions between eligible affiliate counterparties that elect to
clear such transactions, notwithstanding their ability to elect the
clearing exemption under Sec. 50.52. Under the current rules, inter-
affiliate transactions are only exempt from the trade execution
requirement if the eligible affiliate counterparties elect not to clear
the transaction. However, eligible affiliate counterparties that elect
to clear their inter-affiliate transactions are not exempted from the
trade execution requirement despite these transactions also not being
intended to be price forming or arm's length and therefore may not be
suitable for trading on SEFs or DCMs.
Therefore, the Final Rule treats cleared and uncleared inter-
affiliate swap transactions the same with respect to the trade
execution requirement. The Commission believes that this approach will
be beneficial because inter-affiliate swap transactions do not change
the ultimate ownership and control of swap positions (or result in
netting), and permitting them to be executed internally (provided that
they qualify for the clearing exemption under existing Sec. 50.52) may
reduce costs relative to requiring that they be executed on a SEF or a
DCM. Finally, the Commission believes that this exemption may help
ensure that eligible affiliate counterparties are not discouraged from
clearing their inter-affiliate swap transactions in order not to have
to trade them on SEFs or DCMs subject to the trade execution
requirement, which may
[[Page 9000]]
have systemic risk benefits.\70\ Market participants are currently
realizing these benefits pursuant to no-action relief and as discussed
below, inter-affiliate volume in cleared swaps executed off-exchange
appears to be a significant proportion of the overall swap volume that
would be subject to the trade execution requirement in fixed-to-
floating interest rate swaps (``IRS'').
---------------------------------------------------------------------------
\70\ The Commission notes that the Division of Market Oversight
previously provided no-action relief that mirrors this Final Rule so
these benefits may have already been realized. See NAL No. 17-67.
---------------------------------------------------------------------------
In an effort to estimate the scope of the Final Rule, Commission
staff reviewed swap transaction data for fixed-to-floating IRS for the
week ending September 18, 2020. Staff found that approximately $496
billion notional amount was traded in fixed-to-floating IRS subject to
the trade execution requirement (``TER IRS'') during that week.\71\ A
significant proportion of this volume (approximately $176 billion
notional or 35% of the total) was in swap transactions between eligible
affiliate counterparties. Of these inter-affiliate trades,
approximately $96 billion notional was uncleared and approximately $80
billion notional was cleared. About $3 billion in swap transactions
between eligible affiliate counterparties was cleared and executed on-
SEF while the remaining $77 billion in cleared inter-affiliate
transactions in TER IRS was cleared and traded off-exchange pursuant to
no-action relief.
---------------------------------------------------------------------------
\71\ Total volume in fixed-to-floating IRS that week was about
$1.37 trillion notional.
---------------------------------------------------------------------------
The Final Rule also exempts swap transactions that are excepted or
exempted from the clearing requirement under part 50 from the trade
execution requirement. The Commission believes that swap transactions
which are excepted or exempted from the clearing requirement also
benefit from exemption from the trade execution requirement, and that
the same reasoning that supports the clearing exemptions supports an
explicit exemption from the trade execution requirement. The Commission
also believes that exempting these transactions from the trade
execution requirement is consistent with CEA section 2(h)(8) and
adoption of the Final Rule may reduce transaction costs and may permit
some entities to avoid incurring the costs associated with onboarding
on a SEF or DCM.
The Commission's staff analysis identified relatively little volume
in TER IRS that was marked as being executed by end-users, $760 million
notional of which $10 million was traded on-SEF and the rest traded
off-exchange. However, it is unclear whether the data captures all the
TER IRS trades executed by entities that are trading TER IRS off-
exchange pursuant to the no-action relief. In a separate analysis for
the recently adopted amendments to part 50, adopting additional
clearing exemptions, the Commission found that that final rule exempted
only a small fraction of IRS transactions from the clearing
requirement.\72\ Since only a fraction of IRS transactions are subject
to the trade execution requirement, the Commission believes that the
scope of swaps subject to this Final Rule is significantly smaller than
the scope of swaps subject to the recent amendments to part 50.
---------------------------------------------------------------------------
\72\ Specifically, the Commission found using DCO data that
during calendar year 2018, 16 IFIs entered an estimated notional
amount of $220 billion in uncleared interest rate swaps pursuant to
existing no-action relief. During the same time period, eligible
bank holding companies and other eligible financial institutions
entered an estimated notional amount of $235 million in uncleared
interest rate swaps pursuant to existing no-action relief. See Swap
Clearing Requirement Exemptions, 85 FR 76428, 76435 (Nov. 30, 2020).
---------------------------------------------------------------------------
The Commission notes that some swap transactions that are subject
to the trade execution requirement involving entities that are eligible
for existing exemptions (or existing no-action relief) are nevertheless
executed on SEFs (as permitted transactions without restrictions on
execution method) and all market participants will continue to have the
option to execute on SEFs if they determine that they obtain benefits
from trading on a SEF voluntarily.
The Commission believes that the exemptions for certain swaps from
the trade execution requirement will not impose new costs on market
participants or on SEFs and DCMs and, since they are limited in scope
and in some instances involve affiliates and thus are not arm's-length
transactions, will not significantly detract from price discovery or
protection of market participants and the public.
4. Section 15(a) Factors
a. Protection of Market Participants and the Public
The Commission anticipates that the exemptions for certain swaps
from the trade execution requirement should not materially affect the
protection of market participants and the public. The exemptions
finalized today are intended to establish that a limited set of swap
transactions which are otherwise subject to the trade execution
requirement may occur off-exchange (or on-SEF as permitted
transactions). These transactions include inter-affiliate swap
transactions and other swap transactions that are exempt under part 50
from the clearing requirement.
b. Efficiency, Competitiveness, and Financial Integrity of the Markets
The Commission anticipates that the exemptions from the trade
execution requirement, as discussed above, will maintain the current
efficiency of those trades and thus maintain the financial integrity of
the counterparties consistent with statutory intent. The Commission
believes that the exemptions under part 50 are appropriately tailored
and thus, should not materially affect the competitiveness of the swap
markets. The Commission does not believe that there would be a benefit
to competition in the swap markets if inter-affiliate trades were
required to trade on a SEF or on a DCM since these trades merely
transfer positions between different entities within the same corporate
group.
c. Price Discovery
While, as a general matter, the Commission believes that price
discovery in swaps subject to the trade execution requirement should
occur on SEFs or DCMs, the Commission nevertheless believes that the
exemptions from the trade execution requirement should not materially
impact price discovery in the U.S. swaps markets. Most of the
transactions eligible for the exemptions, such as inter-affiliate
trades, are not price forming, while others involve end-users and
similar entities.
d. Sound Risk Management Practices
The Commission anticipates that the exemptions from the trade
execution requirement should not significantly impair the furtherance
of sound risk management practices because firms using the exemptions
should continue to be able to move swap positions between affiliates,
and to take advantage of the statutory end-user exception from the
clearing requirement as well as the exemptions from the clearing
requirement set forth in part 50. The Commission observes that eligible
market participants have been engaging in swaps activity consistent
with this Final Rule pursuant to statutory provisions or CFTC staff no-
action relief and the practice has not been found to impair risk
management practices.
e. Other Public Interest Considerations
The Commission has not identified any effects of the rules and the
trade execution requirement exemption on other public interest
considerations.
[[Page 9001]]
5. Consideration of Alternatives
Commenters were generally supportive of the Proposed Rule and
section 4(c) exemptions and recommended only one viable
alternative.\73\ Specifically, Citadel stated that the Commission
should not preemptively grant a trade execution exemption for swaps
falling under future clearing exemptions, but rather should consider
additional future exemptions from the trade execution requirement on a
case-by-case basis. The Commission is finalizing the rule automatically
granting such exemptions, and as a consequence will consider the costs
and benefits in future rulemakings of both any proposed clearing
exemption and the associated exemption from the trade execution
requirement. Interested persons will have the opportunity to comment on
the appropriateness of both exemptions.
---------------------------------------------------------------------------
\73\ As discussed above, commenters did recommend several other
potential Commission actions that are outside the scope of this
rulemaking and are therefore not addressed in this consideration of
costs and benefits.
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D. Antitrust Considerations
CEA section 15(b) requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the Act, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of the Act.\74\
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\74\ 7 U.S.C. 19(b).
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The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requested and did not receive comments on whether the Proposed Rule
implicates any other specific public interest to be protected by the
antitrust laws. The Commission has considered the Final Rule to
determine whether it is anticompetitive and has identified no
significant anticompetitive effects. Although the Final Rule exempts
certain swaps from the requirement to trade competitively on a SEF or
DCM, as noted above, these exemptions are narrowly circumscribed in
scope, and the Commission has determined the exemptions to be in the
public interest. The Commission also notes that the inter-affiliate
transactions exempted under new Sec. 36.1(b) would not be executed on
a competitive, arm's-length basis even if they were required to occur
on a SEF or DCM.
List of Subjects in 17 CFR Part 36
Trade execution requirement.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 36 as follows:
PART 36--TRADE EXECUTION REQUIREMENT
0
1. The authority citation for part 36 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, and 7b-3, as
amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
0
2. In Sec. 36.1, add paragraphs (b) and (c) to read as follows:
Sec. 36.1 Exemptions to trade execution requirement.
* * * * *
(b) Section 2(h)(8) of the Act does not apply to a swap transaction
that qualifies for the exception under section 2(h)(7) of the Act or an
exception or exemption under part 50 of this chapter, and for which the
associated requirements are met.
(c) Section 2(h)(8) of the Act does not apply to a swap transaction
that is executed between counterparties that have eligible affiliate
counterparty status pursuant to Sec. 50.52(a) of this chapter even if
the eligible affiliate counterparties clear the swap transaction.
Issued in Washington, DC, on December 23, 2020, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Exemptions From Swap Trade Execution Requirement--
Commission Voting Summary and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Concurrence of Commissioner Rostin Behnam
More than two years ago, in November 2018, the Commission voted
to propose a comprehensive overhaul of the existing framework for
swap execution facilities (SEFs).\1\ Today, the Commission issues
two rules finalizing aspects of the SEF Proposal and a withdrawal of
the SEF Proposal's unadopted provisions. This is the final step in a
long road. Last month, the Commission finalized rules emanating from
the SEF Proposal regarding codification of existing no-action
letters regarding, among other things, package transactions.\2\
Today's final rules and withdrawal complete the Commission's
consideration of the SEF Proposal.
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\1\ Swap Execution Facilities and Trade Execution Requirement,
83 FR 61946 (Nov. 30, 2018) (the ``SEF Proposal'').
\2\ Swap Execution Facility Requirements (Nov. 18, 2020),
https://www.cftc.gov/PressRoom/PressReleases/8313-20.
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Back in November 2018, I expressed concern that finalization of
the SEF Proposal would reduce transparency, increase limitations on
access to SEFs, and add significant costs for market
participants.\3\ I also noted that, while the existing SEF framework
could benefit from targeted changes, particularly the codification
of existing no-action relief, the SEF framework has in many ways
been a success. I pointed out that the Commission's work to promote
swaps trading on SEFs has resulted in increased liquidity, while
adding pre-trade price transparency and competition. Nonetheless, I
voted to put the SEF Proposal out for public comment, anticipating
that the notice and comment process would guide the Commission in
identifying a narrower set of changes that would improve the current
SEF framework and better align it with the statutory mandate and the
underling policy objectives shaped after the 2008 financial
crisis.\4\ More than two years and many comment letters later, that
is exactly what has happened. The Commission has been precise and
targeted in its finalization of specific provisions from the SEF
Proposal that provide needed clarity to market participants and
promote consistency, competitiveness, and appropriate operational
flexibility consistent with the core principles.
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\3\ Statement of Concurrence of Commissioner Rostin Behnam
Regarding Swap Execution Facilities and Trade Execution Requirement,
https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement110518a.
\4\ Id.
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In addition to expressing substantive concerns about the
overbreadth of the SEF Proposal, I also voiced concerns that we were
rushing by having a comparatively short 75-day comment period.\5\ In
the end, the comment period was rightly extended, and the Commission
has taken the time necessary to carefully evaluate the
appropriateness of the SEF Proposal in consideration of its
regulatory and oversight responsibilities and the comments received.
I think that the consideration of the SEF Proposal is an example of
how the process is supposed to work. When we move too quickly toward
the finish line and without due consideration of the surrounding
environment, we risk making a mistake that will impact our markets
and market participants.
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\5\ Id.
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Finally, I would like to address the Commission's separate vote
to withdraw the
[[Page 9002]]
unadopted provisions of the SEF Proposal. In the past, I have
expressed concern with such withdrawals by an agency that has
historically prided itself on collegiality and working in a
bipartisan fashion.\6\ In the case of today's withdrawal, the
Commission has voted on all appropriate aspects of the SEF Proposal
through three rules finalized during the past month. The Commission
has voted unanimously on all of these rules, including today's
decision to withdraw the remainder from further consideration. While
normally a single proposal results in a single final rule, in this
instance, multiple final rules have been finalized emanating from
the SEF Proposal. This could lead to confusion regarding the
Commission's intentions regarding the many unadopted provisions of
the SEF Proposal. Under such circumstances, I think it is
appropriate to provide market participants with clarity regarding
the SEF Proposal. Accordingly, I will support today's withdrawal of
the SEF Proposal. But rather than viewing it as a withdrawal of the
SEF Proposal, I see it as an affirmation of the success of the
existing SEF framework and the careful process to markedly improve
the SEF framework in a measured and thoughtful way.
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\6\ Rostin Behnam, Commissioner, CFTC, Dissenting Statement of
Commissioner Rostin Behnam Regarding Electronic Trading Risk
Principles (June 25, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement062520b.
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Appendix 3--Statement of Commissioner Dan M. Berkovitz
I support the Commission's decision to withdraw its 2018
proposal to overhaul the regulation of swap execution facilities
(``SEFs'') \1\ (``2018 SEF NPRM'') and proceed instead with targeted
adjustments to our SEF rules (``Final Rules''). The two Final Rules
approved today will make minor changes to SEF requirements while
retaining the progress we have made in moving standardized swaps
onto electronic trading platforms, which has enhanced the stability,
transparency, and competitiveness of our swaps markets.\2\
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\1\ Swap Execution Facilities and Trade Execution Requirement,
83 FR 61946 (Nov. 30, 2018).
\2\ Dissenting Statement of Commissioner Dan M. Berkovitz
Regarding Proposed Rulemaking on Swap Execution Facilities and Trade
Execution Requirement (Nov, 5, 2018), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement110518a.
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When the Commission issued the 2018 SEF NPRM, I proposed that we
enhance the existing swaps trading system instead of dismantling it.
For example, I urged the Commission to clarify the floor trader
exception to the swap dealer registration requirement and abolish
the practice of post-trade name give-up for cleared swaps. I am
pleased that the Commission already has acted favorably on both of
those matters. Today's rulemaking represents a further positive step
in this targeted approach.
Many commenters to the 2018 SEF NPRM supported this incremental
approach, advocating discrete amendments rather than wholesale
changes. Today, the Commission is adopting two Final Rules that
codify tailored amendments that received general support from
commenters. The first rule--Swap Execution Facilities--amends part
37 to address certain operational challenges that SEFs face in
complying with current requirements, some of which are currently the
subject of no-action relief or other Commission guidance. The second
rule--Exemptions from Swap Trade Execution Requirement--exempts two
categories of swaps from the trade execution requirement, both of
which are linked to exceptions to or exemptions from the swap
clearing requirement.
Swap Execution Facilities: Audit Trail Data, Financial Resources and
Reporting, and Requirements for Chief Compliance Officers
Commission regulations require a SEF to capture and retain all
audit trail data necessary to detect, investigate, and prevent
customer and market abuses, which currently includes identification
of each account to which fills are ultimately allocated.\3\
Following the adoption of these regulations, SEFs represented that
they are unable to capture post-execution allocation data because
the allocations occur away from the SEF, prompting CFTC staff to
issue no-action relief. Other parties, including DCOs and account
managers, must capture and retain post-execution allocation
information and produce it to the CFTC upon request, and SEFs are
required to establish rules that allow them obtain this allocation
information from market participants as necessary to fulfill their
self-regulatory responsibilities. Given that staff is not aware of
any regulatory gaps that have resulted from SEFs' reliance on the
no-action letter, codifying this alternative compliance framework is
appropriate.
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\3\ 17 CFR 37.205(a), b(2)(iv).
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This Swap Execution Facility final rule also will amend part 37
to tie a SEF's financial resource requirements more closely to the
cost of its operations, whether in complying with core principles
and Commission regulations or winding down its operations. Based on
its experience implementing the SEF regulatory regime, the
Commission believes that these amended resource requirements--some
of which simply reflect current practice--will be sufficient to
ensure that a SEF is financially stable while avoiding the
imposition of unnecessary costs. Additional amendments to part 37,
including requirements that a SEF must prepare its financial
statements in accordance with U.S. GAAP standards, identify costs
that it has excluded in determining its projected operated costs,
and notify the Commission within 48 hours if it is unable to comply
with its financial resource requirements, will further enhance the
Commission's ability to exercise it oversight responsibilities.
Finally, this rule makes limited changes to the Chief Compliance
Officer (``CCO'') requirements. As a general matter, I agree that
the Commission should clarify certain CCO duties and streamline CCO
reporting requirements where information is duplicative or not
useful to the Commission. Although the CCO requirements diverge
somewhat from those for futures commission merchants and swap
dealers, the role of SEFs is different and therefore,
standardization is not always necessary or appropriate. I expect
that the staff will continue to monitor the effects of all of the
changes adopted today and inform the Commission if it believes
further changes to our rules are needed.
Exemptions From Swap Trade Execution Requirement
Commodity Exchange Act (``CEA'') section 2(h)(8) specifies that
a swap that is excepted from the clearing requirement pursuant to
CEA section 2(h)(7) is not subject to the requirement to trade the
swap on a SEF. Accordingly, swaps that fall into the statutory swap
clearing exceptions (e.g., commercial end-users and small banks) are
also excepted from the trading mandate. However, the Commission has
also exempted from mandatory clearing swaps entered into by certain
entities (e.g., cooperatives, central banks, and swaps between
affiliates) using different exemptive authorities from section
2(h)(7).
The Exemptions from Swap Trade Execution Requirement final rule
affirms the link between the clearing mandate and the trading
mandate for swaps that are exempted from the clearing mandate under
authorities other than CEA section 2(h)(7). The additional clearing
exemptions are typically provided by the Commission to limited types
of market participants, such as cooperatives or central banks that
use swaps for commercial hedging or have financial structures or
purposes that greatly reduce the need for mandatory clearing and SEF
trading. In addition, limited data provided in the release indicates
that, at least up to this point in time, these exempted swaps
represent a small percentage of the notional amount of swaps traded.
This final rule also exempts inter-affiliate swaps from the
trade execution requirement. These swaps are exempted from the
clearing requirement primarily because the risks on both sides of
the swap are, at least in some respects, held within the same
corporate enterprise. As described in the final rule release, these
swaps may not be traded at arms-length and serve primarily to move
risk from one affiliate to another within the same enterprise.
Neither market transparency nor price discovery would be enhanced by
including these transactions within the trade execution mandate. For
these reasons, I am approving the Exemptions from Swap Trade
Execution Requirement final rule as a sensible exemption consistent
with the relevant sections of the CEA.
Conclusion
These two Final Rules provide targeted changes to the SEF
regulations based on experience from several years of implementing
them. These limited changes, together with the withdrawal of the
remainder of the 2018 SEF NPRM, effectively leave in place the basic
framework of the SEF rules as originally adopted by the Commission.
This framework has enhanced market transparency, improved
competition, lowered transaction costs, and resulted in better swap
prices for end users. While it
[[Page 9003]]
may be appropriate to make other incremental changes going forward,
it is important that we affirm the established regulatory program
for SEFs to maintain these benefits and facilitate further expansion
of this framework.
I thank the staff of the Division of Market Oversight for their
work on these two rules and their helpful engagement with my office.
[FR Doc. 2020-28943 Filed 2-10-21; 8:45 am]
BILLING CODE 6351-01-P
