Further Definition of Swap, Security-Based Swap, and Security-Based Swap Agreement; Mixed Swaps; Security-Based Swap Agreement Recordkeeping

1 17 CFR 145.9.
COMMODITY FUTURES TRADING COMMISSION 17 CFR Part 1 RIN 3038–AD46 SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 230, 240 and 241 [Release No. 33–9338; 34–67453; File No. S7–16–11] RIN 3235–AK65 Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping AGENCY: Commodity Futures Trading Commission; Securities and Exchange Commission. ACTION: Joint final rule; interpretations; request for comment on an interpretation. SUMMARY: In accordance with section 712(a)(8), section 712(d)(1), sections 712(d)(2)(B) and (C), sections 721(b) and (c), and section 761(b) of the Dodd￾Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’), the Commodity Futures Trading Commission (‘‘CFTC’’) and the Securities and Exchange Commission (‘‘SEC’’) (collectively, ‘‘Commissions’’), in consultation with the Board of Governors of the Federal Reserve System (‘‘Board’’), are jointly adopting new rules and interpretations under the Commodity Exchange Act (‘‘CEA’’) and the Securities Exchange Act of 1934 (‘‘Exchange Act’’) to further define the terms ‘‘swap,’’ ‘‘security-based swap,’’ and ‘‘security-based swap agreement’’ (collectively, ‘‘Product Definitions’’); regarding ‘‘mixed swaps;’’ and governing books and records with respect to ‘‘security-based swap agreements.’’ The CFTC requests comment on its interpretation concerning forwards with embedded volumetric optionality, contained in
Section II.B.2.(b)(ii) of this release.
DATES: Effective date: October 12, 2012. Compliance date: The applicable compliance dates are discussed in the
section of the release titled ‘‘IX.
Effective Date and Implementation’’.
Comment date: Comments on the interpretation regarding forwards with embedded volumetric optionality must be received on or before October 12, 2012. ADDRESSES: You may submit comments, identified by RIN number 3038–AD46, by any of the following methods:

• CFTC Web Site: via its Comments
  Online process: http:// comments.cftc.gov. Follow the instructions for submitting comments through the Web site.
• Mail: Address to David A. Stawick,
  Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.
• Hand Delivery/Courier: Same as
  mail above.
• Federal eRulemaking Portal: http://
  www.regulations.gov. Follow the instructions for submitting comments. All comments must be submitted in English or, if not, accompanied by an English translation. Comments will be posted as received to http:// www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the CFTC to consider information that is exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the CFTC’s Regulations.1 The CFTC reserves the right, but shall have no obligation, to review, pre￾screen, filter, redact, refuse or remove any or all of your submission from http://www.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the interpretation will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act. FOR FURTHER INFORMATION CONTACT:
  CFTC: Julian E. Hammar, Assistant General Counsel, at 202–418–5118, jhammar@cftc.gov, Lee Ann Duffy, Assistant General Counsel, at 202–418– 6763, lduffy@cftc.gov; Mark Fajfar, Assistant General Counsel, at 202–418– 6636, mfajfar@cftc.gov, or David E. Aron, Counsel, at 202–418–6621, daron@cftc.gov, Office of General Counsel, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581; SEC: Donna M. Chambers, Special Counsel, at 202–551–5870, or John Guidroz, Attorney-Adviser, at 202– 551–5870, Division of Trading and Markets, or Andrew Schoeffler, Special Counsel, at 202–551–3860, Office of Capital Markets Trends, Division of Corporation Finance, or Wenchi Hu, Senior Special Counsel, at 202–551– 5870, Office of Compliance, Inspections and Examinations, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549. SUPPLEMENTARY INFORMATION:
  Table of Contents
  I. Background
  II. Scope of Definitions of Swap and Security￾Based Swap
  A. Introduction
  B. Rules and Interpretations Regarding Certain Transactions outside the Scope of the Definitions of the Terms ‘‘Swap’’ and ‘‘Security-Based Swap’’

1. Insurance Products
   (a) Types of Insurance Products (b) Providers of Insurance Products (c) Grandfather Provision for Existing Insurance Transactions (d) Alternative Tests (e) ‘‘Safe Harbor’’ (f) Applicability of Insurance Exclusion to Security-Based Swaps (g) Guarantees
2. The Forward Contract Exclusion
   (a) Forward Contracts in Nonfinancial Commodities (i) Forward Exclusion From the Swap and Future Delivery Definitions (ii) Nonfinancial Commodities (iii) Environmental Commodities (iv) Physical Exchange Transactions (v) Fuel Delivery Agreements (vi) Cleared/Exchange-Traded Forwards (b) Commodity Options and Commodity Options Embedded in Forward Contracts (i) Commodity Options (ii) Commodity Options Embedded in Forward Contracts (iii) Certain Physical Commercial Agreements, Contracts or Transactions (iv) Effect of Interpretation on Certain Agreements, Contracts and Transactions (v) Liquidated Damages Provisions (c) Security Forwards
3. Consumer and Commercial Agreements,
   Contracts, and Transactions
   C. Final Rules and Interpretations
   Regarding Certain Transactions Within the Scope of the Definitions of the Terms ‘‘Swap’’ and ‘‘Security-Based Swap’’
4. In General
5. Foreign Exchange Products
   (a) Foreign Exchange Products Subject to the Secretary’s Swap Determination:
   Foreign Exchange Forwards and Foreign Exchange Swaps (b) Foreign Exchange Products Not Subject to the Secretary’s Swap Determination (i) Foreign Currency Options (ii) Non-Deliverable Forward Contracts Involving Foreign Exchange (iii) Currency Swaps and Cross-Currency Swaps (c) Interpretation Regarding Foreign Exchange Spot Transactions (d) Retail Foreign Currency Options
6. Forward Rate Agreements
7. Combinations and Permutations of, or
   Options on, Swaps and Security-Based Swaps
8. Contracts for Differences
   D. Certain Interpretive Issues
9. Agreements, Contracts, or Transactions
   That May Be Called, or Documented

2See Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111–203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act is available at http://www.cftc.gov/LawRegulation/ OTCDERIVATIVES/index.htm. 3Pursuant to section 701 of the Dodd-Frank Act, Title VII may be cited as the ‘‘Wall Street Transparency and Accountability Act of 2010.’’ 4 In addition, section 719(d)(1)(A) of the Dodd￾Frank Act requires the Commissions to conduct a joint study, within 15 months of enactment, to determine whether stable value contracts, as defined in section 719(d)(2) of the Dodd-Frank Act, are encompassed by the swap definition. If the Commissions determine that stable value contracts are encompassed by the swap definition, section 719(d)(1)(B) of the Dodd-Frank Act requires the Commissions jointly to determine whether an exemption for those contracts from the swap definition is appropriate and in the public interest.
Section 719(d)(1)(B) also requires the Commissions
to issue regulations implementing the determinations made under the required study. Until the effective date of such regulations, the requirements under Title VII do not apply to stable value contracts, and stable value contracts in effect prior to the effective date of such regulations are not considered swaps. See section 719(d) of the Dodd￾Frank Act. The Commissions currently are conducting the required joint study and will consider whether to propose any implementing regulations (including, if appropriate, regulations determining that stable value contracts: (i) Are not encompassed within the swap definition; or (ii) are encompassed within the definition but are exempt from the swap definition) at the conclusion of that study. Using Form Contracts Typically Used for, Swaps or Security-Based Swaps
2. Transactions in Regional Transmission
Organizations and Independent System Operators
III. The Relationship Between the Swap
Definition and the Security-Based Swap Definition A. Introduction B. Title VII Instruments Based on Interest Rates, Other Monetary Rates, and Yields

1. Title VII Instruments Based on Interest
   Rates or Other Monetary Rates That Are Swaps
2. Title VII Instruments Based on Yields
3. Title VII Instruments Based on
   Government Debt Obligations
   C. Total Return Swaps
   D. Security-Based Swaps Based on a Single Security or Loan and Single-Name Credit Default Swaps E. Title VII Instruments Based on Futures Contracts F. Use of Certain Terms and Conditions in Title VII Instruments G. The Term ‘‘Narrow-Based Security Index’’ in the Security-Based Swap Definition
4. Introduction
5. Applicability of the Statutory Narrow￾Based Security Index Definition and Past
   Guidance of the Commissions to Title VII Instruments
6. Narrow-Based Security Index Criteria for
   Index Credit Default Swaps (a) In General (b) Rules Regarding the Definitions of ‘‘Issuers of Securities in a Narrow-Based Security Index’’ and ‘‘Narrow-Based Security Index’’ for Index Credit Default Swaps (i) Number and Concentration Percentages of Reference Entities or Securities (ii) Affiliation of Reference Entities and Issuers of Securities With Respect to Number and Concentration Criteria (iii) Public Information Availability Regarding Reference Entities and Securities (iv) Affiliation of Reference Entities and Issuers of Securities With Respect to Certain Criteria of the Public Information Availability Test (v) Application of the Public Information Availability Requirements to Indexes Compiled by a Third-Party Index Provider (vi) Treatment of Indexes Including Reference Entities That Are Issuers of Exempted Securities or Including Exempted Securities
7. Security Indexes
8. Evaluation of Title VII Instruments on
   Security Indexes That Move From Broad￾Based to Narrow-Based or Narrow-Based to Broad-Based (a) In General (b) Title VII Instruments on Security Indexes Traded on Designated Contract Markets, Swap Execution Facilities, Foreign Boards of Trade, Security-Based Swap Execution Facilities, and National Securities Exchanges H. Method of Settlement of Index CDS
   I. Security-Based Swaps as Securities
   Under the Exchange Act and Securities Act
   IV. Mixed Swaps
   A. Scope of the Category of Mixed Swap B. Regulation of Mixed Swaps
9. Introduction
10. Bilateral Uncleared Mixed Swaps
    Entered Into by Dually-Registered Dealers or Major Participants
11. Regulatory Treatment for Other Mixed
    Swaps
    V. Security-Based Swap Agreements
    A. Introduction
    B. Swaps That Are Security-Based Swap Agreements
    C. Books and Records Requirements for
    Security-Based Swap Agreements
    VI. Process for Requesting Interpretations of
    the Characterization of a Title VII Instrument
    VII. Anti-Evasion
    A. CFTC Anti-Evasion Rules
12. CFTC’s Anti-Evasion Authority
    (a) Statutory Basis for the Anti-Evasion Rules
13. Final Rules
    (a) Rule 1.3(xxx)(6)
    (b) Rule 1.6
    (c) Interpretation on the Final Rules
14. Interpretation Contained in the
    Proposing Release
    (a) Business Purpose Test (b) Fraud, Deceit or Unlawful Activity B. SEC Position Regarding Anti-Evasion Rules
    VIII. Miscellaneous Issues
    A. Distinguishing Futures and Options From Swaps B. Transactions Entered Into by Foreign Central Banks, Foreign Sovereigns, International Financial Institutions, and Similar Entities
    C. Definition of the Terms ‘‘Swap’’ and
    ‘‘Security-Based Swap’’ as Used in the Securities Act
    IX. Effective Date and Implementation
    X. Administrative Law Matters—CEA
    Revisions
    A. Paperwork Reduction Act B. Regulatory Flexibility Act
    C. Costs and Benefits Considerations
    XI. Administrative Law Matters—Exchange
    Act Revisions
    A. Economic Analysis
    B. Paperwork Reduction Act
    C. Regulatory Flexibility Act Certification
    XII. Statutory Basis and Rule Text
    I. Backbround
    On July 21, 2010, President Obama signed the Dodd-Frank Act into law.2 Title VII of the Dodd-Frank Act 3 (‘‘Title VII’’) established a comprehensive new regulatory framework for swaps and security-based swaps. The legislation was enacted, among other reasons, to reduce risk, increase transparency, and promote market integrity within the financial system, including by: (i) Providing for the registration and comprehensive regulation of swap dealers, security-based swap dealers, major swap participants, and major security-based swap participants; (ii) imposing clearing and trade execution requirements on swaps and security￾based swaps, subject to certain exceptions; (iii) creating rigorous recordkeeping and real-time reporting regimes; and (iv) enhancing the rulemaking and enforcement authorities of the Commissions with respect to, among others, all registered entities and intermediaries subject to the Commissions’ oversight.
    Section 712(d)(1) of the Dodd-Frank
    Act provides that the Commissions, in consultation with the Board, shall jointly further define the terms ‘‘swap,’’ ‘‘security-based swap,’’ and ‘‘security￾based swap agreement’’ (‘‘SBSA’’).4
    Section 712(a)(8) of the Dodd-Frank Act
    provides further that the Commissions shall jointly prescribe such regulations regarding ‘‘mixed swaps’’ as may be necessary to carry out the purposes of Title VII. In addition, sections 721(b) and 761(b) of the Dodd-Frank Act provide that the Commissions may adopt rules to further define terms included in subtitles A and B, respectively, of Title VII, and sections 721(c) and 761(b) of the Dodd-Frank Act provide the Commissions with authority to define the terms ‘‘swap’’ and ‘‘security-based swap,’’ as well as the terms ‘‘swap dealer,’’ ‘‘major swap participant,’’ ‘‘security-based swap dealer,’’ and ‘‘major security-based swap participant,’’ to include transactions and entities that have been structured to

5 7 U.S.C. 1 et seq.
6The CFTC has issued final rules regarding SDRs and, separately, swap data recordkeeping and reporting. See Swap Data Repositories: Registration Standards, Duties and Core Principles, 76 FR 54538 (Sep. 1, 2011); Swap Data Recordkeeping and Reporting Requirements, 77 FR 2136 (Jan. 13, 2012). The SEC has also issued proposed rules regarding security-based swap data repositories (‘‘SBSDRs’’), including rules specifying data collection and maintenance standards for SBSDRs, as well as rules regarding security-based swap data recordkeeping and reporting. See Security-Based Swap Data Repository Registration, Duties, and Core Principles, 75 FR 77306 (Dec. 10, 2010); Regulation SBSR—Reporting and Dissemination of Security￾Based Swap Information, 75 FR 75208 (Dec. 2, 2010). 7The CFTC has issued final rules regarding recordkeeping requirements for swap dealers and major swap participants. See Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 77 FR 20128 (Apr. 3, 2012). 8Section 721(a) of the Dodd-Frank Act defines the term ‘‘swap’’ by adding section 1a(47) to the CEA, 7 U.S.C. 1a(47). This new swap definition also is cross-referenced in new section 3(a)(69) of the Exchange Act, 15 U.S.C. 78c(a)(69). Citations to provisions of the CEA and the Exchange Act, 15 U.S.C. 78a et seq., in this release refer to the numbering of those provisions after the effective date of Title VII, except as indicated. 9Section 761(a) of the Dodd-Frank Act defines the term ‘‘security-based swap’’ by adding new
section 3(a)(68) to the Exchange Act, 15 U.S.C.
78c(a)(68). This new security-based swap definition also is cross-referenced in new CEA section 1a(42), 7 U.S.C. 1a(42). The Dodd-Frank Act also explicitly includes security-based swaps in the definition of security under the Exchange Act and the Securities Act of 1933 (‘‘Securities Act’’), 15 U.S.C. 77a et seq. 10Section 721(a) of the Dodd-Frank Act describes the category of ‘‘mixed swap’’ by adding new
section 1a(47)(D) to the CEA, 7 U.S.C. 1a(47)(D).
Section 761(a) of the Dodd-Frank Act also includes
the category of ‘‘mixed swap’’ by adding new
section 3(a)(68)(D) to the Exchange Act, 15 U.S.C.
78c(68)(D). A mixed swap is defined as a subset of security-based swaps that also are based on the value of 1 or more interest or other rates, currencies, commodities, instruments of indebtedness, indices, quantitative measures, other financial or economic interest or property of any kind (other than a single security or a narrow-based security index), or the occurrence, non-occurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence (other than the occurrence, non￾occurrence, or extent of the occurrence of an event relating to a single issuer of a security or the issuers of securities in a narrow-based security index, provided that such event directly affects the financial statements, financial condition, or financial obligations of the issuer). 11Section 761(a) of the Dodd-Frank Act defines the term ‘‘security-based swap agreement’’ by adding new section 3(a)(78) to the Exchange Act, 15 U.S.C. 78c(a)(78). The CEA includes the definition of ‘‘security-based swap agreement’’ in subparagraph (A)(v) of the swap definition in CEA
section 1a(47), 7 U.S.C. 1a(47). The only difference
between these definitions is that the definition of SBSA in the Exchange Act specifically excludes security-based swaps (see section 3(a)(78)(B) of the Exchange Act, 15 U.S.C. 78c(a)(78)(B)), whereas the definition of SBSA in the CEA does not contain a similar exclusion. Instead, under the CEA, the exclusion for security-based swaps is placed in the general exclusions from the swap definition (see CEA section 1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x)). Although the statutes are slightly different structurally, the Commissions interpret them to have consistent meaning that the category of security-based swap agreements excludes security￾based swaps. 12See Definitions Contained in Title VII of Dodd￾Frank Wall Street Reform and Consumer Protection Act, 75 FR 51429 (Aug. 20, 2010). The ANPR also solicited comment regarding the definitions of the terms ‘‘swap dealer,’’ ‘‘security-based swap dealer,’’ ‘‘major swap participant,’’ ‘‘major security-based swap participant,’’ and ‘‘eligible contract participant.’’ These definitions are the subject of a separate joint rulemaking by the Commissions. See Further Definition of ‘‘Swap Dealer,’’ ‘‘Security￾Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Participant’’ and ‘‘Eligible Contract Participant,’’ 77 FR 30596 (May 23, 2012) (‘‘Entity Definitions Release’’). The Commissions also provided the public with the ability to present their views more generally on implementation of the Dodd-Frank Act through their Web sites, dedicated electronic mailboxes, and meetings with interested parties. See Public Comments on SEC Regulatory Initiatives Under the Dodd-Frank Act/Meetings with SEC Officials, located at http://www.sec.gov/spotlight/ regreformcomments.shtml; Public Submissions, located at http://comments.cftc.gov/Public Comments/ReleasesWithComments.aspx; External Meetings, located at http://www.cftc.gov/Law Regulation/DoddFrankAct/ExternalMeetings/ index.htm. 13Copies of all comments received by the SEC on the ANPR are available on the SEC’s Internet Web site, located at http://www.sec.gov/comments/s7-16- 10/s71610.shtml. Comments are also available for Web site viewing and printing in the SEC’s Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Copies of all comments received by the CFTC on the ANPR are available on the CFTC’s Internet Web site, located at http://www. cftc.gov/LawRegulation/DoddFrankAct/OTC_2_ Definitions.html. 14See supra note 12. 15See Further Definition of ‘‘Swap,’’ ‘‘Security￾Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 76 FR 29818 (May 23,
2011) (‘‘Proposing Release’’).
16 Id.
17 Information about meetings that CFTC staff have had with outside organizations regarding the implementation of the Dodd-Frank Act is available at http://www.cftc.gov/LawRegulation/DoddFrank Act/ExternalMeetings/index.htm. Information about meetings that SEC staff have had with outside organizations regarding the product definitions is available at http://www.sec.gov/comments/s7-16- 10/s71610.shtml#meetings. evade the requirements of subtitles A and B, respectively, of Title VII.
Section 712(d)(2)(B) of the Dodd￾Frank Act requires the Commissions, in
consultation with the Board, to jointly adopt rules governing books and records requirements for SBSAs by persons registered as swap data repositories (‘‘SDRs’’) under the CEA,5 including uniform rules that specify the data elements that shall be collected and maintained by each SDR.6 Similarly,
section 712(d)(2)(C) of the Dodd-Frank
Act requires the Commissions, in consultation with the Board, to jointly adopt rules governing books and records for SBSAs, including daily trading records, for swap dealers, major swap participants, security-based swap dealers, and security-based swap participants.7 Under the comprehensive framework for regulating swaps and security-based swaps established in Title VII, the CFTC is given regulatory authority over swaps,8 the SEC is given regulatory authority over security-based swaps,9 and the Commissions shall jointly prescribe such regulations regarding mixed swaps as may be necessary to carry out the purposes of Title VII.10 In addition, the SEC is given antifraud authority over, and access to information from, certain CFTC￾regulated entities regarding SBSAs, which are a type of swap related to securities over which the CFTC is given regulatory authority.11 To assist the Commissions in further defining the Product Definitions (as well as certain other definitions) and in prescribing regulations regarding mixed swaps as may be necessary to carry out the purposes of Title VII, the Commissions published an advance notice of proposed rulemaking (‘‘ANPR’’) in the Federal Register on August 20, 2010.12 The comment period for the ANPR closed on September 20,
2010.13 The Commissions received
comments addressing the Product Definitions and/or mixed swaps in response to the ANPR, as well as comments in response to the Commissions’ informal solicitations,14 from a wide range of commenters. Taking into account comments received on the ANPR, the Commissions published a notice of proposed rulemaking in the Federal Register on May 23, 2011.15 The comment period for the Proposing Release closed on July 22, 2011.16 Together, the Commissions received approximately 86 written comment letters in response to the Proposing Release. The Commissions have reviewed and considered the comments received, and the staffs of the Commissions have met with many market participants and other interested parties to discuss the definitions.17 Moreover, the Commissions’ staffs have consulted extensively with each other as required by sections 712(a)(1) and (2) of the Dodd-Frank Act and have consulted with staff of the Board as required by
section 712(d) of the Dodd-Frank Act.
Based on this review and consultation, the Commissions are adopting rules and interpretations regarding, among other things: (i) The regulatory treatment of insurance products; (ii) the exclusion of forward contracts from the swap and security￾mstockstill on DSK4VPTVN1PROD with RULES2

18The Commissions refer to these costs and benefits as programmatic costs and benefits. 19The Commissions refer to these costs as assessment costs. 20See sections 712(a)(1) and (a)(2) of the Dodd￾Frank Act. 21See sections 712(a)(7)(A) and (B) of the Dodd￾Frank Act. 22See CEA section 1a(47)(A), 7 U.S.C. 1a(47)(A). This swap definition is also cross-referenced in new
section 3(a)(69) of the Exchange Act, 15 U.S.C.
78c(a)(69).
23See CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B), clauses (i)–(x). 24See CEA sections 1a(47)(C)–(F), 7 U.S.C. 1a(47)(C)–(F). 25See CEA section 1a(47)(B)(x), 7 U.S.C. 1a(47)(B)(x). 26See section 3(a)(68) of the Exchange Act, 15 U.S.C. 78c(a)(68). based swap definitions; (iii) the regulatory treatment of certain consumer and commercial contracts; (iv) the regulatory treatment of certain foreign-exchange related and other instruments; (v) swaps and security￾based swaps involving interest rates (or other monetary rates) and yields; (vi) total return swaps (‘‘TRS’’); (vii) Title VII instruments based on futures contracts; (viii) the application of the definition of ‘‘narrow-based security index’’ in distinguishing between certain swaps and security-based swaps, including credit default swaps (‘‘CDS’’) and index CDS; and (ix) the specification of certain swaps and security-based swaps that are, and are not, mixed swaps. In addition, the Commissions are adopting rules: (i) To clarify that there will not be additional books and records requirements applicable to SBSAs other than those required for swaps; (ii) providing a mechanism for requesting the Commissions to interpret whether a particular type of agreement, contract, or transaction (or class of agreements, contracts, or transactions) is a swap, security-based swap, or both (i.e., a mixed swap); and (iii) providing a mechanism for evaluating the applicability of certain regulatory requirements to particular mixed swaps. Finally, the CFTC is adopting rules to implement the anti-evasion authority provided in the Dodd-Frank Act. Overall Economic Considerations The Commissions are sensitive to the costs and benefits of their rules. In considering the adoption of the Product Definitions, the Commissions have been mindful of the costs and benefits associated with these rules, which provide fundamental building blocks for the Title VII regulatory regime. There are costs, as well as benefits, arising from subjecting certain agreements, contracts, or transactions to the regulatory regime of Title VII.18 Additionally, there are costs that parties will incur to assess whether certain agreements, contracts, or transactions are indeed subject to the Title VII regulatory regime, and, if so, the costs to assess whether such Title VII instrument is subject to the regulatory regime of the SEC or the CFTC.19 Title VII created a jurisdictional division between the CFTC and SEC. The costs and benefits flowing from an agreement, contract, or transaction being subject to the regulatory regime of the CFTC or the SEC may be impacted by similarities and differences in the Commissions’ regulatory programs for swaps and security-based swaps. Title VII calls on the SEC and the CFTC to consult and coordinate for the purposes of assuring regulatory consistency and comparability to the extent possible.20 Title VII also calls on the agencies to treat functionally or economically similar products or entities in a similar manner, but
does not require identical rules.21 Although the Commissions may differ on certain rulemakings, as the relevant products, entities and markets are different, the Commissions believe that, as the CFTC and SEC regulatory regimes share a statutory basis in Title VII, the costs and benefits of their respective regimes should be broadly similar and complementary. In acknowledging the economic consequences of the final rules, the Commissions recognize that the Product Definitions do not themselves establish the scope or nature of those substantive requirements or their related costs and benefits. In determining the appropriate scope of these rules, the Commissions consider the types of agreement, contract, or transaction that should be regulated as a swap, security-based swap, or mixed swap under Title VII in light of the purposes of the Dodd-Frank Act. The Commissions have sought to further define the terms ‘‘swap,’’ ‘‘security-based swap,’’ and ‘‘mixed swap’’ to include agreements, contracts, and transactions only to the extent that capturing these agreements, contracts, and transactions is necessary and appropriate given the purposes of Title VII, and to exclude agreements, contracts, and transactions to the extent that the regulation of such agreements, contracts, and transactions does not serve the statutory purposes of Title VII, so as not to impose unnecessary burdens for agreements, contracts, and transactions whose regulation may not be necessary or appropriate to further the purposes of Title VII.
II. Scope of Definitions of Swap and
Security-Based Swap
A. Introduction
Title VII of the Dodd-Frank Act applies to a wide variety of agreements, contracts, and transactions classified as swaps or security-based swaps. The statute lists these agreements, contracts, and transactions in the definition of the term ‘‘swap.’’ 22 The statutory definition of the term ‘‘swap’’ also has various exclusions,23 rules of construction, and other provisions for the interpretation of the definition.24 One of the exclusions to the definition of the term ‘‘swap’’ is for security-based swaps.25 The term ‘‘security-based swap,’’ in turn, is defined as an agreement, contract, or transaction that is a ‘‘swap’’ (without regard to the exclusion from that definition for security-based swaps) and that also has certain characteristics specified in the statute.26 Thus, the statutory definition of the term ‘‘swap’’ also determines the scope of agreements, contracts, and transactions that could be security-based swaps. The statutory definitions of the terms ‘‘swap’’ and ‘‘security-based swap’’ are detailed and comprehensive, and the Commissions believe that extensive ‘‘further definition’’ of the terms by rule is not necessary. Nevertheless, the definitions could be read to include certain types of agreements, contracts, and transactions that previously have not been considered swaps or security￾based swaps, and nothing in the legislative history of the Dodd-Frank Act appears to suggest that Congress intended such agreements, contracts, or transactions to be regulated as swaps or security-based swaps under Title VII. The Commissions thus believe that it is important to further clarify the treatment under the definitions of certain types of agreements, contracts, and transactions, such as insurance products and certain consumer and commercial contracts. In addition, commenters also raised questions regarding, and the Commissions believe that it is important to clarify: (i) The exclusion for forward contracts from the definitions of the terms ‘‘swap’’ and ‘‘security-based swap;’’ and (ii) the status of certain commodity-related products (including various foreign exchange products and forward rate agreements) under the definitions of the terms ‘‘swap’’ and ‘‘security-based swap.’’ Finally, the Commissions are providing

27 In response to the ANPR, some commenters raised concerns regarding the treatment of inter￾affiliate swaps and security-based swaps. See, e.g., Letter from Edward J. Rosen, Cleary Gottlieb Steen & Hamilton LLP, Sep. 21, 2010 (‘‘Cleary ANPR Letter’’); Letter from Coalition for Derivatives End Users, Sep. 20, 2010 (‘‘CDEU ANPR Letter’’); Letter from Robert Pickel, Executive Vice President, International Swaps and Derivatives Association, Inc. (‘‘ISDA’’), Sep. 20, 2010; Letter from Richard A. Miller, Vice President and Corporate Counsel, Prudential Financial Inc., Sep. 17, 2010; Letter from Richard M. Whiting, The Financial Services Roundtable, Sep. 20, 2010. A few commenters suggested that the Commissions should further define the term ‘‘swap’’ or ‘‘security-based swap’’ to exclude inter-affiliate transactions. See Cleary ANPR Letter and CDEU ANPR Letter. The Commissions are considering whether inter-affiliate swaps or security-based swaps should be treated differently from other swaps or security-based swaps in the context of the Commissions’ other Title VII rulemakings. 28CEA section 1a(47)(A)(ii), 7 U.S.C. 1a(47)(A)(ii). 29See Proposing Release at 29821. The Commissions continue to believe that it was not the intent of Congress through the swap and security￾based swap definitions to preclude the provision of insurance to individual homeowners and small businesses that purchase property and casualty insurance. See section 2(e) of the CEA, 7 U.S.C. 2(e), and section 6(l) of the Exchange Act, 15 U.S.C. 78f(l) (prohibiting individuals and small businesses that do not meet specified financial thresholds or other conditions from entering into swaps or security-based swaps other than on or subject to the rules of regulated futures and securities exchanges). Historically, insurance has not been regulated as such under the Federal securities laws or under the CEA. See infra note 1283. 30 7 U.S.C. 16(h). Moreover, other provisions of the Dodd-Frank Act address the status of insurance more directly, and more extensively, than Title VII. For example, Title V of the Dodd-Frank Act requires the newly established Federal Insurance Office to conduct a study and submit a report to Congress, within 18 months of enactment of the Dodd-Frank Act, on the regulation of insurance, including the consideration of Federal insurance regulation. Notably, the Federal Insurance Office’s authority under Title V extends primarily to monitoring and information gathering; its ability to promulgate Federal insurance regulation that preempts state insurance regulation is significantly restricted. See
section 502 of the Dodd-Frank Act (codified in
various sections of 31 U.S.C.). Title V also addressed non-admitted insurance and reinsurance. Title X of the Dodd-Frank Act also specifically excludes the business of insurance from regulation by the Bureau of Consumer Financial Protection. See section 1027(m) of the Dodd-Frank Act, 12 U.S.C. 5517(m) (‘‘The [Bureau of Consumer Financial Protection] may not define as a financial product or service, by regulation or otherwise, engaging in the business of insurance.’’); section 1027(f) of the Dodd-Frank Act, 12 U.S.C. 5517(f) (excluding persons regulated by a state insurance regulator, except to the extent they are engaged in the offering or provision of consumer financial products or services or otherwise subject to certain consumer laws as set forth in Title X of the Dodd￾Frank Act). 31 In response to commenters, the Commissions are changing the word ‘‘company’’ from the proposal to ‘‘person.’’ Each of the CEA, the Securities Act, and the Exchange Act contains a definition of a ‘‘person.’’ See, e.g., Letter from Carl B. Wilkerson, Vice President & Chief Counsel, American Council of Life Insurers (‘‘ACLI’’), dated July 22, 2011 (‘‘ACLI Letter’’) and Letter from John P. Mulhern, Dewey & LeBoeuf LLP (‘‘D&L’’), dated July 22, 2011 (‘‘D&L Letter’’). interpretations related to the definitions.27 B. Rules and Interpretations Regarding Certain Transactions Outside the Scope of the Definitions of the Terms ‘‘Swap’’ and ‘‘Security-Based Swap’’

1. Insurance Products
   The statutory definition of the term ‘‘swap’’ includes, in part, any agreement, contract or transaction ‘‘that provides for any purchase, sale, payment or delivery (other than a dividend on an equity security) that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence.’’ 28 As stated in the Proposing Release, the Commissions do not interpret this clause to mean that products historically treated as insurance products should be included within the swap or security-based swap definitions.29 The Commissions are aware of nothing in Title VII to suggest that Congress intended for traditional insurance products to be regulated as swaps or security-based swaps. Moreover, the fact that swaps and insurance products are subject to different regulatory regimes is reflected in section 722(b) of the Dodd-Frank Act which, in new section 12(h) of the CEA, provides that a swap ‘‘shall not be considered to be insurance’’ and ‘‘may not be regulated as an insurance contract under the law of any State.’’ 30 Accordingly, the Commissions believe that state or Federally regulated insurance products that are provided by persons that are subject to state or Federal insurance supervision, that otherwise could fall within the definitions should not be considered swaps or security-based swaps so long as they satisfy the requirements of the Insurance Safe Harbor (as defined below). At the same time, however, the Commissions are concerned that certain agreements, contracts, or transactions that are swaps or security-based swaps might be characterized as insurance products to evade the regulatory regime under Title VII of the Dodd-Frank Act. Accordingly, the Commissions are adopting final rules that (i) clarify that certain agreements, contracts, or transactions that satisfy the requirements of the Insurance Safe Harbor will not be considered to be swaps or security-based swaps, and (ii) provide an Insurance Grandfather exclusion from the swap and security￾based swap definitions for any agreement, contract, or transaction entered into on or before the effective date of the Product Definitions, provided that, when the parties entered into such agreement, contract, or transaction, it was provided in accordance with the Provider Test (as defined below), including a requirement that an agreement, contract or transaction that is provided in accordance with the first prong of the Provider Test must be regulated as insurance under applicable state law or the laws of the United States. The final rules contain four subparts:
   The first subpart addresses the agreement, contract, or transaction; the second subpart addresses the person 31 providing that agreement, contract, or transaction; the third subpart includes a list of traditional insurance products that do not have to meet the requirements set out in the first subpart; and the fourth subpart contains the Insurance Grandfather exclusion (as defined below). More specifically, with respect to the first subpart, the Commissions are adopting paragraph (i)(A) of rule 1.3(xxx)(4) under the CEA and paragraph (a)(1) of rule 3a69–1 under the Exchange Act (the ‘‘Product Test’’) as proposed, with certain modifications to respond to commenters’ concerns. As adopted, the Product Test provides that the terms ‘‘swap’’ and ‘‘security-based swap’’ will not include an agreement, contract, or transaction that, by its terms or by law, as a condition of performance:

• Requires the beneficiary of the
  agreement, contract, or transaction to have an insurable interest that is the subject of the agreement, contract, or transaction and thereby carry the risk of loss with respect to that interest continuously throughout the duration of the agreement, contract, or transaction;
• Requires that loss to occur and be
  proved, and that any payment or indemnification therefor be limited to the value of the insurable interest;
• Is not traded, separately from the
  insured interest, on an organized market or over the counter; and
• With respect to financial guaranty
  insurance only, in the event of payment default or insolvency of the obligor, any acceleration of payments under the policy is at the sole discretion of the insurer. The Commissions are also adopting paragraph (i)(B) of rule 1.3(xxx)(4) under the CEA and paragraph (a)(2) of rule 3a69–1 under the Exchange Act (the ‘‘Provider Test’’) as proposed, with certain modifications to respond to commenters’ concerns. As adopted, the Provider Test requires that an agreement, contract, or transaction that

32The term ‘‘State’’ is defined in section 3(a)(16) of the Exchange Act, 15 U.S.C. 78c(a)(16), to mean ‘‘any State of the United States, the District of Columbia, Puerto Rico, the Virgin Islands, or any other possession of the United States.’’ The CFTC is incorporating this definition into rule 1.3(xxx)(4) for purposes of ensuring consistency between the CFTC and SEC rules further defining the terms ‘‘swap’’ and ‘‘security-based swap.’’ 33For purposes of this release, the term ‘‘instrumentality’’ includes publicly supported, state operated or quasi-state operated insurance programs that may not be subject to state regulatory oversight, such as the Illinois Mine Subsidence Insurance Fund and the Florida Hurricane Catastrophe Fund. 34For purposes of this release, the Commissions anticipate that the parties to an agreement, contract, or transaction will evaluate which state law applies prior to entering into such agreement, contract, or transaction. The Commissions do not anticipate that the parties’ analysis of which state law applies will change as a result of the adoption of the Insurance Safe Harbor. In addition, the Commissions will analyze which state law applies (if necessary, in consultation with state insurance regulatory authorities) if and when such issues arise that the Commissions determine to address. The Commissions note that courts routinely determine what is the ‘‘applicable state law’’ when adjudicating disputes involving insurance. 35For purposes of this release, the term ‘‘reinsurance’’ means the assumption by an insurer of all or part of a risk undertaken originally by another insurer. 36For purposes of this release, the term ‘‘reinsurer’’ means any person who provides reinsurance. 37For purposes of this release, the term ‘‘cedant’’ means the person writing the risk being ceded or transferred to a reinsurer. 38For purposes of this release, the term ‘‘non￾admitted insurance’’ means any property and casualty insurance permitted to be placed directly or through a surplus lines broker with a non￾admitted insurer eligible to accept such insurance. 39For purposes of this release, the term ‘‘non￾admitted insurer’’ means, with respect to any State, an insurer not licensed to engage in the business of insurance in such State, but does not include a risk retention group, as that term is defined in section 2(a)(4) of the Liability Risk Retention Act of 1986, 15 U.S.C. 3901(a)(4). 40See infra notes 88, 89, and 90 and accompanying text. 41For example, if a person uses a weather derivative or catastrophe swap to assume all or part of the risks contained in a portfolio of property and casualty insurance policies, that weather derivative or catastrophe swap would be a Title VII instrument that is subject to regulation under Title VII. 42As was discussed in the Proposing Release, see Proposing Release at 29822 n. 31, certain variable life insurance products and annuities are securities and therefore are excluded from the swap and security-based
swap definitions regardless of whether they meet the requirements under the final rules. See section 1a(47)(B)(v) of the CEA, 7 U.S.C. 1a(47)(B)(v). These securities would not be swaps or security-based swaps whether or not required to be registered under the Securities Act. See SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967) (holding that the accumulation provisions of a ‘‘flexible fund’’ annuity contract were not entitled to exemption under section 3(a)(8) of the Securities Act, 15 U.S.C. 77c(a)(8), for insurance and annuities); SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65 (1959) (holding that a variable annuity was not entitled to exemption under section 3(a)(8) of the Securities Act). 43For the purpose of determining whether an agreement, contract or transaction falls within the Insurance Safe Harbor, Title VII provides the Commissions with flexibility to address the facts and circumstances of new products that may be marketed or sold as insurance, through joint interpretations pursuant to section 712(d)(4) of the Dodd-Frank Act. satisfies the Product Test must be provided:

• By a person that is subject to
  supervision by the insurance commissioner (or similar official or agency) of any state 32 or by the United States or an agency or instrumentality 33 thereof, and such agreement, contract, or transaction is regulated as insurance under applicable state law 34 or the laws of the United States (the ‘‘first prong’’);
• (i) Directly or indirectly by the
  United States, any state or any of their respective agencies or instrumentalities, or (ii) pursuant to a statutorily authorized program thereof ((i) and (ii) together, the ‘‘second prong’’); or
• In the case of reinsurance only 35 by
  a person to another person that satisfies the Provider Test, provided that:
  (i) Such person is not prohibited by applicable state law or the laws of the United States from offering such agreement, contract, or transaction to such person that satisfies the Provider Test; (ii) The agreement, contract, or transaction to be reinsured satisfies the Product Test or is one of the Enumerated Products (as defined below); and (iii) Except as otherwise permitted under applicable state law, the total amount reimbursable by all reinsurers 36 for such agreement, contract, or transaction may not exceed the claims or losses paid by the cedant 37 ((i), (ii), and (iii), collectively, the ‘‘third prong’’); or
• In the case of non-admitted
  insurance 38 by a person who:
  (i) Is located outside of the United States and listed on the Quarterly Listing of Alien Insurers as maintained by the International Insurers Department of the National Association of Insurance Commissioners; or (ii) Meets the eligibility criteria for non-admitted insurers 39 under applicable state law ((i) and (ii) together, the ‘‘fourth prong’’). In response to commenters’ requests that the Commissions codify the proposed interpretation regarding certain enumerated types of traditional insurance products in the final rules,40 the Commissions are also adopting paragraph (i)(C) of rule 1.3(xxx)(4) under the CEA and paragraph (a)(3) of rule 3a69–1 under the Exchange Act. In addition, in response to comments, the Commissions are expanding and revising the enumerated types of traditional insurance products. As adopted, the rule provides that the terms ‘‘swap’’ and ‘‘security-based swap’’ will not include an agreement, contract, or transaction that is provided in accordance with the Provider Test and is any one of the following (collectively, ‘‘Enumerated Products’’):
  Surety bonds; fidelity bonds; life insurance; health insurance; long-term care insurance; title insurance; property and casualty insurance; annuities; disability insurance; insurance against default on individual residential mortgages (commonly known as private mortgage insurance, as distinguished from financial guaranty of mortgage pools); and reinsurance (including retrocession) of any of the foregoing. The Commissions note that the inclusion of reinsurance (including retrocession) as an Enumerated Product is meant to apply to traditional reinsurance and retrocession contracts. Specifically, traditional reinsurance and retrocession contracts that reinsure risks ceded under traditional insurance products included in the Enumerated Product list and provided in accordance with the Provider test do not fall within the swap or security-based swap definitions. An agreement, contract, or transaction that is labeled as ‘‘reinsurance’’ or ‘‘retrocession’’, but is executed as a swap or security-based swap or otherwise is structured to evade Title VII of the Dodd-Frank Act, would not satisfy the Insurance Safe Harbor, and would be a swap or security-based swap.41 In order for an agreement, contract, or transaction to qualify under the final rules as an insurance product that would not be a swap or security-based swap: (i) The agreement, contract, or transaction must satisfy the criteria in the Product Test or be one of the Enumerated Products and (ii) the person providing the agreement, contract or transaction must satisfy one prong of the Provider Test.42 The fact that an agreement, contract, or transaction satisfies the Product Test or is one of the Enumerated Products does not exclude it from the swap or security-based swap definitions if it is not provided by a person that satisfies the Provider Test; nor does the fact that a product is provided by a person that satisfies the Provider Test exclude the product from the swap or security-based swap definitions if the agreement, contract, or transaction does not satisfy the criteria set forth in the Product Test or is not one of the Enumerated Products.43

44See infra notes 178 and 179 and accompanying text. 45The Commissions can engage in rulemakings in a variety of ways including an advanced notice of proposed rulemaking, a notice of proposed rulemaking, or an interim final rule. 46When determining whether a particular product is a swap or security-based swap instead of insurance, if such product does not meet the requirements set out in the Insurance Safe Harbor, the Commissions will consider prior regulation as an insurance contract as one factor in their respective facts and circumstances analysis. 47Requiring that a beneficiary of an insurance policy have a stake in the interest traditionally has been justified on public policy grounds. For example, a beneficiary that does not have a property right in a building might have an incentive to profit from arson. 48Standard CDS documentation stipulates that the incurrence or demonstration of a loss may not be made a condition to the payment on the CDS or the performance of any obligation pursuant to the CDS. See, e.g., ISDA, 2003 ISDA Credit Derivatives Definitions, art. 9.1(b)(i) (2003) (‘‘2003 Definitions’’) (stating that ‘‘the parties will be obligated to perform * * * irrespective of the existence or amount of the parties’ credit exposure to a Reference Entity, and Buyer need not suffer any loss nor provide evidence of any loss as a result of the occurrence of a Credit Event’’). 49See D&L Letter. 50To the extent an insurance product provides for such items as, for example, a rental car for use while the car that is the subject of an automobile insurance policy is being repaired, the Commissions would consider such items as constituting part of the value of the insurable interest. 51See, e.g., ‘‘Life Settlements Task Force, Staff Report to the United States Securities and Exchange Commission’’ (‘‘In an effort to help make the bidding process more efficient and to facilitate trading of policies after the initial settlement occurs, some intermediaries have considered or instituted a trading platform for life settlements.’’), available at http://www.sec.gov/news/studies/2010/ lifesettlements-report.pdf (July 22, 2010). 52See, e.g., ISDA, 2005 Novation Protocol, available at http://www.isda.org/2005novationprot/ docs/NovationProtocol.pdf (2005); ISDA, ISDA Novation Protocol II, available at http:// www.isda.org/isdanovationprotII/docs/NPII.pdf (2005); 2003 Definitions, Exhibits E (Novation Agreement) and F (Novation Confirmation). 53See infra notes 74 and 75 and accompanying text. 54See, e.g., Letter from Kim O’Brien, President & CEO, National Association for Fixed Annuities (‘‘NAFA’’), dated July 21, 2011 (‘‘NAFA Letter’’); Letter from Robert Pickel, Executive Vice Chairman, ISDA, dated July 22, 2011 (‘‘ISDA Letter’’); ACLI Letter; and Letter from Letter from Stephen E. Roth, Frederick R. Bellamy and James M. Cain, Sutherland Asbill & Brennan LLP on behalf of the Committee of Annuity Insurers (‘‘CAI’’), dated July 22, 2011 (‘‘CAI Letter’’).
Further, in response to commenters’ concerns,44 the Commissions are confirming that the Product Test, the Provider Test and the Enumerated Products represent a non-exclusive safe harbor. None of the Product Test, the Provider Test, or the Enumerated Products (collectively, the ‘‘Insurance Safe Harbor’’) implies or presumes that an agreement, contract, or transaction that does not meet any of their respective requirements is a swap or security-based swap. Such an agreement, contract, or transaction will require further analysis of the applicable facts and circumstances, including the form and substance of such agreement, contract, or transaction, to determine whether it is insurance, and thus not a swap or security-based swap. However, future market conditions or other developments may prompt the Commissions to reconsider whether a particular product that satisfies the requirements of the Insurance Safe Harbor should instead fall within the swap or security-based swap definition. Because a determination that such a product is a swap or security-based swap could potentially have an unsettling effect on the domestic insurance or financial markets, the Commissions would only consider making a determination that such a product is a swap or security-based swap through a rulemaking 45 process that would provide market participants with an opportunity to comment.46 (a) Types of Insurance Products Final Rules Product Test The Commissions are adopting the Product Test as proposed, with certain modifications to respond to commenters’ concerns. The Product Test sets forth four criteria for an agreement, contract, or transaction to be considered insurance. First, the final rules require that the beneficiary have an ‘‘insurable interest’’ underlying the agreement, contract, or transaction and thereby carry the risk of loss with respect to that interest continuously throughout the duration of the agreement, contract, or transaction. The requirement that the beneficiary be at risk of loss (which could be an adverse financial, economic, or commercial consequence) with respect to the interest that is the subject of the agreement, contract, or transaction continuously throughout the duration of the agreement, contract, or transaction will ensure that an insurance contract beneficiary has a stake in the interest on which the agreement, contract, or transaction is written.47 Similarly, the requirement that the beneficiary have the insurable interest continuously throughout the duration of the agreement, contract, or transaction is designed to ensure that payment on the insurance product is inextricably connected to both the beneficiary and the interest on which the insurance product is written. In contrast to insurance, a credit default swap (‘‘CDS’’) (which may be a swap or a security-based swap) does not require the purchaser of protection to hold any underlying obligation issued by the reference entity on which the CDS is written.48 One commenter identified the
existence of an insurable interest as a material element to the existence of an insurance contract.49 Because neither swaps nor security-based swaps require the presence of an insurable interest at all (although an insurable interest may sometimes be present coincidentally), the Commissions continue to believe that whether an insurable interest is present continuously throughout the duration of the agreement, contract, or transaction is a meaningful way to distinguish insurance from swaps and security-based swaps. Second, the requirement that a loss occur and be proved similarly ensures that the beneficiary has a stake in the insurable interest that is the subject of the agreement, contract, or transaction. If the beneficiary can demonstrate loss, that loss would ‘‘trigger’’ performance by the insurer on the agreement, contract, or transaction such that, by making payment, the insurer is indemnifying the beneficiary for such loss. In addition, limiting any payment or indemnification to the value of the insurable interest aids in distinguishing swaps and security-based swaps (where there is no such limit) from insurance.50 Third, the final rules require that the insurance product not be traded, separately from the insured interest, on an organized market or over the counter. As the Commissions observed in the Proposing Release, with limited exceptions,51 insurance products traditionally have not been entered into on or subject to the rules of an organized exchange nor traded in secondary market transactions (i.e., they are not traded on an organized market or over the counter). While swaps and security￾based swaps also generally have not been tradable at will in secondary market transactions (i.e., on an organized market or over the counter) without counterparty consent, the Commissions understand that all or part of swaps and security-based swaps are novated or assigned to third parties, usually pursuant to industry standard terms and documents.52 In response to commenter concerns,53 the Commissions are clarifying when assignments of insurance contracts and trading on ‘‘insurances exchanges’’ do not constitute trading the contract separately from the related insurable interest, and thus would not violate the Product Test. The Commissions do not interpret the assignment of an insurance contract as described by commenters 54

55The assignment of the benefits or proceeds of an insurance contract by an owner or beneficiary does not violate the trading restriction in the Product Test. This interpretation does not extend to ‘‘stranger originated’’ products. The transfer of obligations for policyholder benefits between two insurance companies, such as would occur in connection with an insurance company merger or acquisition, also does not violate the trading restriction contained in the Product Test. 56See Letter from Susan E. Voss, Commissioner Iowa Insurance Division & National Association of Insurance Commissioners (‘‘NAIC’’) President, and Therese M. Vaughan, NAIC Chief Executive Officer, dated July 22, 2011 (‘‘NAIC Letter’’). 57See Patient Protection and Affordable Care Act; Establishment of Exchanges and Qualified Health Plans, 76 FR 41866 (Jul. 15, 2011) (proposed). 58Financial guarantee policies are used by entities such as municipalities to provide greater assurances to potential purchasers of their bonds and thus reduce their interest costs. See ‘‘Report by the United States Securities and Exchange Commission on the Financial Guarantee Market:
The Use of the Exemption in section 3(a)(2) of the Securities Act for Securities Guaranteed by Banks and the Use of Insurance Policies to Guarantee Debt Securities’’ (Aug. 28, 1987). 59See, e.g., Letter from Sean W. McCarthy, Chairman, Association of Financial Guaranty Insurers on the ANPR, dated Sept. 20, 2010 (explaining the differences between financial guaranty policies and CDS); Letter from James M. Michener, General Counsel, Assured Guaranty on the ANPR, dated Dec. 14, 2010 (noting that the Financial Accounting Standards Board has issued separate guidance on accounting for financial guaranty insurance and CDS); Letter from Ernest C. Goodrich, Jr., Managing Director—Legal Department, Deutsche Bank AG on the ANPR, dated Sept. 20, 2010 (noting that financial guaranty policies require the incurrence of loss for payment, whereas CDS do not). 60While a CDS requires payment in full on the occurrence of a credit event, the Commissions recognize that there are other financial instruments, such as corporate guarantees of commercial loans and letters of credit supporting payments on loans or debt securities, that allow for acceleration of payment obligations without such guarantees or letters of credit being swaps or security-based swaps. 61See infra note 105 and accompanying text. 62See supra note 41 and accompany text. 63See infra notes 93 and 94 and accompanying text. to be ‘‘trading’’ as that term is used in the Product Test.55 Nor do the Commissions find that the examples of exchanges offered by commenters,56 such as Federal Patient Protection and Affordable Care Act ‘‘exchanges,’’ 57 are exchanges as that term is used in the Product Test, e.g., a national securities exchange or designated contract market. Mandated insurance exchanges are more like marketplaces for the purchase of insurance, and there is no trading of insurance policies separately from the insured interest on these insurance exchanges. Thus, the assignment of an insurance contract as permitted or required by state law, or the purchase or assignment of an insurance contract on an insurance exchange or otherwise, does not constitute trading an agreement, contract, or transaction separately from the insured interest and would not violate the trading restriction in the Product Test. For the foregoing reasons as clarified, the Commissions continue to believe that lack of trading separately from the insured interest is a feature of insurance that is useful in distinguishing insurance from swaps and security-based swaps. Fourth, the final rules provide that in the case of financial guaranty insurance policies, also known as bond insurance or bond wraps, any acceleration of payment under the policy must be at the sole discretion of the provider of the financial guaranty insurance policy in order to satisfy the Product Test.58 Although such products can be economically similar to products such as CDS, they have certain key characteristics that distinguish them from swaps and
security-based swaps.59 For example, under a financial guaranty policy, the insurer typically is required to make timely payment of any shortfalls in the payment of scheduled interest to the holders of the underlying guaranteed obligation. Also, for particular bonds that are covered by a financial guaranty policy, the indenture, related documentation, and/or the financial guaranty policy will provide that a default in payment of principal or interest on the underlying bond will not result in acceleration of the obligation of the insurer to make payment of the full amount of principal on the underlying guaranteed obligation unless the insurer, in its sole discretion, opts to make payment of principal prior to the final scheduled maturity date of the underlying guaranteed obligation. Conversely, under a CDS, a protection seller frequently is required to make payment of the relevant settlement amount to the protection buyer upon demand by the protection buyer after any credit event involving the issuer.60 As noted in the Proposing Release, the Commissions do not believe that financial guaranty policies, in general, should be regulated as swaps or security-based swaps. However, because of the close economic similarity of financial guaranty insurance policies guaranteeing payment on debt securities to CDS, in addition to the criteria noted above with respect to insurance generally, the final rules require that, in order to satisfy the Product Test, financial guaranty policies also must satisfy the requirement that they not permit the beneficiary of the policy to accelerate the payment of any principal due on the debt securities. This requirement further distinguishes financial guaranty policies from CDS because, as discussed above, the latter generally requires payment of the relevant settlement amount on the CDS after demand by the protection buyer. Finally, in response to comments,61 the Commissions are clarifying that reinsurance and retrocession transactions fall within the scope of the Product Test. The Commissions find that these transactions have insurable interests, as the Commissions interpret such interests in this context, if they have issued insurance policies covering the risks that they wish to insure (and reinsure). Moreover, the Commissions find that retrocession transactions are encompassed within the Product Test and the Provider Test because retrocession is reinsurance of reinsurance (provided the retrocession satisfies the other requirements of both tests). In addition, reinsurance (including retrocession) of certain types of insurance products is included in the list of Enumerated Products.62 Requiring all of the criteria in the Product Test will help to limit the application of the final rules to agreements, contracts, and transactions that are appropriately regulated as insurance, and help to assure that agreements, contracts, and transactions appropriately subject to the regulatory regime under Title VII of the Dodd￾Frank Act
are regulated as swaps or security-based swaps. As a result, the Commissions believe that these requirements will help prevent the final rules from being used to circumvent the applicability of the swap and security￾based swap regulatory regimes under Title VII. Enumerated Products In the Proposing Release, the Commissions proposed an interpretation that certain enumerated types of insurance products would be outside the scope of the statutory definitions of swap and security-based swap under the Dodd-Frank Act if provided in accordance with the Provider Test and regulated as insurance. Based on comments received,63 the Commissions are adding three products to the list of products as proposed (fidelity bonds, disability insurance and insurance against default on individual residential mortgages), adding reinsurance (including retrocession) of any of the traditional insurance products included in the list, deleting a requirement applicable to annuities, and codifying the Enumerated Products in the final rules. The revised list of Enumerated Products is: Surety bonds, fidelity bonds, life insurance, health insurance, long-term

64See supra note 41 and accompanying text. 65See ACLI Letter; CAI Letter; ISDA Letter (objecting to the requirement that the risk of loss be held continuously throughout the contact); NAFA Letter; NAIC Letter; and Letter from Kenneth F. Spence III, Executive Vice President & General Counsel, The Travelers Companies, Inc. (‘‘Travelers’’), dated Nov. 14, 2011 (‘‘Travelers Letter’’). 66See ACLI Letter; CAI Letter; ISDA Letter; NAIC Letter; and Travelers Letter. The Commissions understand that some states may define what constitutes an insurable interest with reference to personal or emotional consequence in addition to the financial, economic, or commercial consequence mentioned in the statutory swap definition. 67See NAIC Letter and Travelers Letter. However, one commenter noted that the Product and Provider Tests, as proposed, should be an effective means of helping to distinguish between those contracts that qualify for exclusion from the definition of swap and security-based swap from those contracts that will not. See Letter from Michael A. Bell, Senior Counsel, Financial Policy, The Property Casualty Insurers Association of America, dated July 22, 2011. 68See CAI Letter; ISDA Letter; NAFA Letter; and NAIC Letter. 69See Letter from Nicholas D. Latrenta, Executive Vice President and General Counsel, Metropolitan Life Insurance Companies and its insurance affiliates (‘‘MetLife’’), dated July 22, 2011 (‘‘MetLife Letter’’). 70See ACLI Letter; CAI Letter; ISDA Letter; NAFA Letter; and Travelers Letter. 71See ACLI Letter and Travelers Letter. 72See Travelers Letter. 73See, e.g., ACLI Letter and CAI Letter. 74See ACLI Letter; Letter from Chris Barnard (‘‘Barnard’’), dated June 28, 2011 (‘‘Barnard Letter’’); CAI Letter; NAFA Letter; NAIC Letter; and ISDA Letter. care insurance, title insurance, property and casualty insurance, annuities, disability insurance, insurance against default on individual residential mortgages (commonly known as private mortgage insurance, as distinguished from financial guaranty of mortgage pools), and reinsurance (including retrocession) of any of the foregoing.64 The Commissions believe that the Enumerated Products, as traditional insurance products, are not the types of agreements, contracts, or transactions that Congress intended to subject to the regulatory regime for swaps and security-based swaps under the Dodd￾Frank Act. Codifying the Enumerated Products in the final rules appropriately places traditional insurance products outside the scope of the swap and security-based swap definition so long as such Enumerated Products are provided in accordance with the Provider Test, including a requirement that an Enumerated Product that is provided in accordance with the first prong of the Provider Test must be regulated as insurance under applicable state law or the laws of the United States. Comments Insurable Interest Six commenters objected to the requirement in the Product Test that the beneficiary have an insurable
interest continuously throughout the duration of the contract.65 These commenters noted that, under state law, an insurable interest may not always be required to be present continuously throughout the duration of the policy. For example, commenters noted that life insurance may only require an insurable interest at the time the policy is executed; 66 and some property and casualty or liability insurance may only require an insurable interest at the time a loss occurs.67 Commenters also noted that annuities and health insurance do not require the existence of an insurable interest at all.68 Another commenter suggested that the Commissions modify the Product Test to indicate that annuities would not need to satisfy the ‘‘insurable interest’’ component, or to use terminology other than insurable interest to make clear that annuities are not swaps.69 As discussed above, the Commissions are retaining the insurable interest requirement of the Product Test. The Commissions continue to believe that this requirement is a useful tool to distinguish insurance from swaps and security-based swaps, because swaps and security-based swaps do not require the presence of an insurable interest (or require either counterparty to bear any risk of loss) at any time during the term of the agreement, contract, or transaction. While the Commissions acknowledge commenters who argued that products such as life insurance, property and casualty insurance, and annuities may fail the Product Test because of the insurable interest requirement, the Commissions do not interpret any such failure to mean that life insurance, property and casualty insurance, and annuities are not insurance products. To the contrary, as discussed above, these products are included in the list of Enumerated Products that are excluded from the swap and security-based swap definitions so long as they are provided in accordance with the Provider Test. If a life insurance, property and casualty insurance, or annuity is provided in accordance with the Provider Test, such product is not a swap or security-based swap, whether or not an insurable interest is present at all times during the term of the contract. Indemnification for Loss Five commenters objected to the requirement in the Product Test that a loss occur and be proven, and that any payment be limited to the value of the insurable interest, because payment under many insurance products may not be directly based upon actual losses incurred.70 Two commenters argued that annuities do not provide indemnification for loss and that life insurance products are not constrained by the value of the insurable interest.71 Another argued that many insurance policies pay fixed amounts upon the occurrence of a loss without a requirement that the loss be tied to the value of an insurable interest.72 Disability insurance and long-term care insurance are other products that commenters indicate would not be able to satisfy this requirement of the Product Test.73 As
discussed above, the Commissions are retaining the requirement in the Product Test that a loss occur and be proven and that any payment for such loss be limited to the value of the insurable interest. The Commissions continue to believe that this requirement is a useful tool to distinguish insurance from swaps and security-based swaps, because payments under swaps and security-based swaps may be required when neither party incurs a loss, nor is the amount of payment limited by any such loss. While the Commissions acknowledge commenters who identified various products that may fail this part of the Product Test, the Commissions do not interpret any such failure to mean that products such as annuities, disability insurance, and long-term care insurance are not insurance products. To the contrary, as discussed above, these products are included in the list of Enumerated Products that are excluded from the swap and security-based swap definitions so long as they are provided in accordance with the Provider Test. If long-term care insurance, disability insurance, or an annuity is provided in accordance with the Provider Test, such product is not a swap or a security￾based swap, whether or not a loss occurs, is proven, or indemnification for loss is limited to the value of the insurable interest. Not Traded Separately Six commenters stated that the proposed requirement that the agreement, contract, or transaction not be traded, separately from the insured interest, on an organized market or over the counter, is not an effective criterion in determining whether a product is insurance.74 According to commenters, this criterion is ineffective and should be deleted from the Product Test because many conventional insurance

75 Id. ACLI stated that many conventional insurance products, particularly annuities, can be assigned by the owner, and often state insurance law requires such assignability as a condition for approval of the product for sale under applicable insurance law. ACLI also stated that insurance policies are frequently assigned among family members, to third parties as collateral for loans, and in a host of other situations, and does not believe that these common kinds of assignment should cause an insurance product to be characterized as a swap. 76See Barnard Letter and NAIC Letter. 77See NAIC Letter. The commenter explained that the ‘‘insurance exchanges’’ mandated by the Patient Protection and Affordable Care Act would be marketplaces for insurance policies. The commenter described them as ‘‘cooperatives’’ where people could go to buy insurance policies with standardized terms/actuaries. The commenter noted that the insurable interest would not ‘‘trade’’ separately from the insurance policy in these cooperatives. 78See Travelers Letter. 79See supra notes 54 and 55. 80See supra notes 56 and 57. 81See Letter from Bruce E. Stern, Chairman, Association of Financial Guaranty Insurers (‘‘AFGI’’), dated July 20, 2011 (‘‘AFGI Letter’’); ISDA Letter; and Letter from Kimberly M. Welsh, Vice President and Assistant General Counsel, Reinsurance Association of America (‘‘RAA’’), dated July 22, 2011 (‘‘RAA Letter’’). 82See Letter from Dennis M. Kelleher, President & CEO, Better Markets Inc., dated July 22, 2011 (‘‘Better Markets Letter’’). 83See ISDA Letter and RAA Letter. 84 Id. 85See AFGI Letter. 86 Id. The commenter argued that these burdens would (a) increase instability in the currently fragile municipal bond market and (b) decrease the availability or attractiveness of bond insurance to municipal issuers that would otherwise save money by employing bond insurance. The Commissions understand that only one member of AFGI is currently active in the municipal bond insurance market. 87One commenter noted that ‘‘financial guarantors, for some time and in full compliance with state insurance laws, have issued insurance policies that contemplate acceleration upon events unrelated to an issuer default, e.g., upon the downgrade of the insurer.’’ See AFGI Letter. In response to this comment, the Commissions note that the acceleration requirement in the Product Test refers only to ‘‘payment default or insolvency of the obligor’’ (emphasis added), without precluding other triggers. 88See ACLI Letter; NAIC Letter; RAA Letter; AIA Letter; NAFA Letter; and Letter from Mark R. Thresher, Executive Vice President, Nationwide, dated July 19, 2011 (‘‘Nationwide Letter’’). 89See Travelers Letter. products, such as annuities, are assignable (and therefore tradable), which may violate the trading restriction.75 Two commenters observed that the trading of insurance policies has already occurred and is expected to increase.76 One commenter stated that a number of states have
‘‘insurance exchanges’’ that sell reinsurance and excess or surplus lines, and that the Patient Protection and Affordable Care Act requires states or the Federal government to establish health benefit ‘‘insurance exchanges’’ through which insurers will sell health insurance to individuals and small groups.77 One commenter recommended that the trading restriction apply only to trading by the policyholder or beneficiary of an insurance policy.78 The Commissions are retaining the requirement in the Product Test that the agreement, contract, or transaction not be traded separately from the insured interest, on an organized market or over the counter, and as discussed above have provided a clarification regarding assignments and trading on insurance exchanges. The Commissions continue to believe that using this criterion is an effective way to distinguish insurance from swaps and security-based swaps because swaps and security-based swaps are traded on organized markets and over the counter. As stated above, the Commissions do not interpret the assignment of an insurance contract as described by commenters to be ‘‘trading’’ as that term is used in the Product Test.79 Nor do the Commissions find that the examples of exchanges offered by commenters, such as Federal Patient Protection and Affordable Care Act ‘‘exchanges,’’ are exchanges as that term is used in the Product Test, e.g., a national securities exchange or designated contract market.80 Mandated insurance exchanges are more like marketplaces for the purchase of insurance, and there is no trading of insurance policies separately from the insured interest on these insurance exchanges. Thus, the assignment of an insurance contract as permitted or required by state law, or the purchase or assignment of an insurance contract on an insurance exchange or otherwise, does not constitute trading an agreement, contract, or transaction separately from the insured interest and would not violate the trading restriction in the Product Test. Acceleration Three commenters believed that the proposed requirement that, in the event of payment default or insolvency of the obligor, any acceleration of payments under a financial guaranty insurance policy be at the sole discretion of the insurer, is not an effective criterion in determining whether financial guaranty insurance falls outside the swap and security-based swap definitions and should be deleted from the Product Test.81 However, one commenter supported its inclusion, observing that the proposed requirement is ‘‘firmly based on substantive business realities.’’ 82 Two commenters believed that the acceleration of payments requirement is not useful in distinguishing between financial guaranty insurance and swaps or security-based swaps because it is designed to protect financial guaranty insurers from insolvency.83 They noted that the criterion is a regulatory requirement imposed by state insurance commissioners that is subject to change, and that a state
could not change this regulatory requirement without converting the financial guaranty policy into a swap or security-based swap.84 One commenter stated that the acceleration of payments criterion has been the subject of significant analysis and interpretation by state insurance regulators, and including the requirement in the rules could result in conflicting interpretations and additional legal uncertainty.85 This commenter also stated that this uncertainty will impose significant burdens on financial guaranty insurers that insure municipal bonds.86 The Commissions are retaining the requirement that acceleration be at the sole option of the provider of the financial guaranty insurance policy in the Product Test. In response to commenter concerns, the Commissions are clarifying that they plan to interpret the acceleration limitation in accordance with applicable state law to the extent that it does not contradict the Commissions’ rules, interpretations and/or guidance regarding what is a swap or security-based swap.87 The Commissions continue to believe that, for purposes of further defining swaps and security-based swaps, this criterion is useful to distinguish between financial guaranty insurance on the one hand, and swaps and security-based swaps, such as CDS, on the other because, as discussed above, the latter generally requires payment of the relevant settlement amount on the CDS after demand by the protection buyer. Enumerated Products The Commissions proposed an interpretation that certain enumerated types of insurance products would be outside the scope of the statutory definitions of swap and security-based swap. Several commenters stated that the list of enumerated insurance products should be codified in order to enhance legal certainty.88 In particular, one commenter stated that it is important for the Commissions to codify the interpretation because the traditional insurance products included in the enumerated list may not satisfy the Product Test.89 The commenter also expressed concern that insurance companies and state insurance

90 Id.
91See D&L Letter.
92See infra notes 147 and 148 and accompanying text. 93See ACLI Letter; CAI Letter; MetLife Letter; Nationwide Letter; and RAA Letter. 94See ACLI Letter; AIA Letter; CAI Letter; D&L Letter; NAIC Letter; Letter from Michael A. Bell, Senior Counsel, Financial Policy, RAA Letter; and Letter from Robert J. Duke, The Surety & Fidelity Association of America (‘‘SFAA’’), dated July 13, 2011 (‘‘SFAA Letter’’). ACLI, CAI and RAA requested the addition of other types of annuity and pension plan products, such as group annuity contracts, guaranteed investment contracts, funding agreements, structured settlements, deposit administration contracts, and immediate participation guarantee contracts. D&L requested the addition of reinsurance of any of the enumerated types of traditional insurance products. NAIC requested the addition of mortgage guaranty, accident, and disability insurance. SFAA request the addition of surety and fidelity bonds. 95See Letter from J. Stephen Zielezienski, Senior Vice President & General Counsel, American Insurance Association (‘‘AIA’’), dated July 22, 2011 (‘‘AIA Letter’’). 96See NAIC Letter. The Commissions note that service contracts, although regulated as insurance in some states, comprise consumer warranties, extended service plans, and buyer protection plans of the sort purchased with major appliances, electronics, and the like. The Commissions are addressing these contracts in their interpretation regarding consumer/commercial transactions. See infra part II.B.3. 97SFAA requested that the Commissions issue specific guidance that surety and fidelity bonds are insurance products rather than swaps, noting that all states include surety and fidelity bonds as lines of insurance subject to state oversight. Surety bonds were already included in the list of enumerated insurance products contained in the Proposing Release. 98See supra note 41 and accompanying text. 99See, e.g., RAA Letter; CAI Letter; Letter from Ian K. Shepherd, Managing Director, Alice Corp. Pty Ltd (‘‘Alice Corp.’’), dated July 22, 2011. Alice Corp. stated that industry loss warrants are a contingent instrument with a somewhat illiquid secondary market but ‘‘are currently treated as a reinsurance product and require an insurable interest.’’ Alice Corp. also stated that ‘‘[c]atastrophe bonds may reference a specific insured portfolio or a set of parameters and may be traded in a secondary market and behave like a coupon bond if there is no triggering event but have a contingent element since some or all of the principal may be lost if the referenced event or loss occurs.’’ Id. The Commissions note that catastrophe bonds are ‘‘securities’’ under the Federal securities laws and decline to provide an interpretation regarding industry loss warrants because it is inappropriate to determine whether a complex and novel product is a swap or a security-based swap in a general definitional rulemaking. 100See Acceptance of Public Submissions Regarding the Study of Stable
Value Contracts, 76 FR 53162 (Aug. 25, 2011). 101See ACLI Letter and AFGI Letter. Some states define concepts such as ‘‘insurable interest’’ in statute; in other states definitions have developed through common law. The Commissions recognize that the terms denoting such concepts may vary from state to state; for instance, what one state calls an ‘‘insurable interest’’ may be referred to as a ‘‘material interest’’ in another. See, e.g., New York Insurance Law Section 1101 (‘‘material interest’’). The Commissions believe, however, that both the concepts and their labels are well understood by insurance professionals and that any such variations would not impede market participants from interpreting or applying the final rules. Indeed, one commenter acknowledged this and applied the concepts, labeled differently, to particular products. ‘‘The terms used in the rule’s criteria are different from the terms used with respect to a surety bond. For example, the bond is generally not referred to as a ‘policy.’ In addition, the beneficiary of a bond typically is known as the ‘obligee.’ Further, the bond’s limit is referred to as the ‘penal sum.’ Nevertheless, the criteria can be applied to surety bonds and fidelity bonds, and such application would exclude bonds from the statutory definition of swaps.’’ See SFAA Letter. regulators would face the possibility that the Commissions could revise or withdraw the interpretation in the future, with or without undergoing a formal rulemaking process.90 As noted above, in response to commenters’ concerns, the Commissions are codifying the Enumerated Products in the final rules. One commenter further argued that the enumerated types of insurance products included in the list should not have to additionally satisfy the requirements that the person offering such product be a U.S. domiciled insurer and that the product be regulated in the U.S. as insurance.91 The commenter argued that this additional requirement would result in the Insurance Safe Harbor not applying to traditional insurance products offered by insurers domiciled outside of the U.S. or by insurers that are not organized as insurance companies. The Commissions are retaining the requirement that the Enumerated Products be provided in accordance with the Provider Test. The Commissions also note that, in response to commenters’ concerns, the Commissions have revised the first prong of the Provider Test so that it is not limited to insurance companies or to entities that are domiciled in the U.S. A product that need not satisfy the Product Test must be provided in accordance with the Provider Test, including a requirement that products provided in accordance with the first prong of the Provider Test must be regulated as insurance.92 Five commenters addressed the treatment of annuities in the proposed interpretive guidance, with all recommending that all annuities be excluded from the swap and security￾based definitions regardless of their status under the tax
laws.93 In response to the comments, the Commissions are eliminating the proposed requirement that annuities comply with section 72 of the Internal Revenue Code in order to qualify as an Enumerated Product. The Commissions are persuaded that the proposed reference to the Internal Revenue Code is unnecessarily limiting and does not help to distinguish insurance from swaps and security￾based swaps. Other commenters suggested adding other products to the list of enumerated types of insurance products,94 with one suggesting that the Commissions’ interpretation cover all transactions currently reportable as insurance in the provider’s regulatory and financial reports under a state’s or a foreign jurisdiction’s insurance laws.95 One commenter noted that the list of enumerated types of insurance products does not include other state-regulated products such as service contracts, that may not satisfy the Product Test.96 In response to requests to expand the list of enumerated products, the Commissions are adding fidelity bonds,97 disability insurance, and insurance against default on individual residential mortgages (commonly known as private mortgage insurance, as distinguished from financial guaranty of mortgage pools) to the list of Enumerated Products. The Commissions agree that these are traditional insurance products, and thus their inclusion in the list of Enumerated Products is appropriate. The Commissions have also added reinsurance (including retrocession) of any of the traditional insurance products to the list of Enumerated Products.98 However, the Commissions decline at this time to expand the list of Enumerated Products to include other types of contracts such as, guaranteed investment contracts (‘‘GICs’’), synthetic GICs, funding agreements, structured settlements, deposit administration contracts, immediate participation guaranty contracts, industry loss warrants, and catastrophe bonds.99 These products do not receive the benefit of state insurance guaranty funds; their providers are not limited to insurance companies. The Commissions received little detail on sales of these other products, and do not believe it is appropriate to determine whether particular complex, novel or still evolving products are swaps or security-based swaps in the context of a general definitional rulemaking. Rather these products should be considered in a facts and circumstances analysis. With respect to GICs, the Commissions have published a request for comment regarding the study of stable value contracts. 100 Reliance on State Law Concepts Two commenters noted that the Product Test relies on concepts derived from state law, such as ‘‘insurable interest’’ and ‘‘indemnification for loss,’’ which do not have uniform definitions.101 This would require the

102See ACLI Letter and AFGI Letter.
103See AFGI Letter.
104The Commissions may also diverge from interpretations or determinations of state law based on an analysis of applicable facts and circumstances when determining whether a particular product is a swap or security-based swap. 105See ACLI Letter; CAI Letter; D&L Letter; ISDA Letter; NAFA Letter; Nationwide Letter; and RAA Letter. ACLI noted that the Product Test does not include a reference to reinsurance and that the ‘‘insurable interest’’ requirement under state insurance law generally does not apply to reinsurance products which, therefore, would not satisfy the Product Test. ACLI and CAI state that reinsurance in a chain of reinsurance also should not be considered a swap or security-based swap. In addition to expressly referencing reinsurance and retrocession transactions, ACLI believes that the Product Test should be expanded to include reinsurance and retrocession of insurance risks ceded by non-U.S. insurance companies to domestic insurance companies. RAA recommended adding a new clause to the Product Test to provide that ‘‘[a]ny agreement, contract, or transaction which reinsures any agreement, contract, or transaction meeting the criteria of paragraph (xxx)(4)(i)(A)–(C) of this section is also an insurance product.’’ 106See supra note 41 and accompanying text. 107See Proposing Release at 29824. See also id. at 29825, Request for Comment 7. 108See ACLI Letter; AIA Letter; AFGI Letter; CAI Letter; ISDA Letter; NAFA Letter; NAIC Letter; and Nationwide Letter (concurring with ACLI’s comments). Commenters cited several examples of products that would fail a requirement that payment not be based on the price, rate, or level of a financial instrument, asset, or interest or any commodity. ACLI, CAI and NAFA cited registered and unregistered variable annuities and variable life insurance, and certain fixed annuities and equity indexed annuities, stating that these could be construed as being based on, or related to, a price, rate or level of a financial asset. ACLI also cited financial guaranty insurance, and replacement value property and casualty insurance, where the insurer’s payment obligation may be based on the current price of the insured property or adjusted to reflect inflation. ACLI and ISDA cited crop insurance, because it could call for payment to be based in some way on the market price of the covered crop on the date of loss. ISDA and RAA cited ‘‘dual trigger’’ insurance (such as replacement power insurance); property and casualty policies purchased by some commodity producers (e.g., oil refineries, copper mines) with deductibles that increase or decrease based on the price of the commodity that the company produces; event cancellation insurance that uses commodity indices to determine claims; and weather insurance and malpractice insurance. NAIC cited guaranteed investment contracts, financial guaranty insurance, and mortgage guaranty insurance 109See AIA Letter and AFGI Letter. 110See Barnard Letter and Better Markets Letter.
111See Better Markets Letter. 112See Barnard Letter. 113See Proposing Release at 29827, Request for Comment 17. 114See AFGI Letter; D&L Letter; and ISDA Letter. 115See D&L Letter. Commissions to analyze state insurance law, as well as to determine which state law should apply.102 One of these commenters also requested that such concepts be applied consistently with the historical interpretation by the applicable state.103 State law differences regarding these concepts should not impede the ability of market participants from interpreting or applying the final rules to distinguishing between insurance and swaps or security-based swaps, and thus the Commissions are retaining these concepts in the Product Test. The Commissions intend to interpret these concepts consistently with the existing and developing laws of the relevant state(s) governing the agreement, contract, or transaction in question. However, the Commissions note their authority to diverge from state law if the Commissions become aware of evasive conduct.104 Inclusion of Reinsurance and Retrocession Transactions Several commenters suggested that the Commissions amend the Product Test to explicitly address reinsurance and retrocession (i.e., reinsurance of reinsurance) transactions.105 In response to these comments, the Commissions are clarifying that reinsurance and retrocession transactions may fall within the Insurance Safe Harbor, thus, it is unnecessary for the Product Test to be modified as suggested by these commenters. In addition, the Commissions have modified the final rules to include reinsurance (including retrocession) of certain types of insurance products in the list of Enumerated Products. Reinsurance or retrocession of these Enumerated Products will fall within the Insurance Safe Harbor so long as such reinsurance or retrocession is provided in accordance with the Provider Test.106 Payment Based on the Price, Rate, or Level of a Financial Instrument In the Proposing Release, the Commissions requested comment on whether, in order for an agreement, contract, or transaction to be considered insurance under the Product Test, the Commissions should require that payment not be based on the price, rate, or level of a financial instrument, asset, or interest or any commodity. The Commissions also requested comment on whether variable annuity contracts (where the income is subject to tax treatment under section 72 of the Internal Revenue Code) and variable life insurance should be excepted from such a requirement, if adopted.107 Eight commenters stated that it is inappropriate to include such a requirement in the final rules because a number of traditional insurance products would not satisfy the requirement and suggested that the Commissions should instead consider whether the agreement, contract, or transaction transfers risk and argued that such a requirement is not a useful marker for distinguishing insurance from swaps and security-based swaps.108 Several commenters also
believed that the addition to the Product Test of the criterion that payment not be based on the price, rate, or level of a financial instrument, asset, or interest or any commodity would contribute to greater legal uncertainty.109 Two commenters agreed that such a requirement should be included in the final rules.110 One commenter argued that any insurance instrument that provides for payment based on the price, rate, or level of a financial instrument, asset, or interest in any commodity is in substance a swap or security-based, regardless of its label, and should be regulated as such.111 One of these commenters further recommended that the Commissions exclude annuity and variable universal life insurance from this requirement because these products were investments with some minimal level of life insurance cover or investment guarantee rider on top.112 The Commissions are not adopting an additional requirement for the Product Test that payment not be based on the price, rate, or level of a financial instrument, asset, or interest or any commodity because the Commissions find the requirement to be unsuitable for distinguishing insurance from swaps and security-based swaps. While the provision might work for property and casualty insurance, as many commenters noted, it is not an effective distinction for a number of other traditional insurance products. Accounting Standards In the Proposing Release, the Commissions requested comment on whether the proposed rules relating to insurance should include a provision related to whether a product is recognized at fair value on an ongoing basis with changes in fair value reflected in earnings under U.S. generally accepted accounting principles.113 Three commenters argued that the proposed rules should not include a provision that an insurance product is recognized at fair value under generally accepted accounting principles.114 One commenter argued that the determinants of what is an insurance product should be the existence of an insurable interest, transfer of risk, and indemnification of covered loss.115 Another argued that factoring accounting standards into the analysis of whether a product is a swap

116See ISDA Letter.
117See supra note 32, regarding the definition of ‘‘State’’ contained in the Proposing Release. 118This requirement in the final rules is substantially similar to the requirement included in
section 3(a)(8) of the Securities Act, 15 U.S.C.
77c(a)(8).
119See supra note 34.
120See Proposing Release at 29824.
121See infra notes 139, 140, and 141 and accompanying text. 122The Commissions understand that the surplus lines brokers who place insurance on behalf of non￾admitted insurers are subject to supervision in the states in which they offer non-admitted insurance products. 123See infra notes 145 and 146 and accompanying text. 124See infra notes 147 and 148 and accompanying text. 125See Proposing Release at 29824. 126See Ex Parte Communication between NAIC and CFTC and SEC Staff on October 5, 2011, at http://sec.gov/comments/s7-16-11/s71611-61.pdf. 127The Commissions understand that certain types of Federal and State insurance programs, including crop insurance, are administered by third parties; as a result, the Commissions have added ‘‘directly or indirectly’’ to the second prong of the Provider Test to clarify that it can be satisfied even if the agreement, contract, or transaction is not provided directly by the federal government or a state. See Id. 128See Proposing Release at 29825. 129See infra notes 150, 151, 152, and 153 and accompanying text. or insurance will introduce unnecessary complexity in most cases but that the examination of accounting standards would be useful in cases where the classification of a product as insurance or swap is unclear.116 After considering these comments, the Commissions are not including a reference to accounting standards in the Product Test. (b) Providers of Insurance Products Under the first prong of the Provider Test, the agreement, contract, or transaction must be provided by a person that is subject to supervision by the insurance commissioner (or similar official or agency) of any state117 or by the United States.118 In addition, such agreement, contract, or transaction also must be regulated as insurance under applicable state law119 or the laws of the United States. The Commissions have revised the first prong of the Provider Test from the proposal. As proposed, the first prong of the Provider Test could only be satisfied by a company that was organized as an insurance company whose primary and predominant business activity was the writing of insurance or the reinsuring of risks underwritten by insurance companies.120 The Commissions have revised this prong of the Provider Test to address commenters’ concerns that the proposed rules would exclude insurers that were not organized as ‘‘insurance companies,’’ as well as insurers that were domiciled outside of the United States.121 As adopted, the first prong of the Provider Test can be satisfied by any person that is subject to state or Federal insurance supervision, regardless of that person’s corporate structure or domicile. The Commissions understand that, with the exception of non-admitted insurers,122 foreign insurers are subject to supervision in the states in which they offer insurance products. The treatment of non￾admitted insurers is addressed in the fourth prong of the Provider Test. The Commissions believe that the requirement that the
agreement, contract, or transaction be provided by a person that is subject to state or Federal insurance supervision should help prevent regulatory gaps that otherwise might exist between insurance regulation and the regulation of swaps and security-based swaps by ensuring that products provided by persons that are not subject to state or Federal insurance supervision are not able to be offered by persons that avoid regulation under Title VII of the Dodd￾Frank Act as well. The first prong of the Provider Test also requires that the agreement, contract, or transaction being provided is ‘‘regulated as insurance’’ under applicable state law or the laws of the United States. As stated in the Proposing Release, the purpose of this requirement is that an agreement, contract, or transaction that satisfies the other conditions of the final rules must be subject to regulatory oversight as an insurance product. The Commissions believe that this condition will help prevent products that are not regulated as insurance in the states in which they are offered, and that are swaps or security-based swaps, from being characterized as insurance products in order to evade the regulatory regime under Title VII of the Dodd-Frank Act. As noted by commenters,123 the Commissions recognize that the ‘‘regulated as insurance’’ limitation means that it is possible that a particular product that may not be regulated as insurance in a particular state may not qualify for the Insurance Safe Harbor.124 As stated in the Proposing Release, the Commissions believe that it is appropriate to exclude, from regulation under Title VII, insurance that is issued by the United States or any of its agencies or instrumentalities, or pursuant to a statutorily authorized program thereof, from regulation as swaps or security-based swaps.125 Such insurance includes, for example, Federal insurance of funds held in banks, savings associations, and credit unions; catastrophic crop insurance; flood insurance; Federal insurance of certain pension obligations; and terrorism risk insurance. At the request of commenters,126 the Commissions are persuaded that it is also appropriate to provide a similar exclusion to insurance that is issued by a state or any of its agencies or instrumentalities, or pursuant to a statutorily authorized program thereof. Accordingly, the Commissions have revised the second prong of the Provider Test to provide that products meeting the Product Test are excluded from the swap and security-based swap definitions if they are provided (i) directly or indirectly by the Federal government or a state or (ii) pursuant to a statutorily authorized program of either.127 As stated in the Proposing Release, the Commissions believe that where an agreement, contract, or transaction qualifies for the safe harbor and therefore is considered insurance excluded from the swap and security￾based swap definitions, the lawful reinsurance of that agreement, contract, or transaction similarly
should be excluded.128 Accordingly, the Commissions are adopting the third prong of the Provider Test as proposed, with certain modifications, to provide that an agreement, contract, or transaction of reinsurance will be excluded from the swap and security￾based swap definitions, provided that:
(i) The person offering such reinsurance is not prohibited by applicable state law or the laws of the United States from offering such reinsurance to a person that satisfies the Provider Test; (ii) the agreement, contract, or transaction to be reinsured meets the requirements under the Product Test or is one of the Enumerated Products; and (iii) except as otherwise permitted under applicable state law, the total amount reimbursable by all reinsurers for such insurance product cannot exceed the claims or losses paid by the cedant. In response to commenters’ concerns,129 the Commissions have revised the third prong of the Provider Test from that contained in the Proposing Release. As adopted, the third prong of the Provider Test encompasses all reinsurers wherever incorporated or organized, and not just those based outside of the United States. The Commissions also have revised the third prong of the Provider Test to clarify that the total amount reimbursable by all reinsurers may not exceed the claims or losses paid by the cedant, unless otherwise permitted by applicable state law. It is not the Commissions’ intent to

130See infra note 146 and accompanying text. 131For the purposes of this release, the term ‘‘surplus lines broker’’ means an individual, firm, or corporation that is licensed in a state to sell, solicit, or negotiate insurance on properties, risks, or exposures located or to be performed in a state with non-admitted insurers. 132See supra note 39. With respect to domestic reinsurance, state insurance regulators do retain the authority to prevent or allow a non-admitted company from participating in a state market. Some states compile a list of companies that may sell as non-admitteds; other states list non-admitted companies that may not sell. 133See Subtitle B of Title V of the Dodd-Frank Act. 134Section 524 of the Nonadmitted and Reinsurance Reform Act of 2010 (15 U.S.C. 8204) provides that a state cannot prohibit a surplus lines broker from placing non-admitted insurance with a non-admitted insurer that is listed on the Quarterly Listing of Alien Insurers. According to the NAIC the non-admitted alien insurers whose names appear in the Quarterly Listing of Alien Insurers have filed financial statements, copies of auditors’ reports, the names of their U.S. attorneys or other representatives, and details of U.S. trust accounts with the NAIC’s International Insurers Department and, based upon those documents and other information, appear to fulfill the criteria set forth in the International Insurers Department Plan of Operation for Listing of Alien Nonadmitted Insurers. 135See ACLI Letter; AIA Letter; CAI Letter; D&L Letter; ISDA Letter; NAIC Letter; NAFA Letter; Nationwide Letter; RAA Letter; and Travelers Letter. 136See AIA Letter; D&L Letter; and ISDA Letter. 137 Id. 138See infra notes 147 and 148 and accompanying text. 139See AIA Letter; D&L Letter; ISDA Letter; RAA Letter; NAIC Letter; and Travelers Letter. 140See AIA Letter; D&L Letter; RAA Letter; and Travelers Letter. 141See RAA Letter and Travelers Letter. 142See ACLI Letter; CAI Letter; NAFA Letter; Nationwide Letter; RAA Letter; and Travelers Letter. 143 Id. 144 Id. impose requirements that conflict with state law regarding the calculation of amounts reimbursable under reinsurance contracts. The Commissions have added a fourth prong to the Provider Test to address commenters’ concerns that the proposed Provider Test excluded entities issuing insurance products on a non-admitted basis through surplus lines brokers.130 Non-admitted insurance is typically property and casualty insurance that is permitted to be placed through a surplus lines broker 131 by an insurer that is not licensed to do business in the state where the product is offered.132 In practice, a provider of non-admitted insurance may not satisfy the first prong of the Provider Test because it may not be subject to state or Federal insurance supervision. The Commissions understand that non-admitted insurance plays a very important role in the insurance marketplace. In addition, Congress has explicitly recognized non￾admitted
insurance products as insurance and specified that a state cannot prohibit certain types of entities from offering non-admitted insurance products.133 Because Congress recognized that certain persons qualify as non-admitted insurers, the Commissions find that it is appropriate to add the fourth prong to the Provider Test. A person will qualify under the fourth prong of the Provider Test if it satisfies any one of the following two requirements:

• It is located outside of the United
  States and listed on the Quarterly Listing of Alien Insurers that is compiled and maintained by the International Insurers Department of the National Association of Insurance Commissioners;134 or
• It meets the eligibility criteria for
  non-admitted insurers under applicable state law. Comments General The Commissions received ten comment letters that addressed the Provider Test.135 A few commenters recommended that the Commissions retract the Provider Test.136 These commenters argued that if a product is subject to regulation as insurance in the United States, the regulated status of the insurer is irrelevant.137 The Commissions are retaining the Provider Test with modifications as discussed above. The Commissions believe that insurance products should fall outside the swap or security-based swap definitions only if they are offered by persons subject to state or Federal insurance supervision or by certain reinsurers.138 The Provider Test will help to prevent products that are swaps or security-based swaps from being characterized as insurance in order to evade the regulatory regime under Title VII of the Dodd-Frank Act. Other commenters suggested various modifications to the Provider Test and those comments are discussed in more detail below. ‘‘Insurance Company’’ Limitation Several commenters recommended that the Commissions expand the first prong of the Provider Test so that it is not limited to ‘‘insurance companies,’’ but to all insurers because not all insurers are organized as ‘‘insurance companies,’’139 to accommodate insurers and reinsurers that are domiciled outside of the United States,140 and to cover domestic and foreign insurance companies and other entities that issue insurance products on a non-admitted basis through surplus lines brokers.141 The Commissions have revised the first prong of the Provider Test to remove the ‘‘insurance company’’ limitation and to clarify that any person that is subject to state or Federal insurance supervision will qualify under the first prong of the Provider Test. As noted above, the Commissions also believe that this revision should address commenters’ concerns that the proposed rules could have excluded some foreign insurers since the revised test does not require that a person be domiciled in the United States; it only requires that the person be subject to state or Federal insurance supervision. Several commenters suggested that the proposed Provider Test would permit an insurer that is not organized as an insurance company to evade state insurance oversight by deliberately failing the exemption for insurance products (that is, by issuing a contract that would fail the proposed rules because it would not be issued by an insurance company).142 These commenters were concerned that if a product were to be considered a swap merely because it was not issued by an insurance company, this would render the regulation of such products outside of the scope of state insurance laws due to the Federal preemption of swaps regulation.143 Commenters noted that a likely consequence of this preemption would be that the same product would be subject to substantially different regulation within a state’s jurisdiction based solely on the nature
  of the issuing person.144 The Commissions have revised the first prong of Provider Test to address commenters’ concerns that providers of insurance products could evade state insurance regulation by intentionally failing the Provider Test, i.e., marketing the insurance products as swaps or security-based swaps in order to avoid state insurance supervision. As adopted, any person that provides insurance products (and therefore should be subject to state or Federal insurance supervision) must, in fact, be subject to state or Federal insurance supervision in order to satisfy the first prong of the Provider Test. Persons that are organized as insurance companies or whose business activity is predominantly insurance or reinsurance, but who are not in fact subject to state or Federal insurance supervision, would not satisfy the first prong of the Provider Test. Finally, as discussed below, the Commissions have added a fourth prong

145See RAA Letter and Travelers Letter. 146 Id. These commenters also recommended the addition of a new prong to the Provider Test to cover domestic or foreign entities that issue insurance products on a non-admitted basis through surplus lines brokers. See discussion below. The Commissions note that the first prong of the Provider Test does not apply to reinsurance contracts and the third prong of the Provider Test, which does apply to reinsurance contracts, does not contain the ‘‘regulated as insurance’’ limitation. 147See SFAA Letter. SFAA stated that all states include surety and fidelity bonds as lines of insurance subject to state oversight. However, Travelers stated that surety bonds may not be ‘‘specifically’’ regulated as insurance. See Travelers Letter. 148See ACLI Letter. 149See supra notes 130, 131, and 132 and accompanying text. 150See ACLI Letter; CAI Letter; NAIC Letter; and RAA Letter. 151See RAA Letter. The commenter argued that one state’s prohibition on a reinsurance product should not affect the ability of the reinsurer to offer the product in a state where it is permitted. 152See RAA Letter and Travelers Letter. Both commenters suggested specific edits to the proposed rules. 153See RAA Letter. RAA stated that in an insurance receivership reinsurers are required to comply with the reinsurance contract and pay all amounts due and owing to the estate of the insolvent cedant even if the estate of the cedant may not necessarily pay the full amount of the underlying claims to the applicable policyholders. 154See infra notes 157, 158, 159, and 160 and accompanying text. 155See Proposing Release at 29821. to the Provider Test to provide relief for persons that provide insurance products on a non-admitted basis through surplus lines brokers. ‘‘Regulated as Insurance’’ Limitation Two commenters recommended that the Commissions remove the provision in the first prong of the Provider Test that states ‘‘and such agreement, contract, or transaction is regulated as insurance under the laws of such state or of the United States.’’145 These commenters argued that the provision should be deleted because it was redundant with the Product Test and may exclude certain reinsurers and non￾admitted insurers, as well as products that may not be specifically ‘‘regulated as insurance’’ in all states.146 The Commissions have retained the requirement in the first prong of the Provider Test that an insurance product must be regulated as insurance, but have revised the provision to clarify that an insurance product must be regulated as insurance under applicable state law or the laws of the United States. As discussed above, the Commissions believe that this condition will help prevent products that are not regulated as insurance and are swaps or security￾based swaps from being characterized as insurance products in order to evade the regulatory regime under the Dodd-Frank Act. The Commissions have received conflicting comments regarding whether surety
bonds are currently offered by persons who do not satisfy the Provider Test, in particular the ‘‘regulated as insurance’’ requirement.147 If a person who does not satisfy the Provider Test sells a surety bond incidental to other business activity and is not subject to state or Federal insurance supervision, it does not mean that such surety bond is a swap or security-based swap. The surety bond may not satisfy the Insurance Safe Harbor, but it would be subject to a facts and circumstances analysis. Similarly, one commenter indicated that title insurance is not always subject to state insurance regulation.148 Title insurance sold in a state that does not regulate title insurance as insurance would be in the list of Enumerated Products but would not satisfy the Provider Test and, thus would not qualify for the Insurance Safe Harbor. However, this does not mean that title insurance sold in a state that does not regulate title insurance as insurance is a swap or security-based swap. The title insurance may not satisfy the Insurance Safe Harbor, but it would be subject to a facts and circumstances analysis. The Commissions anticipate that many factors would militate against a determination that such a surety bond or title insurance that fails the Provider Test, because it cannot meet the ‘‘regulated as insurance’’ requirement, is a swap or security-based swap rather than insurance. The Commissions agree that the inclusion of the ‘‘regulated as insurance’’ requirement in the first prong of the Provider Test will have the effect of causing non-admitted insurance products to fall within the swap and security-based swap definitions. In response to commenters’ concerns about the ability of non￾admitted insurers to qualify under the Provider Test, the Commissions have added a fourth prong to the Provider Test to address providers of non￾admitted insurance products.149 Providers of Reinsurance Several commenters recommended that the Commissions expand the third prong of the Provider Test to include domestic reinsurers.150 One commenter requested that the Commissions remove the third prong of the Provider Test from the final rules because it appears to prohibit a reinsurer from offering a product in a state where it is permitted if any other state prohibits that product.151 Two commenters requested revisions to the portion of the third prong of the Provider Test that addresses a cedant’s reimbursable losses.152 One commenter argued this portion of the third prong of the Provider Test may conflict with the state-based insurance receivership law.153 As noted above, the Commissions have revised the third prong of the Provider Test to remove the limitation that a reinsurance provider has to be located outside of the United States, and thereby address commenters’ concerns that domestic reinsurers would not qualify under the reinsurance prong. In addition, in response to commenters’ concerns, the Commissions have clarified the third prong of the Provider Test so
that it does not prohibit a reinsurer from offering a product in a state where it is permitted, even if that product is prohibited in another state, and have revised the portion of the third prong of the Provider Test that addresses a cedant’s reimbursable losses to make it subject to applicable state law so that it does not conflict with state￾based insurance receivership law. (c) Grandfather Provision for Existing Insurance Transactions In the Proposing Release, the Commissions asked whether the proposed rules should include a provision similar to section 302(c)(1) of the Gramm-Leach-Bliley Act that any product regulated as insurance before the date the Dodd-Frank Act was signed into law and provided in accordance with the Provider Test would be considered insurance and not fall within the swap or security-based swap definitions. In response to comments,154 the Commissions are adding a new paragraph (ii) to rule 1.3(xxx)(4) under the CEA and new paragraph (b) to rule 3a69–1 under the Exchange Act that provides that an agreement, contract, or transaction entered into on or before the effective date of the Product Definitions will be considered insurance and not fall within the swap and security-based swap definitions, provided that, at such time it was entered into, such agreement, contract, or transaction was provided in accordance with the Provider Test (the ‘‘Insurance Grandfather’’). As stated in the Proposing Release, the Commissions are aware of nothing in Title VII to suggest that Congress intended for traditional insurance products to be regulated as swaps or security-based swaps.155 The

156The Commissions believe that 60 days after publication of this release should be sufficient time for market participants to enter into pending agreements, contracts, or transactions for which the Insurance Grandfather may provide relief. 157See ACLI Letter; AFGI Letter; CAI Letter; and D&L Letter. 158See ACLI Letter and CAI Letter. ACLI and CAI argued that products that were regulated as insurance prior to the effective date of the Dodd￾Frank Act clearly were not characterized as insurance to avoid the Title VII regulatory regime. See also AFGI Letter; AFGI argued that all insurance contracts issued by state-regulated insurance companies should be excluded from the swap definition but in the alternative, all insurance products regulated as insurance before July 21, 2010 should be grandfathered. See also D&L Letter. D&L stated that prior regulation of insurance products before July 21, 2010 could be a consideration, but not an absolute determinant for exclusion from the swap or security-based swap definitions. 159See ACLI Letter and CAI Letter. 160 Id. 161See ACLI Letter; AGFI Letter; and CAI Letter. 162Section 722(b) of the Dodd-Frank Act provides, (B) Regulation of Swaps Under Federal and State Law.—Section 12 of the Commodity Exchange Act (7 U.S.C. 16) is amended by adding at the end the following: ‘‘(h) Regulation of Swaps as Insurance Under Federal and State Law.—A swap—(1) Shall not be considered to be insurance; and (2) may not be regulated as an insurance contract under the law of any State.’’ Section 767 of the Dodd-Frank Act amended section 28(a) of the Exchange Act, 15 U.S.C. 78bb(a), to provide, ‘‘A security-based swap may not be regulated as an insurance contract under any provision of State law.’’ 163See CAI Letter. CAI suggested that for a product to be regulated as insurance it means that it was provided by an insurance company. See supra part II.B.1.b) for a discussion of the need for the Provider Test portion of the Insurance Safe Harbor. Commissions have designed the Insurance Safe Harbor to provide greater assurance to market participants that traditional insurance products that were regulated as insurance prior to the Dodd-Frank Act will fall outside the swap and security-based swap definitions. Nevertheless, after considering comments received, the Commissions believe that it is appropriate to adopt the Insurance Grandfather in order to assure market participants that those agreements, contracts, or transactions that meet the conditions set out in the Insurance Grandfather will not fall within the swap or security-based swap definitions. In order to qualify for the Insurance Grandfather an agreement, contract, or transaction must meet two requirements. First, it must be entered into on or before the effective date of the Product Definitions. The Commissions are linking the Insurance Grandfather to the effective date of the Product Definitions, rather than the date that the Dodd-Frank Act was signed into law, in order to
avoid unnecessary market disruption.156 Second, such agreement, contract, or transaction must be provided in accordance with the Provider Test. In other words, the provider must be subject to state or Federal insurance supervision or be a non-admitted insurer or a reinsurer that satisfies the conditions for non-admitted insurers and reinsurers that are set out in the Provider Test. The Commissions note that an agreement, contract or transaction that is provided in accordance with the first prong of the Provider Test must also be regulated as insurance under applicable state law or the laws of the United States. By adopting the Insurance Grandfather and the Insurance Safe Harbor, the Commissions are excluding agreements, contracts, and transactions for which the Commissions have found no evidence that Congress intended them to be regulated as swaps or security-based swaps, and are providing greater certainty regarding the treatment of agreements, contracts, and transactions currently regulated as insurance. Comments Four commenters addressed whether the final rules should include a grandfather provision that would exclude certain insurance products from the swap or security-based swap definitions.157 Two commenters suggested that a grandfather provision for all products that were regulated as insurance before the Dodd-Frank Act was signed into law would be appropriate, stating that it would reduce confusion and uncertainty in applying the swap and security-based swap definitions to products that are traditionally regulated as insurance while addressing the Commissions’ stated concern that products might be structured as insurance products to evade Dodd-Frank Act requirements.158 These commenters also stated that it is necessary to add an effective date-based grandfather provision to the final rule providing that any contract or transaction subject to state insurance regulation and entered into prior to any final rules necessary to implement Title VII, including the Product Definitions, are not swaps or security-based swaps.159 These commenters noted that a grandfather provision based on effective date of all the Title VII rules was needed to address product development and variation that occurred between the date the Dodd￾Frank Act was enacted and the effective date of the rules mandated under that statute.160 The Commissions believe that the combination of the Insurance Grandfather along with the Insurance Safe Harbor provides market participants with increased legal certainty with respect to existing agreements, contracts, transactions, and products. In addition, the fact that the Commissions are linking the Insurance Grandfather to the effective date of the Product Definitions, rather than the date that the Dodd-Frank Act was signed into law, takes into account product development and innovation that may have occurred between the date the Dodd-Frank Act was signed into law at the effective date of the Product Definitions. Further, the
Commissions believe that a grandfather provision that would exclude all products regulated as insurance before the Dodd-Frank Act was signed into law, as recommended by some commenters,161 is unnecessary because non-grandfathered regulated insurance transactions generally should fall within the Insurance Safe Harbor. The Commissions believe that market participants could be incentivized to use such a broader grandfather provision to create new swap or security-based swap products with characteristics similar to those of existing categories of regulated insurance contracts for the purpose of evading the Dodd-Frank Act regulatory regime. The Commissions also believe that a broader grandfather provision would be contrary to the explicit direction of sections 722(b) and 767 of the Dodd-Frank Act which provide that swaps and security-based swaps may not be regulated as insurance contracts by any state.162 One commenter argued that the Provider Test should not apply to grandfathered contracts. The commenter stated that it should be enough that the product is regulated as insurance.163 As described above, the grandfather provision will apply only to agreements, contracts, and transactions that are entered into prior to the effective date of the Product Definitions if they were provided in accordance with the Provider Test, including a requirement that an agreement, contract or transaction that is provided in accordance with the first prong of the Provider Test must be regulated as insurance under applicable State law or the laws of the United States. As the Commissions discussed in the Proposing Release, and above in describing the Provider Test, the Commissions believe the requirement that the agreement, contract, or transaction be provided in accordance with the Provider Test should help ensure that persons who are not subject to state or Federal insurance supervision are not able to avoid the oversight

164See ACLI Letter; AIA Letter; AFGI Letter; CAI Letter; MetLife Letter; NAFA Letter; NAIC Letter; Nationwide Letter; and Travelers Letter. 165See ACLI Letter; AIA Letter; AFGI Letter; MetLife Letter; and Travelers Letter. 166See section 12(h) of the CEA, 7 U.S.C. 16(h) (regarding swaps) and section 28(a)(4) of the Exchange Act, 15 U.S.C. 78bb(a)(4) (regarding security-based swaps). 167See section 12(h)(2) of the CEA, 7 U.S.C. 16(h)(2). 168Section 3(a)(8) of the Securities Act excludes the following from all provisions of the Securities Act: Any insurance or endowment policy or annuity contract or optional annuity contract, issued by a corporation subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State or Territory of the United States or the District of Columbia. See infra note 1283 and accompanying text. 169See ACLI Letter; CAI Letter; NAFA Letter; and Nationwide Letter. 170See NAFA Letter. 171See ACLI Letter and CAI Letter. 172See NAIC Letter. 173See ACLI Letter (Appendix 1). See also CAI Letter. CAI stated that it believes that the approach and test recommended by ACLI is a fundamentally sound method for determining those insurance products that are not swaps or security-based swaps and that should remain subject to state regulation, and is more appropriate than the Commissions’ proposals. Nationwide suggested a three-part test to differentiate insurance products from swaps and security-based swaps similar to the test proposed by ACLI. See also Nationwide Letter. 174See ACLI Letter. provided for under Title VII of the Dodd-Frank Act. (d) Alternative Tests A number of commenters proposed that the Commissions adopt alternative tests to distinguish insurance from swaps and security-based swaps.164 After considering each of these alternatives, the Commissions are not adopting them. Several commenters suggested that the sole test for determining whether an agreement, contract, or transaction is insurance should be whether it is subject to regulation as insurance by the insurance commissioner of the applicable state(s).165 The Commissions find this alternative to be unworkable because it does not provide a sufficient means to distinguish agreements, contracts and transactions that are insurance from those that are swaps or security-based swaps. Section 712(d) of the Dodd-Frank Act directs the Commissions to ‘‘further define’’ the terms swap and security-based swap. Neither swaps nor security-based swaps may be regulated as insurance contracts under the laws of any state.166 While insurance contracts have long been subject to state regulation, swaps and security-based swaps were largely unregulated. Since the Dodd-Frank Act created a new regulatory regime for swaps and specifically provides that ‘‘swaps may not be regulated as an insurance contract under the law of any state,167 the Commissions believe that it is important to have a test that distinguishes
insurance from swaps and security-based swaps without relying entirely on the regulatory environment prior to the enactment of the Dodd￾Frank Act. The Product Test is an important element of the Insurance Safe Harbor. Several commenters suggested an approach in which insurance products that qualify for the exclusion contained in section 3(a)(8) of the Securities Act168 would be excluded from the swap definition.169 One commenter argued that ‘‘Section 3(a)(8) has long been recognized as the definitive provision as to where Congress intends to separate securities products that are subject to SEC regulation from ‘insurance’ and ‘annuity’ products that are to be left to state insurance regulation’’ and that the
section 3(a)(8) criteria are well
understood and have a long history of interpretation by the SEC and the courts.170 Other commenters suggest that because section 3(a)(8) includes both a product and a provider requirement, if the Commissions include it in their final rules, it should be a requirement separate from the Product Test and the Provider Test, and should extend to insurance products that are securities.171 While the Commissions agree that the
section 3(a)(8) criteria have a long
history of interpretations by the SEC and the courts, the Commissions find that it is inappropriate to apply the
section 3(a)(8) criteria in this context.
Although section 3(a)(8) contains some conditions applicable to insurance providers that are similar to the prongs of the Provider Test, it does not contain any conditions that are similar to the prongs of the Product Test. Moreover,
section 3(a)(8) provides an exclusion
from the Securities Act and the CFTC has no jurisdiction under the Federal securities laws. Congress directed both agencies to further define the terms ‘‘swap’’ and ‘‘security-based swap.’’ As such, the Commissions find that it is more appropriate to have a standalone rule that incorporates features that distinguish insurance products from swaps and security-based swaps and over which both Commissions will have joint interpretative authority. One commenter suggested yet another approach, recommending that insurance be defined as an agreement, contract, or transaction that by its terms:

• Exists for a specified period of time;
• Where the party (the ‘‘insured’’) to
  the contract promises to make one or more payments such as money, goods or services;
• In exchange for another party’s
  promise to provide a benefit of pecuniary value for the loss, damage, injury, or impairment of an identified interest of the insured as a result of the occurrence of a specified event or contingency outside of the parties’ control; and
• Where such payment is related to a
  loss occurring as a result of a contingency or specified event.172 The Commissions do not find this alternative preferable to the Commissions’ proposal for two reasons. First, the requirements of a specified term and the promise to make payments are present in both insurance products and in agreements, contracts, or transactions that are swaps or security￾based swaps and therefore do not help to distinguish between them. A test based solely on these requirements, then, could be over-inclusive and exclude from the Dodd-Frank Act regulatory regime agreements, contracts, and transactions that have not traditionally been considered insurance. Further, the third and fourth requirements of this alternative test collapse into the Product Test’s requirement that the loss must occur and be proved, and any payment or indemnification therefor must be limited to the value of the insurable interest. One commenter suggested a three-part test in lieu of the Product and Provider Tests. Under this test, the terms ‘‘swap’’ and ‘‘security-based swap’’ would exclude any agreement, contract, or transaction that:
• Is issued by a person who is or is
  required to be organized as an insurance company and subject to state insurance regulation;
• Is the type of contract issued by
  insurance companies; and
• Is not of the type that the
  Commissions determine to regulate. 173 This commenter stated that its approach does not contain a definition of insurance, and believes that is preferable to the Commissions’ approach, which it believes creates legal uncertainty because any attempted definition of insurance has the potential to be over- or under- inclusive.174 As discussed above, the Commissions’ rules and interpretations are not intended to define insurance. Rather, they provide a safe harbor for certain types of traditional insurance products by reference to factors that may be used to distinguish insurance from swaps and security-based swaps, and a list of

175See AIA Letter.
176 Id.
177See supra part II.B.1.c) 178See ACLI Letter; CAI Letter; NAFA Letter (concurring with ACLI and CAI); Nationwide Letter; and Travelers Letter. 179See ACLI Letter. 180See ACLI Letter; CAI Letter; NAFA Letter (concurring with ACLI and CAI); and Nationwide Letter (concurring the ACLI and CAI). 181 Id. The commenters suggested that this ambiguity could be resolved by making it clear in the final rules that an excluded product is neither a swap nor a security-based swap. 182See Proposing Release at 29827. 183The discussion in this subsection relates only to swaps that are not security-based swaps or mixed swaps and has no effect on the laws or regulations applicable to security-based swaps or mixed swaps. 184The Commissions did not express a view regarding whether financial guaranty insurance is a swap or security-based swap in the Entities Release. See Entities Release at 30689, n.1132. 185Subsequent references to ‘‘guarantees’’ in this discussion shall thus be deemed to include ‘‘financial guaranty insurance policies.’’ 186For purposes of this release, the CFTC views a guarantee of a swap to be a collateral promise by a guarantor to answer for the debt or obligation of a counterparty obligor under a swap. A guarantee of a swap does not include for purposes of this release: (i) A ‘‘guarantee agreement’’ as defined in CFTC regulation § 1.3(nn), 17 CFR 1.3(nn); (ii) any assumption by a clearing member of financial or performance responsibility to a derivatives clearing organization (‘‘DCO’’) for swaps cleared by a DCO; or (iii) any guarantee by a DCO with respect to a swap that it clears. 187E.g., a swap counterparty may specify that a guarantee is a Credit Support Document under an Continued products that do not have to satisfy a portion of the safe harbor factors. Agreements, contracts, and transactions that do not qualify for the Insurance Safe Harbor may or may not be insurance, depending upon the facts and circumstances regarding such agreements, contracts and transactions. The Commissions find the first two requirements of the commenter’s three￾part test to be tautologous, and the third provides no greater certainty than the Commissions’ facts and circumstances approach. In addition, the Commissions find that this alternative test could exclude from the Dodd-Frank Act regulatory regime agreements, contracts, and transactions that have not traditionally been considered insurance. Another commenter proposed different approaches for existing products and new products.175 Specifically, if an existing type of agreement, contract or transaction is currently reportable as insurance in the provider’s regulatory and financial reports under a state or foreign jurisdiction’s insurance laws, then that agreement, contract, or transaction would be insurance rather than a swap or security-based swap. On the other hand, for new products, if this approach were inconclusive, this commenter recommended that the Commissions use the Product Test of the Commissions’
rules only.176 As discussed above, rather than treating existing products and new products differently, the Commissions are providing ‘‘grandfather’’ protection for agreements, contracts, and transactions entered into prior to the effective date of the Products Definitions.177 Moreover, this commenter’s test would eliminate the Provider Test for new products, which the Commissions believe is important to help prevent products that are swaps or security-based swaps from being characterized as insurance. In sum, the Commissions find that each of the alternatives proposed by commenters could exclude from the Dodd-Frank Act regulatory regime agreements, contracts, and transactions that have not historically been considered insurance, and that should, in appropriate circumstances, be regulated as swaps or security-based swaps. Accordingly, the Commissions do not find these alternatives to be appropriate for delineating the scope of the Insurance Safe Harbor from the swap and security-based swap definitions. (e) ‘‘Safe Harbor’’ Five commenters recommended that the Product Test, the Provider Test, and related interpretations should be structured as a ‘‘safe harbor’’ so that they do not raise any presumption or inference that products that do not meet the Product Test, Provider Test and related interpretations are necessarily swaps or security-based swaps.178 One commenter suggested that this safe harbor approach could be modeled after Rule 151 under the Securities Act.179 As discussed above, the Commissions do not intend to create a presumption that agreements, contracts, or transactions that do not fall within the Insurance Safe Harbor are necessarily swaps or security-based swaps. As stated above, the Commissions are instead adopting final rules that clarify that certain agreements, contracts, or transactions meeting the requirements of a non-exclusive ‘‘safe harbor’’ established by such rules will not be considered to be swaps or security￾based swaps. An agreement, contract, or transaction that does not fall within the Insurance Safe Harbor will require further analysis of the applicable facts and circumstances to determine whether it is insurance, and thus not a swap or security-based swap. (f) Applicability of Insurance Exclusion to Security-Based Swaps Four commenters expressed concerns that the proposed rules were unclear in their application to both swaps and security-based swaps.180 These commenters argued that the proposed rules do not directly exclude insurance products from the term ‘‘security-based swap’’ because the rules explicitly state that ‘‘[t]he term ‘swap’ does not include’’ the products that meet the Product and Provider Tests, but do not make the same statement as to the term ‘‘security-based swap.’’ 181 The Commissions have revised rule 1.3(xxx)(4) under the CEA and rule 3a69–1 under the Exchange Act to clarify that the exclusion contained therein applies to both swaps and security-based swaps. (g) Guarantees In the Proposing
Release, the Commissions requested comment on whether insurance of an agreement, contract, or transaction that falls within the swap or security-based swap definitions should itself be included in the swap or security-based swap definition. The Commissions also requested comment on whether the Commissions should provide guidance as to whether swap or security-based swap guarantees offered by non￾insurance companies should be considered swaps or security-based swaps.182 Guarantees of Swaps.183 No commenter identified any product that insures swaps (that are not security￾based swaps or mixed swaps) other than financial guaranty insurance. The CFTC finds that insurance of an agreement, contract, or transaction that falls within the swap definition (and is not a security-based swap or mixed swap) is functionally or economically similar to a guarantee of a swap (that is not a security-based swap or mixed swap) offered by a non-insurance company.184 Therefore, the CFTC is treating financial guaranty insurance of swaps (that are not security-based swaps or mixed swaps) the same way it is treating all other guarantees of swaps (that are not security-based swaps or mixed swaps), as discussed below.185 The CFTC is persuaded that when a swap has the benefit of a guarantee,186 the guarantee is an integral part of that swap. The CFTC finds that a guarantee of a swap (that is not a security-based swap or mixed swap) is a term of that swap that affects the price or pricing attributes of that swap.187 When a swap

ISDA Master Agreement. If the guarantor fails to comply with or perform under such guarantee, such guarantee expires or terminates, or if such guarantee ceases to be in full force and effect, the ‘‘Credit Support Default’’ Event of Default under the ISDA Master Agreement would generally be triggered, potentially bringing down the entire swap trading relationship between the parties to the ISDA Master Agreement. See generally the standard 1992 ISDA Master Agreement and 2002 ISDA Master Agreement. However, the CFTC finds the presence of a guarantee to be an integral part of a swap and that affects the price or pricing attributes of a swap whether or not such guarantee is a Credit Support Document under an ISDA Master Agreement. 188This interpretation is consistent with the interpretations of the Commissions in the Entity Definitions Release. See, e.g., Entity Definitions Release at 30689 (‘‘[A]n entity’s swap or security￾based swap positions in general would be attributed to a parent, other affiliate or guarantor for purposes of major participant analysis to the extent that counterparties to those positions would have recourse to that other entity in connection with the position. Positions would not be attributed in the absence of recourse.’’). A swap backed by a partial or limited recourse guarantee will include the guarantee to the extent of such partial or limited recourse; a blanket guarantee that supports both swap and non-swap obligations will be treated as
part of the guaranteed swap only to the extent that
such guarantee backstops obligations under a swap or swaps. In the Entity Definitions Release, the Commissions stated, ‘‘we do not believe that it is necessary to attribute a person’s swap or security￾based swap positions to a parent or other guarantor if the person is already subject to capital regulation by the CFTC or SEC (i.e., swap dealers, security￾based swap dealers, major swap participants, major security-based swap participants, FCMs and broker￾dealers) or if the person is a U.S. entity regulated as a bank in the United States. Positions of those regulated entities already will be subject to capital and other requirements, making it unnecessary to separately address, via major participant regulations, the risks associated with guarantees of those positions.’’ Id. In a footnote, the Commissions continued, ‘‘As a result of this interpretation, holding companies will not be deemed to be major swap participants as a result of guarantees to certain U.S. entities that are already subject to capital regulation.’’ Id. As a result of interpreting the term ‘‘swap’’ (that is not a security-based swap or mixed swap) to include a guarantee of such swap, to the extent that a counterparty to a swap position would have recourse to the guarantor in connection with the position, and based on the reasoning set forth above from the Entity Definitions Release in connection with major swap participants, the CFTC will not deem holding companies to be swap dealers as a result of guarantees to certain U.S. entities that are already subject to capital regulation. It may, however, be appropriate to regulate as a swap dealer a parent or other guarantor who guarantees swap positions of persons who are not already subject to capital regulation by the CFTC (i.e., who are not swap dealers, major swap participants or FCMs). The CFTC is addressing guarantees provided to non-U.S. entities, and guarantees by non-U.S. holding companies, in its proposed interpretive guidance and policy statement regarding the cross-border application of the swaps provisions of the CEA, 77 FR 41214 (Jul. 12, 2012). 189Briefly, in the separate CFTC release the CFTC anticipates proposing reporting requirements with respect to guarantees of swaps under Parts 43 and 45 of the CFTC’s regulations and explaining the extent to which the duties and obligations of swap dealers and major swap participants pertaining to guarantees of swaps, as an integral part of swaps, are already satisfied to the extent such obligations are satisfied with respect to the related guaranteed swaps. The CFTC also anticipates addressing in the separate CFTC release the effect, if any, of the interpretation regarding guarantees of swaps on position limits and large trader reporting requirements. 190See AFGI Letter and ISDA Letter. 191 ISDA Letter. 192 Id. 193See Better Markets Letter. 194See Better Markets Letter. 195 ‘‘AIGFP’s obligations were guaranteed by its highly rated parent company * * * an arrangement that
facilitated easy money via much lower interest rates from the public markets, but ultimately made it difficult to isolate AIGFP from its parent, with disastrous consequences.’’ Congressional Oversight Panel, The AIG Rescue, Its Impact on Markets, and the Government’s Exit Strategy 20 (2010). 196See ISDA Letter. 197See AFGI Letter. counterparty typically provides a guarantee as credit support for its swap obligations, the market will not trade with that counterparty at the same price, on the same terms, or at all without the guarantee. The guarantor’s resources are added to the analysis of the swap; if the guarantor is financially more capable than the swap counterparty, the analysis of the swap becomes more dependent on the creditworthiness of the guarantor. Therefore, the CFTC is interpreting the term ‘‘swap’’ (that is not a security-based swap or mixed swap) to include a guarantee of such swap, to the extent that a counterparty to a swap position would have recourse to the guarantor in connection with the position.188 The CFTC anticipates that a ‘‘full recourse’’ guarantee would have a greater effect on the price of a swap than a ‘‘limited’’ or ‘‘partial recourse’’ guarantee; nevertheless, the CFTC is determining that the presence of any guarantee with recourse, no matter how robust, is price forming and an integral
part of a guaranteed swap.
The CFTC’s interpretation of the term ‘‘swap’’ to include guarantees of swaps does not limit or otherwise affect in any way the relief provided by the Insurance Grandfather. In a separate release, the CFTC will address the practical implications of interpreting the term ‘‘swap’’ to include guarantees of swaps (the ‘‘separate CFTC release’’).189 Comments Three commenters provided comments regarding the treatment of guarantees. Two commenters 190 opposed treating insurance or guarantees of swaps as swaps. Suggesting that the products are not economically similar, one commented that insurance wraps of swaps do not ‘‘necessarily replicate the economics of the underlying swap, and only following default could the wrap provider end up with the same payment obligations as a wrapped defaulting swap counterparty.’’ 191 This commenter also stated that the non-insurance guarantees are not swaps because the result of most guarantees is that the guarantor is responsible for monetary claims against the defaulting party, which in this commenter’s view is a different obligation than the arrangement provided by the underlying swap itself.192 One commenter supported treating financial guaranty insurance of a swap or security-based swap as itself a swap or a security-based swap. This commenter argued that financial guaranty insurance of a swap or security-based swap transfers the risk of counterparty non-performance to the guarantor, making it an embedded and essential feature of the insured swap or security-based swap. This commenter further argued that the value of such swap or security-based swap is largely determined by the likelihood that the proceeds from the financial guaranty insurance policy will be available if the counterparty does not meet its obligations.193 This commenter maintained that financial guaranty insurance of swaps and security-based swaps serves a very similar function to credit default swaps in hedging counterparty default risk.194 The CFTC is persuaded that when a swap (that is not a security-based swap or mixed swap) has the benefit of a guarantee, the guarantee and related guaranteed swap must be analyzed together. The events surrounding the failure of AIG Financial Products (‘‘AIGFP’’) highlight how guarantees can cause major risks to flow to the guarantor.195 The CFTC finds that the regulation of swaps and the risk exposures associated with them, which is an essential concern of the Dodd￾Frank Act, would be less effective if the CFTC did not interpret the term ‘‘swap’’ to include a guarantee of a swap. Two commenters cautioned against unnecessary and duplicative regulation. One commented that, because the underlying swap, and the parties to it, will be regulated and reported to the extent required by Title VII, there is no need for regulation of non-insurance guarantees.196 The other commented that an insurance policy on a swap would be subject to state regulation; without addressing non-insurance guarantees, this commenter stated
that additional Federal regulation would be duplicative.197 The CFTC disagrees with these arguments. As stated above, the CFTC is treating financial guaranty insurance of swaps and all other guarantees of swaps in a similar manner because they are functionally or

198See AFGI Letter. Of the members of AFGI, only Assured Guaranty (or its affiliates) is currently writing financial guaranty insurance policies on U.S. municipal obligations. 199See Regulation SBSR Proposing Release infra note 1231. 200See sections 768(a)(1) and 761(a)(2) of the Dodd-Frank Act (amending sections 2(a)(1) of the Securities Act, 15 U.S.C. 77b(a)(1), and 3(a)(10) of the Exchange Act, 15 U.S.C. 78c(a)(10), respectively). 201See section 2(a)(1) of the Securities Act, 15 U.S.C. 77b(a)(1). 202The SEC has previously addressed the treatment of financial guaranty insurance under the Federal securities laws. See supra note 58. 203See Proposing Release at 29827. 204CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii). 205The discussion in subsections (a) and (b) of this section applies solely to the exclusion of nonfinancial commodity forwards from the swap definition in the CEA. 206See infra part II.B.2(a)(i)(F). 207Statutory Interpretation Concerning Forward Transactions, 55 FR 39188 (Sep. 25, 1990) (‘‘Brent Interpretation’’). 208Exemption for Certain Contracts Involving Energy Products, 58 FR 21286–02 (Apr. 20, 1993) (‘‘Energy Exemption’’). 209CEA section 1a(27), 7 U.S.C. 1a(27). 210See 156 Cong. Rec. H5248–49 (June 30, 2010) (introducing into the record a letter authored by Senator Blanche Lincoln, Chairman of the U. S. Senate Committee on Agriculture, Nutrition and Forestry, and Christopher Dodd, Chairman U. S. Senate Committee on Banking, Housing, and Urban Affairs, stating that the CFTC is encouraged ‘‘to clarify through rulemaking that the exclusion from the definition of swap for ‘any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled’ is intended to be consistent with the forward contract exclusion that is currently in the [CEA] and the CFTC’s established Continued economically similar products. If a guarantee of a swap is not treated as an integral part of the underlying swap, price forming terms of swaps and the risk exposures associated with the guarantees may remain hidden from regulators and may not be regulated appropriately. Moreover, treating guarantees of swaps as part of the underlying swaps ensures that the CFTC will be able to take appropriate action if, after evaluating information collected with respect to the guarantees and the underlying swaps, such guarantees of swaps are revealed to pose particular problems in connection with the swaps markets. In the separate CFTC release, the CFTC will clarify the limited practical effects of the CFTC’s interpretation, which should address concerns regarding duplicative regulation. One commenter also argued that regulating financial guaranty of swaps as swaps would cause monoline insurers to withdraw from the market, which could adversely affect the U.S. and international public finance, infrastructure and structured finance markets, given that insuring a related swap often is integral to
the insurance of municipal bonds and other securities.198 The CFTC finds this argument unpersuasive. The CFTC understands that the 2008 global financial crisis severely affected most monolines and only one remains active in U.S. municipal markets. Thus, it appears that the monolines have, for the most part, already exited these markets. In addition, as stated above, the CFTC will clarify in the separate CFTC release the limited practical effects of the CFTC’s interpretation, which should address these concerns. Guarantees of Security-Based Swaps The SEC believes that a guarantee of an obligation under a security-based swap, including financial guaranty insurance of a security-based swap, is not a separate security-based swap. Further, the SEC is not adopting an interpretation that a guarantee of a security-based swap is part of the security-based swap. Instead, the SEC will consider requiring, as part of its rulemaking relating to the reporting of security-based swaps,199 the reporting of information about any guarantees and the guarantors of obligations under security-based swaps in connection with the reporting of the security-based swap transaction itself. In addition, the SEC will consider issues involving cross-border guarantees of security￾based swaps in a separate release addressing the cross-border application of Title VII. The SEC notes that security￾based swaps are included in the definition of ‘‘security’’ contained in the Securities Act and the Exchange Act.200 Under the Securities Act, a guarantee of a security also is a ‘‘security.’’ 201 Therefore, a guarantee of a security￾based swap is a security subject to Federal securities law regulation.202
2. The Forward Contract Exclusion
As the Commissions explained in the Proposing Release, the definitions of the terms ‘‘swap’’ and ‘‘security-based swap’’ do not include forward contracts.203 These definitions exclude ‘‘any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled.’’ 204 The Commissions provided an interpretation in the Proposing Release regarding the applicability of the exclusion from the swap and security￾based swap definition for forward contracts with respect to nonfinancial commodities 205 and securities. The Commissions are restating this interpretation as set forth in the Proposing Release with certain modifications in response to commenters. (a) Forward Contracts in Nonfinancial Commodities The CFTC provided an interpretation in the Proposing Release regarding the forward contract exclusion for nonfinancial commodities and is restating this interpretation with certain modifications in response to commenters. These clarifications include that the CFTC will interpret the forward contract exclusion consistent with the entire body of CFTC precedent.206 The CFTC is also clarifying what ‘‘commercial participant’’ means under the ‘‘Brent Interpretation.’’ 207 In addition, while the CFTC is withdrawing its 1993 ‘‘Energy Exemption’’ 208 as proposed, it is clarifying that certain alternative delivery procedures will not disqualify a transaction from the forward contract exclusion. In response to comments, the CFTC is providing a new interpretation regarding book-out documentation, as well as additional factors that may be considered in its ‘‘facts and circumstances’’ analysis of whether a particular contract is a forward. (i) Forward Exclusion From the Swap and Future Delivery Definitions (A) Consistent Interpretation The wording of the forward contract exclusion from the swap definition with respect to nonfinancial commodities is similar, but not identical, to the forward exclusion from the definition of the term ‘‘future delivery’’ that applies to futures contracts, which excludes ‘‘any sale of any cash commodity for deferred shipment or delivery.’’ 209 In the Proposing Release, the CFTC proposed an interpretation clarifying the scope of the exclusion of forward contracts for nonfinancial commodities from the swap definition and from the ‘‘future delivery’’ definition in a number of respects. After considering the comments received, the CFTC is restating substantially all of its interpretation regarding these forward exclusions set forth in the Proposing Release, but with several clarifications in response to commenters. The CFTC is restating from the Proposing Release that the forward exclusion for nonfinancial commodities in the swap definition will be interpreted in a manner consistent with the CFTC’s historical interpretation of the existing forward exclusion with respect to futures contracts, consistent with the Dodd-Frank Act’s legislative history.210 In addition, in
response to a

policy and orders on this subject, including situations where commercial parties agree to ‘book￾out’ their physical delivery obligations under a forward contract.’’). See also 156 Cong. Rec. H5247 (June 30, 2010) (colloquy between U. S. House Committee on Agriculture Chairman Collin Peterson and Representative Leonard Boswell during the debate on the Conference Report for the Dodd-Frank Act, in which Chairman Peterson stated: ‘‘Excluding physical forward contracts, including book-outs, is consistent with the CFTC’s longstanding view that physical forward contracts in which the parties later agree to book-out their delivery obligations for commercial convenience are excluded from its jurisdiction. Nothing in this legislation changes that result with respect to commercial forward contracts.’’). 211See Letter from Craig Donahue, Chief Executive Officer, CME Group Inc. (‘‘CME’’), dated July 22, 2011 (‘‘CME Letter’’) (requesting this clarification). But see below regarding the CFTC’s response to CME’s comment concerning the Brent Interpretation that it may be inconsistent, in CME’s view, with more recent CFTC adjudicatory decisions. 212See, e.g., Brent Interpretation, supra note 207. 213See Brent Interpretation, supra note 207. The CFTC has reiterated this view in more recent adjudicative orders. See, e.g., In re Grain Land Coop., [2003–2004 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 29,636 (CFTC Nov. 25, 2003); In re Competitive Strategies for Agric., Ltd., [2003–2004 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 29,635 (CFTC Nov. 25, 2003). Courts have expressed this view as well. See, e.g., Salomon Forex, Inc. v. Tauber, 8 F.3d 966, 971 (4th Cir. 1993) (‘‘[C]ash forwards are generally individually negotiated sales

• • • in which actual delivery of the commodity
      is anticipated, but is deferred for reasons of commercial convenience or necessity.’’); CFTC v. Int’l Fin. Serv. (N.Y.), 323 F. Supp. 2d 482, 495 (S.D.N.Y. 2004). See also CFTC v. Co Petro Mktg. Grp., Inc., 680 F.2d 573, 579–580 (9th Cir. 1982); CFTC v. Noble Metals Int’l, Inc., 67 F.3d 766, 772– 773 (9th Cir. 1995; CFTC v. Am. Metal Exch. Corp., 693 F. Supp. 168, 192 (D.N.J. 1988); CFTC v. Morgan, Harris & Scott, Ltd., 484 F. Supp. 669, 675 (S.D.N.Y. 1979) (forward contract exclusion does not apply to speculative transactions in which delivery obligations can be extinguished under the terms of the contract or avoided for reasons other than commercial convenience or necessity). 214The CFTC observed in its decision in In re Wright that ‘‘it is well-established that the intent to make or take delivery is the critical factor in determining whether a contract qualifies as a forward.’’ In re Wright, CFTC Docket No. 97–02, 2010 WL 4388247 at *3 (CFTC Oct. 25, 2010) (citing In re Stovall, et al., [1977–1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) 20,941 (CFTC Dec. 6, 1979); Brent Interpretation, supra note 207). In Wright, the CFTC noted that ‘‘[i]n distinguishing futures from forwards, the [CFTC] and the courts have assessed the transaction as a whole with a critical eye toward its underlying purpose. Such an assessment entails a review of the overall effect of the transaction as well as a determination as to what the parties intended.’’ Id. at *3 (quoting Policy Statement Concerning Swap Transactions, 54 FR 30694 (Jul. 21, 1989) (‘‘Swap Policy Statement’’) (citations and internal quotations omitted)). 215 In Wright, the CFTC applied its facts and circumstances test in an administrative enforcement action involving hedge-to-arrive contracts for corn, and observed that ‘‘[o]ur views of the appropriateness of a multi-factor analysis remain unchanged.’’ Wright, note 214, supra, n.13. The CFTC let stand the administrative law judge’s conclusion that the hedge-to-arrive contracts at issue in the case were forward contracts. Id. at 5–

6. See also Grain Land, supra note 213; Competitive
   Strategies for Agric., supra note 213. 216See Brent Interpretation, supra note 207. The CFTC issued the Brent Interpretation in response to a Federal court decision that held that certain 15- day Brent system crude oil contracts were illegal off-exchange futures contracts. See Transnor (Bermuda) Ltd. v. BP N. Am. Petroleum, 738 F. Supp. 1472 (S.D.N.Y. 1990). The Brent Interpretation provided clarification that the 15-day Brent system crude oil contracts were forward contracts that were excluded from the CEA definition of ‘‘future delivery,’’ and thus were not futures contracts. See Brent Interpretation, supra note 207. 217The Brent Interpretation described these ‘‘book-outs’’ as follows: ‘‘In the course of entering into 15-day contracts for delivery of a cargo during a particular month, situations often arise in which two counterparties have multiple, offsetting positions with each other. These situations arise as a result of the effectuation of multiple, independent commercial transactions. In such circumstances, rather than requiring the effectuation of redundant deliveries and the assumption of the credit, delivery and related risks attendant thereto, the parties may, but are not obligated to and may elect not to, terminate their contracts and forego such deliveries and instead negotiate payment-of-differences pursuant to a separate, individually-negotiated cancellation agreement referred to as a ‘book-out.’ Similarly, situations regularly arise when participants find themselves selling and purchasing oil more than once in the delivery chain for a particular cargo. The participants comprising these ‘circles’ or ‘loops’ will frequently attempt to negotiate separate cancellation agreements among themselves for the same reasons and with the same effect described above.’’ Brent Interpretation, supra note 207, at 39190. 218 Id. at 39192. 219 Id. at 39189. commenter, the CFTC is clarifying that the entire body of CFTC precedent regarding forwards should apply to the forward exclusions from the swap and future delivery definitions.211 The CFTC’s historical interpretation has been that forward contracts with respect to nonfinancial commodities are ‘‘commercial merchandising transactions.’’ 212 The primary purpose of a forward contract is to transfer ownership of the commodity and not to transfer solely its price risk. As the CFTC has noted and reaffirms today:
   The underlying postulate of the [forward] exclusion is that the [CEA’s] regulatory scheme for futures trading simply should not apply to private commercial merchandising transactions which create enforceable obligations to deliver but in which delivery is deferred for reasons of commercial convenience or necessity.213 As noted in the Proposing Release, because a forward contract is a commercial merchandising transaction, intent to deliver historically has been an element of the CFTC’s analysis of whether a particular contract is a forward contract.214 In assessing the parties’ expectations or intent regarding delivery, the CFTC consistently has applied a ‘‘facts and circumstances’’ test.215 Therefore, the CFTC reads the ‘‘intended to be physically settled’’ language in the swap definition with respect to nonfinancial commodities to reflect a directive that intent to deliver a physical commodity be a part of the analysis of whether a given contract is a forward contract or a swap, just as it is a part of the CFTC’s analysis of whether a given contract is a forward contract or a futures contract. (B) Brent Interpretation In this interpretation, the CFTC is restating, with certain clarifications in response to commenters, its interpretation from the Proposing Release that the principles underlying the CFTC’s ‘‘Brent Interpretation’’ regarding book-outs developed in connection with the forward exclusion from futures apply to the forward exclusion from the swap definition as well. Book-out transactions meeting the requirements specified in the Brent Interpretation that are effectuated through a subsequent, separately negotiated agreement qualify for the safe harbor under the forward exclusions. As was noted in the Proposing Release, the issue of book-outs first arose in 1990 in the Brent Interpretation 216 because the parties to the crude oil contracts in that case could individually negotiate cancellation agreements, or ‘‘book-outs,’’ with other parties.217 In describing these transactions, the CFTC stated:
   It is noteworthy that while such [book-out] agreements may extinguish a party’s delivery obligation, they are separate, individually negotiated, new agreements, there is no obligation or arrangement to enter into such agreements, they are not provided for by the terms of the contracts as initially entered into, and any party that is in a position in a distribution chain that provides for the opportunity to book-out with another party or parties in the chain is nevertheless entitled to require delivery of the commodity to be made through it, as required under the contracts.218 Thus, in the scenario at issue in the Brent Interpretation, the contracts created a binding obligation to make or take delivery without providing any right to offset, cancel, or settle on a payment-of-differences basis. The ‘‘parties enter[ed] into such contracts with the recognition that they may be required to make or take delivery.’’ 219 On these facts, the Brent Interpretation concluded that the contracts were forward contracts, not futures contracts:
   Under these circumstances, the [CFTC] is of the view that transactions of this type which are entered into between commercial participants in connection with their business, which create specific delivery obligations that impose substantial economic risks of a commercial nature to these participants, but which may involve, in

220 Id. at 39192.
221See CME Letter (noting that, although the Brent Interpretation applies to ‘‘commercial market participants,’’ the proposed guidance in the Proposing Release was described as applying to ‘‘market participants’’ (omitting the word ‘‘commercial’’) who ‘‘regularly make or take delivery of the referenced commodities * * * in the ordinary course of business.’’ See also Proposing Release at 29829. 222Brent Interpretation, supra note 207, at 39192. 223See CME Letter. In connection with its comment regarding ‘‘market participants’’ described above, see supra note 221, the CME further requests confirmation that the CFTC intends to apply the Brent Interpretation to market participants who can demonstrate that they meet the standard in the guidance as proposed, but are not themselves commercial actors:
Because the Commission‘s interpretation does not explicitly refer to commercial market participants, it would seem to cover financial players as long as those entities regularly make or take delivery of the underlying commodity in connection with their business. Examples of such entities would be hedge funds or other investment vehicles that regularly make or take delivery of commodities (e.g. gold) in conjunction with their line of business—that is, as
part of their investment strategies. [CME] asks that
the [CFTC] confirm that the Brent safe harbor would be available to these types of market participants that technically are not ‘‘commercial’’ actors. See CME Letter. 224Brent Interpretation, supra note 207, at 39191. See also dissent of Commissioner Fowler West (stating that commercial means ‘‘in the traditional sense of those who produce, process, use or * * * handle the underlying commodity.’’). Note that being a commercial market participant with respect to an agreement, contract or transaction in one commodity, or grade of a commodity, neither makes an entity, nor precludes an entity from being, a commercial market participant with respect to an agreement, contract or transaction in a different grade of the commodity or a different commodity. For example, a West Texas Intermediate oil producer may or may not also be a commercial with respect to Brent. Similarly, that same West Texas Intermediate oil producer may or may not have commercial corn operations. In determining whether an entity is a commercial market participant with respect to an agreement, contract or transaction in a commodity, the CFTC will consider the facts and circumstances, though it is not unlikely that an entity that is a commercial market participant with respect to one commodity may also be a commercial market participant with respect to either a different grade of the commodity or a closely related commodity. 225See infra part II.B.2(a)(ii), with respect to the CFTC’s interpretation concerning nonfinancial commodities. 226The CFTC reminds market participants that this does not mean, as was noted in the Brent Interpretation, that these transactions or persons who engage in them are wholly outside the reach of the CEA for all purposes. See, e.g., CEA section 8(d), 7 U.S.C. 12(d), which directs the CFTC to investigate the marketing conditions of commodities and commodity products and byproducts, including supply and demand for these commodities, cost to the consumer, and handling and transportation charges; CEA sections 6(c), 6(d), and 9(a)(2), 7 U.S.C. 9, 13b, and 13(a)(2), which proscribe any manipulation or attempt to manipulate the price of any commodity in interstate commerce; and CEA section 6(c) as amended by
section 753 of the Dodd-Frank Act, which contains
prohibitions regarding manipulation and false reporting with respect to any commodity in interstate commerce, including prohibiting any person to (i) ‘‘use or employ, or attempt to use or employ * * * any manipulative or deceptive device or contrivance’’ (section 6(c)(1)); (ii) ‘‘to make any false or misleading statement of material fact’’ to the CFTC or ‘‘omit to state in any such statement any material fact that is necessary to make any statement of material fact made not misleading in any material respect’’ (section 6(c)(2)); and (iii) ‘‘manipulate or attempt to manipulate the price of any swap, or of any commodity in interstate commerce * * * (section 6(c)(3)). See also Rule 180.1(a) under the CEA, 17 CFR 180.1(a) (broadly prohibiting in connection with a commodity in interstate commerce manipulation, false or misleading statements or omissions of material fact to the Commission, fraud or deceptive practices or courses of business, and false reporting). 227These include pre-transaction netting agreements that result in offsetting physical delivery obligations, ‘‘bona fide termination rights,’’ and certain other methods by which parties may settle their delivery obligations. See Energy Exemption, supra note 208, at 21293. certain circumstances, string or chain deliveries of the type described * * * are within the scope of the [forward contract] exclusion from the [CFTC’s] regulatory jurisdiction.220 Although the CFTC did not expressly discuss intent to deliver, the Brent Interpretation concluded that transactions retained their character as commercial merchandising transactions, notwithstanding the practice of terminating commercial parties’ delivery obligations through ‘‘book￾outs’’ as described. At any point in the chain, one of the parties could refuse to enter into a new contract to book-out the transaction and, instead, insist upon delivery pursuant to the parties’ obligations under their contract. The CFTC also is clarifying that commercial market participants that regularly make or take delivery of the referenced commodity in the ordinary course of their business meet the commercial participant standard of the Brent Interpretation.221 The CFTC notes that the Brent Interpretation applies to ‘‘commercial participants in connection with their business.’’ 222 The CFTC intends that the interpretation in this release be consistent with the Brent Interpretation, and accordingly is adding ‘‘commercial’’ before ‘‘market participants’’ in this final interpretation. Such entities qualify for the forward exclusion from both the future delivery and swap definitions for their forward transactions in nonfinancial commodities under the Brent Interpretation even if they enter into a subsequent transaction to ‘‘book out’’ the contract rather than make or take delivery. Intent to make or take delivery can be inferred from the binding delivery obligation for the commodity referenced in the contract and the fact that the parties to the contract do, in fact,
regularly make or take delivery of the referenced commodity in the ordinary course of their business. Further, in this final interpretation, the CFTC clarifies, in response to a comment received, that an investment vehicle taking delivery of gold as part of its investment strategy would not be engaging in a commercial activity within the meaning of the Brent Interpretation.223 By contrast, were the investment vehicle, for example, to own a gold mine and sell the output of the gold mine for forward delivery, or own a chain of jewelry stores that produces its own jewelry from raw materials and purchase a supply of gold from another entity’s gold mine in order to provide raw materials for its jewelry stores, such contracts could qualify as forward contracts under the Brent Interpretation—provided that such contracts otherwise satisfy the terms thereof. In sum, the CFTC is interpreting the term ‘‘commercial’’ in the context of the Brent Interpretation in the same way it has done since 1990: ‘‘related to the business of a producer, processor, fabricator, refiner or merchandiser.’’ 224 While a market participant need not be solely engaged in ‘‘commercial’’ activity to be a ‘‘commercial market participant’’ within the meaning of the Brent Interpretation under this interpretation, the business activity in which it makes or takes delivery must be commercial activity for it to be a commercial market participant. A hedge fund’s investment activity is not commercial activity within the CFTC’s longstanding view of the Brent Interpretation. In addition, the CFTC is expanding the Brent Interpretation, which applied only to oil, to all nonfinancial commodities, as proposed.225 As a result, book-outs are permissible (where the conditions of the Brent Interpretation are satisfied) for all nonfinancial commodities with respect to the exclusions from the definition of the term ‘‘swap’’ and the definition of the term ‘‘future delivery’’ under the CEA.226 (C) Withdrawal of the Energy Exemption Because the CFTC has expanded the Brent Interpretation to nonfinancial commodities in this final interpretation, the CFTC also has determined to withdraw the Energy Exemption as proposed. In response to comments received, the CFTC is clarifying that certain alternative delivery procedures discussed in the Energy Exemption 227 will not disqualify a transaction from the Brent Interpretation safe harbor. In the Proposing Release, the CFTC proposed to withdraw the Energy Exemption, which, among other things,

228See Proposing Release at 29829. The CFTC also noted that, to avoid any uncertainty, the Dodd￾Frank Act supersedes the Swap Policy Statement. Id. at 29829 n. 74. The CFTC reaffirms that such is the case. 229Compare Energy Exemption, supra note 208, at 21293 with Brent Interpretation, supra note 207, at 39192. 230See Energy Exemption, supra note 208, at 21293. 231See also infra part II.B.2(b)(v) for a discussion of liquidated damages. 232Energy Exemption, supra note 208, at 21293. 233 Id. 234 Id. 235The CFTC will carefully scrutinize whether market participants are legitimately relying on the Brent Interpretation safe harbor. For example, if non-commercial market participants are intermediate purchasers in a delivery chain, then the transaction is not actually a commercial merchandising transaction, and the parties cannot rely on the Brent Interpretation safe harbor. 236By definition, if two parties exchange (i.e., physically deliver) one physical commodity for another physical commodity in settlement of the parties’ delivery obligations, each seller has delivered the commodity that is the subject of its delivery obligation under the relevant agreement, contract or transaction. Depending on the settlement timing, such transactions, which resemble barter transactions, would be spot transactions or forward transactions. While the most common forward transaction involves an exchange of a physical commodity for cash, neither the Brent Interpretation nor any other CFTC authority requires payment for a forward delivery to be made in cash. Thus, a physical exchange of one quality, grade or type of physical commodity for another quality, grade, or type of physical commodity does not affect the characterization of the transaction as a spot or forward transaction. As for the sellers passing title and buyers, instead of taking delivery of the commodity, passing title to another intermediate purchaser in a chain, this is consistent with the description of Brent transactions in the Brent Interpretation, provided that, as set forth therein, delivery is required and ‘‘the delivery obligations create substantial economic risk of a commercial nature to the parties required to make or take delivery * * * includ[ing, without limitation,] demurrage, damage, theft or deterioration.’’ That description was based on the industry delivery structure as it existed prior to the Brent Interpretation. To the extent other industries are similarly structured for commercial reasons, the delivery-by-title-and-related-bill-of-lading-transfer delivery method would be able to rely on the Brent Interpretation if it otherwise satisfied the terms thereof. However, to the extent persons seek to establish such a delivery structure for new products and markets (e.g., not actually delivering the commodity to most of the participants in a chain), that could, depending on the applicable facts and circumstances, be viewed as outside the Brent Interpretation safe harbor or evasion. The CFTC
expects that the limitation of counterparties eligible to rely on the Brent Interpretation to those with a commercial purpose for entering into the transaction should limit the development of such markets to those with commercial reasons for such a delivery structure. 237See Letter from R. Michael Sweeney, Jr., Hunton & Williams LLP, on behalf of the Working Group of Commercial Energy Firms (‘‘WGCEF’’), dated July 22, 2011 (‘‘WGCEF Letter’’). 238See Proposing Release at 29831, Request for Comment 27. 239Most commenters opposed adding a minimum contract size or other conditions to the CFTC’s interpretation of the forward exclusion. One commenter argued that such an approach would be inconsistent with CFTC precedent, citing the fact that neither the Brent Interpretation nor subsequent CFTC precedent interpreting the forward exclusion mention contract size. See CME Letter. Another commenter pointed out that Congress did not impose such a requirement, and thus believes that the CFTC should not do so. See Letter from David M. Perlman, Partner, Bracewell & Giuliani LLP, Counsel to the Coalition of Physical Energy Companies (‘‘COPE’’), dated July 22, 2011 (‘‘COPE Letter’’). Similarly, a third commenter argued that the only condition Congress placed on the forward exclusion is intent to physically settle, and contract size is not relevant to such intent. See Letter from Natural Gas Supply Association/National Corn Growers Association (‘‘NGSA/NCGA’’), dated July 22, 2011 (‘‘NGSA/NCGA Letter’’). Two commenters questioned the reasonableness in instituting a minimum contract size below which a transaction would become regulated, but otherwise would not. See Letter from Craig G. Goodman, Esq., President, The National Energy Marketers Association (‘‘NEMA’’), dated July 21, 2011, (‘‘NEMA Letter’’) and Letter from Phillip G. Lookadoo on behalf of the International Energy expanded the Brent Interpretation to energy commodities other than oil, on the basis that the exemption was no longer necessary in light of the extension of the Brent Interpretation to nonfinancial commodities.228 The Energy Exemption, like the Brent Interpretation, requires binding delivery obligations at the outset, with no right to cash settle or offset transactions.229 Each requires that book-outs be undertaken pursuant to a subsequent, separately negotiated agreement. As discussed above, the CFTC is extending the Brent Interpretation to the swap definition and applying it to all nonfinancial commodities for both the swap and future delivery definitions, but is withdrawing the Energy Exemption. With regard to netting agreements that were expressly permitted by the Energy Exemption,230 the CFTC clarifies that a physical netting agreement (such as, for example, the Edison Electric Institute Master Power Purchase and Sale Agreement) that contains a provision contemplating the reduction to a net delivery amount of future, unintentionally offsetting delivery obligations, is consistent with the
intent of the book out provision in the Brent Interpretation—provided that the parties had a bona fide intent, when entering into the transactions, to make or take delivery (as applicable) of the commodity covered by those transactions. The CFTC also has determined that, notwithstanding the withdrawal of the Energy Exemption, a failure to deliver as a result of the exercise by a party of a ‘‘bona fide termination right’’ does not render an otherwise binding delivery obligation as non-binding.231 In the Energy Exemption, the CFTC provided the following examples of bona fide termination rights: force majeure provisions and termination rights triggered by events of default, such as counterparty insolvency, default or other inability to perform.232 The CFTC confirms that market participants who otherwise qualify for the forward exclusion may continue to rely on the bona fide termination right concept as set forth in this interpretation, although, as was stated in the Energy Exemption, such right must be bona fide and not for the purpose of evasion. In this regard, the CFTC further clarifies, consistent with the Energy Exemption, that a bona fide termination right must be triggered by something not expected by the parties at the time the contract is entered into.233 The Energy Exemption also discussed a number of methods by which parties to energy contracts settle their obligations, including: The seller’s passage of title and the buyer’s payment and acceptance of the underlying commodity; taking delivery of the commodity in some instances and in others instead passing title to another intermediate purchaser in a chain; and physically exchanging (i.e., delivering) one quality, grade or type of physical commodity for another quality, grade or type of physical commodity.234 The CFTC clarifies that these settlement methods generally 235 are not inconsistent with the Brent Interpretation.236 (D) Book-Out Documentation The CFTC has taken into consideration comments regarding the documentation of book-outs.237 Under the Brent Interpretation, what is relevant is that the book out occur through a subsequent, separately negotiated agreement. While the CFTC is sensitive to existing recordkeeping practices for book-outs, in order to prevent abuse of the safe harbor, the CFTC clarifies that in the event of an oral agreement, such agreement must be followed in a commercially reasonable timeframe by a confirmation in some type of written or electronic form. (E) Minimum Contract Size and Other Contextual Factors In the Proposing Release, the CFTC requested comment about potentially imposing additional conditions (such as, for example, a minimum contract size) in order for a transaction to qualify as a forward contract under the Brent Interpretation with respect to the future delivery and swap definitions.238 The CFTC has determined that a minimum contract size should not be required in order for a contract to qualify as a forward contract under the Brent
Interpretation.239 However, as suggested

Credit Association (‘‘IECA’’), dated July 28, 2011 (‘‘IECA Letter’’). Two commenters believed that such an approach would be contrary to the purposes of Dodd-Frank in regulating transactions that would affect systemic risk. See NEMA Letter and Letter from Dan Gilligan and Michael Trunzo, Petroleum Marketers Association of America and New England Fuel Institute (‘‘PMAA/NEFI’’), dated July 22, 2011 (‘‘PMAA/NEFI Letter’’). One commenter urged that the Brent Interpretation be applied with minimal restrictive overlay. It believed that contract size is a ‘‘contextual factor’’ that may be considered in evaluating the existence of intent to deliver, but should not be viewed as an independent determinant. See ISDA Letter. One commenter argued that the forward exclusion should be strengthened with additional conditions to preclude evasion. Its suggested conditions include defining the required regularity of delivery (such as a predominance, or ‘‘more often than not’’ standard); providing a quantitative test of bona fide intent to deliver (such as a demonstrable commercial need for the product and justifying non-physical settlement based on a change in commercial circumstances); and re-evaluating the book-outs aspect of the Brent Interpretation. See Better Markets Letter. 240See ISDA Letter. 241See Letter from Lisa Yoho, Director, Regulatory Affairs, BGA, dated July 22, 2011) (‘‘BGA Letter’’); COPE Letter; Letter from Michael Bardee, General Counsel, Federal Energy Regulatory Commission (‘‘FERC’’), dated July 22, 2011 (‘‘FERC Staff Letter’’); Letter from Stephanie Bird, Chief Financial Officer, Just Energy, dated July 22, 2011 (‘‘Just Energy Letter’’); Letter from the Electric Trade Associations (the Electric Power Supply Association, National Rural Electric Cooperative Association, Large Public Power Council, Edison Electric Institute and American Power Association) (‘‘ETA Letter’’), dated July 22, 2011. 242See ETA Letter (citing the ‘‘Lincoln-Dodd Letter’’ printed at 156 Cong. Rec. H5248–249). 243See ETA Letter. The commenter requests that the CFTC ‘‘further define the statutory term ‘swap’ by defining relevant terms in the Dodd-Frank Act, reconciling the wording used in the various provisions in the CEA as amended by the Dodd￾Frank Act, and setting forth in the [CFTC’s] rules the factors that are determinative in drawing the distinction between a ‘swap’ and a ‘nonfinancial commodity forward contract.’’’ The commenter suggests rule text to codify the CFTC’s interpretation regarding the exclusion of nonfinancial commodity forward contracts. Id. 244See FERC Staff Letter. 245See, e.g. Brent Interpretation, supra note 207; Energy Exemption, supra note 208; Characteristics Distinguishing Cash and Forward Contracts and ‘‘Trade’’ Options, 50 FR 39656 (Sep. 30, 1985) (‘‘1985 CFTC OGC Interpretation’’). 246See supra note 210 and accompanying text. 247See 156 Cong. Rec. H5248–49 (June 30, 2010). 248This is particularly true given that the CFTC intends to interpret
the forward exclusion from the swap definition consistently with its interpretation of the forward exclusion from the term ‘‘future delivery,’’ with which market participants have had decades of experience. 249See BGA Letter; COPE Letter; ISDA Letter; IECA Letter; Letter from Stuart J. Kaswell, Executive Vice President & Managing Director, Managed Funds Association (‘‘MFA’’), dated July 22, 2011 (‘‘MFA Letter’’); NGSA/NCGA Letter; Letter from Charles F. Conner, President and CEO, National Council of Farmer Cooperatives (‘‘NCFC’’), dated July 22, 2011 (‘‘NCFC Letter’’); NEMA Letter; PMAA/NEFI Letter; WGCEF Letter. 250See CME Letter. 251 Grain Land, supra note 213. 252Wright, supra note 214. by a commenter, the CFTC may consider contract size as a contextual factor in determining whether a particular contract is a forward.240 Moreover, the CFTC may consider other contextual factors when determining whether a contract qualifies as a forward, such as a demonstrable commercial need for the product, the underlying purpose of the contract (e.g. whether the purpose of the claimed forward was to sell physical commodities, hedge risk, or speculate), the regular practices of the commercial entity with respect to its general commercial business and its forward and swap transactions more specifically, or whether the absence of physical settlement is based on a change in commercial circumstances. These contextual factors are consistent with the CFTC’s historical facts-and￾circumstances approach to the forward contract exclusion outside of the Brent Interpretation safe harbor. Comments Several commenters believed that the CFTC should codify its proposed interpretation regarding the Brent Interpretation in rule text to provide greater legal certainty.241 One commenter further commented that the Dodd-Frank Act’s legislative history expressly directed the CFTC to clarify through rulemaking that the nonfinancial commodity forward contract exclusion from the swap definition is intended to be consistent with the forward contract exclusion from the term ‘‘future delivery.’’242 The commenter also stated its view that the interpretation as proposed does not provide notice to the electricity industry as to how to determine whether a nonfinancial commodity agreement is a swap or a nonfinancial commodity forward contract, nor as to which factors the CFTC would consider in distinguishing between swaps and nonfinancial forward contracts.243 Moreover, another commenter suggested that the CFTC should include in regulatory text a representative, non￾exhaustive list of the kinds of contracts that are excluded from the swap definition.244 The CFTC has determined not to codify its interpretation in rule text. The CFTC has never codified its prior interpretations of the forward contract exclusion with respect to the future delivery definition as a rule or regulation;245 thus, providing an interpretation is consistent with the manner in which the CFTC has interpreted the forward
exclusion in the past, which in turn is consistent with the Dodd-Frank Act legislative history.246 Moreover, Congress did not direct the CFTC to write rules regarding the forward exclusion. The Dodd￾Lincoln letter, cited by a commenter in support of its argument, ‘‘encourages’’ the CFTC to clarify the forward exclusion ‘‘through rulemaking’’ in the generic sense of that term (i.e., through the rulemaking process of notice and comment), not specifically through rule text.247 Similarly, the CFTC is not providing in rule text a representative list of contracts in nonfinancial commodities that are excluded from the swap definition as forwards. The CFTC believes that its interpretation provides sufficient clarity with respect to the forward contract exclusion from the swap and future delivery definitions.248 The CFTC also believes that the interpretation provides sufficient notice to the public regarding how the forward exclusions from the swap and future delivery definitions will be interpreted. As noted above, the CFTC’s historical approach to the forward contract exclusion from the future delivery definition developed on a case-by-case basis, not by rule. Commenters generally supported applying the Brent Interpretation to the forward exclusion from the swap definition and expanding it to all nonfinancial commodities for purposes of the forward exclusion from both the definitions of the terms ‘‘future delivery’’ and ‘‘swap.’’ 249 However, in addition to the requests for clarification to which the CFTC has responded in its final interpretation provided above, commenters raise other requests for clarification. One commenter,250 for example, believed that the CFTC’s adjudicatory decisions in Grain Land 251 and Wright 252 should be construed to have expanded the Brent Interpretation’s safe harbor. This commenter stated its view that in Grain Land, the CFTC recognized that cancellation provisions or an option to roll the delivery date within flexible hedge-to-arrive contracts did not render the transactions futures contracts, as opposed to forwards. As such, this commenter believed this case may be at odds with the literal terms of the Brent Interpretation regarding book-outs, which required that, to be a forward contract, any cancellation of delivery must be effected through a subsequent, separately negotiated agreement. The commenter argued that cases subsequent to the Brent Interpretation, such as Grain Land and Wright, recognized the need for flexibility and innovation in the commercial merchandising transactions that are eligible for the forward exclusion. Therefore, this commenter requested that the CFTC consider the body of

253See CME Letter.
254As described above in the interpretation, the CFTC has addressed CME’s other comments on the forward exclusion, including the interpretation’s applicability to commercial market participants and CME’s hedge fund example. 255See COPE Letter Appendix. 256See IECA Letter. 257See MFA Letter. 258Ex Parte Communication between MFA and CFTC Staff on September 15, 2011, at http:// comments.cftc.gov/PublicComments/ViewExParte. aspx?id=387&SearchText= . 259See ISDA Letter. 260See, e.g., In re Bybee, 945 F.2d 309, 315 (9th Cir. 1991). 261See WGCEF Letter. 262The Commissions requested comment in the Proposing Release on whether they should provide guidance regarding the scope of the term ‘‘nonfinancial commodity’’ and, if so, how and where the line should be drawn between financial and nonfinancial commodities. See Proposing Release at 29832. 263As noted above, the CEA definition of the term ‘‘swap’’ excludes ‘‘any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled.’’ CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii). Thus, the forward exclusion from the swap definition is limited to transactions in nonfinancial commodities. To the extent the CFTC uses the term ‘‘nonfinancial commodity’’ in other contexts in this release, such as in connection with the Brent Interpretation (including as it applies with respect to the ‘‘future delivery’’ definition), the term will have the same meaning as discussed in this section in those contexts. 264The CEA defines an ‘‘exempt commodity’’ as ‘‘a commodity that is not an excluded commodity or an agricultural commodity.’’ CEA section 1a(20), 7 U.S.C. 1a(20). A security is an excluded commodity as discussed below, and therefore is not an exempt commodity. 265The CFTC has defined the term ‘‘agricultural commodity’’ in its regulations at Rule 1.3(zz) under the CEA, 17 CFR 1.3(zz). See Agricultural Commodity Definition, 76 FR 41048 (Jul. 13, 2011). 266The CEA defines an ‘‘excluded commodity’’ at CEA section 1a(19), 7 U.S.C. 1a(19). forward contract precedent as a whole and extend the Brent Interpretation’s safe harbor to situations like those presented in Grain Land, notwithstanding the absence of a subsequent, separately-negotiated agreement.253 While, as noted above, the CFTC has clarified that the entire body of its precedent applies to its interpretation of the forward exclusion for nonfinancial commodities in the swap definition, the CFTC does not believe that there is a conflict between the Brent Interpretation and the Grain Land or Wright cases. In Grain Land, the CFTC concluded that the fact that a contract includes a termination right, standing alone, is not determinative of whether the contract is a forward. Rather, as the CFTC has always interpreted the forward exclusion, it looks to the facts and circumstances of the transaction. Similarly in Wright, which cited Grain Land with approval, the CFTC stated that ‘‘[i]n
assessing the parties’ expectations or intent regarding delivery, the Commission applies a ‘facts and circumstances’ test rather than a bright-line test focused on the contract’s terms * * * .’’ In contrast, the Brent Interpretation is a safe harbor that assures commercial parties that book￾out their contracts through a subsequent, separately negotiated agreement that their contracts will not fall out of the forward exclusion. The CFTC’s conclusion that application of its facts-and-circumstances approach demonstrated that the particular contracts at issue in Grain Land and Wright were forwards did not expand the scope of the safe harbor afforded by the Brent Interpretation.254 Several commenters suggested that the Energy Exemption should not be withdrawn. One commenter noted that the Energy Exemption, along with the Brent Interpretation, should inform the CFTC’s interpretation of the forward exclusion.255 Another commenter believed that the Energy Exemption appears entirely consistent with the Dodd-Frank Act and should be included in the rules as a non-exclusive exemption to ensure continued clarity.256 A third commenter requested clarification that revoking the Energy Exemption will not harm market participants, stating that the Proposing Release did not sufficiently explain the rationale for withdrawing the Energy Exemption or the possible consequences for energy market participants. This commenter sought confirmation that, despite the withdrawal of the Energy Exemption, market participants will be permitted to rely on the Brent Interpretation, as expanded by the Energy Exemption, particularly as it relates to alternative delivery procedures.257 This commenter expressed concern that by withdrawing the Energy Exemption, the CFTC would be revoking the ability of market participants to rely on pre-transaction netting agreements to offset physical delivery obligations as an alternative to separately negotiating book-outs after entering into the transactions.258 As discussed above, the CFTC has determined to withdraw the Energy Exemption as proposed, but has provided certain clarifications to address commenters’ concerns. One commenter suggested the deletion of ‘‘commercial merchandising transaction’’ as a descriptive term in the interpretation. Although recognizing its provenance from the Brent Interpretation, this commenter believed that the phrase was anachronistic at that time, and that it is misleading and narrow in the current evolving commercial environment.259 Contrary to this commenter’s suggestion, the CFTC has determined to retain the phrase ‘‘commercial merchandising transaction’’ in its final interpretation regarding forward contracts. The CFTC characterized forward transactions in this manner in the Brent Interpretation, as well as in its subsequent adjudications. Courts also have characterized forwards as commercial merchandising transactions or cited the CFTC’s characterization with approval.260 Accordingly, the CFTC believes that
‘‘commercial merchandising transaction’’ continues to be an accurate descriptive term for characterizing forward transactions. Another commenter requested that the CFTC clarify that a subsequent, separately-negotiated agreement to effectuate a book-out under the Brent Interpretation may be oral or written. This commenter noted that the pace at which certain energy markets transact and the frequency with which book-outs may sometimes occur, makes formal written documentation of all book-outs impracticable.261 The CFTC has provided an interpretation above regarding the documentation of book￾outs in response to this commenter’s concerns. (ii) Nonfinancial Commodities In response to commenters,262 the CFTC is providing an interpretation regarding the scope of the term ‘‘nonfinancial commodity’’ in the forward exclusion from the swap definition.263 The CFTC interprets the term ‘‘nonfinancial commodity’’ to mean a commodity that can be physically delivered and that is an exempt commodity 264 or an agricultural commodity.265 Unlike excluded commodities, which generally are financial,266 exempt and agricultural commodities by their nature generally are nonfinancial. The requirement that the commodity be able to be physically delivered is designed to prevent market participants from relying on the forward exclusion to enter into swaps based on indexes of exempt or agricultural commodities outside of the Dodd-Frank Act and settling them in cash, which would be inconsistent with the historical limitation of the forward exclusion to commercial merchandising transactions. However, to the extent that a transaction is intended to be physically settled, otherwise meets the terms of the forward contract exclusion and uses an index merely to determine the price to be paid for the nonfinancial commodity intended to be delivered,

267See supra part II.B.2.a)iii), regarding environmental commodities. An emission allowance buyer also can consume the allowance by retiring it without emitting the permitted amount of pollutant. 268See Letter from Steven J. Mickelsen, Counsel, 3Degrees Group, Inc., dated July 22, 2011 (‘‘3Degrees Letter’’); ETA Letter; and Letter from Kari S. Larsen, General Counsel, Chief Regulatory Officer, Green Exchange LLC, dated July 22, 2011 (‘‘GreenX Letter’’). Each of these commenters proposed its own definition of ‘‘nonfinancial commodity.’’ The interpretation above incorporates many of their suggestions. 269See ETA Letter. This is consistent with CFTC practice in providing an interpretation rather than regulations where warranted. In this context, the CFTC is providing an interpretation rather than rule text because the CFTC is not limiting the definition of ‘‘nonfinancial commodity’’ to exempt and agricultural commodities (the latter category includes agricultural commodity indexes (see 17 CFR 1.3(zz)(4))). The definition also requires physical deliverability and, with respect to intangible commodities, ownership transferability and consumability. Whether a commodity has these features may require interpretation. In any case, courts can rely on agency interpretations. 270See Proposing Release at 29832, Request for Comment 32, asked: Should the forward contract exclusion from the swap definition apply to environmental commodities such as emissions allowances, carbon offsets/credits, or renewable energy certificates? If so, please describe these commodities, and explain how transactions can be physically settled where the commodity lacks a physical existence (or lacks a physical existence other than on paper)? Would application of the forward contract exclusion to such environmental commodities permit transactions that should be subject to the swap regulatory regime to fall outside the Dodd-Frank Act? 271Because the CFTC has determined, as discussed elsewhere in this release, to interpret the forward exclusion from the swap definition consistently with the forward exclusion from the ‘‘future delivery’’ definition, the discussion in this
section applies equally to the forward exclusion
from future delivery.
272See also Letter from Gene Grace, Senior Counsel, American Wind Energy Association (‘‘AWEA’’), dated July 22, 2011 (‘‘AWEA Letter’’) (providing a general description of renewable energy credits (‘‘RECs’’), emission allowances, and offsets, which the commenter collectively termed ‘‘environmental commodities’’ for purposes of its letter). 273Thus, market participants should apply the interpretation to their facts to determine whether their specific circumstances support reliance on the forward exclusion from the swap definition. 274Several commenters appear to have confused these concepts. The term ‘‘commodity’’ is defined in CEA section 1a(9), 7 U.S.C. 1a(9). The forward exclusion in CEA section 1a(47)(B)(ii), 7 U.S.C. 1a(47)(B)(ii), excludes from the swap definition ‘‘any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled.’’ 275See supra part II.B.2.a)i)(A). 276 7 U.S.C. 1a(47)(B)(ii). 277As commenters also note, each Commission or its staff has previously indicated that environmental commodities, in the CFTC’s case, and securities, in the SEC’s case, can be physically settled. See Letter from Kyle Danish, Van Ness Feldman, P.C., on behalf of Coalition for Emission Reduction Policy (‘‘CERP’’), dated July 18, 2011 (‘‘CERP Letter’’) and 3Degrees Letter. Also, the recent Carbon Report suggested that the forward exclusion could apply to agreements, contracts or transactions in environmental commodities. See Interagency Working Group for the Study on Oversight of Carbon Markets (‘‘Interagency Working Group’’), Report on the Oversight of Existing and Prospective Carbon Markets (January 2011) (‘‘Carbon Report’’). The Carbon Report specifically stated that—[n]o set of laws currently exist that apply a comprehensive regulatory regime—such as that which exists for derivatives—specifically to secondary market trading of carbon allowances and offsets. Thus, for the most part, absent specific action by Congress, a secondary market for carbon allowances and offsets may operate outside the routine oversight of any market regulator. 278One commenter maintains that a transaction in an environmental allowance represents a physically-settled transaction because its primary purpose is to transfer ownership of the right to emit a specified unit of pollution. See Letter from Andrew K. Soto, American Gas Association (‘‘AGA’’), dated July 22, 2011 (‘‘AGA Letter’’). Compare to Proposing Release at 29828 (stating that ‘‘[t]he primary purpose of the contract is to transfer ownership of the commodity’’). 279Another commenter states that, from a practical standpoint, the buyer must take delivery to satisfy a compliance obligation, which typically requires surrender of allowances and offset credits, and likens such transactions to forward sales of more tangible commodities, noting they are not devices for transferring price risk. See CERP Letter. Continued the transaction may
qualify for the forward exclusion from the swap definition. In addition, the CFTC is providing an interpretation that an intangible commodity (that is not an excluded commodity) which can be physically delivered qualifies as a nonfinancial commodity if ownership of the commodity can be conveyed in some manner and the commodity can be consumed. One example of an intangible nonfinancial commodity that qualifies under this interpretation, as discussed in greater detail below, is an environmental commodity, such as an emission allowance, that can be physically delivered and consumed (e.g., by emitting the amount of pollutant specified in the allowance).267 The interpretation provided herein recognizes that transactions in intangible commodities can, in appropriate circumstances, qualify as forwards, while setting forth certain conditions to assure that the forward exclusion may not be abused with respect to intangible commodities. Comments Several commenters believed that the CFTC should provide an interpretation regarding the meaning of the term ‘‘nonfinancial commodity’’ to provide clarity to market participants on the applicability of the forward exclusion.268 The CFTC is providing the interpretation discussed above to address these commenters’ concerns but, contrary to one commenter’s request, declines to adopt a regulation.269 (iii) Environmental Commodities The Commissions requested comment on whether environmental commodities should fall within the forward exclusion from the swap definition and, if so, subject to what parameters.270 In response to commenters, the CFTC is providing an interpretation regarding the circumstances under which agreements, contracts or transactions in environmental commodities will satisfy the forward exclusion from the swap definition.271 The CFTC did not propose a definition of the term ‘‘environmental commodity’’ in the Proposing Release and is not doing so in this release.272 The CFTC believes it is not necessary to define the term ‘‘environmental commodity’’ because any intangible commodity—environmental or otherwise—that satisfies the terms of the interpretation provided herein is a nonfinancial commodity, and thus an agreement, contract or transaction in such a commodity is eligible for the forward exclusion from the swap definition.273 The forward exclusion from the swap definition does not apply to commodities themselves, but to certain types of agreements, contracts or transactions in a specified type of commodity (i.e., a ‘‘nonfinancial’’ commodity).274 Environmental commodities that meet the interpretation regarding nonfinancial commodities discussed in subsection (ii) above are nonfinancial commodities and, therefore, a sale for deferred shipment or delivery in such a commodity, so long as the transaction is intended to be physically settled, may qualify for the forward exclusion from the swap definition. The intangible nature of environmental, or other, commodities does not disqualify contracts based on
such commodities from the forward exclusion from the swap definition, notwithstanding that the core of the forward exclusion is intent to deliver the underlying commodity.275 As commenters noted, securities are intangible (with the exception of the rare certificated security) and yet they are expressly permitted by CEA section 1a(47)(B)(ii) 276 to be the subject of the forward exclusion; this reflects recognition by Congress that the forward exclusion can apply to intangible commodities.277 The CFTC understands that market participants often engage in environmental commodity transactions in order to transfer ownership 278 of the environmental commodity (and not solely price risk),279 so that the buyer

Compare to Proposing Release at 29828 (stating that ‘‘[t]he primary purpose of the contract is * * * not to transfer solely * * * price risk’’). This commenter also advises that delivery of RECs and offsets is typically deferred for commercial convenience, consistent with the Brent Interpretation, because ‘‘not all of the purchased RECs and offsets are generated at the time of the transaction’’ and ‘‘long-term contracts with deferred delivery are important for renewable energy projects to ensure a consistent revenue stream over a long period of time.’’ See CERP Letter. 280Consumption also can be part of a commercial merchandising transaction in the chain of commerce. See, e.g., Brent Interpretation, supra note 207 (dissent of Commissioner Fowler West) (citing the 1985 CFTC OGC Interpretation and cases cited therein for the proposition that ‘‘parties to forward contracts * * * seek to profit in their businesses from producing, processing, distributing, storing, or consuming the commodity’’). 281Similarly, the settlement method for the types of environmental commodity transactions described by commenters such as RECs, emission allowances, and offsets are equivalent to that of physical commodities where ownership is transferred by delivering a warehouse receipt from the seller to the buyer, thereby indicating the presence in the warehouse of the contracted for commodity volume. See GreenXLetter. See also REMA letter (averring that ‘‘[i]n effect, the REC is an intangible contract right or interest in that specific quantity of energy; thus, it is quite analogous to a warehouse receipt that represents title to a physical commodity’’). Another similarity between these environmental commodity transactions and tangible commodities is that it is possible to manipulate the deliverable supply of an environmental commodity just as it is for a tangible commodity. The CFTC reminds market participants of its continuing authority over forwards under the CEA’s anti-manipulation provisions prohibiting manipulation, making false and misleading statements and omissions of material fact to the CFTC, fraud and deceptive practices, and false reporting. See supra note 226. 282See Letter from Jennifer Martin, Executive Director, Center for Research Solutions (‘‘CRS’’), dated July 22, 2011 (‘‘CRS Letter’’). 283See 3Degrees Letter. 284See GreenX Letter. 285One commenter provided a general description of renewable energy credits (‘‘RECs’’), emission allowances, offsets, (which the commenter collectively termed ‘‘environmental commodities’’ for purposes of its letter), and related transactions. See AWEA Letter. According to the commenter, RECs are created by state regulatory bodies in conjunction with the production of electricity from a qualifying renewable energy facility. The forward sale of a REC transfers ownership of the REC from the producing entity to another entity that can use the REC for compliance with an obligation to sell a certain percentage of renewable
energy. Many times, this forward sale takes place prior to the construction of a project to enable developers to secure related project financing. See AWEA Letter. See also Letter from Mary Anne Mason, HoganLovells LLP on behalf of Southern California Edison Company, Pacific Gas and Electric Company and San Diego Gas and Electric Company (‘‘California Utilities’’), dated July 22, 2011 (‘‘California Utilities Letter’’) (stating that the California Utilities transact in allowances, under the EPA’s and anticipated California cap-and-trade programs, as well as in RECs, in order to comply with or participate in various regulatory and voluntary programs). The CFTC understands that, in the United States, emission allowances and offsets are issued by the U.S. Environmental Protection Agency (‘‘EPA’’), state government entities and private entities. Emission allowances and offsets are transferred between counterparties, often through forward contracts, with the purchasing party obtaining the ability to use the allowances or offsets for compliance with clean air or greenhouse gas regulations. The forward sale of allowances and offsets allows market participants to hedge the compliance obligations associated with expected emissions, or to meet a voluntary emissions reduction commitment or make an environmental claim. See, e.g., AWEA Letter; Letter from Henry Derwent, President and CEO, International Emissions Trading Association, dated July 22, 2011 (defining a carbon offset as a ‘‘credit[] granted by a state or regional governmental body or an independent standards organization in an amount equal to the generation of electricity from a qualifying renewable energy facility.’’). 286See 3Degrees Letter. See also WGCEF Letter (advising that ‘‘physical delivery takes place the moment that title and ownership in the environmental commodity itself is transferred from the seller to the buyer[,] whether through the execution of a legally binding contract or attestation, or submission of records to a centralized data base, such as a registry’’); Letter from the Hons. Jeffrey A. Merkley, Sherrod Brown and Jeanne Shaheen, U.S. Senators, dated January 13, 2012 (‘‘Senators Letter’’) (relaying that ‘‘[t]he purchase or sale of a REC is settled through the transfer of title to the REC, either electronically over a tracking system or via a paper attestation’’); Letter from Harold Buchanan, Chief Executive Officer, CE2 Carbon Capital, LLC (‘‘CE2’’), dated July 22, 2011 (‘‘CE2 Letter’’); Letter from Jason M. Rosenstock, ML Strategies LLC on behalf of The Business Council for Sustainable Energy (‘‘BCSE’’), dated January 24, 2012 (‘‘BCSE Letter’’); NEMA Letter (stating that RECs must be physically settled through a REC registry, which ‘‘ensures that there is a physical megawatt hour from a green generator behind the REC’’). 287See 3Degrees Letter. See also GreenX Letter (stating that environmental commodities share the same characteristics as tangible physical commodities ‘‘in
all key respects,’’ including that they are in limited supply). 288See CRS Letter. CRS explains that retirement occurs through a registry or electronic tracking system by transfer into a retirement account (or, alternatively, an exchange of paperwork) and that, once retired, an environmental commodity cannot be resold. The CRS also argues that such environmental commodity transactions are commercial merchandising transactions, and thus may be forward contracts, because the primary purpose of the transactions is to transfer ownership so that the purchaser may comply with an applicable environmental program. See also 3Degrees Letter and AWEA Letter. 289See Letter from Josh Lieberman, General Manager, Renewable Energy Markets Association (‘‘REMA’’), dated July 22, 2011 (‘‘REMA Letter’’) (distinguishing RECs, which allow the buyer to own environmental attributes, from a pure financial swap, where only price risk is transferred); See also GreenX Letter (likening the settlement of an environmental commodity transaction (where delivery typically would take place by electronic delivery from the registry account of the seller to the registry account of the buyer) to that of transactions in many tangible physical commodities, such as agricultural commodities and metals, where settlement is evidenced by an can consume the commodity in order to comply with the terms of mandatory or voluntary environmental programs.280 Those two features—ownership transfer and consumption—distinguish such environmental commodity transactions from other types of intangible commodity transactions that cannot be delivered, such as temperatures and interest rates. The ownership transfer and consumption features render such environmental commodity transactions similar to tangible commodity transactions that clearly can be delivered, such as wheat and gold.281 For such transactions, in addition to the factors discussed above, intent to deliver is readily determinable,282 delivery failures generally result from frustration of the parties’ intentions,283 and cash-settlement is insufficient because delivery of the commodity is necessary for compliance purposes.284 For the foregoing reasons, environmental commodities can be nonfinancial commodities that can be delivered through electronic settlement or contractual attestation. Therefore, an agreement, contract or transaction in an environmental commodity may qualify for the forward exclusion from the swap definition if the transaction is intended to be physically settled. Comments Several commenters responded to the Commission’s request for comment regarding the applicability of the forward exclusion from the swap definition for agreements, contracts and transactions in environmental commodities.285 Most commenters responding to the Commissions’ request for comment concerning the appropriate treatment of agreements, contracts or transactions in environmental commodities asserted that emission allowances, carbon offsets/credits, or RECs
should be able to qualify for the forward exclusion from the swap definition. In support of this view, several commenters explained that the settlement process for environmental commodity transactions generally involves ‘‘the transfer of title via a tracking system, registry or contractual attestation, in exchange for a cash payment.’’ 286 One commenter stated that this form of settlement demonstrates that the lack of physical existence of a commodity is not relevant to whether a transaction in the commodity physically settles for purposes of the forward exclusion.287 Another commenter contended that title transfer constitutes physical delivery because the settlement results in the environmental commodity being consumed to meet an environmental obligation or goal, which occurs through ‘‘retirement’’ of the environmental commodity.288 Other commenters compared the settlement of a transaction in an environmental commodity through an electronic registry system to a warehouse receipt that represents title to a physical commodity.289

electronic transfer of a warehouse receipt in the records of the warehouse and the underlying commodity does not move—it remains in the warehouse or vault—but its ownership changes)). 290See CRS Letter. See also CERP Letter (claiming that Congress did not intend for the phrase ‘‘physically settled’’ in the forward exclusion to be limited to tangible commodities because, like environmental commodities, securities only exist ‘‘on paper.’’). See also AWEA Letter. 291See CRS Letter (‘‘unlike a stock or a bond, which can be resold for its cash value, purchasers of environmental commodities intend to take delivery of RECs or carbon offsets for either compliance purposes or in order to make an environmental claim regarding their renewable energy use or carbon footprint.’’). See also GreenX Letter. 292Such a provision would preclude reliance on the forward exclusion. 293See 3Degrees Letter. 294See Adaptation of Regulations to Incorporate Swaps, 76 FR 33066, June 7, 2011. 295See California Utilities Letter. 296See Letter from Michelle Chan, Director, Economic Policy Programs, Friends of the Earth, dated July 22, 2011. 297While the commenter contended that ‘‘the intangible nature of carbon makes it much easier for speculators or those simply seeking to hedge carbon price risk to take delivery of the carbon itself rather than enter into a derivatives transaction,’’ as the CFTC states in section VII.A.2.c), infra, deciding to enter into a forward transaction rather than a swap does not constitute evasion. Thus, if the transaction in question is a forward contract, that is the end of the analysis, absent the presence of other factors that may indicate evasion. See AWEA Letter. 298See Letter from Katherine Gensler, Director, Regulatory Affairs, SEIA, dated August 5, 2011 (‘‘SEIA Letter’’). 299See Proposing Release at 29832 n.104. 300However, in section II.B.3., infra, the Commissions provide an interpretation regarding the applicability of the swap definition to consumer transactions. 301See Letter from Lauren Newberry, Jeffrey C. Fort, Jeremy D. Weinstein, and Christopher B. Berendt, Environmental Markets Association, dated July 21, 2011. 302See AGA Letter. 303 Id. This commenter noted that gas utilities often can receive gas at more than one interconnection or delivery point on a pipeline. 304 Id. 305 Id. A few commenters also analogized environmental commodities to securities, which (with the exception of certificated securities) are intangible. Some commenters, for example, asserted that the language of the forward exclusion from the swap definition means that non-physical items can be physically settled because the exclusion, which references securities, ‘‘implies that securities—which lack a strict physical existence—may be physically settled.’’ 290 Some commenters assured the Commissions that applying the forward exclusion to transactions in environmental commodities would not permit transactions that should be subject to the swap regulatory regime to
fall outside it. One commenter submitted that intent to deliver with respect to environmental commodities will be readily determinable.291 Another commenter contended that:
environmental commodity contracts almost universally require delivery and that failure to do so is an event of default; to the best of its knowledge, it is rare for such a contract to include the right to unilaterally terminate an agreement under a pre-arranged contractual provision permitting financial settlement; 292 and defaults generally are the result of something frustrating parties’ intentions.293 Still other commenters distinguished environmental commodities from other intangible commodities, such as the nonfinancial commodities (such as interest rates and temperatures) that the CFTC referred to in its Adaptation Notice of Proposed Rulemaking,294 because RECs and emissions allowances or offsets can be physically transferred from one account to another, whereas ‘‘it is not possible to move and physically transfer an interest rate or a temperature reading.’’ 295 As discussed above, the CFTC has addressed the foregoing concerns of commenters by providing an interpretation that agreements, contracts and transactions in environmental commodities may qualify for the forward exclusion from the swap definition. One commenter stated its view that the forward exclusion from the swap definition should not be available for carbon transactions because they should be standardized and conducted on open, transparent and regulated exchanges.296 This commenter acknowledged the possibility that carbon transactions can be physically settled (as the statute requires of excluded forward contracts) but argued that, in light of the fact that there is no cost associated with making or taking delivery of carbon, there is no cost to store it, and there is no delay in delivering it, a forward exclusion for carbon transactions may allow financial speculators to escape regulation otherwise required by the Dodd-Frank Act. The CFTC believes that if a transaction satisfies the terms of the statutory exclusion, the CFTC lacks the authority to deprive the transaction of the exclusion, absent evasion.297 One commenter stated that ‘‘[i]n the solar industry, RECs are often traded by an individual consumer as an assignment of a right owned by that consumer.’’ 298 This commenter also advised that many individual consumers transact forward contracts through solar REC (‘‘SREC’’) aggregators at a fixed price. The CFTC notes 299 that a transaction entered into by a consumer cannot be a forward transaction, and accordingly should not be the subject of an interpretation of the forward exclusion.300 One commenter takes the position that, because EPA emission allowances are issued in transactions with the EPA, only resales of such allowances (secondary market transactions) could be swaps because the EPA’s initial issuance of allowances would be excluded from the swap definition under CEA section 1a(47)(B)(ix).301 The CFTC declines to address the commenter’s legal conclusion regarding the application of CEA section 1a(47)(B)(ix), but agrees that an emission allowance created by the EPA
is a nonfinancial commodity and that agreements, contracts and transactions in such allowances may fall within the forward exclusion from the swap definition. (iv) Physical Exchange Transactions The Commissions received a comment letter seeking clarification that physical exchange transactions are forward contracts excluded from the swap definition.302 As described by the commenter, physical exchange transactions involve ‘‘a gas utility entering into a transaction with another gas utility or other market participant to take delivery of natural gas at one delivery point in exchange for the same quantity of gas to be delivered at an alternative delivery point * * * for the primary purpose of transferring ownership of the physical commodity in order to rationalize the delivery of physical supplies to where they are needed’’ at a price ‘‘generally reflecting the difference in value at the delivery points.’’ 303 This commenter stated that ‘‘exchange transactions create binding obligations on each party to make and take delivery of physical commodities [, i]n essence constituting paired forward contracts that are intended to go to physical delivery.’’ 304 The commenter added that, to the extent an exchange transaction payment is based on an index price, such pricing is not severable from the physical exchange.305 The CFTC interprets the exchange transactions described by the commenter, to the extent they are for deferred delivery, as examples of transactions in nonfinancial commodities that are within the forward exclusion from the definition of the terms ‘‘swap’’ and ‘‘future delivery.’’ Based on the information supplied by the commenter, they are commercial merchandising transactions, the primary purpose of which is to transfer

306However, if such payment stems from an embedded option, the interpretation set forth in the embedded option section of this release, see infra
part II.B.2(b)(v), also would be relevant to
determining whether an exchange transaction were covered by the forward exclusion from the swap definition. 307While the commenter also states that ‘‘[g]as utilities contract with interstate pipelines for capacity rights to have their gas supplies delivered to specific delivery points,’’ its discussion of exchange transactions appears unrelated to such capacity rights. Therefore, the CFTC’s guidance on exchange transactions does not address exchange transactions with capacity elements, which, depending on their structures, may be covered by the guidance set forth in the embedded option
section of this release or by the CFTC’s recent
Commodity Options release. See infra note 317. Conversely, that parties to an exchange transaction separately enter into a capacity transaction with a pipeline operator to transport natural gas delivered via an exchange transaction is not relevant to today’s guidance regarding exchange transactions. 308This interpretation is limited to the facts and circumstances described herein; the CFTC is not opining on different facts or circumstances, which could change the CFTC’s interpretation. 309See Proposing Release at 29831–29832, Request for Comment 30. 310See Letter from Peter Krenkel, President and CEO, NGX, dated Nov. 4, 2010, resubmitted by email to CFTC staff on Sept. 14, 2011 (‘‘NGX Letter’’). One other commenter addressed a related issue, asserting that the Commissions should clarify that cleared forwards between commercial participants should be permitted under the forward contract exclusion. See Ex Parte Communication among Evolution Markets Inc. (‘‘Evolution’’), Ogilvy Government Relations (‘‘Ogilvy’’) and CFTC staff on May 18, 2011 at http://comments.cftc.gov/Public Comments/ViewExParte.aspx?id=197& SearchText=. 311 Id. 312As used in this release, the term ‘‘commodity option’’ refers to an option that is subject to the CEA. 313See Proposing Release at 29829–30. 314 17 CFR Parts 32 and 33. 315See Commodity Options and Agricultural Swaps, 76 FR 6095 (Feb. 3, 2011) (proposed). 316 7 U.S.C. 6c(b). ownership of natural gas between two parties who intend to physically settle such transactions. That exchange transactions may involve, in addition to gas deliveries at two separate delivery points, a cash payment by one party to the other reflecting the difference in value of the gas at different delivery points, or that such payment may be based on an index, does not necessarily affect the nature of the transactions as forward transactions.306 For an exchange transaction to fall within the forward exclusion, though, the parties to the transaction must intend for the transaction to be physically settled, and the exchange transaction must satisfy all applicable interpretations set forth herein, including that relating to book￾outs.307 (v) Fuel Delivery Agreements The CFTC understands that fuel delivery agreements can generally be described as agreements whereby two or more parties agree to divide the cost of acquiring fuel for generation facilities based on some formula or factors, which can include, for example, their respective financial contributions to developing the source of the fuel (e.g., a natural gas field). One example of a fuel delivery agreement could involve a joint power agency providing to a municipal utility a long-term supply of natural gas from a natural gas project developed by the joint power agency and other entities to provide fuel for, among others, the joint power agency’s and the municipal utility’s natural gas￾fired electric generating facilities. The municipal utility would pay the joint power agency through direct capital
contributions to the entity formed to develop the natural gas project for the cost of developing it. In addition, the municipal utility would pay the joint power agency a monthly fee for the natural gas supplied from the natural gas project. The monthly fee would be composed of an operating cost fee component, an interstate pipeline transportation cost fee component and an operating reserve cost fee component. The municipal utility’s natural gas-fired electric generating facility would be used to supply a portion of its expected retail electric load. Such agreements are forward transactions if they otherwise meet the interpretation set forth in this release regarding the forward exclusions (e.g., no optionality other than as permitted by the interpretation). Monthly or other fees that are not in the nature of option premiums do not convert the transactions from forwards to options. Because the transactions as described above do not appear to exhibit optionality as to delivery, and no other aspect of the transactions as described above seem to exhibit optionality, the fees would not seem to resemble option premiums.308 (vi) Cleared/Exchange-Traded Forwards In the Proposing Release, the Commissions requested comment regarding whether forwards executed on trading platforms should fall within the forward exclusion from the swap definition and, if so, subject to what parameters.309 One commenter requested that the CFTC adopt a non￾exclusive safe harbor providing that exchange-traded contracts with respect to which more than 50 percent of contracts, on average on a rolling three￾month basis, go to delivery and where 100 percent of the counterparties are commercial counterparties, are neither futures nor swaps (‘‘50/100 Forward Safe Harbor’’).310 This commenter further requested that the CFTC provide an appropriate transition period once those thresholds are breached. This commenter contended that two hallmarks of the exchange-traded forward markets, which it characterized as ‘‘a relatively new development,’’ are that the participants generally are commercials and a high percentage of contracts go to delivery, notwithstanding netting of delivery obligations.311 This commenter added that, while parties to such contracts intend to go to delivery when they enter into them, their delivery needs may change as time passes. The CFTC declines to address this request for the 50/100 Forward Safe Harbor, which raises policy issues that are beyond the scope of this rulemaking. Should the CFTC consider the implications of the requested 50/100 Forward Safe Harbor, including possible additional conditions for relief, it would be appropriate for the CFTC to obtain further comment from the public on this discrete proposal. For the same reasons, the CFTC declines to address at this time the comment requesting that the CFTC take the view that cleared forwards between commercial participants fall within the scope of the forward contract exclusion. (b) Commodity Options and
Commodity Options Embedded in Forward Contracts (i) Commodity Options 312 The CFTC noted in the Proposing Release 313 that the statutory swap definition explicitly provides that commodity options are swaps, that it had proposed revisions to its existing options rules in parts 32 and 33 of its regulations 314 with respect to the treatment of commodity options under the Dodd-Frank Act, and that it had requested comment on those proposed revisions in that rulemaking proceeding.315 Accordingly, the CFTC did not propose an additional interpretation in the Proposing Release with respect to commodity options. The CFTC reaffirms that commodity options are swaps under the statutory swap definition, and is not providing an additional interpretation regarding commodity options in this release. The CFTC recently addressed commodity options in the context of a separate final rulemaking and interim final rulemaking, under its plenary options authority in CEA section 4c(b).316 There, the CFTC adopted a modified trade option exemption, and has invited

317See Commodity Options, 77 FR 25320 (Apr. 27, 2012). 318See Letter from Brian Knapp, Policy Advisor, American Petroleum Institute (‘‘API’’), dated January 31, 2012 (‘‘API Letter’’); BGA Letter; COPE Letter; ETA Letter; Just Energy Letter; NGSA/NCGA Letter; and WGCEF Letter. 319For example, one commenter asserted that, similar to a forward contract on a nonfinancial commodity, a commodity option conveys no ability for a party to unilaterally require a financial settlement. Reasoning that both commodity options and forward contracts on nonfinancial commodities are intended to settle by physical delivery, this commenter contended that they should have the same regulatory treatment. See COPE Letter. Similarly, another commenter argued that the forward exclusion ‘‘plainly covers’’ commodity options because they are: (i) Contracts for the sale of physical, nonfinancial commodities, (ii) for deferred delivery, and (iii) intended to be physically settled, given that purchasers have an absolute right to physical delivery and sellers have an absolute obligation to physically deliver the amounts called for by the purchasers if the option is exercised. See NGSA/NCGA Letter. A third commenter recommended that the CFTC interpret the forward exclusion ‘‘broadly’’ to include options that, if exercised, become forwards in nonfinancial commodities in light of the particular circumstances of the electricity industry, where electric companies use commodity options to efficiently meet the demands of electric customers by hedging or mitigating commercial risks due to seasonal and geographically unique weather and load patterns and fluctuations. See ETA letter. In the alternative, a fourth commenter requested that the CFTC exercise its plenary options authority under CEA section 4c(b), 7 U.S.C. 6c(b), to establish a separate regulatory regime for commodity options analogous to the trade option exemption under former CFTC Rule 32.4. See WGCEF Letter. See 17 CFR 32.4 (2011). 320See CEA section 1a(47)(A)(i), 7 U.S.C. 1a(47)(A)(i) (defining a swap as, among other things, ‘‘a put, call * * * or option of any kind

• • • for the purchase or sale * * * of * * *
      commodities’’) and CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B) (not excluding commodity options from the swap definition). 321See 1985 CFTC OGC Interpretation, supra note

245. In this regard, an option cannot be a forward
     under the CFTC’s precedent, because under the terms of the contract the optionee has the right, but not the obligation, to make or take delivery, while under a forward contract, both parties must have binding delivery obligations: one to make delivery and the other to take delivery. 322See supra part II.B.2(a)(i)(A). 323See supra note 317. 324See Proposing Release at 29830. 325See 1985 CFTC OGC Interpretation, supra note 245. 326Wright, supra note 214. 327See Proposing Release at 29830. 328Wright, supra note 214, at n.5. In Wright, the CFTC affirmed the Administrative Law Judge’s holding that an option embedded in a hedge-to￾arrive contract did not violate CFTC rules regarding the sale of agricultural trade options. The CFTC first concluded that the puts at issue operated to adjust the forward price and did not render the farmer’s overall obligation to make delivery optional. Then, turning to the next step of the analysis, the CFTC explained that ‘‘the put and [hedge-to-arrive contract] operated as a single contract, and in most cases were issued simultaneously * * *. We do not find that any put was severed from its forward or that either of [the put or the hedge-to-arrive contract] was traded separately from the other. We hold that in these circumstances, no freestanding option came into being * * *.’’ Id. at *7. 329See Proposing Release at 29830. 330Options in the plural would include, for example, a situation in which the embedded optionality involves option combinations, such as costless collars, that operate on the price term of the agreement, contract, or transaction. 331For example, a forward with an embedded option with a formulaic strike price based on an index value that may not be known until after exercise would be a forward if it meets the rest of the 3 components of this interpretation. Triggering an option to buy or sell one commodity based on the price of a different commodity reaching a specified level, such as in a cross-commodity transaction, does not constitute an adjustment to the forward contract price within the meaning of this 3-part interpretation. 332See Wright, supra note 214, at 6–7. 333This facts and circumstances approach to determining whether a particular embedded option Continued public comment on the interim final rules.317 Comments Several commenters in response to the Proposing Release argued that commodity options should not be regulated as swaps.318 In general, these commenters believed that commodity options should qualify for the forward exclusion from the swap definition, emphasizing similarities between commodity options and forward contracts on nonfinancial commodities.319 The CFTC is not providing an interpretation that commodity options qualify as forward contracts in nonfinancial commodities. Such an approach would be contrary to the plain language of the statutory swap definition, which explicitly provides that commodity options are swaps.320 This approach also would be a departure from the CFTC’s
     and its staff’s longstanding interpretation of the forward exclusion with respect to the term ‘‘future delivery,’’ 321 which the CFTC has determined above to apply to the forward exclusion from the swap definition as well.322 Further, the CFTC notes that it has recently issued final and interim final rules adopting a modified version of the CFTC’s existing trade option exemption.323 (ii) Commodity Options Embedded in Forward Contracts The CFTC is restating the interpretation regarding forwards with embedded options from the Proposing Release, but with certain modifications based on comments received. The CFTC is providing additional interpretations regarding forwards with embedded volumetric optionality, optionality in the form of evergreen and renewal provisions, and optionality with respect to delivery points and delivery dates. As was noted in the Proposing Release, the question of the application of the forward exclusion from the swap definition with respect to nonfinancial commodities, where commodity options are embedded in forward contracts (including embedded options to cash settle such contracts), is similar to that arising under the CEA’s existing forward contract exclusion from the definition of the term ‘‘future delivery.’’ 324 The CFTC’s Office of General Counsel addressed forward contracts that contained embedded options in the 1985 CFTC OGC Interpretation,325 which recently was adhered to by the CFTC in its adjudicatory Order in the Wright case.326 While both were issued prior to the effective date of the Dodd￾Frank Act, the CFTC believes that, as was stated in the Proposing Release, it is appropriate to apply this interpretation to the treatment of forward contracts in nonfinancial commodities that contain embedded options under the Dodd-Frank Act.327 In Wright, the CFTC stated that it traditionally has engaged in a two-step analysis of ‘‘embedded options’’ in which the first step focuses on whether the option operates on the price or the delivery term of the forward contract and the second step focuses on secondary trading.328 As was stated in the Proposing Release, these same principles can be applied with respect to the forward contract exclusion from the swap definition for nonfinancial commodities in the Dodd-Frank Act, too.329 Utilizing these principles, the CFTC is providing a final interpretation that a forward contract that contains an embedded commodity option or options 330 will be considered an excluded nonfinancial commodity forward contract (and not a swap) if the embedded option(s):
246. May be used to adjust the forward
     contract price,331 but do not undermine the overall nature of the contract as a forward contract;
247. Do not target the delivery term, so
     that the predominant feature of the contract is actual delivery; and
248. Cannot be severed and marketed
     separately from the overall forward contract in which they are embedded.332 In evaluating whether an agreement, contract, or transaction qualifies for the forward contract exclusions from the swap definition for nonfinancial commodities, the CFTC will look to the specific facts and circumstances of the transaction as a whole to evaluate whether any embedded optionality operates on the price or delivery term of the contract, and whether an embedded commodity option is marketed or traded separately from the underlying contract.333 Such an approach will help

takes a transaction out of the forward contract exclusion for nonfinancial commodities is consistent with the CFTC’s historical approach to determining whether a particular embedded option takes a transaction out of the forward contract exclusion from the definition of the term ‘‘future delivery’’ in the CEA. See id. at *5 (‘‘As we have held since Stovall, the nature of a contract involves a multi-factor analysis * * *.’’). 334The CFTC requested comment on, among other things: whether there are other factors that should be considered in determining how to characterize forward contracts with embedded options with respect to nonfinancial commodities; and whether there are provisions in forward contracts with respect to nonfinancial commodities, other than delivery and price, containing embedded optionality. See Proposing Release at 29832. 335One commenter characterized ‘‘volumetric optionality’’ as the optionality in a contract settling by physical delivery and used to meet varying customer demand for a commodity.’’ See WGCEF Letter. See also BGA Letter (stating that ‘‘it is commonplace for energy suppliers to enter into commercial transactions with customers (local distribution companies, electric utility companies, industrial, commercial and residential customers, power plants, etc.), which provide volumetric, price and delivery-related flexibility and variability’’). BGA claims that commercial transactions containing embedded volumetric optionality ‘‘include, but are not limited to, full requirements contracts, interruptible load agreements, capacity contracts, tolling agreements, energy management agreements, natural gas transportation contracts and natural gas storage contracts.’’ Id. 336See, e.g., WGCEF Letter (submitting that ‘‘‘volumetric optionality’ is [a] separate and distinct concept from ‘deliverability optionality’’’); BGA Letter; AGA Letter; Letter from Jeffrey Perryman, Director, Contracts and Compliance, Atmos Energy Holdings, Inc. (‘‘Atmos’’), dated July 22, 2011 (‘‘Atmos Letter’’); NGSA/NCGA Letter; Letter from Paul M. Architzel, Wilmer Hale LLP on behalf of ONEOK, Inc. (‘‘ONEOK’’), dated July 22, 2011 (‘‘ONEOK Letter’’); COPE Letter. 337When a forward contract includes an embedded option that is severable from the forward contract, the forward can remain subject to the forward contract exclusion, if the parties document the severance of the embedded option component and the resulting transactions, i.e. a forward and an option. Such an option would be subject to the CFTC’s regulations applicable to commodity options. 338See discussion in section II.B.2.(a)(i)(B), supra. 339See, e.g., BGA Letter (advising that ‘‘[v]ariability associated with an energy customer’s physical demand is influenced by factors outside the control of * * * energy suppliers (and sometimes * * * consumers) * * * including, but not limited to, load growth, weather and certain operational considerations (e.g., available transportation capacity to deliver
physical natural gas purchased on the spot market)’’). 340 Volumetric optionality in this category would include, for example, a supply contract entered into to satisfy a regulatory requirement that a supplier procure, or be able to provide upon demand, a specified volume of commodity (e.g., electricity). To the extent the optionality covers an amount of the commodity in excess of the regulatory requirement, such optionality would not necessarily be covered by this aspect of the guidance, though it may nevertheless be covered by the guidance if such excess volumetric optionality is based on physical factors within the meaning of the guidance. For example, the California Utilities explained that the California Public Utilities Commission (‘‘CPUC’’) requires them to file a supply plan with the CPUC demonstrating that they have procured sufficient capacity resources (including reserves) needed to serve their aggregate system load on a monthly and yearly basis. See California Utilities Letter. Each utility’s system requirement is 100 percent of its peak-hourly forecast load plus a 15–17 percent reserve margin. The California Utilities enter into resource adequacy agreements to procure electric power generating capacity to meet these requirements. The ability to call on the additional 15 to 17% reserve reflected in such an agreement is covered by the regulatory requirements part of this element. To the extent the California Utilities may have a business need to procure additional capacity resources beyond the foregoing regulatory requirement (e.g., because they wish to maintain a slightly larger reserve margin than required due to a recent upswing in unscheduled plant outages due to aging plants), that may be covered under the interpretation if the additional capacity is required due to physical factors beyond the control of the parties (i.e., the unscheduled outage, in the foregoing example). 341 In other words, the predominant basis for failing to exercise the option would be that the demand or supply (as applicable) that the optionality was intended to satisfy, if needed, never materialized, materialized at a level below that for which the parties contracted or changed due to physical factors or regulatory requirements outside the parties’ control. Such failure to exercise, or an exercise for a reduced amount of the underlying commodity, could, for example, be due to colder than expected weather during the summer decreasing demand for air conditioning, in turn decreasing demand for power to run the air conditioning. The Commission does not interpret this to mean that absolutely all factors involved in the decision to exercise an option must be beyond the parties’ control, but rather the decision must be predominantly driven by factors affecting supply and demand that are beyond a parties control. This also means that the forward contract with embedded volumetric optionality needs to be a commercially appropriate method for securing the purchase or
sale of the nonfinancial commodity for deferred shipment at the time it is entered into. The CFTC cautions market participants that, to the extent a party relies on the forward exclusion from the swap or future delivery definitions, notwithstanding that there is volumetric optionality, if that volumetric optionality is inconsistent with the seventh element of the interpretation, the agreement, contract or transaction may be an option. 342See discussion in part II.B.2.(a)(i)(B), supra. See also supra note 321. assure that commodity options that should be regulated as swaps do not circumvent the protections established in the Dodd-Frank Act through the forward contract exclusion for nonfinancial commodities instead. The CFTC also is providing an interpretation, in response to commenters,334 with respect to forwards with embedded volumetric optionality.335 Several commenters asserted that agreements, contracts, and transactions that contain embedded ‘‘volumetric options,’’ and that otherwise satisfy the terms of the forward exclusions, should qualify as excluded forwards, notwithstanding their embedded optionality.336 The CFTC believes that agreements, contracts, and transactions with embedded volumetric optionality may satisfy the forward exclusions from the swap and future delivery definitions under certain circumstances. Accordingly, the CFTC is providing an interpretation that an agreement, contract, or transaction falls within the forward exclusion from the swap and future delivery definitions, notwithstanding that it contains embedded volumetric optionality, when:

1. The embedded optionality does not
   undermine the overall nature of the agreement, contract, or transaction as a forward contract;
2. The predominant feature of the
   agreement, contract, or transaction is actual delivery;
3. The embedded optionality cannot
   be severed and marketed separately from the overall agreement, contract, or transaction in which it is embedded; 337
4. The seller of a nonfinancial
   commodity underlying the agreement, contract, or transaction with embedded volumetric optionality intends, at the time it enters into the agreement, contract, or transaction to deliver the underlying nonfinancial commodity if the optionality is exercised;
5. The buyer of a nonfinancial
   commodity underlying the agreement, contract or transaction with embedded volumetric optionality intends, at the time it enters into the agreement, contract, or transaction, to take delivery of the underlying nonfinancial commodity if it exercises the embedded volumetric optionality;
6. Both parties are commercial
   parties; 338 and
7. The exercise or non-exercise of the
   embedded volumetric optionality is based primarily on physical factors,339 or regulatory requirements,340 that are outside the control of the parties and are influencing demand for, or supply of, the nonfinancial commodity.341 The first two elements of the interpretation for embedded volumetric optionality, which mirror the CFTC’s historical embedded option interpretation discussed above, have been modified to reflect that embedded volumetric optionality relates to delivery rather than price. As noted above, the predominant feature of a forward contract is a binding, albeit deferred, delivery obligation. It is essential that any embedded option in a forward contract as to volume must not undermine a forward contract’s overall purpose.342 The CFTC recognizes that the nature of commercial operations are such that supply and demand requirements cannot always be accurately predicted and that forward contracts that allow for some optionality as to the amount of a nonfinancial commodity actually delivered offer a great deal of value to commercial

343 In evaluating whether the predominant feature of a transaction is actual delivery, the CFTC will look at the contract as a whole. Thus, with respect to this contract, the CFTC would consider the intent element of the forward exclusions to be satisfied because the contract requires the seller to deliver a non-nominal volume of a commodity (i.e., 10,000 bushels of wheat), viewing the contract as a whole. As a result, if the other elements of the guidance above are satisfied, this contract would be a forward contract, even if the party did not exercise the option for the additional 5,000 bushels. 344The fact that the CFTC is expressly including the fourth through sixth elements in the embedded optionality guidance for volumetric options but not elsewhere does not mean that intent to deliver and the ability to make or take delivery expressed in these elements are not part of the facts and circumstances the CFTC will consider in the context of determining whether other agreements, contracts, and transactions qualify for the forward exclusions. Intent to deliver and the ability to make or take delivery have long been a part of the CFTC’s facts-and-circumstances approach to making that determination, and they remain so. The CFTC is emphasizing these elements in this guidance because the CFTC has not previously expressed the view that an agreement, contract, or transaction with embedded volumetric optionality which affects the delivery term may qualify as a forward if these facts and circumstances are present. 345See, e.g., AGA Letter (advising that ‘‘[i]n general, retail demand for natural gas is weather driven * * * as a result [of which], a gas utility’s peaking supplies must have significant flexibility

• • • [and g]as utilities * * * use a variety of
      contracts with gas suppliers to physically deal with peak periods of demand’’); BGA Letter (citing gas supply curtailment due to a pipeline outage and power generation curtailment by an Independent System Operator for operational reasons as factors outside the control of energy suppliers and which could impact the amount of a commodity delivered). The CFTC understands BGA’s comment to address involuntary curtailments, but also recognizes that power buyers may agree in advance that the relevant Regional Transmission Organization or Independent System Operator may, in order to maintain system reliability, curtail power deliveries to the buyers. While voluntary curtailments are within the control of the power buyer, the potential system reliability issue is not. Therefore, such voluntary curtailments would be within the guidance because, if triggered, they would be based on a physical factor (e.g., supply constraints). 346See Letter from Keith M. Sappenfield, II, Director, US Regulatory Affairs, Encana Marketing (USA) Inc. (‘‘Encana’’), dated July 22, 2011 (‘‘Encana Letter’’). 347See ONEOK Letter. The CFTC notes that this commenter discussed full requirements contracts in the context of supply agreements between one of its affiliates and retail customers. If such customers are non-commercial customers, such contracts are not forwards, but nevertheless they may not be swaps under the Commissions’ guidance regarding the non-exhaustive list of consumer transactions, or otherwise if they have characteristics or factors described under the consumer transaction interpretation, see infra part II.B.3. 348See, e.g., NY UCC § 2–306(1) (stating that ‘‘[a] term which measures the quantity by the output of the seller or the requirements of the buyer means such actual output or requirements as may occur in good faith.* * *’’). This commenter cited Corbin on Contracts for the proposition that the mere fact that the quantity term of the contract is ‘‘the buyer’s needs or requirements’’ does not render the requirements contract ‘‘a mere options contract’’ because ‘‘the buyer’s promise is not illusory * * * [but] is conditional upon the existence of an objective need for the commodity.’’ See ONEOK Letter (citing Corbin on Contracts § 6.5 at 240–53 (1995)). participants. Where an agreement, contract, or transaction requires delivery of a non-nominal volume of a nonfinancial commodity, even if an embedded volumetric option is exercised, the CFTC believes that the predominant feature of the contract, notwithstanding the embedded volumetric optionality, is actual delivery. This is the case in many forward contracts that have an embedded option that allows a party to buy or sell an additional amount of a commodity beyond the fixed amount called for in the underlying forward contract. For instance, a forward contract could call for the delivery of 10,000 bushels of wheat and include an option for an additional 5,000 bushels of wheat.343 The third element is substantially
      the same as the third element of the interpretation above with respect to commodity options embedded in forward contracts generally. The fourth and fifth elements are designed to ensure that both parties intend to make or take delivery (as applicable), subject to the relevant physical factors or regulatory requirements, which may lead the parties to deliver more or less than originally intended. This distinguishes a forward contract from a commodity option, where only the option seller must at all times be prepared to deliver during the term of the option. The sixth element is intended to ensure that the interpretation is not abused by market participants not engaged in a commercial business involving the nonfinancial commodity underlying the embedded volumetric optionality.344 The seventh element is based on comments stating that parties to agreements, contracts, and transactions with embedded volumetric optionality intend to make or take delivery (as applicable) of a commodity, and that it is merely the volume of a commodity that would be required to be delivered if the option is exercised, that varies. It is designed to ensure that the volumetric optionality is primarily driven by physical factors or regulatory requirements that influence supply and demand and that are outside the parties’ control, and that the optionality is a commercially reasonable way to address uncertainty associated with those factors.345 Element seven must be interpreted with the other elements set forth here. For instance, even if the optionality is consistent with element seven, such optionality cannot undermine the overall nature of the contract as a forward contract as discussed above. As discussed in the interpretation regarding forwards with embedded optionality discussed above, in evaluating whether an agreement, contract or transaction with embedded volumetric optionality qualifies for the forward exclusions, the CFTC will look to the relevant facts and circumstances of the transaction as a whole to evaluate whether the transaction qualifies for the forward exclusions from the definitions of the terms ‘‘swap’’ and ‘‘future delivery.’’ The CFTC is providing further interpretations to explain how it would treat some of the specific contracts described in the comment letters. According to one commenter, a ‘‘full requirements contract’’ can be described as a ‘‘contract where the seller agrees to provide all requirements for a specific customer’s location or delivery point.’’ 346 According to another commenter, ‘‘[a] full requirements contract * * * is a well-established concept in contract law’’ and ‘‘[i]n a requirements contract, the purchaser
• • • deals exclusively with one
      supplier.’’ 347 This commenter added that, while the amount of commodity delivered can vary, it is based on an objective need and that the Uniform Commercial Code imposes on the buyer ‘‘an obligation to act in good faith with respect to the varying amount that is called for delivery.’’ 348 Based upon this description, the CFTC believes that a going commercial concern with an exclusive supply contract has no option but to get its supply requirements met through that exclusive supplier consistent with the terms of the contract. Any instance where nominal or zero delivery occurred would have to be because the commercial requirements changed or did not materialize. Furthermore, any variability in delivery amounts under the contract appears to be driven directly by the buyer’s commercial requirements and is not dependent upon the exercise of any commodity option by the contracting parties. Accordingly, full requirements contracts, as described above, appear not to contain embedded volumetric options. Therefore, a full requirements contract may qualify for the forward exclusion under the same facts and circumstances analysis applicable to all other agreements, contracts, and transactions that might be forwards. The same analysis would apply to an output

349See Letter from Phillip g. Lookadoo, Esq., Reed Smith LLP and Jeremy D. Weinstein, Esq. on behalf of IECA dated May 23, 2012 (suggesting that output contracts, in addition to full requirements contracts, should be within the forward exclusion). An output contract has been defined as ‘‘a contract pursuant to which the obligor’s duty to supply the promised commodity is quantified (and therefore limited) by reference to its production thereof.’’ See Boyd v. Kmart Corp., 110 F.3d 73 (10th Cir. 1997). 350See California Utilities Letter. 351See NEMA Letter. 352See California Utilities Letter. 353 Id. 354See infra part II.B.2.(b)(iii). 355See AGA Letter. 356See Atmos Letter. 357See IECA Letter. 358The CFTC refers in this and the prior sentence to ‘‘additional deliveries’’ because the IECA’s example involves an agreement calling for delivery of a physical nonfinancial commodity. 359Using extension or evergreen provisions to avoid delivery, however, as was the case with the ‘‘rolling spot’’ contracts at issue in CFTC v. Zelener, 373 F.3d 861 (7th Cir. 2004), could constitute evasion or violate other provisions of the CEA (e.g., CEA section 4(a), 7 U.S.C. 6(a)). This interpretation does not limit the CFTC’s other interpretations in this release regarding when delivery does not occur (e.g., the Brent Interpretation). 360See NGSA/NCGA Letter (requesting clarification of the phrase ‘‘target the delivery term.’’). 361See Proposing Release at 29830, n.81. 362See COPE Letter. 363See AGA Letter; API Letter; Atmos Letter; ONEOK Letter; NGSA/NCGA Letter; WGCEF Letter. 364See AGA Letter; Atmos Letter. contract satisfying the terms of this interpretation.349 With respect to capacity contracts, transmission (or transportation) services agreements, and tolling agreements, the CFTC understands that: (i) Capacity contracts are generally products designed to ensure that sufficient physical generation capacity is available to meet the needs of an electrical system;350 (ii) transmission (or transportation) services agreements are generally agreements for the use of electricity transmission lines (or gas pipelines) that allow a power generator to transmit electricity (or gas supplier to transport gas) to a specific location;351 and (iii) tolling agreements, as described by commenters, provide a purchaser the right to the capacity, energy, ancillary services and any other product derived from a specified generating unit, all based upon a delivered fuel price and agreed heat rate.352 Such agreements, contracts and transactions, may have features that will satisfy the ‘‘forwards with embedded volumetric optionality’’ interpretation discussed above, or, like full requirements contracts, may not contain embedded volumetric options and may satisfy other portions of the forward interpretations herein. For example, according to one commenter, the delivery obligations in some tolling agreements are not optional which is indicative that the predominant feature of such tolling
agreements is actual delivery.353 It is also possible, based on descriptions provided to the CFTC, that tolling agreements could fit within the interpretation concerning certain physical agreements, contracts, or transactions,354 or other interpretations herein. Some commenters focused on forwards with embedded volumetric optionality in the natural gas industry. For example, one commenter stated that ‘‘peaking supply’’ natural gas contracts do not render delivery optional. Although the purchaser has the option to specify when and if the quantity of gas will be delivered on any given day, this commenter asserted that there is no cash settlement alternative. If the purchaser does not exercise the right to purchase, then the right is terminated. The seller under the transaction must deliver the entire quantity of gas that the purchaser specifies, or pay liquidated damages. Moreover, the option is not severable and cannot be marketed separately from the supply agreement itself.355 Similarly, another commenter said that there is no ability to sever an embedded option from a natural gas forward contract. Moreover, it stated that the ability for a gas purchaser to specify a quantity of gas for a certain day is not to encourage speculative activity; rather, it is because the exact quantity of gas to be needed on that future day is unknown, and many gas purchasers have weather-dependent needs that cannot accurately be predicted in advance.356 Depending on the relevant facts and circumstances, these types of agreements, contracts, and transactions—capacity contracts, transmission (or transportation) services agreements, tolling agreements, and peaking supply contracts—may satisfy the elements of the ‘‘forwards with embedded volumetric options’’ interpretation set forth above, or may satisfy other portions of this interpretation. If they do, they would fall within the forward exclusions from the swap and future delivery definitions. In addition, the CFTC is providing an interpretation in response to a comment that contracts with evergreen or extension terms should be considered forwards.357 The CFTC is clarifying that an extension term in a commercial contract, such as a renewal term in a five year power purchase agreement (which, due to the renewal, would require additional deliveries), is not an option on the delivery term within the meaning of the CFTC’s interpretation, and consequently would not render such a contract ineligible for the forward exclusions from the definitions of the terms ‘‘swap’’ and ‘‘future delivery.’’ Similarly, an evergreen provision, which automatically renews a contract (and, as such, would require additional deliveries)358 absent the parties affirmatively terminating it, would not render such a contract ineligible for the forward exclusions from the swap or future delivery definitions.359 When the Proposing Release stated that a forward contract containing an embedded option that does not ‘‘target the delivery term’’ is an
excluded forward contract,360 it meant that the embedded option does not affect the delivery amount.361 Also, in response to a commenter,362 the CFTC clarifies that embedded optionality as to delivery points and delivery dates will not cause a transaction that otherwise qualifies as a forward contract to be considered a swap. The CFTC emphasizes, however, that delivery must occur at some delivery point and on some date, or the lack of delivery must be due to the transaction being booked out or otherwise be consistent with the CFTC’s interpretation regarding the forward exclusions from the swap and future delivery definitions. Comments Commenters generally supported the CFTC’s proposed interpretation regarding forwards with embedded options, but many believed that it should be modified or expanded. As noted above, several commenters believed that forward contracts with embedded options that contain optionality as to the quantity/volume of the nonfinancial commodity to be delivered should qualify as forwards, and that the CFTC’s proposed interpretation (which only mentions price optionality) should be modified accordingly.363 In this regard, several commenters focused on forwards with embedded volumetric options in the natural gas industry.364 One commenter noted that, although the 1985 CFTC OGC Interpretation distinguishes forward contracts from trade options, it is based on a limited number of agricultural contract examples, so additional guidance is needed, particularly in light of the wide range of cash market and commercial merchandising contracting practices in

365See ONEOK Letter. This commenter noted that it offers its customers a number of types of contracts for delivery of natural gas under which the amount called for delivery may vary. In each of these types of contracts, this commenter stated that both parties intend the contracts to result in delivery of the commodity, as needed. The purpose of these contracts is to ensure that customers, most of which are gas or electric utilities, have an adequate supply of natural gas regardless of day-to-day changes in demand that may be caused by variation in weather, operational considerations, or other factors. They are not designed for one-way price protection as would be the case with an option. See ONEOK Letter. 366See COPE Letter, Appendix. 367See WGCEF Letter; 7 U.S.C. 6c(b). 368 77 FR 25320 (Aug. 27, 2012). Encana believed that the guidance on forwards with embedded options should include embedded physical delivery options because it asserted that many of the contracts currently used by participants in the wholesale natural gas market contain an option for the physical delivery of natural gas. See Encana Letter. To the extent that Encana’s comment goes beyond volumetric optionality, commodity options are discussed supra in section II.B.2(b). 369See Letter from Roger Cryan, Vice President for Milk Marketing and Economics, National Milk Producers Federation (‘‘NMPF’’), dated July 22, 2011 (‘‘NMPF Letter’’). 370See ETA Letter. Similarly, COPE comments that a nonfinancial commodity forward contract that, ‘‘by its terms,’’ is intended to settle physically should be permitted to contain optionality without being transformed into a swap unless such optionality negates the physical settlement element of the contract. That is, if one party can exercise an option to settle the contract financially based upon the value change in an underlying cash market, then the intent for physical settlement is not contained in ‘‘the four corners of the contract’’ and may render the contract a swap. See COPE Letter. As discussed elsewhere in this release, the CFTC historically has eschewed approaches to the forward exclusion that rely on the ‘‘four corners of the contract,’’ which can provide a roadmap to evasion of statutory requirements. 371Accordingly, this commenter believed that the CFTC should provide in its rules that an embedded option or embedded optionality will not result in a nonfinancial forward being a swap unless: (i) Delivery is optional; (ii) financial settlement is allowed; and (iii) transfer and trading of the option separately from the forward is permitted. See ETA Letter. 372See also NCFC Letter (supporting the CFTC’s guidance because it provides legal certainty). 373See also Commodity Options, 77 FR 25320, 25324 n. 25 (Apr. 27, 2012) (discussing the CFTC’s conclusion that an ‘‘option[] to redeem’’ under the USDA Commodity Credit Corporation’s marketing loan program constitutes a cotton producer’s contractual right to repay its marketing loan and
‘‘redeem’’ the collateral (cotton) to sell in the open market). 374Separately, it is expected that CFTC staff will be issuing no-action relief with respect to the conditions of the modified trade option exemption (except the enforcement provisions retained in § 32.3(d)) until December 31, 2012. This extension will afford the CFTC an opportunity to review and evaluate the comments received on both the interpretation above regarding embedded volumetric optionality, and the modified trade option exemption, in order to determine whether any changes thereto are appropriate. which delivery terms and amounts vary.365 In addition, another commenter requested more generally that any embedded option (for example, price, quantity, delivery point, delivery date, contract term) that does not permit a unilateral election of financial settlement based upon the value change in an underlying cash market should not render the contract a swap.366 As discussed above, the CFTC has provided an additional interpretation with respect to forwards with embedded volumetric options to address commenters’ concerns. The CFTC also has provided an interpretation above, regarding price optionality, optionality with respect to delivery points and delivery dates specifically in response to this commenter, and optionality as to certain contract terms (such as evergreen and renewal provisions) to address particular concerns raised by commenters. The CFTC declines to adopt a more expansive approach with respect to ‘‘any’’ embedded option. One commenter requested that an option to purchase or sell a physical commodity, whether embedded in a forward contract or stand alone, should either (i) fall within the statutory forward exclusion from the swap definition, or (ii) alternatively, if deemed by the CFTC to be a swap, should be exempt from the swap definition pursuant to a modified trade option exemption pursuant to CEA
section 4c(b).367 The CFTC has modified
its proposed interpretation regarding forwards with embedded options as discussed above; contracts with embedded options that are swaps under this final interpretation may nevertheless qualify for the modified trade option exemption recently adopted by the CFTC and discussed above.368 Another commenter urged the CFTC to broadly exempt commercial forward contracting from swap regulation by generally excluding from the swap definition any forward contract with embedded optionality between end users ‘‘whose primary purpose is consistent with that of an ‘end user’, and in which any embedded option is directly related to ‘end use.’ ’’ 369 The CFTC believes that this interpretation is vague and overbroad, and declines to adopt it. Another commenter believed that the CFTC’s ‘‘facts and circumstances’’ approach to forwards with embedded options does not provide the legal certainty required by nonfinancial entities engaging in commercial contracts in the normal course of business.370 This commenter further argued that many option-like contract terms could be determined to ‘‘target the delivery term’’ under a facts and circumstances analysis.371 The CFTC has long applied a facts￾and-circumstances approach to the forward exclusion, including with respect to forwards with embedded options, and thus it is an approach with which market participants are familiar. That approach balances the need for legal certainty against the risk of providing opportunities for evasion.372 The CFTC’s additional interpretation noted above, including clarification about the meaning of the phrase ‘‘target the delivery term,’’ and forwards with embedded volumetric optionality, provides enhanced legal certainty in response to the commenter’s concerns. 373 Request for Comment The CFTC’s interpretation regarding forwards with volumetric options is an interpretation of the CFTC and may be relied upon by market participants. However, the CFTC believes that it would benefit from public comment about its interpretation, and therefore requests public comment on all aspects of its interpretation regarding forwards with embedded volumetric options,374 and on the following questions:

1. Are the elements set forth in the
   interpretation to distinguish forwards with embedded volumetric optionality from commodity options appropriate? Why or why not?
2. Are there additional elements that
   would be appropriate? Please describe and provide support for why such elements would serve to distinguish forwards with embedded volumetric optionality from commodity options.
3. Is the seventh element that, to
   ensure that an agreement, contract, or transaction with embedded volumetric optionality is a forward and not an option, the volumetric optionality is based primarily on physical factors, or regulatory requirements, that are outside the control of the parties and are influencing demand for, or supply of, the nonfinancial commodity, necessary and appropriate? Why or why not? Is the statement of this element sufficiently clear and unambiguous? If not, what adjustments would be appropriate?
4. Are there circumstances where
   volumetric optionality is based on other factors? Please describe. Would such factors, if made a part of the interpretation, serve to distinguish forwards with embedded volumetric optionality from commodity options? If so, how?
5. Does the interpretation provide
   sufficient guidance as to whether agreements, contracts, or transactions

375See BGA Letter and California Utilities Letter. This interpretation also may apply to firm transmission agreements pursuant to which transmission service may not be interrupted for any reason except during an emergency when continued delivery of power is not possible. See http:// www.interwest.org/wiki/index.php?title=Firm_ transmission_service. 376See California Utilities Letter. 377 In this regard, the usage rights offered for sale should be limited to the capacity of the specified facility. While overselling such capacity would not per se be inconsistent with satisfying the terms of this interpretation, the CFTC cautions market participants that overselling not based on reasonable commercial expectations of the use of the specified facility could lead the contract to be deemed evasion and lead to an agreement, contract or transaction being considered a swap, as it would undermine the ‘‘right’’ being offered. For example, given physical constraints of the power grid and gas pipelines, overselling transmission or transportation capacity would be per se inconsistent with satisfying the terms of this interpretation. 378See BGA Letter and California Utilities Letter. 379See BGA Letter. with embedded volumetric optionality permitting a nominal amount, or no amount, of a nonfinancial commodity to be delivered are forwards or options, viewing the agreements, contracts, or transactions as a whole, if they satisfy the seven elements of the interpretation? Why or why not? Does this interpretation encourage evasion, or do the seven elements sufficiently distinguish forwards from agreements, contracts, and transactions that may evade commodity options regulation?
6. Is the interpretation sufficiently
clear with respect to capacity contracts, transmission (or transportation) services agreements, peaking supply contracts, or tolling agreements? Why or why not? Do capacity contracts, transmission (or transportation) services agreements, peaking supply contracts, or tolling agreements generally have features that satisfy the forwards with volumetric options interpretation included in this release? If so, which ones? If not, why not? Could these types of agreements, contracts, and transactions qualify for the forward exclusions under other parts of the interpretation set forth above? Are there material differences in the structure, operation, or economic effect of these types of agreements, contracts, and transactions as compared to full requirements contracts that are relevant to whether such agreements, contracts, and transactions are options under the CEA? Please explain. If so, what are the material differences?
7. Do the agreements, contracts, and
transactions listed in question No. 6 above have embedded optionality in the first instance? Based on descriptions by commenters, it appears that they may have a binding obligation for delivery, but have no set amount specified for delivery. Instead, delivery (including the possibility of nominal or zero delivery) is determined by the terms and conditions contained within the agreement, contract, or transaction (including, for example, the satisfaction of a condition precedent to delivery, such as a commodity price or temperature reaching a level specified in the agreement, contract, or transaction). That is, the variation in delivery is not driven by the exercise of embedded optionality by the parties. Do the agreements, contracts, and transactions listed in question No. 6 exhibit these kinds of characteristics? If so, should the CFTC consider them in some manner other than its forward interpretation? Why or why not? (iii) Certain Physical Commercial Agreements, Contracts or Transactions The CFTC is providing an interpretation in response to comments regarding certain physical commercial agreements for the supply and consumption of energy that provide flexibility, such as tolls on power plants, transportation agreements on natural gas pipelines, and natural gas storage agreements.375 Commenters recognized that these types of agreements, contracts or transactions may have option-like features, but analogized them to leases and concluded that they were forwards rather than swaps. One commenter, for example, characterized taking power produced pursuant to a physical tolling agreement—which can involve one party thereto providing fuel for a generation plant and having the exclusive right to take the power produced by that plant from the fuel provided—thus, in effect, ‘‘renting’’ the plant to the extent the plant is used to produce power from the fuel provided— as more akin to a lease than to an option.376 The CFTC will interpret an agreement, contract or transaction not to be an option if the following three elements are satisfied: (1) The subject of the agreement, contract or transaction is usage of a specified facility or part thereof rather than the purchase or sale of the commodity that is to be created, transported, processed or stored using the specified facility; (2) the agreement, contract or transaction grants the buyer the exclusive use of the specified facility or part thereof during its term, and provides for an unconditional obligation on the part of the seller to grant the buyer the exclusive use of the specified facility or part thereof; 377 and (3) the payment for the use of the specified facility or part thereof represents a payment for its use rather than the option to use it. In such agreements, contracts and transactions, while there is optionality as to whether the person uses the specified facility, the person’s right to do so is legally established, does not depend upon any further exercise of an option and merely represents a
decision to use that for which the lessor already has paid. In this context, the CFTC would not consider actions such as scheduling electricity transmission, gas transportation or injection of gas into storage to be exercising an option if all three elements of the interpretation above are satisfied. As with the interpretation regarding forwards with embedded options generally, discussed above, in evaluating whether flexible physical commercial agreements that meet the 3-part test qualify for the forward exclusions, the CFTC will look to the specific facts and circumstances of the agreement, contract or transaction as a whole to evaluate whether the agreement, contract or transaction qualifies for the forward exclusions from the definitions of ‘‘swap’’ and ‘‘future delivery.’’ However, in the alternative, if the right to use the specified facility is only obtained via the payment of a demand charge or reservation fee, and the exercise of the right (or use of the specified facility or part thereof) entails the further payment of actual storage fees, usage fees, rents, or other analogous service charges not included in the demand charge or reservation fee, such agreement, contract or transaction is a commodity option subject to the swap definition. Comments Two commenters addressed ‘‘lease￾like’’ physical agreements, contracts or transactions.378 One of these commenters asserted that there are many physical commercial agreements for the supply and consumption of energy that effectively provide leases on flexible energy assets, such as tolls on power plants, transportation agreements on natural gas pipelines and natural gas storage agreements.379 According to this commenter, these assets have the capability to be turned on and off to meet fluctuating demand due to weather and other factors; physical contracts around these assets transfer that delivery flexibility to the contract holder. The commenter believed that these types of commercial arrangements should not be considered commodity options, but rather should be excluded forwards. The other commenter described tolling agreements as having the characteristics of a lease, in that the

380See California Utilities Letter.
381See Request for Comment 35, which stated:
How would the proposed interpretive guidance set forth in this section affect full requirements contracts, capacity contracts, reserve sharing agreements, tolling agreements, energy management agreements, and ancillary services? Do these agreements, contracts, or transactions have optionality as to delivery? If so, should they—or any other agreement, contract, or transaction in a nonfinancial commodity that has optionality as to delivery—be excluded from the swap definition? If so, please provide a detailed analysis of such agreements, contracts, or transactions and how they can be distinguished from options that are to be regulated as swaps pursuant to the Dodd-Frank Act. To what extent are any such agreements, contracts, or transactions in the electric industry regulated by the Federal Energy Regulatory Commission (‘‘FERC’’), State regulatory authorities, regional transmission organizations (‘‘RTOs’’), independent system operators (‘‘ISOs’’) or market monitoring units associated with RTOs or ISOs? See Proposing Release at 29832. 382 Id. 383See Atmos Letter; BGA Letter; California Utilities Letter; COPE Letter; ETA Letter; Encana Letter; FERC Staff Letter; IECA Letter; NEMA Letter; ONEOK Letter; and Letter from Kenneth R. Carretta, General Regulatory Counsel—Markets, PSEG Services Corp., on behalf of the Public Service Electric and Gas Company, PSEG Power LLC, and PSEG Energy Resources & Trade LLC (‘‘PSEG Companies’’), dated July 22, 2011 (‘‘PSEG Letter’’). 384See Better Markets Letter. This commenter stated that ancillary services are in substance swaps based on congestion costs between two transmission points, measured by the difference between actual prices assigned at those points by the grid operator. Capacity contracts are often documented using trading agreements for transactions in physicals, but this commenter believed that they constitute swaps that are used to hedge the price risk associated with periodic auctions of the contracts to provide reliable capacity to the grid operator. This commenter asserted that such contracts do not meet the CFTC’s appropriate tests to exclude them, which should be made explicit in the guidance. This commenter stated that basic power contracts often do not meet the intent to deliver test because power buyers and sellers each schedule delivery to/from the grid, and such transactions can be settled based on readily available price differentials rather than scheduling capacity and load as a pair. At a minimum, this commenter believed that guidance should be provided to require that, in order to demonstrate intent to deliver, secondary delivery-related costs (e.g., congestion charges and penalties to which those scheduling capacity and load on the grid are subject) must be allocated by contract. Id. 385See supra note 317. 386 16 U.S.C. 824(f). 387 7 U.S.C. 6(c)(6). 388See, e.g., Encana Letter and BGA Letter. 389See, e.g., The Royal Bank of Scotland Group plc, Order Approving Notice To Engage in Activities
Complementary to a Financial Activity, 2008 Federal Reserve Bulletin volume 94. 390 Id. 391See, e.g., Energy Management Agreement between Long Island Lighting Company and Long Island Power Authority, available at http:// www.lipower.org/pdfs/company/papers/contract/ energy.pdf. 392Similarly, using an EMA would not render swaps entered as a result of or pursuant to an EMA spot or forward transactions. purchasing entity obtains the exclusive right to the use of the power plant during the term of the agreement.380 This commenter asserted that such agreements should not be considered commodity options, but rather forwards because the obligations are not contingent. The CFTC is providing the above interpretation that these types of agreements, contracts and transactions are not commodity options if the above conditions are satisfied, but may qualify for the forward exclusions under the facts and circumstances, in response to these commenters’ concerns. (iv) Effect of Interpretation on Certain Agreements, Contracts and Transactions In the Proposing Release,381 the CFTC requested comment regarding how its proposed interpretation concerning the forward contract exclusion would affect full requirements contracts, reserve sharing agreements, tolling agreements, energy management agreements and ancillary services. The CFTC asked whether such agreements, contracts or transactions have optionality as to delivery and, if so, whether they, or any other agreement, contract or transaction in a nonfinancial commodity, should be excluded from the swap definition.382 Commenters generally believed that such types of agreements, contracts and transactions, although they may contain delivery optionality, should be considered forwards rather than swaps or commodity options.383 By contrast, one commenter believed that traded power markets involve many types of contracts that are actually exchanges of cash flows based on referenced values and that have no relevant characteristics of physical delivery.384 With the exception of energy management agreements, which are discussed below, the interpretations that the CFTC has already provided above may apply to such types of agreements, contracts and transactions. Specifically, to the extent that such types of agreements, contracts and transactions are forwards with embedded volumetric options, the CFTC has provided an additional interpretation in section II.B.2.b(iii) above. To the extent such types of agreements, contracts or transactions are physical commercial agreements, contracts or transactions discussed in section II.B.2.b(iii), supra, the CFTC has provided an interpretation in that section. To the extent such types of agreements, contracts and transactions are considered commodity options, the CFTC has addressed commodity options under the separate rulemaking establishing a modified trade option exemption.385 And to the extent that such types of agreements, contracts, and transactions, such as ancillary services, occur
in Regional Transmission Organizations or Independent System Operators, or entered into between entities described in section 201(f) of the Federal Power Act,386 they may be addressed through the public interest waiver process in CEA section 4(c)(6).387 With regard to Energy Management Agreements (‘‘EMAs’’), in general, commenters expressed the view that EMAs are forwards, and not swaps, although they did not provide analysis to support that conclusion.388 They also did not provide a working definition of EMAs. The CFTC understands that EMAs can cover a number of services and transactions, which can include spot, forward and swap transactions. EMAs can include services such as: (i) Acting as a financial intermediary by substituting one party’s credit and liquidity for those of a less credit worthy owner of illiquid energy producing assets (i.e. the other party to the EMA) to facilitate the owner’s purchase of fuel and sale of power; 389 (ii) providing market information to assist the owner in developing and refining a risk-management plan for the plant; 390 and (iii) procuring fuel, arranging delivery and storage, selling excess power not needed to serve load for another party.391 The entity carrying out these activities may receive a portion of the revenue generated from such activities as compensation for its efforts. Because commenters did not provide a working definition of EMAs, the CFTC cannot state categorically that EMAs are or are not swaps. However, if the fuel acquisition, sales of excess generation and any other transactions executed under the auspices of an EMA are not swaps, nothing about the fact that the transactions are executed as a result of or pursuant to an EMA transforms the transactions into swaps. For example, if one party hires another party to enter into spot or forward transactions on its behalf, the fact that their relationship is governed by an EMA does not render those transactions swaps.392 Conversely, were swaps to be executed by one party on behalf of another party as a result of, or pursuant to, an EMA, the parties thereto would need to consider their respective roles thereunder (e.g. principal versus agent) and whether commodity trading advisor, introducing broker, futures commission merchant, or other registration or other elements of the Dodd-Frank Act regime were implicated. At a minimum, the fact that a swap was executed would implicate

393This interpretation is limited to the facts and circumstances described herein; the CFTC is not opining on different facts or circumstances, which could change the CFTC’s interpretation. 394With respect to performance guarantees, the fact that a failure to deliver a nonfinancial commodity triggers a payment under a performance guaranty does not excuse the performance, nor render delivery optional. Accordingly, such a payment trigger would not itself preclude an agreement, contract, or transaction from being covered by the forward exclusion from the swap or future delivery definitions. But see supra part II.B.1.g, which provides that the CFTC is interpreting the term ‘‘swap’’ (that is not a security￾based swap or mixed swap) to include a guarantee of such swap, to the extent that a counterparty to a swap position would have recourse to the guarantor in connection with the position. 395See 1985 CFTC OGC Interpretation, supra note 245 (stating generally that while ‘‘[s]ome contracts provide for a liquidated damages of penalty clause if the producer fails to deliver, the presence of such clauses in a contract does not change the analysis of the nature of the contract [if] * * * it is intended that delivery of the physical crop occur, absent destruction of all or a portion of the crop by forces which neither party can control’’). See generally Corbin on Contracts § 58.1 (characterizing liquidated damages provisions as designed to ‘‘[d]etermin[e] the amount of damages that are recoverable for a breach of contract’’). 396 In that regard, see 1985 CFTC OGC Interpretation, supra note 245 (stating that ‘‘a contract provision which permitted a producer to avoid delivery for a reason other than for an intervening condition not in the control of either party could change any conclusion about the nature of the contract’’). 397See ETA Letter. 398 Id. This commenter cited FERC Order No. 890, which recognizes that ‘‘[w]hile any party to any contract can choose to fail to perform, that does not convey a contractual right to fail to perform’’ and that the Edison Electric Institute Master Power Purchase and Sale Agreement (‘‘EEI MPPSA’’) clearly obligates the supplier to provide power, except in cases of force majeure. As the ETA explains, ‘‘[t]he EEI MPPSA is a master agreement frequently used to document transactions for deferred delivery and receipt of nonfinancial electric energy, and the terms of the ISDA North American Power Annex contain substantially identical master agreement provisions * * *.’’ Id. 399According to this commenter, parties typically include liquidated damages provisions in their agreements, contracts and transactions to address situations in which ‘‘one party or the other may be unable, excused or prevented for commercial reasons from performing its contractual obligations to deliver or receive [the relevant commodity],’’ not to serve as ‘‘a financial settlement ‘option’ analogous to a financial settlement option in a trading
instrument.’’ Id. 400See AGA Letter. 401 Id. See also Atmos Letter (stating that there is no financial incentive for a seller to fail to deliver natural gas under contracts used in the natural gas industry, as the standard remedy for such a failure to deliver is to pay liquidated damages sufficient to compensate the purchaser for having to obtain its required natural gas). 402The discussion above regarding the exclusion from the swap definition for forward contracts on nonfinancial commodities does not apply to the exclusion from the swap and security-based swap definitions for security forwards or to the distinction between security forwards and security futures products. 403See Proposing Release at 29830. 404See sections 1a(47)(B)(ii), (v), and (vi) of the CEA, 7 U.S.C. 1a(47)(B)(ii), (v), and (vi). 405See section 1a(47)(B)(v) of the CEA, 7 U.S.C. 1a(47)(B)(v) (excluding from the swap and security￾based swap definitions ‘‘any agreement, contract, or transaction providing for the purchase or sale of 1 or more securities on a fixed basis that is subject to [the Securities Act and Exchange Act]’’); and
section 1a(47)(B)(vi) of the CEA, 7 U.S.C.
1a(47)(B)(vi) (excluding from the swap and security￾based swap definitions ‘‘any agreement, contract, or transaction providing for the purchase or sale of 1 or more securities on a contingent basis that is subject to [the Securities Act and Exchange Act], unless the agreement, contract, or transaction predicates the purchase or sale on the occurrence of a bona fide contingency that might reasonably be expected to affect or be affected by the creditworthiness of a party other than a party to the agreement, contract, or transaction’’). 406See section 1a(47)(B)(ii) of the CEA, 7 U.S.C. 1a(47)(B)(ii). 407The Commissions note that calling an agreement, contract, or transaction a swap or security-based swap does not determine its status. See supra part II.D.1. reporting and recordkeeping requirements.393 (v) Liquidated Damages Provisions The Commissions also received several comments discussing contractual liquidated damages provisions. The CFTC is clarifying that the presence, in an agreement, contract, or transaction involving physical settlement of a nonfinancial commodity, of a liquidated damages provision (which may be referred to by another name, such as a ‘‘cover costs’’ or ‘‘cover damages’’ provision) does not necessarily render such an agreement, contract, or transaction ineligible for the forward exclusion.394 Such a provision in an agreement, contract, or transaction is consistent with the use of the forward exclusion, provided that the parties intend the transaction to be physically settled.395 However, liquidated damages provisions can be used to mask a lack of intent to deliver.396 In light of the possibility for evasion of the Dodd￾Frank Act, the CFTC will continue to utilize its historical facts-and￾circumstances approach in determining whether the parties to a particular agreement, contract, or transaction with a liquidated damage provision have the requisite intent to deliver. Comments One commenter notes that a commercial merchandising arrangement involving a nonfinancial commodity may provide that the remedy for a failure to make or take delivery is the payment of a market-rate replacement price, a payment on a performance guaranty, or ‘‘cover damages’’ to compensate the non-breaching party for the failure of the other party to fulfill its contractual obligations.397 Such a contractual damages or remedy provision, this commenter contended, is not analogous to a financial settlement option in a trading instrument.398 This commenter further asserted that one party or the other may be unable to perform, or excused or prevented for commercial reasons from performing, its contractual obligations to make or take delivery of a nonfinancial commodity, and therefore may be liable to the other party for a monetary payment, calculated in accordance with the contract.399 Another commenter noted that physically settled gas contracts, including peaking contracts (both for daily and monthly supply), bullet day contracts and weather contracts, use
the NAESB Base Contract, which does not provide for financial settlement other than a liquidated damages provision, which would compensate a utility for its cost of obtaining alternative supply at the prevailing market price if the seller fails to deliver.400 This commenter stated its view that the seller has no real opportunity to arbitrage its obligation to deliver based on changes in price, and the purchaser has no incentive to fail to take delivery of its specified quantities of gas, because they are needed for the physical operations of its system.401 The CFTC generally agrees with these comments regarding liquidated damages provisions, and has provided the final interpretation described above to address them. (c) Security Forwards 402 As the Commissions stated in the Proposing Release, the Commissions believe it is appropriate to address how the exclusions from the swap and security-based swap definitions apply to security forwards and other purchases and sales of securities.403 The Commissions are restating the interpretation set out in the Proposing Release without modification. The Dodd-Frank Act excludes purchases and sales of securities from the swap and security-based swap definitions in a number of different clauses.404 Under these exclusions, purchases and sales of securities on a fixed or contingent basis 405 and sales of securities for deferred shipment or delivery that are intended to be physically delivered 406 are explicitly excluded from the swap and security￾based swap definitions.407 The exclusion from the swap and security￾based swap definitions of a sale of a security for deferred shipment or delivery involves an agreement to purchase one or more securities, or groups or indexes of securities, at a future date at a certain price. As with other purchases and sales of securities, security forwards are

408A purchase or sale of a security occurs at the time the parties become contractually bound, not at the time of settlement (regardless of whether cash or physically settled). See Securities Offering Reform, 70 FR 44722 (Aug. 3, 2005). 409See section 1a(47)(B)(ii) of the CEA, 7 U.S.C. 1a(47)(B)(ii). 410See sections 1a(47)(B)(v) and (vi) of the CEA, 7 U.S.C. 1a(47)(B)(v) and (vi). 411The Commissions provided the interpretation in the Proposing Release in response to commenters on the ANPR. See Proposing Release at 29830. These commenters requested clarification that forward sales of MBS guaranteed or sold by Fannie Mae, Freddie Mac and Ginnie Mae would not be included in the swap and security-based swap definitions in order to provide the certainty needed to avoid unnecessary disruption of this market. Id. 412Task Force on Mortgage-Backed Securities Disclosure, ‘‘Staff Report: Enhancing Disclosure in the Mortgage-Backed Securities Markets,’’ part II.E.2 (Jan. 2003), which is available at http:// www.sec.gov/news/studies/mortgagebacked.htm (‘‘MBS Staff Report’’). 413 Id. 414 Id. 415 Id. 416 Id. The good delivery guidelines, titled ‘‘Uniform Practices for the Clearance and Settlement of Mortgage-Backed Securities and Other Related Securities,’’ which govern the mechanics of trading and settling MBS, contain specific guidelines for trading and settling MBS guaranteed or sold by Fannie Mae, Freddie Mac and Ginnie Mae in the TBA market. The good delivery guidelines outline the basic terms and conditions for trading, confirming, delivering and settling MBS. The good delivery guidelines set forth the basic characteristics that MBS guaranteed or sold by Fannie Mae, Freddie Mac and Ginnie Mae must have to be able to be delivered to settle an open TBA transaction. Id. The Securities Industry and Financial Markets Association (‘‘SIFMA’’) is the successor to the Bond Market Association and publishes the good delivery guidelines, which are available at http://www.sifma.org/services/ standard-forms-and-documentation/securitized￾products/. 417See section 1a(47)(B)(ii) of the CEA, 7 U.S.C. 1a(47)(B)(ii). 418See sections 1a(47)(B)(v) and (vi) of the CEA, 7 U.S.C. 1a(47)(B)(v) and (vi). 419See Letter from Lisa M. Ledbetter, Vice President and General Counsel, Legislative & Regulatory Affairs, Freddie Mac, Jul. 21, 2011. 420See Better Markets Letter. 421 Id. 422 Id. 423 Id. 424See supra note 408. excluded from the swap and security￾based swap definitions. The sale of the security in this case occurs at the time the forward contract is entered into with the performance of the contract deferred or delayed.408 If such agreement, contract, or transaction is intended to be physically settled, the Commissions believe it would be within the security forward exclusion and therefore outside the swap and security-based swap definitions.409 Moreover, as a purchase or sale of a security, the Commissions believe it also would be within the exclusions for the purchase or sale of
one or more securities on a fixed basis (or, depending on its terms, a contingent basis) and, therefore, outside the swap and security-based swap definitions.410 In the Proposing Release, the Commissions provided the following specific interpretation in the context of forward sales of mortgage-backed securities (‘‘MBS’’) guaranteed or sold by the Federal National Mortgage Association (‘‘Fannie Mae’’), the Federal Home Loan Mortgage Corporation (‘‘Freddie Mac’’), and the Government National Mortgage Association (‘‘Ginnie Mae’’).411 The Commissions are restating their interpretation regarding such forward sales. MBS guaranteed or sold by Fannie Mae, Freddie Mac and Ginnie Mae are eligible to be sold in the ‘‘To-Be￾Announced’’ (‘‘TBA’’) market, which is essentially a forward or delayed delivery market.412 The TBA market has been described as one that ‘‘allows mortgage lenders essentially to sell the loans they intend to fund even before the loans are closed.’’ 413 In the TBA market, the lender enters into a forward contract to sell MBS and agrees to deliver MBS on the settlement date in the future. The specific MBS that will be delivered in the future may not yet be created at the time the forward contract is entered into.414 In a TBA transaction, the seller and the buyer agree to five terms before entering into the transaction: (i) The type of security, which will usually be a certain type of MBS guaranteed or sold by Fannie Mae, Freddie Mac or Ginnie Mae and the type of mortgage underlying the MBS; (ii) the coupon or interest rate; (iii) the face value (the total dollar amount of MBS the purchaser wishes to purchase); (iv) the price; and (v) the settlement date.415 The purchaser will contract to acquire a specified dollar amount of MBS, which may be satisfied when the seller delivers one or more MBS pools at settlement.416 The Commissions are confirming that such forward sales of MBS in the TBA market would fall within the exclusion for sales of securities on a deferred settlement or delivery basis even though the precise MBS are not in existence at the time the forward MBS sale is entered into.417 Moreover, as the purchase or sale of a security, the Commissions also are confirming that such forward sales of MBS in the TBA market would fall within the exclusions for the purchase or sale of one or more securities on a fixed basis (or, depending on its terms, a contingent basis) and therefore would fall outside the swap and security-based swap definitions.418 Comments The Commissions received two comments on the interpretation regarding security forwards. One commenter recommended that the Commissions codify in the text of the final rules the interpretation regarding forward sales of MBS in the TBA market.419 The Commissions are not codifying the interpretation because codification will create a bright-line test. The Commissions note that the analysis as to whether any product falls within the exclusion for sales of securities on a deferred
settlement or delivery basis requires flexibility, including the consideration of applicable facts and circumstances. Because the interpretation regarding forward sales of MBS in the TBA market is based on particular facts and circumstances, the Commissions do not believe that a bright-line test is appropriate. Another commenter suggested that the Commissions narrow the exclusion for contracts for the purchase and sale of securities for subsequent delivery as applied to security-based swaps because parties can use the formal characterization of a delivery contract for securities to disguise a transaction that is substantively a security-based swap.420 This commenter was concerned because this commenter believes that the securities subject to such a delivery obligation are often easily convertible into cash, which facilitates cash settlement without actual delivery.421 As such, this commenter suggested that the Commissions should provide a test for determining whether parties have a bona fide intent to deliver.422 This commenter recommended that such test should prohibit cash settlement options in contracts for subsequent delivery and should not consider a party that frequently unwinds physical positions with cash settlements using side agreements as having the requisite intent to deliver.423 The Commissions are not providing a test at this time for determining whether parties have a bona fide intent to deliver because the analysis as to whether sales of securities for deferred shipment or delivery are intended to be physically delivered is a facts and circumstances determination and a bright-line test will not allow for the flexibility needed in such analysis. Further, the Commissions note that the purchase and sale of a security occurs at the time the forward contract is entered into.424

425See Proposing Release at 29832.
426 Id.
427 Id.
428 Id.
429 Id. If these types of arrangements were subject to Title VII, the persons that could enter into or engage in them could be restricted because Title VII imposes restrictions on entering into swaps and security-based swaps with persons who are not eligible contract participants (‘‘ECPs’’). See sections 723(1), 763(e), and 768(b) of the Dodd-Frank Act. The Dodd-Frank Act amended the Securities Act and the Exchange Act to require that security-based swap transactions involving a person that is not an ECP must be registered under the Securities Act and effected on a national securities exchange, and also amended the CEA to require that swap transactions involving a person that is not an ECP must be entered into on, or subject to the rules of, a board of trade designated as a contract market. Id. The Commissions note that many consumers and commercial and non-profit entities may not be ECPs. See section 1a(18) of the CEA, 7 U.S.C. 1a(18). Further, if these types of arrangements were subject to Title VII, they would be subject to the full regulatory scheme for swaps and security-based swaps created by Title VII. These requirements could increase costs for consumers and commercial and non-profit entities and potentially disrupt their ability to enter into these arrangements. 430See Proposing Release at 29832–33. 431See infra note 447 and accompanying text. 432For example, a mortgage broker may arrange a rate lock on behalf of a consumer borrower. 433The Commissions are not addressing here the applicability of any other provisions of the CEA, the Federal securities laws or the Commissions’ regulations to such agreements, contracts or transactions. 434These agreements, contracts, or transactions require the parties respectively to make and take delivery of the underlying commodity to each other directly; delivery may be deferred for convenience or necessity. But see section 2(c)(2)(D) of the CEA, 7 U.S.C. 2(c)(2)(D), generally prohibiting certain leveraged, margined or financed agreements, contracts and transactions with non-ECPs when actual delivery does not occur within 28 days). The Commissions view consumer agreements, contracts, and transactions involving periodic or future purchases of consumer products and services as transactions that are not swaps. This interpretation does not extend to consumer agreements, contracts or transactions containing embedded optionality or embedded derivatives other than those discussed in the text associated with this footnote. This analysis of consumer contracts is separate from the forward contract analysis for commercial merchandising transactions discussed in supra part II.B.2. The CFTC continues to view the forward contract exclusion for nonfinancial commodities as limited to commercial merchandising transactions. 435An example of a consumer loan with a variable rate of interest is credit card debt that includes a ‘‘teaser’’ rate. The teaser rate is a low, adjustable introductory interest rate that is
temporary. 436One commenter indicated that such service agreements, contracts, or transactions may be regulated as insurance in some but not all states. However, the Commissions believe that it is appropriate to address these agreements, contracts, or transactions in the context of their guidance regarding consumer and commercial arrangements. See NAIC Letter. 437The Commissions believe that options entered into by consumers that result in physical delivery of the commodity, if exercised, are not the type of agreements, contracts or transactions that Congress intended to regulate as swaps or security-based swaps. Conversely, options entered into by consumers that cash settle based on the difference between the market price and the contract price of a commodity are not within the scope of this interpretation. 438Examples of these types of transactions include consumer transactions that may be cancelled pursuant to the Federal Reserve Board’s Regulation Z, 12 CFR Part 226 (i.e. certain consumer credit transactions that involve a lien on the consumer’s principal dwelling), consumer mail/ telephone orders that may be cancelled when orders have not been filled under 16 CFR Part 435, and other consumer transactions that have cancellations rights conferred by statute or regulation.
3. Consumer and Commercial
Agreements, Contracts, and Transactions The Commissions noted in the Proposing Release that ‘‘[c]onsumers enter into various types of agreements, contracts, and transactions as part of their household and personal lives that may have attributes that could be viewed as falling within the swap or security-based swap definition.425 Similarly, businesses and other entities, whether or not for profit, also enter into agreements, contracts, and transactions as part of their operations relating to, among other things, acquisitions or sales of property (tangible and intangible), provisions of services, employment of individuals, and other matters that could be viewed as falling within the definitions.’’ 426 Commenters on the ANPR pointed out a number of areas in which a broad reading of the swap and security-based swap definitions could cover certain consumer and commercial arrangements that historically have not been considered swaps or security-based swaps.427 Examples of such instruments cited by those commenters included evidences of indebtedness with a variable rate of interest; commercial contracts containing acceleration, escalation, or indexation clauses; agreements to acquire personal property or real property, or to obtain mortgages; employment, lease, and service agreements, including those that contain contingent payment arrangements; and consumer mortgage and utility rate caps.428 The Commissions also stated in the Proposing Release that they ‘‘do not believe that Congress intended to include these types of customary consumer and commercial agreements, contracts, or transactions in the swap or security-based swap definition, to limit the types of persons that can enter into or engage in them, or to otherwise to subject these agreements, contracts, or transactions to the regulatory scheme for swaps and security-based swaps.’’ 429 Accordingly, the Commissions proposed an interpretation in the Proposing Release to assist consumers and commercial and non-profit entities in understanding whether certain agreements, contracts, or transactions that they enter into would be regulated as swaps or security-based swaps.430 The Commissions are adopting the interpretation set out in the Proposing Release with certain modifications in response to commenters.431 With respect to consumers, the Commissions have determined that the types of agreements, contracts, or transactions that will not be considered swaps or security-based swaps when entered into by consumers (natural persons) as principals (or by their agents)432 primarily for personal, family, or household purposes, include:433

• Agreements, contracts, or
  transactions to acquire or lease real or personal property, to obtain a mortgage, to provide personal services, or to sell or assign rights owned by such consumer (such as intellectual property rights);
• Agreements, contracts, or
  transactions to purchase products or services for personal, family or household purposes at a fixed price or a capped or collared price, at a future date or over a certain time period (such as agreements to purchase for personal use or consumption nonfinancial energy commodities, including agreements to purchase home heating fuel or agreements involving residential fuel storage, in either case, where the consumer takes delivery of and uses the fuel, and the counterparty is a merchant that delivers in the service area where the consumer resides);434
• Agreements, contracts, or
  transactions that provide for an interest rate cap or lock on a consumer loan or mortgage, where the benefit of the rate cap or lock is realized only if the loan or mortgage is made to the consumer;
• Consumer loans or mortgages with
  variable rates of interest or embedded interest rate options, including such loans with provisions for the rates to change upon certain events related to the consumer, such as a higher rate of interest following a default; 435
• Service agreements, contracts, or
  transactions that are consumer product warranties, extended service plans, or buyer protection plans, such as those purchased with major appliances and electronics; 436
• Consumer options to acquire, lease,
  or sell real or personal property, such as options to lease apartments or purchase rugs and paintings, and purchases made through consumer layaway plans; 437
• Consumer agreements, contracts, or
  transactions where, by law or regulation, the consumer may cancel the transaction without legal cause; 438 and

439See supra note 96 and accompanying text. See also infra notes 436, 454 and 455 and accompanying text. 440The additional example regarding consumer options to acquire, lease, or sell real or personal property was added in response to a commenter on the ANPR. See Letter from White & Case LLP, dated September 20, 2010. The Commissions also are providing as additional examples consumer agreements, contracts, or transactions where, by law or regulation, the consumer may cancel the transaction without legal cause, and consumer guarantees of credit card debt, automobile loans, and mortgages of a friend or relative. 441These business combination transactions include, for example, a reclassification, merger, consolidation, or transfer of assets as defined under the Federal securities laws or any tender offer subject to section 13(e) and/or section 14(d) or (e) of the Exchange Act, 15 U.S.C. 78m(e) and/or 78n(d) or (e). These business combination agreements, contracts, or transactions can be contingent on the continued validity of representations and warranties and can contain earn-out provisions and contingent value rights. 442The Commissions believe that such lending arrangements included in this category are traditional borrower/lender arrangements documented using, for example, a loan agreement or indenture, as opposed to a synthetic lending arrangement documented in the form of, for example, a total return swap. The Commissions also note that securitization transaction agreements also may contain contingent obligations if the representations and warranties about the underlying assets are not satisfied. 443While the Commissions have included fixed or variable interest rate commercial loans entered into by banks, the Commissions understand that the CEA does not apply to, and the CFTC may not exercise regulatory authority over, identified banking products, and that the definitions of the terms ‘‘security-based swap’’ and ‘‘security-based swap agreement’’ do not include identified banking products. See infra note 488, regarding identified banking products. However, such loans and mortgages provided by certain banks may not qualify as identified banking products because those banks may not satisfy the definition of ‘‘bank’’ for purposes of the ‘‘identified banking products’’ definition. See 7 U.S.C. 27(a). 444See infra notes 456 and 461 and accompanying text.

• Consumer guarantees of credit card
  debt, automobile loans, and mortgages of a friend or relative. The Commissions have included in the interpretation above several additional examples of consumer arrangements that the Commissions do not consider to be swaps or security-based swaps. These additional examples have been included in response to commenters 439 and the Commissions’ determination that such additional examples would assist consumers in identifying other agreements, contracts, or transactions that they enter into that would not be regulated as swaps or security-based swaps.440 The types of commercial agreements, contracts, or transactions that involve customary business arrangements (whether or not involving a for-profit entity) and will not be considered swaps or security-based swaps under this interpretation include:
• Employment contracts and
  retirement benefit arrangements;
• Sales, servicing, or distribution
  arrangements;
• Agreements, contracts, or
  transactions for the purpose of effecting a business combination transaction; 441
• The purchase, sale, lease, or transfer
  of real property, intellectual property, equipment, or inventory;
• Warehouse lending arrangements in
  connection with building an inventory of assets in anticipation of a securitization of such assets (such as in a securitization of mortgages, student loans, or receivables); 442
• Mortgage or mortgage purchase
  commitments, or sales of installment loan agreements or contracts or receivables;
• Fixed or variable interest rate
  commercial loans or mortgages entered into by banks 443 and non-banks, including the following:
• Fixed or variable interest rate
  commercial loans or mortgages entered into by the Farm Credit System institutions and Federal Home Loan Banks;
• Fixed or variable interest rate
  commercial loans or mortgages with embedded interest rate locks, caps, or floors, provided that such embedded interest rate locks, caps, or floors are included for the sole purpose of providing a lock, cap, or floor on the interest rate on such loan or mortgage and do not include additional provisions that would provide exposure to enhanced or inverse performance, or other risks unrelated to the interest rate risk being addressed;
• Fixed or variable interest rate
  commercial loans or mortgages with embedded interest rate options, including such loans or mortgages that contain provisions causing the interest rate to change upon certain events related to the borrower, such as a higher rate of interest following a default, provided that such embedded interest rate options do not include additional provisions that would provide exposure to enhanced or inverse performance, or other risks unrelated to the primary reason the embedded interest rate option is included; and
• Commercial agreements, contracts,
  and transactions (including, but not limited to, leases, service contracts, and employment agreements) containing escalation clauses linked to an underlying commodity such as an interest rate or consumer price index. In response to commenters,444 the Commissions have included in the interpretation above several additional examples of commercial arrangements that the Commissions do not consider to be swaps or security-based swaps. The Commissions intend for this interpretation to enable consumers to engage in transactions relating to their households and personal or family activities without concern that such arrangements would be considered swaps or security-based swaps. Similarly, with respect to commercial business arrangements, this interpretation should allow commercial and non-profit entities to continue to operate their businesses and operations without significant disruption and provide that the swap and security￾based swap definitions are not read to include commercial and non-profit operations that historically have not been considered to involve swaps or security-based swaps. The types of agreements, contracts, and transactions discussed above are not intended to be exhaustive of the customary consumer or commercial arrangements that should not be considered to be swaps or security￾based swaps. There may be other, similar types of agreements, contracts, and transactions that also should not be considered to be swaps or security￾based swaps. In determining whether similar types of agreements, contracts, and transactions entered into by consumers or commercial entities are swaps or security-based swaps, the Commissions intend to consider the characteristics and factors that are common to the consumer and commercial transactions listed above:
• They do not contain payment
  obligations, whether or not contingent, that are severable from the agreement, contract, or transaction;
• They are not traded on an organized
  market or over-the-counter; and
• In the case of consumer
  arrangements, they:
  —Involve an asset of which the consumer is the owner or beneficiary, or that the consumer is purchasing, or they involve a service provided, or to be provided, by or to the consumer, or
• In the case of commercial
  arrangements, they are entered into:
  —By commercial or non-profit entities as principals (or by their agents) to serve an independent commercial, business, or non-profit purpose, and —Other than for speculative, hedging, or investment purposes. Two of the key components reflected in these characteristics that distinguish these agreements, contracts, and transactions from swaps and security￾based swaps are that: (i) The payment provisions of the agreement, contract, or transaction are not severable; and (ii)

445There also are alternative regulatory regimes that have been enacted as part of the Dodd-Frank Act specifically to provide enhanced protections to consumers relating to various consumer transactions. See, e.g., the Consumer Financial Protection Act of 2010, Public Law 111–203, tit. X, 124 Stat. 1376 (Jul. 21, 2010) (establishing the Bureau of Consumer Financial Protection to regulate a broad category of consumer products and amending certain laws under the jurisdiction of the Federal Trade Commission); the Mortgage Reform and Anti-Predatory Lending Act, Public Law 111– 203, tit. XIV, 124 Stat. 1376 (Jul. 21, 2010) (amending existing laws, and adding new provisions, related to certain mortgages). Some of these agreements, contracts, or transactions are subject to regulation by the Federal Trade Commission and other Federal financial regulators and state regulators. 446See infra note 470. 447See BGA Letter; Letter from The Coalition for Derivatives End-Users, Jul. 22, 2011, (‘‘CDEU Letter’’); ETA Letter; Letter from Robbie Boone, Vice President, Government Affairs, Farm Credit Council, Jul. 22, 2011 (‘‘FCC Letter’’); FERC Staff Letter; Letter from Warren N. Davis, Of Counsel, Sutherland Asbill & Brennan LLP, on behalf of the Federal Home Loan Banks, Jul. 22, 2011 (‘‘FHLB Letter’’); IECA Letter; ISDA Letter; Just Energy Letter; PMAA/NEFI Letter; and SEIA Letter. 448See ETA Letter; FERC Letter; IECA Letter; and Just Energy Letter. 449See IECA Letter. 450See Proposing Release at 29832. 451See ISDA Letter. 452 Id. 453See CDEU Letter; FCC Letter; FERC Letter; FHLB Letter; ISDA Letter; Just Energy Letter; PMAA/NEFI Letter; and SEIA Letter. 454See Just Energy Letter. the agreement, contract, or transaction is not traded on an organized market or over-the-counter, and therefore such agreement, contract, or transaction does not involve risk-shifting arrangements with financial entities, as would be the case for swaps and security-based swaps.445 In response to commenters,446 the Commissions clarify that merely because an agreement, contract, or transaction is assignable does not mean that it is ‘‘traded’’ or that the agreement, contract, or transaction is a swap or security-based swap. An assignment of a contractual obligation must be analyzed to assure that the result is not to sever the payment obligations. This interpretation is not intended to be the exclusive means for consumers and commercial or non-profit entities to determine whether their agreements, contracts, or transactions fall within the swap or security-based swap definition. If there is a type of agreement, contract, or transaction that is not enumerated above, or does not have all the characteristics and factors that are listed above (including new types of agreements, contracts, or transactions that may be developed in the future), the agreement, contract, or transaction will be evaluated based on its particular facts and circumstances. Parties to such an agreement, contract or
transaction may also seek an interpretation from the Commissions as to whether the agreement, contract or transaction is a swap or security-based swap. Comments Eleven commenters provided comments on the proposed interpretation set forth in the Proposing Release regarding consumer and commercial arrangements.447 While most commenters supported the proposed interpretation, these commenters suggested certain changes. Four commenters recommended that the Commissions codify the proposed interpretation regarding consumer and commercial arrangements.448 The Commissions are not codifying the interpretation. The interpretation is intended to provide guidance to assist consumers and commercial and non￾profit entities in evaluating whether certain arrangements that they enter into will be regulated as swaps or security￾based swaps. The interpretation is intended to allow the flexibility necessary, including the consideration of the applicable facts and circumstances by the Commissions, in evaluating consumer and commercial arrangements to ascertain whether they may be swaps or security-based swaps. The representative characteristics and factors taken together are indicators that a consumer or commercial arrangement is not a swap or security-based swap and the Commissions have provided specific examples demonstrating how these characteristics and factors apply to some common types of consumer and commercial arrangements. However, as the interpretation is not intended to be a bright-line test for determining whether a particular consumer or commercial arrangement is a swap or security-based swap, if the particular arrangement does not meet all of the identified characteristics and factors, the arrangement will be evaluated based on its particular facts and circumstances. One commenter was concerned that the interpretation itself implicitly suggests that many types of consumer and commercial arrangements could be swaps, although none of these arrangements historically has been considered a swap.449 The Commissions do not intend to suggest that many types of consumer and commercial arrangements that historically have not been considered swaps are within the swap or security-based swap definitions. The Commissions provided the interpretation in response to comments received on the ANPR. Commenters on the ANPR identified areas in which a broad reading of the swap and security-based swap definitions could cover certain consumer and commercial arrangements that historically have not been considered swaps or security-based swaps.450 The Commissions believe it is appropriate to provide the interpretation to allow consumers and commercial and non-profit entities to engage in such transactions without concern that such arrangements would be considered swaps or security-based swaps. One commenter requested that the Commissions remove the term ‘‘customary’’ from the description of consumer and commercial arrangements in the interpretation.451 The Commissions note that
the use of the term ‘‘customary’’ was not intended to limit the interpretation, but rather was used to describe certain types of arrangements that consumers and businesses may normally or generally enter into. The Commissions also note that the term ‘‘customary’’ is itself not a separate representative characteristic or factor for purposes of the interpretation. This commenter also requested that specific examples of consumer and commercial arrangements that are not swaps or security-based swaps include ‘‘any other similar agreements, contracts, or transactions.’’ 452 The specific examples are not intended to be an exhaustive list and the Commissions do not believe that it is necessary to include a general catchall provision. The interpretation also includes a list of representative characteristics and factors to be used to analyze other consumer and commercial arrangements. Several commenters suggested additional examples of consumer and commercial arrangements that the Commissions should not consider to be swaps or security-based swaps.453 One commenter suggested that the Commissions should expand the example of ‘‘consumer agreements, contracts, or transactions to purchase products or services at a fixed price or a capped or collared price, at a future date or over a certain time period (such as agreements to purchase home heating fuel)’’ to include all nonfinancial energy commodities in the parenthetical example.454 The Commissions have modified the identified consumer example to include all nonfinancial energy commodities. The parenthetical example was not intended to be limited to agreements to purchase home heating fuel. One commenter suggested that the Commissions should include as an

455See PMAA/NEFI Letter. 456See CDEU Letter; FCC Letter; and FHLB Letter. 457See FCC Letter and FHLB Letter. 458See infra note 488, regarding identified banking products. 459See 7 U.S.C. 27(a). See also FCC Letter and FHLB Letter. 460See supra note 457. 461See CDEU Letter; FCC Letter; and FHLB Letter. These commenters indicated that such arrangements are similar to the arrangements included in the list of examples of consumer arrangements that the Commissions would not consider to be swaps or security-based swaps. 462See section 1a(47)(A)(i) of the CEA, 7 U.S.C. 1a(47)(A)(i). Similarly, with respect to consumer agreements, contracts and transactions providing for an interest rate cap or an interest rate lock on a consumer loan or mortgage, the Commissions are limiting this example to interest rate caps and interest rate locks entered into in connection with the consumer loan or mortgage and prior to closing on the loan or mortgage. For this purpose, both because obtaining a consumer loan or mortgage can involve a great deal of documentation, which can be entered into at different times during the process, and because consumers may have some flexibility as to their deadline for deciding when to include or exclude an interest rate cap or lock in their consumer loans or mortgages, the Commissions will consider an interest rate cap or lock to be entered into in connection with a consumer loan or mortgage if it is included in the final terms of the loan at closing. 463See BGA Letter (commercial physical transactions in the natural gas and electric power markets should also fall under the category of exemptions from the swap definition); FERC Letter (commercial transactions executed or traded on RTOs/ISOs should be included in the interpretation); Just Energy Letter (commercial arrangements to purchase products or services at a fixed price or a capped or collared price, at a future date or over a certain time period); and PMAA/NEFI Letter (petroleum fuel and gas storage contracts between bona fide commercial market participants or entities other than financial entities). 464See supra part II.B.2. The Commissions note that they provided the interpretation regarding consumer arrangements because the CFTC in the past has not interpreted the forward contract exclusion for nonfinancial commodities to apply to consumer arrangements. See supra note 434. 465See supra note 317 and accompanying text. 466See FCC Letter. 467See ETA Letter and ISDA Letter. 468 Id. additional example residential fuel storage contracts.455 The Commissions agree that these arrangements should not be considered swaps or security￾based swaps, provided that they are residential fuel storage contracts where the consumer takes delivery of and consumes the fuel, and the counterparty is a merchant (or agent of a merchant) that delivers in the service area where the consumer’s residence is located. Although the consumer may not immediately consume the fuel contracted for, because it will
ultimately consume the fuel for personal, family, or household purposes, such a transaction is a type of customary consumer transaction excluded from the swap and security-based swap definitions. Three commenters requested clarification that commercial loans and mortgages would fall within the interpretation regardless of whether entered into by a bank or non-bank.456 Two of these commenters were concerned that the specific example was limited to commercial loans and mortgages entered into by non-banks and did not address commercial loans and mortgages entered into by financial institutions that are banks but whose loans and mortgages do not qualify as identified banking products.457 The Commissions are revising the example to clarify that it includes fixed or variable interest rate commercial loans or mortgages entered into by both banks and non-banks, including such loans and mortgages entered into by the Farm Credit System institutions and Federal Home Loan Banks. The Commissions understand that the CEA does not apply to, and the CFTC may not exercise regulatory authority over, and the definitions of the terms ‘‘security-based swap’’ and ‘‘security-based swap agreement’’ do not include, any fixed or variable interest rate commercial loan or mortgage entered into by a bank that is an identified banking product.458 However, loans and mortgages provided by certain banks may not qualify as identified banking products because those banks do not satisfy the definition of ‘‘bank’’ for purposes of the ‘‘identified banking products’’ definition.459 According to commenters,460 while this definition of ‘‘bank’’ includes insured depository institutions, certain foreign banks, credit unions, institutions regulated by the Federal Reserve and trust companies, it does not include certain other financial institutions that provide commercial loans or mortgages, such as government￾sponsored enterprises (including the Federal Home Loan Banks) and certain cooperatives (including the Farm Credit System institutions). Three commenters suggested that the Commissions should include as additional examples commercial rate lock agreements and commercial loans with interest rate caps, floors, or options.461 The Commissions agree that these arrangements should not be considered swaps or security-based swaps, provided that the interest rate locks, caps, or floors, or interest rate options are embedded in the commercial loans or mortgages and not entered into separately from the commercial loans and mortgages, and are including these arrangements as examples in the interpretation. However, the Commissions are limiting the interpretation to embedded interest rate locks, caps, or floors, and interest rate options because interest rate locks, caps, or floors, or interest rate options that are entered into separately from the commercial loans and mortgages fall within the swap definition.462 In order to further distinguish these arrangements from swaps and security￾based swaps,
the interpretation provides the following: (i) The embedded interest rate lock, cap, or floor must be included for the sole purpose of providing a lock, cap, or floor on the interest rate on such loan or mortgage and may not include additional provisions that would provide exposure to enhanced or inverse performance, or other risks unrelated to the interest rate risk being addressed, and (ii) the embedded interest rate option may not include additional provisions that would provide exposure to leverage, inverse performance, or other risks unrelated to the primary reason the embedded interest rate option is included in the commercial loan or mortgage. Four commenters suggested additional examples of commercial arrangements that relate to nonfinancial energy commodities.463 These arrangements are more appropriately addressed in the context of the forward contract exclusion for nonfinancial commodities 464 or the trade option exemption.465 One commenter supported the representative characteristics and factors the Commissions set forth to distinguish consumer and commercial arrangements from swaps and security￾based swaps.466 Two commenters were concerned with certain of these characteristics and factors because these commenters believed that such characteristics and factors are common in a wide variety of consumer and commercial arrangements.467 Both commenters suggested that the Commissions remove ‘‘for other than speculative, hedging or investment purposes’’ from the interpretation because many of the types of transactions listed as examples may be undertaken for speculative, hedging or investment purposes and because all commercial merchandising transactions are ‘‘risk-shifting’’ of commercial obligations and risks, and ‘‘hedge’’ the enterprise’s commercial risks.468 The Commissions are not revising the interpretation to remove or otherwise modify this representative characteristic and factor. The Commissions believe that commercial arrangements undertaken for speculative, hedging or investment purposes may be a swap or a security-based swap depending on the particular facts and circumstances of the arrangement.

469See ISDA Letter.
470 Id.
471See ETA Letter.
472 16 U.S.C. Chapter 12H.
473Letter from Virginia K. Schaeffer, Attorney, Office of General Counsel, Bonneville Power Administration, Jul. 22, 2011 (‘‘BPA Letter’’). This commenter refers to the implementation of Section 5(c) of the Northwest Power Act, 16 U.S.C. 839c(c), as the ‘‘Residential Exchange Program.’’ See Id. 474See BPA Letter. This commenter explained that, under the REP: ‘‘A Pacific Northwest electric utility has a right to * * * sell power to Bonneville at the utility’s average system cost (ASC) of providing that power * * * Bonneville[] is required to purchase that power at the utility’s ASC, and then sell an equivalent amount of power back to the utility at Bonneville’s rates[,] which are based in substantial part on low cost Federal hydro power. As required by the Residential Exchange Statute, the amount of such power ‘‘exchanged’’ is based on the related utility’s residential and small farm customer’s power needs (also known as ‘‘loads’’) in the Pacific Northwest Region. Under this ‘‘exchange,’’ no actual power is transferred to or from Bonneville. Instead, consistent with Congressional intent, the exchange transaction is implemented as an accounting device that avoids the costs and burdens associated with a physical exchange of power and that results in the payment of funds by Bonneville to the REP exchanging utilities. Reduced to the essentials, the Residential Exchange Statute as implemented in * * * REP contracts results in Bonneville making cash payments for the positive difference between the utility’s ASC and Bonneville’s lower rate multiplied by the qualifying residential and small farm loads. And, as required under the Residential Exchange Statute, the entire monetary benefit Bonneville provides to the REP exchanging utilities is in turn passed through to the residential and small farm power consumers of that utility.’’ Id. 475A spread option is ‘‘an option in which the payout is based on the difference in performance between two assets.’’ Superderivatives, ‘‘Spread option in EQ’’ definition, available at http:// www.sdgm.com/Support/Glossary.aspx?letter=S. See also S.J. Denga and S.S. Oren, Electricity derivatives and risk management, Science Direct at 945 (2006), available at http://www.ieor. berkeley.edu/∼oren/pubs/Deng%20and%20Oren￾86.pdf (defining a spark spread options as ‘‘cross￾commodity options paying out the difference between the price of electricity sold by generators and the price of the fuels used to generate it’’); Chicago Mercantile Exchange, Soybean-Corn Price Ratio Options Fact Card (describing its soybean￾corn price ratio option contract as ‘‘an option on the ratio between the price of the referencing Soybean futures contract and the price of the referencing Corn futures contract * * *’’), available at http:// www.cmegroup.com/trading/agricultural/files/AC￾440-Soybean-CornRatioOptionsFC.pdf. 476Even a hedging party assumes the risk that the market can move against its hedging position, causing the hedge to reduce the profit it
otherwise would have made on an unhedged position. 477The fact that the Commissions are relying in
part on this aspect of REP transactions to interpret
such transactions to be neither swaps nor security￾based swaps does not mean that market participants should conclude, in other contexts, that a lack of market risk removes an agreement, contract, or transaction from the swap and security-based swap definitions. The Commissions’ conclusion as to REP transactions is based on the unique facts and circumstances presented by the commenter. 478See, e.g., Paul M. Murphy, Northwest Public Power Association, Background and Summary of the Residential Exchange Program Settlement Agreement, March 16, 2011, available at http:// www.nwppa.org/cwt/external/wcpages/wcmedia/ documents/background_and_summary_of_rep_ settlement_agreement.pdf (characterizing the REP as ‘‘require[ing] BPA to subsidize the residential and small farm consumers of the higher cost utilities in the Pacific Northwest’’). 479See Proposing Release at 29834. One of these commenters also suggested the Commissions remove ‘‘do not contain payment obligations that are severable’’ from the interpretation because assignment of rights and delegation of obligations are common in a wide variety of consumer and commercial transactions.469 The Commissions are not revising the interpretation to remove or otherwise modify this representative characteristic and factor. The Commissions believe that the severability of payment obligations could be indicative of a consumer or commercial arrangement that may be a swap or a security-based swap depending on the particular facts and circumstances of the arrangement because the severability of payment obligations could be indicative of an instrument that is merely an exchange of payments, such as is the case with swaps and security-based swaps. One of these commenters also suggested that the Commissions remove ‘‘not traded on an organized market or over the counter’’ from the interpretation because many of the types of contracts listed as examples are assignable and frequently assigned or traded.470 The other commenter did not suggest removing this factor, but requested that the factor be modified to provide that the arrangement is not traded on a ‘‘registered entity’’ in order not to include transactions on organized wholesale electricity markets.471 The Commissions are not revising the interpretation to remove or otherwise modify this representative characteristic and factor. The Commissions believe that the trading of an instrument on an organized market or over the counter could be indicative of a consumer or commercial arrangement that may be a swap or a security-based swap depending on the particular facts and circumstances of the arrangement. However, as noted above, the Commissions are clarifying that merely because an arrangement is assignable does not mean that it is ‘‘traded’’ or that the arrangement is a swap or security￾based swap. An assignment of a contractual obligation must be analyzed to assure that the result is not to sever the payment obligations. Further, as noted above, the representative
characteristics and factors are not intended to be a bright￾line test for determining whether a particular consumer or commercial arrangement is a swap or security-based swap. These representative characteristics and factors taken together are indicators that a consumer or commercial arrangement is not a swap or security-based swap. These representative characteristics and factors also do not imply or presume that a consumer or commercial arrangement that does not meet all of these characteristics and factors is a swap or security-based swap. As noted above, if a particular arrangement does not meet all of these characteristics and factors, the parties will need to evaluate the arrangement based on the particular facts and circumstances. Moreover, as noted above, if there is a type of consumer or commercial arrangement that does not meet all of these characteristics and factors, a party to the arrangement can seek an interpretation from the Commissions as to whether the arrangement is outside the scope of the swap and security-based swap definitions. Residential Exchange Program One commenter requested that the CFTC further define the term ‘‘swap’’ to exclude consumer benefits under the Pacific Northwest Electric Power Planning and Conservation Act of 1980 (‘‘Northwest Power Act’’) 472 and transactions under the ‘‘Residential Exchange Program’’ (‘‘REP’’).473 According to this commenter, the REP was established by Congress ‘‘[t]o extend the benefits of low cost Federal System hydro power to residential and small farm electric power consumers throughout the Pacific Northwest Region.’’ 474 Based on the commenter’s description, REP transactions do not appear to be among the types of transactions historically considered swaps or security-based swaps. Although the REP transactions described by the commenter share some features with spread options (e.g., they settle in cash based on the difference between two price sources),475 in both swaps and security-based swaps, each party assumes market risk.476 By contrast, neither party assumes or hedges risk in an REP transaction.477 Instead, the Commissions view an REP transaction essentially as a subsidy provided to residential and small farm utility customers.478 Accordingly, the Commissions do not consider the REP transactions described by the commenter to be swaps or security￾based swaps. Loan Participations The Commissions provided an interpretation in the Proposing Release regarding the treatment of loan participations.479 The Commissions are

480See infra note 504 and accompanying text. 481See Loan Market Association, ‘‘Guide to Syndicated Loans,’’ section 6.2.4 (‘‘A [loan] participation * * * is made between the existing lender and the participant. This creates new contractual rights between the existing lender and the participant which mirror existing contractual rights between the existing lender and the borrower. However this is not an assignment of those existing rights and the existing lender remains in a direct contractual relationship with the borrower.’’), available at http://www.lma.eu.com/uploads/files/ Introductory_Guides/Guide_to_Par_Syndicated _Loans.pdf. 482See Letter from R. Bram Smith, Executive Director, The Loan Syndications and Trading Association, Jan. 25, 2011 (‘‘January LSTA Letter’’); Letter from Elliot Ganz, General Counsel, The Loan Syndications and Trading Association, Mar. 1, 2011 (‘‘March LSTA Letter’’); and Letter from Clare Dawson, Managing Director, The Loan Market Association, Feb. 23, 2011. The Commissions understand that neither type of loan participation is a ‘‘synthetic’’ transaction. See March LSTA Letter. Both types of loan participations are merely transfers of cash loan positions and the ratio of underlying loan to participation is always one to one. Id. 483The LSTA is The Loan Syndications and Trading Association. 484The LMA is The Loan Market Association. 485See Letter from Clare Dawson, Managing Director, The LMA, Jul. 22, 2011 (‘‘July LMA Letter’’). 486See Id. The participant may exercise an ‘‘elevation’’ right and request that the grantor use commercially reasonable efforts to cause the participant to become the legal owner, by assignment, of the underlying loan or commitment. Id. 487See sections 1a(47)(B)(v) and (vi) of the CEA, 7 U.S.C. 1a(47)(b)(v) and (vi), as amended by
section 721(a)(21) of the Dodd-Frank Act (excluding
purchases and sales of a security on a fixed or contingent basis, respectively from the swap definition). 488See section 403(a) of the Legal Certainty for Bank Products Act of 2000, 7 U.S.C. 27a(a), as amended by section 725(g)(2) of the Dodd-Frank Act (providing that, under certain circumstances, the CEA shall not apply to, and the CFTC shall not exercise regulatory authority over, identified banking products, and the definitions of the terms ‘‘security-based swap’’ and ‘‘security-based swap agreement’’ shall not include identified banking products). 489See infra note 504 and accompanying text. See also infra notes 490, 491, and 492 and accompanying text. 490See July LMA Letter. 491 Id. 492 Id. 493Proposing Release at 29834. 494See infra note 503 and accompanying text. restating the interpretation set out in the Proposing Release with certain modifications in response to commenters.480 Loan participations arise when a lender transfers or offers a participation in the economic risks and benefits of all or a portion of a loan or commitment it has entered into with a borrower to another party as an alternative or precursor to assigning to such person the loan or commitment or an interest in the loan or commitment.481 The Commissions understand that two types of loan participations exist in the market today,482 LSTA-style participations483 and LMA-style participations.484 LSTA￾style participations transfer a beneficial ownership interest in the underlying loan or commitment to the participant.485 LMA-style participations do not transfer a beneficial ownership interest in the underlying loan or commitment to the participant, but rather create a debtor-creditor relationship between the grantor and the participant under which a future beneficial ownership interest is conveyed.486 Depending on the facts and circumstances, a loan participation may be a security under the Federal securities laws and, as such, the loan participation would be excluded from the swap definition as the purchase and sale of a security on a fixed or contingent basis.487 In addition, depending on the facts and circumstances, a loan participation may be an identified banking product and, as such, would be excluded from CFTC jurisdiction and from the security-based swap and security-based swap agreement definitions.488 The Commissions believe it is important to provide further guidance as to the other circumstances in which certain loan participations would not fall within the swap and security-based swap definitions. Consistent with the proposal, the Commissions do not interpret the swap and security-based swap definitions to include loan participations that reflect an ownership interest in the underlying loan or commitment. The Commissions believe that for a loan participation to not be considered a swap or security-based swap, the loan participation must represent a current or future direct or indirect ownership interest in the loan or commitment that is the subject of the loan
participation. In evaluating whether the loan participation represents such an ownership interest, the Commissions believe the following characteristics should be present:

• The grantor of the loan
  participation is a lender under, or a participant or sub-participant in, the loan or commitment that is the subject of the loan participation.
• The aggregate participation in the
  loan or commitment that is the subject of the loan participation does not exceed the principal amount of such loan or commitment. Further, the loan participation does not grant, in the aggregate, to the participant in such loan participation a greater interest than the grantor holds in the loan or commitment that is the subject of the loan participation.
• The entire purchase price for the
  loan participation is paid in full when acquired and not financed. The Commissions believe a purchase price would not be paid in full if the grantor of the loan participation extends financing to the participant or if such participant levers its purchase, including by posting collateral to secure a future payment obligation.
• The loan participation provides the
  participant all of the economic benefit and risk of the whole or part of the loan or commitment that is the subject of the loan participation. These characteristics, which were identified by commenters,489 are intended to distinguish loan participations from swaps and security￾based swaps based on loans. The first characteristic above addresses the ownership of the underlying loan or commitment. Swaps and security-based swaps may be created using a synthetic or derivative structure that does not require ownership of the underlying loan.490 The second characteristic above addresses the ratio of the participation to the underlying loan or commitment. Swaps and security-based swaps based on loans may involve synthetic exposure to a loan that is a multiple of the principal amount.491 The third characteristic above addresses leverage in the financing of a loan participation. Leverage could be indicative of an instrument that is merely an exchange of payments and not a transfer of the ownership of the underlying loan or commitment, such as may be the case with a swap or security-based swap.492 The fourth characteristic above addresses the level of participation in the economic benefits and risks of the underlying loan or commitment. This characteristic is indicative of ownership when analyzed with the other characteristics and, as noted above, swaps and security-based swaps may be created using a synthetic or derivative structure that does not require ownership of the underlying loan. The Commissions agree with commenters that the loan participation does not have to be a ‘‘true participation,’’ as the Commissions had stated in their interpretation in the Proposing Release,493 in order for the loan participation to fall outside the swap and security-based swap definitions.494 The Commissions note that the ‘‘true participation’’ analysis is used to determine whether a transaction has resulted in the underlying assets being legally isolated from a transferor’s creditors for U.S. bankruptcy law

495 Id.
496 Id.
497 Id.
498See supra note 482. See infra note 501. 499See infra note 506 and accompanying text. 500See January LSTA Letter. 501See FCC Letter; Letter from Richard M. Whiting, Executive Director and General Counsel, Financial Services Roundtable, Jul. 22, 2011 (‘‘FSR Letter’’); July LMA Letter; Letter from R. Bram Smith, Executive Director, The LSTA, Jul. 22, 2011 (‘‘July LSTA Letter’’); MFA Letter; and Letter from Kenneth E. Bentsen, Jr., Executive Vice President, Public Policy and Advocacy, SIFMA, Jul. 22, 2011 (‘‘SIFMA Letter’’). 502See FSR Letter; July LMA Letter; July LSTA Letter; MFA Letter; and SIFMA Letter. Commenters indicated that both LSTA-style participations and LMA-style participations represent a current or future direct or indirect ownership interest in the related loan or commitment. Id. 503See July LMA Letter; July LSTA Letter; MFA Letter; and SIFMA Letter. These commenters indicated that neither LMA-style participations nor certain LSTA-style participations are true participations. See July LMA Letter; July LSTA Letter; and SIFMA Letter. Further, according to the July LSTA Letter, ‘‘[l]oan market participants in the United States will likely interpret the ‘true participation’ requirement as a requirement that loan participations must qualify for ‘true sale’ treatment in order to avoid classification as a ‘swap.’ A ‘true sale’ or ‘true participation’ analysis is a test aimed at determining whether a transaction has resulted in the underlying assets being legally isolated from the transferor’s creditors for U.S. bankruptcy law purposes. Its underlying purpose is to distinguish between a sale and a financing, not between a sale and a swap.’’ If this is the case, certain LSTA-style participations, which typically are offered in the United States, could be determined under a ‘‘true sale’’ analysis to be a financing and not a true participation. See July LSTA Letter. 504See July LMA Letter; July LSTA Letter; MFA Letter; and SIFMA Letter. Commenters recommended that the Commissions revise the interpretation by providing that the Commissions do not interpret the swap and security-based swap definitions to include loan participations in which (1) the participant is acquiring a current or future direct or indirect ownership interest in the related loan or commitment, and (2) the agreement pursuant to which the participant is acquiring such an interest (i) is a participation agreement that is, or any similar agreement of a type that has been, is presently, or in the future becomes, customarily entered into in the primary or secondary loan markets, (ii) requires the grantor to represent that it is a lender under, or a participant or sub￾participant in, the loan or commitment, (iii) provides that the participant is entitled to receive from the grantor all of the economic benefit of the whole or part of a loan or commitment to the extent of payments received by the grantor in respect of such loan or commitment, and (iv) requires that 100% of the
purchase price calculated with respect to the loan or commitment is paid on the settlement date. See id. The characteristics identified by these commenters are reflected in the Commission’s revised interpretation. 505See July LMA Letter. 506 Id. 507See section 1a(47)(B) of the CEA, 7 U.S.C. 1a(47)(B). purposes.495 This analysis is unrelated to and does not inform whether a loan participation is a swap or security-based swap. This analysis also may be subject to varying interpretations.496 Further, the Commissions understand that this analysis could result in certain loan participations that reflect an ownership interest in the underlying loan or commitment being included in the swap and security-based swap definitions, which the Commissions do not intend.497 Rather, as noted above, the Commissions believe that the analysis as to whether a loan participation is outside the swap and security-based swap definitions should be based on whether the loan participation reflects an ownership interest in the underlying loan or commitment. The Commissions understand that the characteristics noted above are indicative, based on comments received,498 of whether a loan participation represents such an ownership interest. Further, in response to commenters,499 the Commissions are clarifying that the interpretation applies to loan participations that are entered into both with respect to outstanding loans and with respect to a lender’s commitments to lend and fund letters of credit (e.g., under a revolving credit facility). The Commissions believe that the interpretation will prevent disruption in the syndicated loan market for loan participations. Loan participations facilitate a lender’s diversification of its portfolio holdings, provide a key component of the efficient settlement process, and enhance liquidity in the global syndicated loan market.500 The interpretation will enable this market to continue operating as it did prior to the enactment of Title VII. Comments Commenters supported the interpretation that certain loan participations should not be included in the swap and security-based swaps definitions.501 Commenters agreed with the proposal that a loan participation should represent a current and future direct or indirect ownership interest in the loan or commitment that is the subject of the loan participation.502 However, commenters disagreed with the proposal that a loan participation should be required to be a ‘‘true participation’’ in order for the loan participation to fall outside the swap and security-based swap definitions because LMA-style participations do not represent a beneficial ownership in the underlying loan or commitment such that they would be considered a true participation.503 Commenters requested that the Commissions remove this factor and instead recognize additional factors.504 The Commissions agree that a loan participation does not have to be a true participation in order for the loan participation to fall outside the swap
and security-based swap definitions and are revising the interpretation as noted above. One commenter also indicated that loan participations are entered into both with respect to outstanding loans and with respect to a lender’s commitments to lend and fund letters of credit (e.g., under a revolving credit facility).505 This commenter requested that the Commissions revise the proposed interpretation to reflect both outstanding loans and a lender’s commitments.506 The Commissions agree and are revising the interpretation to reflect both outstanding loans and loan commitments as noted above.
C. Final Rules and Interpretations
Regarding Certain Transactions Within the Scope of the Definitions of the Terms ‘‘Swap’’ and ‘‘Security-Based Swap’’

1. In General
   In light of provisions in the Dodd￾Frank Act that specifically address certain foreign exchange products, the Commissions in the Proposing Release proposed rules to clarify the status of products such as foreign exchange forwards, foreign exchange swaps, foreign exchange options, non￾deliverable forwards involving foreign exchange (‘‘NDFs’’), and cross-currency swaps. The Commissions also proposed a rule to clarify the status of forward rate agreements and provided interpretations regarding: (i) Combinations and permutations of, or options on, swaps or security-based swaps; and (ii) contracts for differences (‘‘CFDs’’). The Commissions are adopting the rules as proposed without modification and are restating the interpretations provided in the Proposing Release without modification. In addition, the Commissions are providing additional interpretations regarding foreign exchange spot transactions and retail foreign currency options. As adopted, rule 1.3(xxx)(2) under the CEA and rule 3a69–2 under the Exchange Act explicitly define the term ‘‘swap’’ to include certain foreign exchange-related products and forward rate agreements unless such products are excluded by the statutory exclusions in subparagraph (B) of the swap definition.507 In adopting these rules, the Commissions do not mean to suggest that the list of agreements, contracts, and transactions set forth in rule 1.3(xxx)(2) under the CEA and rule

508See section 1a(47)(E)(i) of the CEA, 7 U.S.C. 1a(47)(E)(i). The Secretary published in the Federal Register a request for comment as to whether an exemption from the swap definition for foreign exchange swaps, foreign exchange forwards, or both, is warranted, and on the application of the statutory factors that the Secretary must consider in making a determination regarding whether to exempt these products. See Determinations of Foreign Exchange Swaps and Forwards, 75 FR 66829 (Oct. 28, 2010). Subsequently, the Secretary published in the Federal Register a proposed determination to exempt both foreign exchange swaps and foreign exchange forwards from the definition of the term ‘‘swap’’ in the CEA. See Determination of Foreign Exchange Swaps and Foreign Exchange Forwards Under the Commodity Exchange Act, Notice of Proposed Determination, 76 FR 25774 (May 5, 2011) (‘‘Notice of Proposed Determination’’). The comment period on the Secretary’s proposed determination closed on June 6, 2011. A final determination has not yet been issued. 509See section 1a(24) of the CEA, 7 U.S.C. 1a(24). 510See section 1a(25) of the CEA, 7 U.S.C. 1a(25). 511The Secretary’s determination also does not affect the CFTC’s jurisdiction over retail foreign currency agreements, contracts, or transactions pursuant to section 2(c)(2) of the CEA, 7 U.S.C. 2(c)(2). See section 1a(47)(F)(ii) of the CEA, 7 U.S.C. 1a(47)(F)(ii). 512See, e.g., sections 1a(47)(E)(iii) and (iv) of the CEA, 7 U.S.C. 1a(47)(E)(iii) and (iv) (reporting and business conduct standards, respectively). In addition, a determination by the Secretary does not exempt any foreign exchange forward or foreign exchange swap traded on a designated contract market or a swap execution facility, or cleared by a derivatives clearing organization, from any applicable antifraud or anti-manipulation provision under the CEA. See sections 1a(47)(F)(i) and 1b(c) of the CEA, 7 U.S.C. 1a(47)(F)(i) and 1b(c). 513See rules 1.3(xxx)(3)(iii) and (iv) under the CEA and rule 3a69–2(c)(3) and (4) under the Exchange Act. 514See rules 1.3(xxx)(2)(i)(C) and (D) under the CEA and rules 3a69–2(b)(1)(iii) and (iv) under the Exchange Act. The rules further provide that foreign exchange forwards and forward exchange swaps are not swaps if they fall within one of the exclusions set forth in subparagraph (B) of the statutory swap definition. See rule 1.3(xxx)(2)(ii) under the CEA and rule 3a69–2(b)(2) under the Exchange Act. 515See rule 1.3(xxx)(3) under the CEA and rule 3a69–2(c) under the Exchange Act. 516See rule 1.3(xxx)(3)(ii) under the CEA and rule 3a69–2(c)(2) under the Exchange Act. The exclusion of foreign exchange forwards and foreign exchange swaps would become effective upon the Secretary’s submission of the determination to exempt to the appropriate Congressional Committees. See sections 1a(47)(E)(ii) and 1b of the CEA, 7 U.S.C. 1a(46)(E)(ii) and 1b. 517See CME Letter and SIFMA Letter. 518See CME Letter. This commenter also
believes that if the Secretary exempts foreign exchange swaps and foreign exchange forwards from the swap definition, it would create an ‘‘awkward’’ situation both for the CFTC and market participants, given that options on such products would be swaps but the products into which they exercise would not be swaps, and would result in a lack of clarity and consistency for market participants. Id. 519See SIFMA Letter. 520These costs market participants may incur relate to the upfront and ongoing costs associated with the regulation of Title VII instruments generally. See infra parts X and XI, for a discussion of these costs. The Commissions also note that the final rules will reduce (and may eliminate), the costs of determining whether foreign exchange swaps and foreign exchange forwards are subject to Title VII, as well as the costs associated with determining which provisions of the new Title VII regulatory regime will apply to these instruments. Id. 521Compare section 712(d)(1) of the CEA (Commissions’ joint rulemaking authority to further define the term ‘‘swap’’), with section 1a(47)(E) and 1b of the CEA (Secretary’s authority to determine to exempt foreign exchange swaps and foreign exchange forwards from the definition of ‘‘swap.’’). 3a69–2(b) under the Exchange Act is an exclusive list.
2. Foreign Exchange Products
(a) Foreign Exchange Products Subject to the Secretary’s Swap Determination:
Foreign Exchange Forwards and Foreign Exchange Swaps The CEA, as amended by the Dodd￾Frank Act, provides that ‘‘foreign exchange forwards’’ and ‘‘foreign exchange swaps’’ shall be considered swaps under the swap definition unless the Secretary of the Treasury (‘‘Secretary’’) issues a written determination that either foreign exchange swaps, foreign exchange forwards, or both: (i) Should not be regulated as swaps; and (ii) are not structured to evade the Dodd-Frank Act in violation of any rule promulgated by the CFTC pursuant to section 721(c) of the Dodd-Frank Act.508 A foreign exchange forward is defined in the CEA as ‘‘a transaction that solely involves the exchange of two different currencies on a specific future date at a fixed rate agreed upon on the inception of the contract covering the exchange.’’ 509 A foreign exchange swap, in turn, is defined as ‘‘a transaction that solely involves an exchange of 2 different currencies on a specific date at a fixed rate that is agreed upon on the inception of the contract covering the exchange; and a reverse exchange of the 2 currencies described in subparagraph (A) at a later date and at a fixed rate that is agreed upon on the inception of the contract covering the exchange.’’ 510 Under the Dodd-Frank Act, if foreign exchange forwards or foreign exchange swaps are no longer considered swaps due to a determination by the Secretary, nevertheless, certain provisions of the CEA added by the Dodd-Frank Act would continue to apply to such transactions.511 Specifically, those transactions still would be subject to certain requirements for reporting swaps, and swap dealers and major swap participants engaging in such transactions still would be subject to certain business conduct standards.512 The Commissions are adopting the rules as proposed to explicitly define by rule the term ‘‘swap’’ to include foreign exchange forwards and foreign exchange swaps (as those terms are defined in the CEA),513 in order to include in one rule the definitions of those terms and the related regulatory authority with respect to foreign exchange forwards and foreign exchange swaps.514 The final rules incorporate the provision of the Dodd-Frank Act that foreign exchange forwards and foreign exchange swaps will no longer be considered swaps if the Secretary issues the written determination described above to exempt such products from the swap definition.515 The final rules also reflect the continuing applicability of certain reporting requirements and business conduct standards in the event that the Secretary makes such a determination.516 Comments Two commenters recommended that the Commissions defer action on defining foreign exchange swaps and foreign exchange forwards in their regulations until the Secretary has made his final determination about whether to exempt them.517 One commenter believed that finalizing the Commissions’ proposal prior to the Secretary’s final determination would be ‘‘premature.’’ 518 The other
commenter believed that the industry will be ‘‘better positioned’’ to assess the need to clarify the scope of the swap definition with respect to foreign exchange derivatives after the Secretary has made his determination.519 The Commissions understand that, if the final rules are effective before the Secretary issues a written determination, market participants entering into foreign exchange forwards and foreign exchange swaps might incur costs in order to comply with the requirements of the CEA (as amended by the Dodd-Frank Act) that could be rendered unnecessary if the Secretary subsequently were to issue a written determination to exempt.520 The Commissions, however, believe the final rules are necessary because in the event the Secretary issues a written determination to exempt, certain reporting requirements and business conduct standards will continue to apply to the exempted instruments, and the final rules set forth those requirements that will continue to apply. Further, the Commissions do not believe that adopting the rules is premature, as the Secretary may issue a determination at any time, and the Secretary’s authority to do so is independent of the Commissions’ authority to issue these rules to further define the term ‘‘swap.’’ 521 The

522See rule 1.3(xxx)(3)(ii) under the CEA and rule 3a69–2(c)(2) under the Exchange Act. The statutory requirements that remain applicable, notwithstanding a written determination by the Secretary to exempt, are that foreign exchange swaps and foreign exchange forwards shall be reported to either a swap data repository, or, if there is no swap data repository that would accept such swaps or forwards, to the CFTC pursuant to section 4r of the CEA, 7 U.S.C. 6r, within such time period as the CFTC may by rule or regulation prescribe, and any party to a foreign exchange swap or forward that is a swap dealer or major swap participant shall conform to the business conduct standards contained in section 4s(h) of the CEA, 7 U.S.C. 6s(h). Section 1a(47)(E)(iii) and (iv) of the CEA, 7 U.S.C. 1a(47)(E)(iii) and (iv). 523See rule 1.3(xxx)(3)(v) under the CEA and rule 3a69–2(c)(5) under the Exchange Act. 524See rule 1.3(xxx)(2)(i) under the CEA and rule 3a69–2(b)(1) under the Exchange Act. The final rules provide, however, that none of these products are swaps if they fall within one of the exclusions set forth in subparagraph (B) of the statutory swap definition. See rule 1.3(xxx)(2)(ii) under the CEA and rule 3a69–2(b)(2) under the Exchange Act. Also, the rules do not define the term ‘‘swap’’ to include currency swaps because they are already included in the statutory definition, but the rules clarify that currency swaps are not subject to the Secretary’s determination. See section 1a(47)(A)(iii)(VII) of the CEA, 7 U.S.C. 1a(47)(A)(iii)(VII); rule 1.3(xxx)(3)(v)(A) under the CEA; and rule 3a69–2(c)(5)(i) under the Exchange Act. 525This discussion is not intended to address, and has no bearing on, the CFTC’s jurisdiction over foreign currency options in other contexts. See, e.g., CEA sections 2(c)(2)(A)(iii) and 2(c)(2)(B)–(C), 7 U.S.C. 2(c)(2)(A)(iii) and 2(c)(2)(B)–(C) (off￾exchange options in foreign currency offered or entered into with retail customers). 526See section 1a(47)(A)(i) of the CEA, 7 U.S.C. 1a(47)(A)(i). 527See section 1a(47)(B)(iv) of the CEA, 7 U.S.C. 1a(47)(B)(iv). 528A comment regarding the CFTC’s jurisdiction over retail foreign currency options is discussed below. 529See rule 1.3(xxx)(2)(ii) under the CEA and rule 3a69–2(b)(1) under the Exchange Act. The final rules treat the terms foreign currency options, currency options, foreign exchange options, and foreign exchange rate options as synonymous. Moreover, for purposes of the final rules, foreign currency options include options to enter into or terminate, or that otherwise operate on, a foreign exchange swap or foreign exchange forward, or on the terms thereof. As discussed above, foreign exchange options traded on an NSE are securities and therefore are excluded from the swap definition. See supra note 527 and accompanying text. 530See rule 1.3(xxx)(3)(v) under the CEA and rule 3a69–2(c)(5) under the Exchange Act. 531See Proposing Release at 29836. 532A deliverable forward foreign
exchange contract is an obligation to buy or sell a specific currency on a future settlement date at a fixed price set on the trade date. See Laura Lipscomb, Federal Reserve Bank of New York, ‘‘An Overview of Non￾Deliverable Foreign Exchange Forward Markets,’’ 1 (May 2005) (citation omitted) (‘‘Fed NDF Overview’’). 533See id. at 1–2 (citation omitted). 534See id. at 2. Being long the emerging market currency means that the holder of the NDF contract is the ‘‘buyer’’ of the emerging market currency and the ‘‘seller’’ of dollars. Conversely, if the emerging market currency appreciates relative to the previously agreed forward rate, the holder of the contract that is short the emerging market currency must pay its counterparty the difference between the spot market rate and the contracted forward price, multiplied by the notional amount. See id. at 2, n.4. 535See Proposing Release at 29836. Commissions’ final rules are consistent with this statutory framework by specifically providing that, in the event a determination to exempt is issued, foreign exchange swaps and foreign exchange forwards will not be considered swaps, and will be subject only to those CEA requirements that are specified in the statute.522 As such, the final rules accommodate the possibility of (rather than the certainty of) an exemptive determination made by the Secretary. Moreover, commenters provided no support for the assertion that the situation would be awkward for market participants because options on foreign exchange forwards and foreign exchange swaps will be swaps, regardless of whether the Secretary determines to exempt the underlying transactions from the swap definition. The Commissions note that Congress drew the distinction in the statute between foreign currency options and foreign exchange forwards and foreign exchange swaps. The Commissions conclude that adopting these final rules would not contribute to a lack of clarity or consistency for market participants, regardless of any determination the Secretary makes. (b) Foreign Exchange Products Not Subject to the Secretary’s Swap Determination The Commissions are adopting rules as proposed stating that a determination by the Secretary that foreign exchange forwards or foreign exchange swaps, or both, should not be regulated as swaps would not affect certain other products involving foreign currency, such as foreign currency options, NDFs, currency swaps and cross-currency swaps.523 The rules explicitly define the term ‘‘swap’’ to include such products, irrespective of whether the Secretary makes a determination to exempt foreign exchange forwards or foreign exchange swaps from the swap definition.524 (i) Foreign Currency Options 525 As discussed above, the statutory swap definition includes options, and it expressly enumerates foreign currency options. It encompasses any agreement, contract, or transaction that is a put, call, cap, floor, collar, or similar option of any kind that is for the purchase or sale, or
based on the value, of 1 or more interest or other rates, currencies, commodities, securities, instruments of indebtedness, indices, quantitative measures, or other financial or economic interests or property of any kind.526 Foreign exchange options traded on a national securities exchange (‘‘NSE’’), however, are securities under the Federal securities laws and not swaps or security-based swaps.527 Any determination by the Secretary, discussed above, that foreign exchange forwards or foreign exchange swaps should not be regulated as swaps would not impact foreign currency options because a foreign currency option is neither a foreign exchange swap nor a foreign exchange forward, as those terms are defined in the CEA. The Commissions did not receive any comments either on the proposed rule further defining the term ‘‘swap’’ to include foreign currency options or the proposed rule clarifying that foreign currency options are not subject to the Secretary’s determination to exempt foreign exchange swaps and foreign exchange forwards.528 Consequently, the Commissions are adopting rules to explicitly define the term ‘‘swap’’ to include foreign currency options (other than foreign currency options traded on an NSE).529 The rules also state that foreign currency options are not foreign exchange forwards or foreign exchange swaps under the CEA.530 (ii) Non-Deliverable Forward Contracts Involving Foreign Exchange As explained by the Commissions in the Proposing Release,531 an NDF generally is similar to a forward foreign exchange contract,532 except that at maturity the NDF does not require physical delivery of currencies; rather, the contract typically is settled in a reserve currency, such as U.S. dollars. One of the currencies involved in the transaction, usually an emerging market currency, may be subject to capital controls or similar restrictions, and is therefore said to be ‘‘nondeliverable.’’ 533 If the spot market exchange rate on the settlement date is greater (in foreign currency per dollar terms) than the previously agreed forward exchange rate, the party to the contract that is long the nondeliverable (e.g. emerging market) currency must pay its counterparty the difference between the contracted forward price and the spot market rate, multiplied by the notional amount.534 NDFs are not expressly enumerated in the swap definition, but as was stated in the Proposing Release,535 they satisfy clause (A)(iii) of the swap definition because they provide for a future

536See section 1a(47)(A)(iii) of the CEA, 7 U.S.C. 1a(47)(A)(iii) (providing that a swap is an agreement, contract, or transaction ‘‘that provides on an executory basis for the exchange, on a fixed or contingent basis, of 1 or more payments based on the value or level of 1 or more interest or other rates, currencies, commodities, securities, instruments of indebtedness, indices, quantitative measures, or other financial or economic interests or property of any kind, or any interest therein or based on the value thereof, and that transfers, as between the parties to the transaction, in whole or in part, the financial risk associated with a future change in any such value or level without also conveying a current or future direct or indirect ownership interest in an asset (including any enterprise or investment pool) or liability that incorporates the financial risk so transferred * * * .’’). 537 In addition, as was noted in the Proposing Release, at least some market participants view NDFs as swaps today, and thus NDFs also may fall within clause (A)(iv) of the swap definition as ‘‘an agreement, contract, or transaction that is, or in the future becomes, commonly known to the trade as a swap.’’ See Proposing Release at 29836. See also
section 1a(47)(A)(iv) of the CEA, 7 U.S.C.
1a(47)(A)(iv). Cf. rule 35.1(b)(1)(i) under the CEA, 17 CFR 35.1(b)(1)(i) (providing that the definition of ‘‘swap agreement’’ includes a ‘‘forward foreign exchange agreement,’’ without reference to convertibility or delivery). 538 In the Notice of Proposed Determination, the Secretary stated that his authority to issue a determination ‘‘is limited to foreign exchange swaps and forwards and does not extend to other foreign exchange derivatives’’ and noted that ‘‘NDFs may not be exempted from the CEA’s definition of ‘‘swap’’ because they do not satisfy the statutory definitions of a foreign exchange swap or forward.’’ See Notice of Proposed Determination. 539Likewise, the Commissions have determined that a foreign exchange transaction, which initially is styled as or intended to be a ‘‘foreign exchange forward,’’ and which is modified so that the parties settle in a reference currency (rather than settle through the exchange of the 2 specified currencies), does not conform with the definition of ‘‘foreign exchange forward’’ in the CEA. See infra note 626. 540Currency is an excluded commodity under the CEA. See section 1a(19)(i) of the CEA, 7 U.S.C. 1a(19)(i). In accordance with the interpretation regarding nonfinancial commodities, which as discussed above, see supra part II.B.2(a), are exempt and agricultural commodities that can be physically delivered, currency does not qualify as a nonfinancial commodity for purposes of the forward exclusion from the swap definition. 541See Proposing Release at 29836. 542See Fed NDF Overview at 5 (‘‘[E]stimates vary but many major market participants estimate as much as 60 to 80 percent of NDF volume is generated by speculative interest, noting growing participation from international hedge funds.’’) and 4 (‘‘[D]ealers note that much of the volume in Chinese yuan NDFs is generated by speculative positioning based on expectations for an alteration in China’s current, basically fixed exchange rate.’’) (italics in original). 543See id. at 4 (noting that ‘‘[much of the] Korean won NDF volume[,] * * * estimated to be the largest of any currency, * * * is estimated to originate with international investment portfolio managers hedging the currency risk associated with their onshore investments’’). 544See CDEU Letter; Letter from The Committee on Investment of Employee Benefit Assets, dated Jul. 22, 2011 (‘‘CIEBA Letter’’); Letter from Bruce C. Bennett, Covington & Burling LLP, dated Jul. 22, 2011 (‘‘Covington Letter’’); and Letter from Karrie McMillan and Cecelia Calaby, the Investment Company Institute/American Bar Association Securities Association, dated Jul. 22, 2011 (‘‘ICI/ ABASA Letter’’). 545See Covington Letter and ICI/ABASA Letter. CLS Bank operates the largest multi-currency cash settlement system to eliminate settlement risk in the foreign exchange market. 546See Covington Letter and ICI/ABASA Letter. 547See Covington Letter. 548See supra note 520. 549See ICI/ABASA Letter. (executory) payment based on an
exchange rate, which is an ‘‘interest or other rate[ ]’’ within the meaning of clause (A)(iii).536 Each party to an NDF transfers to its counterparty the risk of the exchange rate moving against the counterparty, thus satisfying the requirement that there be a transfer of financial risk associated with a future change in rate. This financial risk transfer in the context of an NDF is not accompanied by a transfer of an ownership interest in any asset or liability. Thus, an NDF is a swap under clause (A)(iii) of the swap definition.537 Moreover, the Commissions have determined that NDFs do not meet the definitions of ‘‘foreign exchange forward’’ or ‘‘foreign exchange swap’’ set forth in the CEA.538 NDFs do not involve an ‘‘exchange’’ of two different currencies (an element of the definition of both a foreign exchange forward and a foreign exchange swap); instead, they are settled by payment in one currency (usually U.S. dollars).539 Notwithstanding their ‘‘forward’’ label, NDFs also do not fall within the forward contract exclusion of the swap definition because currency is outside the scope of the forward contract exclusion for nonfinancial commodities.540 Nor have NDFs traditionally been considered commercial merchandising transactions. Rather, as the Commissions observed in the Proposing Release,541 NDF markets appear to be driven in large part by speculation 542 and hedging,543 which features are more characteristic of swap markets than forward markets. Comments Commenters who addressed the nature of NDFs believed that NDFs should not be considered swaps, but rather should be categorized as foreign exchange forwards. In general, commenters maintained that NDFs are functionally and economically equivalent to foreign exchange forwards, and therefore should be treated in the same manner for regulatory purposes.544 In support of this view, commenters made several arguments, including that both NDFs and foreign exchange forwards require the same net value to be transferred between counterparties; the purpose for using them is the same—to cover foreign currency exchange risk; both are typically short term transactions; and both may be cleared by CLS Bank.545 In addition, commenters believed that not treating NDFs as foreign exchange forwards or foreign exchange swaps would be contrary to both domestic and international market practices. As specific examples, commenters noted that NDFs typically are traded as part of a bank’s or broker’s foreign exchange desk; the Federal Reserve Bank of New York has described an NDF in a 1998 publication as an instrument ‘‘similar to an outright forward,’’ except that there is no physical delivery or transfer of the local currency; the Bank for International Settlements (‘‘BIS’’) categorizes NDFs in its ‘‘outright forward’’ category; various European regulations do not distinguish between the two transaction types; standard foreign exchange trading documentation includes both net- and physically￾settled foreign
exchange transactions in general definitions of foreign exchange transactions; and special rules under the U.S. tax code apply equally to physically settled and cash settled foreign exchange forwards.546 Commenters also raised potential negative consequences to certain U.S. market participants if NDFs are not considered to be foreign exchange forwards. For example, one commenter argued that treating NDFs as swaps will put U.S. corporations doing business in emerging markets at a disadvantage relative to U.S. corporations doing business solely in developed markets.547 This commenter stated that NDFs are widely used by U.S. corporations that do business in emerging markets to hedge their exposure to the currencies of those markets, and that regulating NDFs as swaps would significantly increase the cost of hedging those exposures.548 With respect to the Commissions’ legal conclusion that NDFs are not foreign exchange forwards, and thus are not subject to the Secretary’s determination, one commenter stated that the Commissions’ reading of the definition of the term ‘‘foreign exchange forward’’ as not including NDFs is ‘‘too restrictive.’’ 549 In this regard, this commenter believed that the term ‘‘exchange’’ should be read to include ‘‘the economic exchange that occurs in net settlement rather than being narrowly read as the physical ‘exchange’ of two different currencies.’’ One commenter, in contrast, agreed with the Commissions’ interpretation that NDFs are not encompassed within the definition of the term ‘‘foreign

550See CIEBA Letter.
551 7 U.S.C. 6(c).
552See ICI/ABASA Letter.
553See Webster’s New World Dictionary (3d College Ed. 1988). 554See Black’s Law Dictionary. 555This commenter’s request that the CFTC exempt NDFs from the swap definition using its exemptive authority under section 4(c) of the CEA, 7 U.S.C. 6(c), and that the SEC exercise its exemptive authority under section 36 of the Exchange Act, 78 U.S.C. 78mm, with respect to NDFs, is beyond the scope of this rulemaking. 556A swap that exchanges a fixed rate against a fixed rate is known as a currency swap. See Federal Reserve System, ‘‘Trading and Capital-Markets Activities Manual,’’ section 4335.1 (Jan. 2009). 557Cross-currency swaps with a fixed leg based on one rate and a floating leg based on another rate, where the two rates are denominated in different currencies, are generally referred to as cross￾currency coupon swaps, while those with a floating leg based on one rate and another floating leg based on a different rate are known as cross-currency basis swaps. Id. Cross-currency swaps also include annuity swaps and amortizing swaps. In cross￾currency annuity swaps, level cash flows in different currencies are exchanged with no exchange of principal; annuity swaps are priced such that the level payment cash flows in each currency have the same net present value at the inception of the transaction. An amortizing cross￾currency swap is structured with a declining principal schedule, usually designed to match that of an amortizing asset or liability. Id. See also Derivatives ONE, ‘‘Cross Currency Swap Valuation’’ (‘‘A cross currency swap is swap of an interest rate in one currency for an interest rate payment in another currency * * * This could be considered an interest rate swap with a currency component.’’), available at http:// www.derivativesone.com/cross-currency-swap￾valuation/; Financial Accounting Standards Board, ‘‘Examples Illustrating Application of FASB Statement No. 138,’’ Accounting for Certain Derivative Instruments and Certain Hedging Activities, section 2, Example 1, at 3 (‘‘The company designates the cross-currency swap as a fair value hedge of the changes in the fair value of the loan due to both interest and exchange rates.’’), available at http://www.fasb.org/derivatives/ examples.pdf. 558BMO Capital Markets, ‘‘Cross Currency Swaps,’’ available at http://www.bmocm.com/ products/marketrisk/intrderiv/cross/default.aspx. 559See section 1a(47)(A)(iii)(VII) of the CEA, 7 U.S.C. 1a(47)(A)(iii)(VII). 560Clause (A)(iii) of the swap definition expressly refers to a cross-currency rate swap. See section 1a(47)(A)(iii)(V) of the CEA, 7 U.S.C. 1a(47)(A)(iii)(V). Although the swap industry appears to use the term ‘‘cross-currency swap,’’ rather than ‘‘cross-currency rate swap’’ (the term used in section 1a(47)(A)(iii)(V) of the CEA), the Commissions interpret these terms as synonymous. 561See rule 1.3(xxx)(2)(i)(A) under the CEA and rule 3a69–2(b)(1)(i) under the Exchange Act. 562But see supra note 227. exchange forward.’’ 550 This commenter
requested, though, that the CFTC exempt NDFs from the swap definition, using its exemptive authority under
section 4(c) of the CEA.551
While commenters raised a number of objections to the Commissions’ proposal to define NDFs as swaps, these objections primarily raise policy arguments. No commenter has provided a persuasive, alternative interpretation of the statute’s plain language in the definition of the term ‘‘foreign exchange forward’’ to overcome the Commissions’ conclusion that, under the CEA, NDFs are swaps, not foreign exchange forwards. One commenter believed that the Commissions’ interpretation of ‘‘exchange of 2 different currencies’’ as used in the foreign exchange forward definition is too restrictive, and that the phrase should be read broadly to mean an economic exchange of value in addition to physical exchange; the Commissions believe that this contention is misplaced.552 This commenter essentially asks the Commissions to interpret the statutory language to mean an exchange of foreign currencies themselves, as well as an exchange based on the value of such currencies. However, only the word ‘‘exchange’’ appears in the relevant definitions, reinforcing the conclusion that Congress intended the definition of ‘‘foreign exchange forward’’ to be distinct from other types of transactions covered by the definition of ‘‘swap’’ in the CEA. Moreover, the language of each definition emphasizes that these transactions may ‘‘solely’’ involve an exchange. The ordinary meaning of the verb ‘‘exchange’’ is to ‘‘barter’’ 553 or ‘‘part with, give or transfer for an equivalent,’’ 554 i.e., each party is both giving to and receiving from the other party. This does not occur under an NDF, in which only a single party makes a payment. Elsewhere in the CEA, Congress used explicit language that potentially could provide support for a broader interpretation of the type advocated by this commenter, but such language is absent from the definition of the term ‘‘foreign exchange forward.’’ For example, section 2(a)(1)(C)(ii) confers exclusive jurisdiction on the CFTC over ‘‘contracts of sale for future delivery of a group or index of securities (or any interest therein or based upon the value thereof) [that meet certain requirements]’’. If the phrase ‘‘exchange of 2 different currencies’’ had been intended to include economic exchanges of value, as suggested by this commenter, that phrase would have included language similar to ‘‘based on the value thereof’’ to indicate that other mechanisms of transferring value may occur in these particular types of transactions. Instead, as noted above, Congress limited the scope of each of these particular transactions by using the words ‘‘solely involves the exchange of 2 different currencies’’. The Commissions conclude that the use of the word ‘‘solely’’ provides further support for the Commissions’ interpretation that exchange means an actual interchange of the 2 different currencies involved in the transaction.555 (iii) Currency Swaps and Cross￾Currency Swaps A currency swap 556 and a cross￾currency swap 557 each generally can be described as a swap
in which the fixed legs or floating legs based on various interest rates are exchanged in different currencies. Such swaps can be used to reduce borrowing costs, to hedge currency exposure, and to create synthetic assets 558 and are viewed as an important tool, given that they can be used to hedge currency and interest rate risk in a single transaction. Currency swaps and cross-currency swaps are not foreign exchange swaps as defined in the CEA because, although they may involve an exchange of foreign currencies, they also require contingent or variable payments in different currencies. Because the CEA defines a foreign exchange swap as a swap that ‘‘solely’’ involves an initial exchange of currencies and a reversal thereof at a later date, subject to certain parameters, currency swaps and cross-currency swaps would not be foreign exchange swaps. Similarly, currency swaps and cross-currency swaps are not foreign exchange forwards because foreign exchange forwards ‘‘solely’’ involve an initial exchange of currencies, subject to certain parameters, while currency swaps and cross-currency swaps contain additional elements, as discussed above. Currency swaps are expressly enumerated in the statutory definition of the term ‘‘swap.’’ 559 Cross-currency swaps, however, are not.560 Accordingly, based on the foregoing considerations, the Commissions are adopting rules explicitly defining the term ‘‘swap’’ to include cross-currency swaps.561 The rules also state that neither currency swaps nor cross￾currency swaps are foreign exchange forwards or foreign exchange swaps as those terms are defined in the CEA. The Commissions did not receive any comments either on the rule further defining the term ‘‘swap’’ to include cross-currency swaps or the rule clarifying that cross-currency swaps and currency swaps are not subject to the Secretary’s determination to exempt foreign exchange swaps and foreign exchange forwards. (c) Interpretation Regarding Foreign Exchange Spot Transactions The CEA generally does not confer regulatory jurisdiction on the CFTC with respect to spot transactions.562 In

563Bank for International Settlements, Triennial Central Bank Survey, Report on Global Foreign Exchange Market Activity in 2010 at 32 (Dec. 2010) (defining a foreign exchange spot transaction to provide for cash settlement within 2 business days); Sam Y. Cross, Federal Reserve Bank of New York, ‘‘All About * * *. The Foreign Exchange Market in the United States’’ at 31–32 (1998). 564See CFTC Division of Trading and Markets, Report on Exchange of Futures for Physicals at 124– 127 (1987) (noting that foreign currency spot transactions settle in 2 days). 565See CFTC v. Frankwell Bullion, Ltd., 99 F.3d 299, 300 (9th Cir. 1996) (‘‘Spot transactions in foreign currencies call for settlement within two days.’’); CFTC v. Int’l Fin. Servs. (NewYork), Inc., 323 F. Supp. 2d 482, 495 (S.D.N.Y. 2004) (noting that spot transactions ordinarily call for settlement within two days); Bank Brussels Lambert, S.A. v. Intermetals Corp., 779 F.Supp. 741, 742 (S.D.N.Y.
1991) (same). But the Commissions understand that
the settlement cycle for spot transactions exchanging Canadian dollars for U.S. dollars (or vice versa) is T+1. See Cross, supra 563, at 31. 566 In this regard, while the Commissions will look at the relevant facts and circumstances, they will not expect that an unintentional settlement failure or delay for operational reasons or due to a market disruption will undermine the character of a bona fide spot foreign exchange transaction as such. 567The interpretation herein with respect to Security Conversion Transactions is limited to such transactions. 568 7 U.S.C. 2(c)(2)(C). Similarly, a Securities Conversion Transaction is not an option, option on a futures contract or futures contract and thus would not be subject to CEA section 2(c)(2)(B), 7 U.S.C. 2(c)(2)(B). Of course, optionality as to settlement would render the transaction an option and is inconsistent with a ‘‘spot’’ characterization. 569Cf. 12 CFR 220.8(b)(1) under Regulation T (12 CFR Part 220) (generally permits a customer to purchase a security (including a foreign security) in a cash account, rather than a margin account, even if the customer has no collateral in the account, if payment for the security is made within the appropriate payment period). Similarly, if a foreign exchange buyer in a Securities Conversion Transaction posts no margin or collateral on the trade date, the CFTC does not consider that transaction to be ‘‘margined’’ within the meaning of 7 U.S.C. 2(c)(2)(C)(i)(I)(bb). 570See section 2(c)(2)(C)(i)(II) of the CEA, 7 U.S.C. 2(c)(2)(C) (‘‘[s]ubclause (I) of this clause shall not apply to * * * a contract of sale that * * * results in delivery within 2 days’’). 571The CFTC notes, for example, that Congress recognized that settlement in various spot markets in commodities other than foreign exchange can be longer than two days. See CEA section 2(c)(2)(D)(ii)(III)(aa) (disapplying the DCM-trading requirement for certain commodity transactions with non-ECPs when the contract ‘‘results in actual delivery within 28 days or such other longer period as the [CFTC] may determine by rule or regulation based on the typical commercial practice in cash or spot markets for the commodity involved’’). 572This interpretation is not intended to address, and has no bearing on, the CFTC’s interpretation of the term ‘‘actual delivery’’ as set forth in section 2(c)(2)(D)(ii)(III)(aa), 7 CFR 2(c)(2)(D)(ii)(III)(aa). See Retail Commodity Transactions under the Commodity Exchange Act, 76 FR 77670, Dec. 14, 2011. 573See SIFMA Letter. the context of foreign currency, spot transactions typically settle within two business days after the trade date (‘‘T+2’’).563 The accepted market practice of a two-day settlement for spot foreign currency transactions has been recognized by the CFTC564 and the courts.565 The Commissions recognize that the new foreign exchange forward definition in the CEA, which was added by the Dodd-Frank Act and which applies to an exchange of two different currencies ‘‘on a
specific future date,’’ could be read to apply to any foreign exchange transaction that does not settle on the same day. Such a reading could render most foreign exchange spot transactions foreign exchange forwards under the CEA; as a result, such transactions would be subject to the CEA reporting and business conduct standards requirements applicable to foreign exchange forwards even if the Secretary determines to exempt foreign exchange forwards from the definition of ‘‘swap.’’ The Commissions do not believe that Congress intended, solely with respect to foreign exchange transactions, to extend the reach of the CEA to transactions that historically have been considered spot transactions. At the same time, however, the Commissions do not want to enable market participants simply to label as ‘‘spot’’ foreign exchange transactions that regularly settle after the relevant foreign exchange spot market settlement deadline, or with respect to which the parties intentionally delay settlement, both of which would be properly categorized as foreign exchange forwards, or CEA section 2(c)(2) transactions (discussed separately below), in order to avoid applicable foreign exchange regulatory requirements. Accordingly, the Commissions are providing an interpretation that a bona fide foreign exchange spot transaction, i.e., a foreign exchange transaction that is settled on the customary timeline of the relevant spot market, is not within the definition of the term ‘‘swap.’’ In general, a foreign exchange transaction will be considered a bona fide spot transaction if it settles via an actual delivery of the relevant currencies within two business days. In certain circumstances, however, a foreign exchange transaction with a longer settlement period concluding with the actual delivery of the relevant currencies may be considered a bona fide spot transaction depending on the customary timeline of the relevant market.566 In particular, as discussed below, the Commissions will consider a foreign exchange transaction that is entered into solely to effect the purchase or sale of a foreign security to be a bona fide spot transaction where certain conditions are met. The CFTC will consider the following to be a bona fide spot foreign exchange transaction: An agreement, contract or transaction for the purchase or sale of an amount of foreign currency equal to the price of a foreign security with respect to which (i) the security and related foreign currency transactions are executed contemporaneously in order to effect delivery by the relevant securities settlement deadline and (ii) actual delivery of the foreign security and foreign currency occurs by such deadline (such transaction, a ‘‘Securities Conversion Transaction’’).567 For Securities Conversion Transactions, the CFTC will consider the relevant foreign exchange spot market settlement deadline to be the same as the securities settlement deadline. As noted above, while the CFTC will look at the relevant facts and
circumstances, it does not expect that an unintentional settlement failure or delay for operational reasons or due to a market disruption will undermine the character of a bona fide spot foreign exchange transaction as such. The CFTC also will interpret a Securities Conversion Transaction as not leveraged, margined or financed within the meaning of section 2(c)(2)(C) of the CEA.568 While it is possible to view the fact that the buyer of a currency in such a transaction does not pay for the currency until it is delivered as leverage (in that the buyer puts nothing down until taking delivery, thus achieving 100% leverage) or a financing arrangement, the CFTC does not interpret it as such for purposes of CEA
section 2(c)(2)(C).569 Congress
recognized that settlement of bona fide spot foreign exchange transactions typically takes two days.570 The fact that Congress expressly excluded these types of bona fide spot foreign exchange transactions does not mean that Congress intended to subject Security Conversion Transactions to regulation under the retail foreign exchange regime.571 For the foregoing reasons, the CFTC will interpret a Securities Conversion Transaction as not leveraged, margined or financed within the meaning of section 2(c)(2)(C) of the CEA.572 Comments One commenter requested clarification regarding the status of foreign exchange spot transactions.573 This commenter recommended that the Commissions clarify that foreign exchange spot transactions, which this commenter defined as ‘‘transactions of

574 Id. In this commenter’s view, such clarification is necessary to avoid the statutory foreign exchange forward definition ‘‘unwittingly captur[ing] many typical foreign exchange spot transactions * * * settl[ing] within a customary settlement cycle,’’ which this commenter stated is generally ‘‘T+2’’ in the United States, but can be ‘‘T+3’’ in some other countries. 575See Letter from Phoebe A. Papageorgiou, Senior Counsel, American Bankers Ass’n and James Kemp, Managing Director, Global Foreign Exchange Division, dated April 18, 2012 (‘‘ABA/Global FX Letter’’). This commenter requested clarification that the purchase, sale or exchange of a foreign currency by a bank on behalf of a retail customer for the sole purpose of effecting a purchase or sale of a foreign security or in order to clear or settle such purchase or sale, when the settlement period for such FX transaction is within the settlement cycle for such foreign security, is excluded from the retail foreign exchange under the CEA. The CFTC has provided the clarification regarding the meaning of ‘‘leveraged, margined or financed’’ under section 2(c)(2)(C) of the CEA to address this commenter’s concern. 576 7 U.S.C. 2(c)(2)(B). 577See section 1a(47)(B)(i) of the CEA, 7 U.S.C. 1a(47)(B)(i). Sections 2(c)(2)(B), (C), and (D) of the CEA, 7 U.S.C. 2(c)(2)(B), (C), and (D), govern certain types of off-exchange transactions in commodities, including foreign currency, in which one of the parties to the transaction is not an ECP. 578ECPs are defined in section 1a(18) of the CEA, 7 U.S.C. 1a(18). 579Section 2(c)(2)(B)(i) of the CEA provides: (i) This Act applies to, and the Commission shall have jurisdiction over, an agreement, contract, or transaction in foreign currency that—(I) is a contract of sale of a commodity for future delivery (or an option on such a contract) or an option (other than an option executed or traded on a national securities exchange registered pursuant to section 6(a) of the Securities Exchange Act of 1934, 15 U.S.C. 78f(a)); and (II) is offered to, or entered into with, a person that is not an eligible contract participant, unless the counterparty, or the person offering to be the counterparty, of the person is [certain regulated counterparties enumerated in the statute.] 7 U.S.C. 2(c)(2)(B)(i). Thus, under section 2(c)(2)(B)(i) of the CEA, the CEA’s exchange-trading requirement generally applies with respect to futures, options on futures, and options on foreign currency. See section 4(a) of the CEA, 7 U.S.C. 6(a) (generally requiring futures contracts to be traded on or subject to the rules of a DCM); section 4c(b) of the CEA, 7 U.S.C. 6c(b) (prohibiting trading options subject to the CEA contrary to CFTC rules, regulations or orders permitting such trading); Part 32 of the CFTC’s rules, 17 CFR Part 32 (generally prohibiting entering into options subject to the CEA (other than options on futures) other than on or subject to the rules of a DCM); and CFTC Rule 33.3(a), 17
CFR 33.3(a) (prohibiting entering into options on futures other than on or subject to the rules of a DCM). However, if the counterparty to the non-ECP is an enumerated regulated entity identified in section 2(c)(2)(B)(i)(II) of the CEA, 7 U.S.C. 2(c)(2)(B)(i)(II), the CEA’s exchange-trading requirement does not apply. Accordingly, an enumerated regulated entity—including a banking institution regulated by the OCC—can, pursuant to
section 2(c)(2)(B) of the CEA, lawfully enter into a
future, an option on a future, or an option on foreign currency with a non-ECP counterparty on an off-exchange basis. 580See section 1a(47)(B)(i) of the CEA, 7 U.S.C. 1a(47)(B)(i). 581See Proposing Release at 29835 n.125. 582 7 U.S.C. 2(e). 583The CFTC notes in this regard that repeals by implication are strongly disfavored by the courts. See, e.g., Village of Barrington, Ill. v. Surface Transp. Bd., 636 F.3d 650, 662 (D.C. Cir. 2011) (‘‘Repeals by implication, however, are strongly disfavored ‘absent a clearly expressed congressional intention’ ’’) (quoting Branch v. Smith, 538 U.S. 254, 273, 123 S.Ct. 1429 (2003)); Agri Processor Co., Inc. v. N.L.R.B., 514 F.3d 1, 4 (D.C. Cir. 2008) (‘‘[a]mendments by implication, like repeals by implication, are not favored’’ and ‘‘will not be found unless an intent to repeal [or amend] is ‘clear and manifest.’ ’’) (quoting United States v. Welden, 377 U.S. 95, 102 n. 12, 84 S.Ct. 1082 (1964) and Rodriguez v. United States, 480 U.S. 522, 524, 107 S.Ct. 1391 (1987)). 584See, e.g., Singer and Singer, Sutherland Statutes and Statutory Construction § 47:38 (7th ed.
2011) (‘‘Words may be supplied in a statute * * *
where omission is due to inadvertence, mistake, accident, or clerical error’’). one currency into another that settle within a customary settlement cycle,’’ are neither foreign exchange forwards nor swaps.574 Another commenter indicated that the customary settlement cycle for purchases of most non-U.S. denominated securities is ‘‘T+3’’ (in some securities markets, such as South Africa, the settlement cycle can take up to seven days), and requires the buyer to pay for the foreign securities in the relevant foreign currency.575 Typically, according to this commenter, a broker￾dealer or bank custodian acting on behalf of the buyer or seller will enter into a foreign currency transaction to settle on a T+3 basis (or the relevant settlement period) as well. Timing the foreign exchange transaction to settle at the same time as the securities transaction benefits the customer by reducing his or her exposure to currency risk on the securities transaction between trade date and settlement date. The Commissions have provided the interpretation described above regarding the interplay between the foreign exchange forward definition, the meaning of ‘‘leveraged, margined or financed’’ under section 2(c)(2)(C) of the CEA, and bona fide foreign exchange spot transactions to address these commenters’ concerns. (d) Retail Foreign Currency Options The CFTC is providing an interpretation regarding the status of retail foreign currency options that are described in section 2(c)(2)(B) of the CEA.576 As noted above, the Commissions proposed to include foreign currency options generally within the definition of the term ‘‘swap,’’ subject to the statutory exclusions in subparagraph (B) of the definition. The statutory exclusions from the swap definition encompass transactions described in sections 2(c)(2)(C) and (D) of the CEA, but not those in section 2(c)(2)(B) of the CEA.577
Section 2(c)(2)(B) of the CEA applies to
futures, options on futures and options on foreign currency (other than foreign currency options executed or traded on a national securities exchange), and permits such transactions to be entered into with counterparties who are not ECPs 578 on an off-exchange basis by certain enumerated regulated entities.579 No issue arises with respect to futures or options on futures in foreign currency that are covered by section 2(c)(2)(B) of the CEA, because they are expressly excluded from the statutory swap definition.580 Commodity options, including options on foreign currency, however, are not excluded from the swap definition (other than foreign currency options executed or traded on a national securities exchange). The CFTC notes that, in further defining the term ‘‘swap’’ to include foreign currency options, the Proposing Release stated that the proposal was not intended to address, and had no bearing on, the CFTC’s jurisdiction over foreign currency options in other contexts, specifically citing section 2(c)(2)(B) of the CEA.581 Nonetheless, the CFTC acknowledges the ambiguity in the statute regarding the status of off￾exchange foreign currency options with non-ECPs that are subject to section 2(c)(2)(B) of the CEA. While foreign currency options are swaps, they also are subject to section 2(c)(2)(B) of the CEA when entered into off-exchange with non-ECPs, and there is no statutory exclusion from the swap definition for
section 2(c)(2)(B) transactions. If foreign
currency options were deemed to be swaps, then, pursuant to section 2(e) of the CEA, as added by the Dodd-Frank Act,582 they could not be entered into by non-ECP counterparties, except on a DCM. This would render the provisions of section 2(c)(2)(B) of the CEA, permitting off-exchange foreign currency options with non-ECPs by enumerated regulated entities, a nullity. The CFTC believes that Congress did not intend the swap definition to overrule and effectively repeal another provision of the CEA in such an oblique fashion.583 Nor is there anything in the legislative history of the Dodd-Frank Act to suggest a congressional intent to prohibit only one type of off-exchange foreign currency transaction with non￾ECPs (out of the three types of off￾exchange foreign currency transactions with non-ECPs that are addressed in CEA section 2(c)(2)(B)). The omission of
section 2(c)(2)(B) of the CEA from the
exclusions set forth in the statutory swap definition appears to be a scrivener’s error.584 Accordingly, the CFTC is applying the exclusion from the swap definition to foreign currency options described in CEA section 2(c)(2)(B).

585See rules 1.3(xxx)(2)(i)(E) under the CEA and rule 3a69–2(b)(1)(v) under the Exchange Act. 586See generally ‘‘Trading and Capital-Markets Activities Manual,’’ supra note 556, section 4315.1 (‘‘For example, in a six-against-nine-month (6x9) FRA, the parties agree to a three-month rate that is to be netted in six months’ time against the prevailing three-month reference rate, typically LIBOR. At settlement (after six months), the present value of the net interest rate (the difference between the spot and the contracted rate) is multiplied by the notional principal amount to determine the amount of the cash exchanged between the parties

• • • . If the spot rate is higher than the contracted
      rate, the seller agrees to pay the buyer the differences between the prespecified forward rate and the spot rate prevailing at maturity, multiplied by a notional principal amount. If the spot rate is lower than the forward rate, the buyer pays the seller.’’). 587 It appears that at least some in the trade view FRAs as swaps today. See, e.g., The Globecon Group, Ltd., ‘‘Derivatives Engineering: A Guide to Structuring, Pricing and Marketing Derivatives,’’ 45 (McGraw-Hill 1995) (‘‘An FRA is simply a one￾period interest-rate swap.’’); DerivActiv, Glossary of Financial Derivatives Terms (‘‘A swap is * * * a strip of FRAs.’’), available at http://www.derivactiv. com/definitions.aspx?search=forward+rate+ agreements. Cf. Don M. Chance, et al., ‘‘Derivatives in Portfolio Management,’’ 29 (AIMR 1998) (‘‘[An FRA] involves one specific payment and is basically a one-date swap (in the sense that a swap is a combination of FRAs[,] with some variations).’’). Thus, FRAs also may fall within clause (A)(iv) of the swap definition, as ‘‘an agreement, contract, or transaction that is, or in the future becomes, commonly known to the trade as a swap.’’ See
      section 1a(47)(a)(iv) of the CEA, 7 U.S.C.
      1a(47)(a)(iv).
      588See section 1a(47)(A)(iii) of the CEA, 7 U.S.C. 1a(47)(A)(iii). CFTC regulations have defined FRAs as swap agreements. See rule 35.1(b)(1)(i) under the CEA, 17 CFR 35.1(b)(1)(i); Exemption for Certain Swap Agreements, 58 FR 5587 (Jan. 22, 1993). The CFTC recently repealed that rule and amended Part 35 of its rules in light of the enactment of Title VII of the Dodd-Frank Act. See Agricultural Swaps, 76 FR 49291 (Aug. 10, 2011). 589See Regulation of Hybrid and Related Instruments, 52 FR 47022, 47028 (Dec. 11, 1987) (stating ‘‘[FRAs] do not possess all of the characteristics of forward contracts heretofore delineated by the [CFTC]’’). 590The Commissions note that Current European Union law includes FRAs in the definition of ‘‘financial instruments.’’ See Markets in Financial Instruments Directive (MiFID), ‘‘Directive 2004/39/ EC of the European Parliament and of the Council,’’
      Annex I(C), 4, 5, 10 (Apr. 21, 2004), available at
      http://eur-lex.europa.eu/LexUriServ/LexUri Serv.do?uri=CONSLEG:2004L0039:
      20070921:EN:PDF. European Commission legislation on derivatives, central clearing, and trade repositories applies to FRAs that are traded over-the-counter and, thus, would subject such transactions to mandatory clearing, reporting and other regulatory requirements. See Regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories, tit. I, art. 2 (1(3b)), 7509/1/12 REV 1 (Mar. 19, 2012). 591See section 1a(47)(vi) of the CEA, 7 U.S.C. 1a(47)(vi). Clause (A)(vi) of the swap definition refers specifically to other types of swaps in the swap definition. However, because section 3(a)(68) of the Exchange Act defines a security-based swap as a swap [with some connection to a security], clause (A)(vi) of the swap definition is relevant to determining whether any combination or permutation of, or option on, a security-based swap is a security-based swap. 592See Proposing Release at 29838. 593Forward swaps are also commonly known as forward start swaps, or deferred or delayed start swaps. A forward swap can involve two offsetting swaps that both start immediately, but one of which ends on the deferred start date of the forward swap itself. For example, if a counterparty wants to hedge its risk for four years, starting one year from today, it could enter into a one-year swap and a five-year swap, which would partially offset to create a four￾year swap, starting one year forward. A forward swap also can involve a contract to enter into a swap or security-based swap at a future date or with a deferred start date. A forward swap is not a nonfinancial commodity forward contract or security forward, both of which are excluded from the swap definition and discussed elsewhere in this release. 594This category could include categories of agreements, contracts or transactions that do not yet exist as well as more esoteric swaps that exist but that Congress did not refer to by name in the statutory swap definition. 595See Proposing Release at 29838. 596See Ontario Securities Commission, Staff Notice 91–702, ‘‘Offerings of Contracts for Difference and Foreign Exchange Contracts to Investors in Ontario,’’ at part IV.1 (defining a CFD as ‘‘a derivative product that allows an investor to obtain economic exposure (for speculative, investment or hedging purposes) to an underlying asset * * * such as a share, index, market sector, currency or commodity, without acquiring ownership of the underlying asset’’), available at Continued

3. Forward Rate Agreements
   The Commissions are adopting rules as proposed to explicitly define the term ‘‘swap’’ to include forward rate agreements (‘‘FRAs’’).585 The Commissions did not receive any comments on the proposed rules regarding the inclusion of FRAs in the swap definition. In general, an FRA is an over-the￾counter contract for a single cash payment, due on the settlement date of a trade, based on a spot rate (determined pursuant to a method agreed upon by the parties) and a pre-specified forward rate. The single cash payment is equal to the product of the present value (discounted from a specified future date to the settlement date of the trade) of the difference between the forward rate and the spot rate on the settlement date multiplied by the notional amount. The notional amount itself is not exchanged.586 An FRA provides for the future (executory) payment based on the transfer of interest rate risk between the parties as opposed to transferring an ownership interest in any asset or liability.587 Thus, the Commissions believe that an FRA satisfies clause (A)(iii) of the swap definition.588 Notwithstanding their ‘‘forward’’ label, FRAs do not fall within the forward contract exclusion from the swap definition. FRAs do not involve nonfinancial commodities and thus are outside the scope of the forward contract exclusion. Nor is an FRA a commercial merchandising transaction, as there is no physical product to be delivered in an FRA.589 Accordingly, the Commissions believe that the forward contract exclusion from the swap definition for nonfinancial commodities does not apply to FRAs.590 Based on the foregoing considerations, the Commissions are adopting rules to provide greater clarity by explicitly defining the term ‘‘swap’’ to include FRAs. As with the foreign exchange-related products discussed above, the final rules provide that FRAs are not swaps if they fall within one of the exclusions set forth in subparagraph (B) of the swap definition.
4. Combinations and Permutations of, or
   Options on, Swaps and Security-Based Swaps Clause (A)(vi) of the swap definition provides that ‘‘any combination or permutation of, or option on, any agreement, contract, or transaction described in any of clauses (i) through (v)’’ of the definition is a swap.591 The Commissions provided an interpretation regarding clause (A)(vi) in the Proposing Release.592 The Commissions received no comments on the interpretation provided in the Proposing Release regarding combinations and permutations of, or options on, swaps and security-based swaps and are restating their interpretation of clause (A)(vi) of the swap definition with one technical correction and one clarification. Clause (A)(vi) means, for example, that an option on a swap or security￾based swap (commonly known as a ‘‘swaption’’) would itself be a swap or security-based swap, respectively. The Commissions also interpret clause (A)(vi) to mean that a ‘‘forward swap’’ would itself be a swap or security-based swap, respectively.593 By listing examples here, the Commissions do not intend to limit the broad language of clause (A)(vi) of the swap definition, which is designed to capture those agreements, contracts and transactions that are not expressly enumerated in the CEA swap definition but that nevertheless are swaps.594
5. Contracts for Differences
   As the Proposing Release notes, the Commissions have received inquiries over the years regarding the treatment of CFDs under the CEA and the Federal securities laws.595 A CFD generally is an agreement to exchange the difference in value of an underlying asset between the time at which a CFD position is established and the time at which it is terminated.596 If the value increases, the

http://www.osc.gov.on.ca/documents/en/Securities￾Category9/sn_20091030_91-702_cdf.pdf (Oct. 30, 2009); Financial Services Authority, Consultation Paper 7/20, ‘‘Disclosure of Contracts for Difference—Consultation and draft Handbook text,’’ at part 2.2 (defining a CFD on a share as ‘‘a derivative product that gives the holder an economic exposure, which can be long or short, to the change in price of a specific share over the life of the contract’’), available at http:// www.fsa.gov.uk/pubs/cp/cp07_20.pdf (Nov. 2007). 597See, e.g., Int’l Swaps and Derivatives Ass’n, ‘‘2002 ISDA Equity Derivatives Definitions,’’ art. 10 (Dividends) and 11 (Adjustments and Modifications Affecting Indices, Shares and Transactions). 598 In some cases, depending on the facts and circumstances, the SEC may determine that a particular CFD on an equity security, for example, should be characterized as constituting a purchase or sale of the underlying equity security and, therefore, be subject to the requirements of the Federal securities laws applicable to such purchases or sales. 599See Covington Letter and ICI/ABASA Letter. 600See infra note 606. 601See Proposing Release at 29839. 602For example, a company obligated to deliver its product to a customer in Los Angeles would instead deliver the product in Albany to a different company’s customer on behalf of that other company. In return, the company with the obligation to deliver a product to its customer in Albany would deliver the product instead in Los Angeles to the customer of the company obligated to deliver its product to that customer in Los Angeles. 603See, e.g., Haekel v. Refco, 2000 WL 1460078, at *4 (CFTC Sept. 29, 2000) (‘‘[T]he labels that parties apply to their transactions are not necessarily controlling’’); Reves v. Ernst & Young, 494 U.S. 56, 61 (1990) (stating that the purpose of the securities laws is ‘‘to regulate investments, in whatever form they are made and by whatever name they are called’’) (emphasis in original). 604As noted in the Proposing Release, the CFTC consistently has found that the form of a transaction is not dispositive in determining its nature, citing Grain Land, supra note 213, at *16 (CFTC Nov. 25,
2003) (holding that contract substance is entitled to
at least as much weight as form); In the Matter of First Nat’l Monetary Corp., [1984–1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 22,698 at 30,974 (CFTC Aug. 7, 1985) (‘‘When instruments have been determined to constitute the functional equivalent of futures contracts neither we nor the courts have hesitated to look behind whatever self￾serving labels the instruments might bear.’’); Stovall, supra note 63 (holding that the CFTC ‘‘will not hesitate to look behind whatever label the parties may give to the instrument’’). As also noted in the Proposing Release, the form of a transaction is not dispositive in determining whether an agreement, contract, or transaction falls within the regulatory regime for securities. See SEC v. Merch. Capital, LLC, 483 F.3d 747, 755 (11th Cir. 2007) (‘‘The Supreme Court has repeatedly emphasized that economic reality is to govern over form and that the definitions of the various types of securities should not hinge on exact and literal tests.’’) (quoting Williamson v. Tucker, 645 F.2d 404, 418 (5th Cir. 1981)); Robinson v. Glynn, 349 F.3d 166, 170 (4th Cir. 2003) (‘‘What matters more than the form of an investment scheme is the ‘economic reality’ that it represents. * * *’’) (internal citation omitted); Caiola v. Citibank, N.A., New York, 295 F.3d 312, 325 (2d Cir. 2002) (quoting United Housing Foundation v. Foreman, 421 U.S. 837, 848 (1975) (‘‘In searching for the meaning and scope of the word ‘security’ * * * the emphasis should be on economic reality’’)). See Proposing Release at 29839 n. 152. 605The Commissions note, though, that documentation is not controlling in evaluating whether an agreement, contract or transaction is a swap, security-based swap, or neither. seller pays the buyer the difference; if the value decreases, the buyer pays the seller the difference. CFDs can be traded on a number of products, including treasuries, foreign exchange rates, commodities, equities, and stock indexes. Equity CFDs closely mimic the purchase of actual shares. The buyer of an equity CFD receives cash dividends and participates in stock splits.597 In the case of a long position, a dividend adjustment is credited to the client’s account. In the case of a short position, a dividend adjustment is debited from the client’s account. CFDs generally are traded over-the-counter (though they also are traded on the Australian Securities Exchange) in a number of countries outside the United States. The Commissions provided an interpretation in the Proposing Release regarding the treatment of CFDs. The Commissions are restating the interpretation set out in the Proposing Release without modification. CFDs, unless otherwise excluded, fall within the scope of the swap or security-based swap definition, as applicable.598 Whether a CFD is a swap or security-based swap will depend on the underlying product of that particular CFD transaction. Because CFDs are highly variable and a CFD can contain a variety of elements that would affect
its characterization, the Commissions believe that market participants will need to analyze the features of the underlying product of any particular CFD in order to determine whether it is a swap or a security-based swap. The Commissions are not adopting rules or additional interpretations at this time regarding CFDs. Comments Two commenters requested that the Commissions clarify that non￾deliverable forward contracts are not CFDs.599 These commenters requested that the Commissions determine that NDFs involving foreign exchange are not swaps. Given that the Commissions are defining NDFs as swaps and that CFDs involving foreign currency also would be swaps, there is no need to distinguish NDFs involving foreign exchange from CFDs involving foreign exchange. D. Certain Interpretive Issues

1. Agreements, Contracts, or
   Transactions That May Be Called, or Documented Using Form Contracts Typically Used for, Swaps or Security￾Based Swaps The Commissions are restating the interpretation provided in the Proposing Release regarding agreements, contracts, or transactions that may be called, or documented using form contracts typically used for, swaps or security￾based swaps with one modification in response to a commenter.600 As was noted in the Proposing Release,601 individuals and companies may generally use the term ‘‘swap’’ to refer to certain of their agreements, contracts, or transactions. For example, they may use the term ‘‘swap’’ to refer to an agreement to exchange real or personal property between the parties or to refer to an agreement for two companies that produce fungible products and with delivery obligations in different locations to perform each other’s delivery obligations instead of their own.602 However, the name or label that the parties use to refer to a particular agreement, contract, or transaction is not determinative of whether it is a swap or security-based swap.603 It is not dispositive that the agreement, contract, or transaction is documented using an industry standard form agreement that is typically used for swaps and security-based swaps,604 but it may be a relevant factor.605 The key question is whether the agreement, contract, or transaction falls within the statutory definitions of the term ‘‘swap’’ or ‘‘security-based swap’’ (as further defined and interpreted pursuant to the final rules and interpretations herein) based on its terms and other characteristics. Even if one effect of an agreement is to reduce the risk faced by the parties (for example, the ‘‘swap’’ of physical delivery obligations described above may reduce the risk of non￾delivery), the agreement would not be a swap or security-based swap unless it otherwise meets one of those statutory definitions, as further defined by the Commissions. If the agreement, contract, or transaction satisfies the swap or security-based swap definitions, the fact that the parties refer to it by another name would not take it outside the Dodd-Frank Act regulatory regime. Conversely, if an agreement, contract, or transaction is not a swap or security￾based swap, as those terms are defined in the CEA and the Exchange Act and the rules and regulations thereunder, the fact that the parties refer to it, or document it, as a swap or security-based swap will not subject that agreement, contract, or transaction to regulation as a swap or a security-based swap.

606See IECA Letter. This commenter noted that ‘‘[e]ven though swaps are commonly documented on the ISDA Master Agreements without annexes, physical transactions under such agreements with power or natural gas annexes are not swaps because they are physically settled forward contracts that are exempt under 1a47(B)’’). Id. 607 7 U.S.C. 6(c)(6). 608The Commissions note that this approach should not be taken to suggest any finding by the Commissions as to whether or not FTRs or any other FERC-regulated instruments or transactions are swaps (or futures contracts). 609See supra part II.B.2(a). 610See supra note 317. 611See COPE Letter; ETA Letter; and FERC Staff Letter. 612 Id. 613See COPE Letter. 614 Id. 615See ETA Letter. 616See FERC Staff Letter. 617See Better Markets Letter. 618See NEMA Letter and WGCEF Letter. 619See COPE Letter. 620 15 U.S.C. 1011–1015. Comments The Commissions requested comment regarding what agreements, contracts, or transactions that are not swaps or security-based swaps are documented using industry standard form agreements that are typically used for swaps and security-based swaps, and asked for examples thereof and details regarding their documentation, including why industry standard form agreements typically used for swaps and security-based swaps are used. One commenter stated its view that documentation can be a relevant factor in determining whether an agreement, contract or transaction is a swap or security-based swap.606 The Commissions are persuaded by the commenter and are modifying the interpretation to clarify that in determining whether an agreement, contract or transaction is a swap or security-based swap, documentation may be a relevant (but not dispositive) factor.
2. Transactions in Regional
Transmission Organizations and Independent System Operators The CFTC declines to address the status of transactions in Regional Transmission Organizations (‘‘RTOs’’) and Independent System Operators (‘‘ISOs’’), including financial transmission rights (‘‘FTRs’’) and ancillary services, within this joint definitional rulemaking. As was noted in the Proposing Release, section 722 of the Dodd-Frank Act specifically addresses certain instruments and transactions regulated by FERC that also may be subject to CFTC jurisdiction.
Section 722(f) added CEA section
4(c)(6),607 which provides that, if the CFTC determines that an exemption for FERC-regulated instruments or other specified electricity transactions would be in accordance with the public interest, then the CFTC shall exempt such instruments or transactions from the requirements of the CEA. Given that specific statutory directive, the treatment of these FERC-regulated instruments and transactions should be considered under the standards and procedures specified in section 722 of the Dodd-Frank Act for a public interest waiver, rather than through this joint rulemaking to further define the terms ‘‘swap’’ and ‘‘security-based swap.’’ 608 The CFTC notes that it has been engaged in discussions with a number of RTOs and ISOs regarding the possibility of a petition seeking an exemption pursuant to CEA section 4(c)(6) for certain RTO and ISO transactions. The CFTC also notes that the status of some RTO and ISO transactions may have been addressed in the interpretation above regarding embedded options and the forward exclusion from the swap definition,609 and/or indirectly through the CFTC’s recent interim final rulemaking relating to trade options.610 Comments The CFTC received a number of comments discussing transactions in RTOs and ISOs.611 These commenters argued that the CFTC should further define the term ‘‘swap’’ to exclude transactions executed or traded on RTOs and ISOs.612 One commenter argued that the CEA section 4(c)(6) exemptive approach will leave regulatory ambiguity for market participants, since the CFTC might not grant an exemption, later revoke an existing exemption, grant a partial or conditional exemption, or limit an exemption to existing products.613 This commenter also noted that FERC has complete regulatory authority over RTOs and ISOs and their transactions, and that Congress expected the CFTC and FERC to avoid duplicative, unnecessary regulation.614 Another commenter argued that the CFTC should exclude RTO and ISO transactions in the same manner as insurance has been excluded.615 A third commenter stated that RTO and ISO transactions are commercial merchandising transactions and thus forwards or, alternatively, that defining them as swaps is inconsistent with the text, goals, and purpose of the Dodd￾Frank Act.616 By contrast, one commenter asserted that FTRs are in substance swaps and should be regulated as such.617 Two commenters supported the CFTC’s use of its section 722(f) authority to exempt FERC-regulated transactions and other transactions in RTOs or ISOs.618 As discussed above,
section 722(f) of the Dodd-Frank Act
added new section 4(c)(6) to the CEA specifically addressing how the CFTC should approach certain instruments and transactions regulated by FERC that also may be subject to CFTC jurisdiction. The CFTC continues to believe, as was stated in the Proposing Release, that such an approach is the more appropriate means of considering issues relating to the instruments and transactions specified in CEA section 4(c)(6). One commenter’s argument that the CEA section 4(c)(6) exemptive approach will cause regulatory ambiguity is not a convincing basis on which to forego a process specifically designated by Congress for the issue at hand.619 The CFTC also believes that the ability to tailor exemptive relief, after notice and public comment, to the complex issues presented by transactions on RTOs and ISOs, is further reason to favor such an approach over the more general directive to further define the terms ‘‘swap’’ and ‘‘security-based swap’’ that is the subject of this rulemaking. In response to one commenter’s contentions that FERC has complete regulatory authority over RTOs and ISOs and their transactions, and that Congress expected the CFTC and FERC to avoid duplicative, unnecessary regulation, the CFTC notes that Congress addressed this issue not by excluding RTO and ISO transactions from the comprehensive regime for swap regulation, but rather by enacting the exemptive process in CEA section 4(c)(6). And in response to another commenter’s contention that the CFTC should exclude RTO and ISO transactions in the same manner as insurance has been excluded, the CFTC notes that Congress provided neither an exemptive process equivalent to CEA
section 4(c)(6) for insurance, nor an
energy market-equivalent to the McCarran-Ferguson Act.620 As noted above, FERC staff opines that defining RTO and ISO transactions as swaps would be inconsistent with the text, goals, and purpose of the Dodd￾Frank Act. The CFTC can consider concerns of the sort expressed by FERC staff in connection with any petition for a CEA section 4(c)(6) exemption that

621CEA section 4(c)(6) requires the CFTC to determine that an exemption pursuant to such
section ‘‘is consistent with the public interest and
the purposes of th[e CEA].’’ 7 U.S.C. 6(c)(6). 622See section 1a(47) of the CEA, 7 U.S.C. 1a(47). 623See section 3(a)(68) of the Exchange Act, 15 U.S.C. 78c(a)(68). 624 In some cases, the Title VII instrument may be a mixed swap. Mixed swaps are discussed further in section IV below. 625The determination must be made no later than when the parties offer to enter into the Title VII instrument because persons are prohibited from offering to sell, offering to buy or purchase, or selling a security-based swap to any person who is not an ECP unless a registration statement is in effect as to the security-based swap. See section 5(e) of the Securities Act. This analysis also would apply with respect to mixed swaps and security￾based swap agreements. With respect to swaps, the determination also would need to be made no later than the time that provisions of the CEA and the regulations thereunder become applicable to a Title VII Instrument. For instance, certain duties apply to swaps prior to execution. See Daily Trading Records under Rule 23.202 under the CEA, 17 CFR 23.202, and Subpart H of Part 23 of the CFTC’s regulations, 17 CFR Part 23, Subpart H (Business Conduct Standards for Swap Dealers and Major Swap Participants Dealing with Counterparties, Including Special Entities). 626See infra part III.G.5(a), for a discussion regarding the evaluation of Title VII Instruments on security indexes that move from broad-based to narrow-based or narrow-based to broad-based. 627These secured lending rates are the Eurepo, The Depository Trust & Clearing Corporation’s General Collateral Finance Repo Index, the Repurchase Overnight Index Average Rate and the Tokyo Repo Rate. 628See supra part I, under ‘‘Overall Economic Considerations’’. 629See infra part III.F, regarding the use of certain terms and conditions. 630 Interbank lending rates are measured by surveys of the loan rates that banks offer other banks, or by other mechanisms. The periods of time for such loans may range from overnight to 12 months or longer. The interbank offered rates listed here are frequently called either a ‘‘reference rate,’’ the rate of ‘‘reference banks,’’ or by a designation that is specific to the service that quotes the rate. For some of the interbank offered rates listed here, there is a similar rate that is stated as an interbank bid rate, which is the average rate at which a group of banks bid to borrow money from other banks. For example, the bid rate similar to LIBOR is called LIBID. 631Today, LIBOR is used as a rate of reference for the following currencies: Australian Dollar, may be submitted to the CFTC.621 Interested parties on all sides of the issue would receive an opportunity to comment on the scope and other aspects of any proposed exemptive relief at that time.
III. The Relationship Between the Swap
Definition and the Security-Based Swap Definition A. Introduction Title VII of the Dodd-Frank Act defines the term ‘‘swap’’ under the CEA,622 and also defines the term ‘‘security-based swap’’ under the Exchange Act.623 Pursuant to the regulatory framework established in Title VII, the CFTC has regulatory authority over swaps and the SEC has regulatory authority over security-based swaps. The Commissions are further defining the terms ‘‘swap’’ and ‘‘security-based swap’’ to clarify whether particular agreements, contracts, or transactions are swaps or security-based swaps based on characteristics including the specific terms and conditions of the instrument and the nature of, among other things, the prices, rates, securities, indexes, or commodities upon which the instrument is based. Because the discussion below is focused on whether particular agreements, contracts, or transactions are swaps or security-based swaps, the Commissions use the term ‘‘Title VII instrument’’ in this release to refer to any agreement, contract, or transaction that is included in either the definition of the term ‘‘swap’’ or the definition of the term ‘‘security-based swap.’’ Thus, the term ‘‘Title VII instrument’’ is synonymous with ‘‘swap or security￾based swap.’’ 624 The determination of whether a Title VII instrument is either a swap or a security-based swap should be made based on the facts and circumstances relating to the Title VII instrument prior to execution, but no later than when the parties offer to enter into the Title VII instrument.625 If the Title VII instrument itself is not amended, modified, or otherwise adjusted during its term by the parties, its characterization as a swap or security￾based swap will not change during its duration because of any changes that may occur to the factors affecting its character as a swap or security-based swap.626 Classifying a Title VII instrument as a swap or security-based swap is straightforward for most instruments. However, the Commissions provided an interpretation in the Proposing Release to clarify the classification of swaps and security-based swaps in certain areas and to provide an interpretation regarding the use of certain terms and conditions in Title VII instruments. The Commissions are restating the interpretation set out in the Proposing Release with certain modifications to the interpretation regarding TRS. B. Title VII Instruments Based on Interest Rates, Other Monetary Rates, and Yields Parties frequently use Title VII instruments to manage risks related to, or to speculate on, changes in interest rates, other monetary rates or amounts, or the return on various types of assets. Broadly speaking, Title VII instruments based on interest or other monetary rates would be swaps, whereas Title VII instruments based on the yield or value of a single security, loan, or narrow￾based security index would be security￾based swaps. However, market participants and financial professionals sometimes use the terms
‘‘rate’’ and ‘‘yield’’ in different ways. The Commissions proposed an interpretation in the Proposing Release regarding whether Title VII instruments that are based on interest rates, other monetary rates, or yields would be swaps or security-based swaps and are restating the interpretation, but with a modification to the list of examples of reference rates to include certain secured lending rates under money market rates.627 The Commissions find that this interpretation is an appropriate way to address Title VII instruments based on interest rates, other monetary rates, or yields and is designed to reduce costs associated with determining whether such instruments are swaps or security-based swaps.628

1. Title VII Instruments Based on
   Interest Rates or Other Monetary Rates That Are Swaps The Commissions believe that when payments exchanged under a Title VII instrument are based solely on the levels of certain interest rates or other monetary rates that are not themselves based on one or more securities, the instrument would be a swap and not a security-based swap.629 Often swaps on interest rates or other monetary rates require the parties to make payments based on the comparison of a specified floating rate (such as the London Interbank Offered Rate (‘‘LIBOR’’)) to a fixed rate of interest agreed upon by the parties. A rate swap also may require payments based on the differences between two floating rates, or it may require that the parties make such payments when any agreed-upon events with respect to interest rates or other monetary rates occur (such as when a specified interest rate crosses a threshold, or when the spread between two such rates reaches a certain point). The rates referenced for the parties’ obligations are varied, and examples of such rates include the following:
   Interbank Offered Rates: An average of rates charged by a group of banks for lending money to each other or other banks over various periods of time, and other similar interbank rates,630 including, but not limited to, LIBOR (regardless of currency); 631 the Euro

Canadian Dollar, Danish Krone, Euro, Japanese Yen, New Zealand Dollar, Pound Sterling, Swedish Krona, Swiss Franc, and U.S. Dollar. 632Other interbank offered rates include the following (with the country or city component of the acronym listed in parentheses): AIDIBOR (Abu Dhabi); BAIBOR (Buenos Aires); BKIBOR (Bangkok); BRAZIBOR (Brazil); BRIBOR/BRIBID (Btatislava); BUBOR (Budapest); CHIBOR (China); CHILIBOR (Chile); CIBOR (Copenhagen); COLIBOR (Columbia); HIBOR (Hong Kong); JIBAR (Johannesburg); JIBOR (Jakarta); KAIBOR (Kazakhstan); KIBOR (Karachi); KLIBOR (Kuala Lumpur); KORIBOR ((South) Korea); MEXIBOR (Mexico); MIBOR (Mumbai); MOSIBOR (Moscow); NIBOR (Norway); PHIBOR (Philippines); PRIBOR (Prague); REIBOR/REIBID (Reykjavik); RIGIBOR/ RIGIBID (Riga); SHIBOR (Shanghai); SIBOR (Singapore); SOFIBOR (Sofia); STIBOR (Stockholm); TAIBOR (Taiwan); TELBOR (Tel Aviv); TRLIBOR and TURKIBOR (Turkey); VILIBOR (Vilnius); VNIBOR (Vietnam); and WIBOR (Warsaw). 633A Title VII instrument based solely on the level of a constant maturity U.S. Treasury rate would be a swap because U.S. Treasuries are exempted securities that are excluded from the security-based swap definition. Conversely, a Title VII instrument based solely on the level of a constant maturity rate on a narrow-based index of non-exempted securities under the security-based swap definition would be a security-based swap. 634The TED spread is the difference between the interest rates on interbank loans and short-term U.S. government debt (Treasury bills or ‘‘T-bills’’). The latter are exempted securities that are excluded from the statutory definition of the term ‘‘security￾based swap.’’ Thus, neither any aspect of U.S. Treasuries nor interest rates on interbank loans can form the basis of a security-based swap. For this reason, a Title VII instrument on a spread between interbank loan rates and T-bill rates also would be a swap, not a security-based swap. 635See CME Letter and SIFMA Letter. 636 Id. 637See supra note 633. 638See, e.g., Securities Confirmations, 47 FR 37920 (Aug. 27, 1982). Interbank Offered Rate (‘‘Euribor’’); the Canadian Dealer Offered Rate (‘‘CDOR’’); and the Tokyo Interbank Offered Rate (‘‘TIBOR’’); 632 Money Market Rates: A rate established or determined based on actual lending or money market transactions, including, but not limited to, the Federal Funds Effective Rate; the Euro Overnight Index Average (‘‘EONIA’’ or ‘‘EURONIA’’) (which is the weighted average of overnight unsecured lending transactions in the Euro-area interbank market); the EONIA Swap Index; the Eurepo (the rate at which, at 11.00 a.m. Brussels time, one bank offers, in the euro-zone and worldwide, funds in euro to another bank if in exchange the former receives from the latter the best collateral within the most actively-traded European repo market); the Australian dollar RBA 30 Interbank Overnight Cash Rate; the Canadian Overnight Repo Rate Average (‘‘CORRA’’); The Depository Trust & Clearing
Corporation’s General Collateral Finance (‘‘GCF’’) Repo Index (an average of repo rates collateralized by U.S. Treasury and certain other securities); the Mexican interbank equilibrium interest rate (‘‘TIIE’’); the NZD Official Cash Rate; the Sterling Overnight Interbank Average Rate (‘‘SONIA’’) (which is the weighted average of unsecured overnight cash transactions brokered in London by the Wholesale Markets Brokers’ Association (‘‘WMBA’’)); the Repurchase Overnight Index Average Rate (‘‘RONIA’’) (which is the weighted average rate of all secured overnight cash transactions brokered in London by WMBA); the Swiss Average Rate Overnight (‘‘SARON’’); the Tokyo Overnight Average Rate (‘‘TONAR’’) (which is based on uncollateralized overnight average call rates for interbank lending); and the Tokyo Repo Rate (average repo rate of active Japanese repo market participants). Government Target Rates: A rate established or determined based on guidance established by a central bank including, but not limited to, the Federal Reserve discount rate, the Bank of England base rate and policy rate, the Canada Bank rate, and the Bank of Japan policy rate (also known as the Mutan rate); General Lending Rates: A general rate used for lending money, including, but not limited to, a prime rate, rate in the commercial paper market, or any similar rate provided that it is not based on any security, loan, or group or index of securities; Indexes: A rate derived from an index of any of the foregoing or following rates, averages, or indexes, including but not limited to a constant maturity rate (U.S. Treasury and certain other rates),633 the interest rate swap rates published by the Federal Reserve in its ‘‘H.15 Selected Interest Rates’’ publication, the ISDAFIX rates, the ICAP Fixings, a constant maturity swap, or a rate generated as an average (geometric, arithmetic, or otherwise) of any of the foregoing, such as overnight index swaps (‘‘OIS’’)—provided that such rates are not based on a specific security, loan, or narrow-based group or index of securities; Other Monetary Rates: A monetary rate including, but not limited to, the Consumer Price Index (‘‘CPI’’), the rate of change in the money supply, or an economic rate such as a payroll index; and Other: The volatility, variance, rate of change of (or the spread, correlation or difference between), or index based on any of the foregoing rates or averages of such rates, such as forward spread agreements, references used to calculate the variable payments in index amortizing swaps (whereby the notional principal amount of the agreement is amortized according to the movement of an underlying rate), or correlation swaps and basis swaps, including but not limited to, the ‘‘TED spread’’ 634 and the spread or correlation between LIBOR and an OIS. As discussed above, the Commissions believe that when payments under a Title VII instrument are based solely on any of the foregoing, such Title VII instrument would be a swap.
Comments Two commenters believed that constant maturity swaps always should be treated as swaps, rather than mixed swaps, because they generally are viewed by market participants as rates trades instead of trades on securities.635 According to the commenters, the ‘‘bulk’’ of constant maturity swaps are based on exempted securities, but the commenters noted that the constant maturity leg may be based on a number of different rates or yields, including, among other things, U.S. Treasury yields, Treasury auction rates, yields on debt of foreign governments, and debt related to indices of mortgage-backed securities.636 As discussed above, the Commissions are adopting the interpretation as proposed. The statutory language of the swap and security-based swap definitions explicitly states that a Title VII instrument that is based on a non￾exempted security should be a security￾based swap and not a swap.637
2. Title VII Instruments Based on Yields
The Commissions proposed an interpretation in the Proposing Release clarifying the status of Title VII instruments in which one of the underlying references of the instrument is a ‘‘yield.’’ The Commissions received no comments on the interpretation set out in the Proposing Release regarding Title VII instruments based on yields and are restating the interpretation without modification. In cases when a ‘‘yield’’ is calculated based on the price or changes in price of a debt security, loan, or narrow-based security index, it is another way of expressing the price or value of a debt security, loan, or narrow-based security index. For example, debt securities often are quoted and traded on a yield basis rather than on a dollar price, where the yield relates to a specific date, such as the date of maturity of the debt security (i.e., yield to maturity) or the date upon which the debt security may be redeemed or called by the issuer (e.g., yield to first whole issue call).638 Except in the case of certain exempted securities, when one of the underlying

639Section 3(a)(68)(C) of the Exchange Act, 15 U.S.C. 76c(a)(68)(C). 640As of January 11, 1983, the date of enactment of the Futures Trading Act of 1982, Public Law 97– 444, 96 Stat. 2294, section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), provided that, among other securities, ‘‘exempted securities’’ include: (i) Securities which are direct obligations of, or obligations guaranteed as to principal or interest by, the United States; (ii) certain securities issued or guaranteed by corporations in which the United States has a direct or indirect interest as designated by the Secretary of the Treasury; and (iii) certain other securities as designated by the SEC in rules and regulations. 641Public Law 97–444, 96 Stat. 2294 (1983). 642While this guidance focuses on TRS overlying securities and loans, TRS also may overlie other commodities. Such TRS may be structured differently due to the nature of the underlying. 643See supra part I, under ‘‘Overall Economic Considerations.’’ 644See Proposing Release at 29842. 645Where the underlying security is an equity security, a TRS is also known as an ‘‘equity swap.’’ A bond may also be the underlying security of a TRS. 646 If the total return is negative, the seller receives this amount from the buyer. TRS can be used to synthetically reproduce the payoffs of a position. For example, two counterparties may enter into a 3-year TRS where the buyer of the TRS receives the positive total return on XYZ security, if any, and the seller of the TRS receives LIBOR plus 30 basis points and the absolute value of the negative total return on XYZ security, if any. 647However, if the underlying reference of the TRS is a broad-based security index, it is a swap (and an SBSA) and not a security-based swap. In addition, a TRS on an exempted security, such as a U.S. Treasury, under section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), as in effect on the date of enactment of the Futures Trading Act of 1982 (other than any municipal security as defined in section 3(a)(29) of the Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on the date of enactment of the Futures Trading Act of 1982), is a swap (and an SBSA), and not a security-based swap. Similarly, and as discussed in more detail below, an LTRS based on two or more loans that are not securities (‘‘non-security loans’’) are swaps, and not security-based swaps. references of the Title VII instrument is the ‘‘yield’’ of a debt security, loan, or narrow-based security index in the sense where the term ‘‘yield’’ is used as a proxy for the price or value of the debt security loan, or narrow-based security index, the Title VII instrument would be a security-based swap. And, as a result, in cases where the underlying reference is a point on a ‘‘yield curve’’ generated from the different ‘‘yields’’ on debt securities in a narrow-based security index (e.g., a constant maturity yield or rate), the Title VII instrument would be a security-based swap. However, where
certain exempted securities, such as U.S. Treasury securities, are the only underlying reference of a Title VII instrument involving securities, the Title VII instrument would be a swap. Title VII instruments based on exempted securities are discussed further below. The above interpretation would not apply in cases where the ‘‘yield’’ referenced in a Title VII instrument is not based on a debt security, loan, or narrow-based security index of debt securities but rather is being used to reference an interest rate or monetary rate as outlined above in subsection one of this section. In these cases, this ‘‘yield’’ reference would be considered equivalent to a reference to an interest rate or monetary rate and the Title VII instrument would be, under the interpretation in this section, a swap (or mixed swap depending on other references in the instrument).
3. Title VII Instruments Based on
Government Debt Obligations The Commissions provided an interpretation in the Proposing Release regarding instances in which the underlying reference of the Title VII instrument is a government debt obligation. The Commissions received no comments on the interpretation provided regarding instances in which the underlying reference of the Title VII instrument is a government debt obligation and are restating such interpretation without modification. The security-based swap definition specifically excludes any agreement, contract, or transaction that meets the definition of a security-based swap only because it ‘‘references, is based upon, or settles through the transfer, delivery, or receipt of an exempted security under [section 3(a)(12) of the Exchange Act], as in effect on the date of enactment of the Futures Trading Act of 1982 (other than any municipal security as defined in [section 3(a)(29) of the Exchange Act]

• • *), unless such agreement, contract,
    or transaction is of the character of, or is commonly known in the trade as, a put, call, or other option.’’ 639 As a result of this exclusion in the security-based swap definition for ‘‘exempted securities,’’640 if the only underlying reference of a Title VII instrument involving securities is, for example, the price of a U.S. Treasury security and the instrument does not have any other underlying reference involving securities, then the instrument would be a swap. Similarly, if the Title VII instrument is based on the ‘‘yield’’ of a U.S. Treasury security and does not have any other underlying reference involving securities, then the instrument also would be a swap, regardless of whether the term ‘‘yield’’ is a proxy for the price of the security. Foreign government securities, by contrast, were not ‘‘exempted securities’’ as of the date of enactment of the Futures Trading Act of 1982 641 and thus do not explicitly fall within this exclusion from the security-based swap definition. Therefore, if the underlying reference of the Title VII instrument is the price, value, or ‘‘yield’’ (where ‘‘yield’’ is a proxy for price or value) of a foreign government security, or a point on a yield curve derived from a narrow-based security index composed of foreign government securities, then the instrument is a security-based swap.
    C. Total Return Swaps
    The Commissions are restating the interpretation regarding TRS set out in the Proposing Release with certain changes with respect to quanto and compo equity TRS and loan TRS based on two or more loans, and to reflect that TRS can overlie reference items other than securities, loans, and indexes of securities or loans.642 The Commissions find that this interpretation is an appropriate way to address TRS and is designed to reduce the cost associated with determining whether a TRS is a swap or a security-based swap.643 As was described in the Proposing Release,644 a TRS is a Title VII instrument in which one counterparty, the seller of the TRS, makes a payment that is based on the price appreciation and income from an underlying security or security index.645 A TRS also can overlie a single loan, two or more loans and other underliers. The other counterparty, the buyer of the TRS, makes a financing payment that is often based on a variable interest rate, such as LIBOR (or other interbank offered rate or money market rate, as described above), as well as a payment based on the price depreciation of the underlying reference. The ‘‘total return’’ consists of the price appreciation or depreciation, plus any interest or income payments.646 Accordingly, where a TRS is based on a single security or loan, or a narrow-based security index, the TRS would be a security-based swap.647 In addition, the Commissions are providing a final interpretation providing that, generally, the use of a variable interest rate in the TRS buyer’s payment obligations to the seller is incidental to the purpose of, and the risk that the counterparties assume in, entering into the TRS, because such payments are a form of financing reflecting the seller’s (typically a security-based swap dealer) cost of financing the position or a related hedge, allowing the TRS buyer to receive payments based on the price appreciation and income of a security or security index without purchasing the security or security index. As stated in

648See infra part IV.
649See, e.g., Moorad Chowdry, ‘‘Total Return Swaps: Credit Derivatives and Synthetic Funding Instruments,’’ at 3–4 (noting that the spread to the TRS financing rate is a function of: The credit rating of the counterparty paying the financing rate; the amount, value, and credit quality of the reference asset; the dealer’s funding costs; a profit margin; and the capital charge associated with the TRS), available at http://www.yieldcurve.com/ Mktresearch/LearningCurve/TRS.pdf. 650For example, a security-based swap on an equity security priced in U.S. dollars in which payments are made in Euros based on the U.S. dollar/Euro spot rate at the time the payment is made would not be a mixed swap. As the Commissions stated in the Proposing Release, under these circumstances, the currency is merely referenced in connection with the method of payment, and the counterparties are not hedging the risk of changes in currency exchange rates during the term of the security-based swap See Proposing Release at 29842, n. 176. 651See Mixed Swaps, infra part IV. 652See SIFMA Letter. 653 Id. 654Handbook of Corporate Equity Derivatives and Equity Capital Markets (‘‘Corporate Equity Derivatives Handbook’’), § 1.2.10, at 23, available at http://media.wiley.com/product_data/excerpt/05/ 11199759/1119975905-83.pdf last visited May 4, 2012. 655 James M. Mahoney, Correlation Products and Risk Management Issues, FRBNY Economic Policy Review/October 1995 at 2, available at http:// www.ny.frb.org/research/epr/95v01n3/ 9510maho.pdf last visited May 4, 2012. 656While applicable in general, this logic, which merely expands upon the principle that the character of a Title VII instrument as either a swap or a security-based swap should follow the underlying factors which are incorporated into the cash flows of the instrument—a security, yield, loan, or other trigger for SEC jurisdiction or as a commodity triggering CFTC jurisdiction (or both for joint jurisdiction), should not be extrapolated to other Title VII instruments, for which other principles may override. 657Although the SIFMA Letter describes quanto equity swaps in terms of equity indexes, if the underlying reference of a quanto equity swap is a single security, the result would be the same. The Commissions also note that if a security index underlying a quanto equity swap is not narrow￾based, the quanto equity swap is a swap. In that event, it is not a mixed swap because no element of the quanto equity swap is a security-based swap and, to be a mixed swap, a Title VII instrument must have both swap and security-based swap components. 658See generally Corporate Equity Derivatives Handbook, supra note 654, § 1.2.9, at 21–23. the Proposing Release, the Commissions believe that when such interest rate payments act merely as a financing component in a TRS, or in any other security-based swap, the inclusion of such interest rate terms would not cause the TRS to be characterized as a mixed swap.648 Financing terms may also involve
adding or subtracting a spread to or from the financing rate,649 or calculating the financing rate in a currency other than that of the underlying reference security or security index.650 However, where such payments incorporate additional elements that create additional interest rate or currency exposures that are unrelated to the financing of the security-based swap, or otherwise shift or limit risks that are related to the financing of the security-based swap, those additional elements may cause the security-based swap to be a mixed swap. For example, where the counterparties embed interest-rate optionality (e.g., a cap, collar, call, or put) into the terms of a security-based swap in a manner designed to shift or limit interest rate exposure, the inclusion of these terms would cause the TRS to be both a swap and a security-based swap (i.e., a mixed swap). Similarly, if a TRS is also based on non-security-based components (such as the price of oil, or a currency), the TRS would also be a mixed swap.651 The Commissions also are providing an additional interpretation regarding a quanto equity swap, in response to comments raised by one commenter,652 and for illustrative purposes, a similar but contrasting product, a compo equity swap. A quanto equity swap, which ‘‘can provide a U.S. investor with currency-protected exposure to a non￾U.S. equity index by translating the percentage equity return in the currency of such non-U.S. equity index into U.S. dollars,’’ 653 can be described as:
An equity swap in which [(1)] the underlying is denominated in a currency (the foreign currency) other than that in which the equity swap is denominated (the domestic currency) * * * [and (2) t]he final value of the underlying is denominated in the foreign currency and is converted into the domestic currency using the exchange rate prevailing at inception[,] result[ing in] the investor * * * not [being] exposed to currency risk.654 While a quanto equity swap, therefore, effectively ‘‘exposes the dealer on the foreign leg of the correlation product to a variable notional principal amount that changes whenever the exchange rate or the foreign index fluctuates,’’ 655 such exposure results from the choice of hedges for the quanto equity swap, not from the cash flows of the quanto equity swap itself.656 Thus, that exposure could be viewed as created in the seller by the act of entering into the quanto equity swap, rather than as a transfer between the parties, as is required by the third prong of the statutory swap definition. Consequently, the dealer’s exchange rate exposure could be seen as incidental to the securities exposure desired by the party initiating the quanto equity swap. The Commissions view a quanto equity swap as a security-based swap, and not a mixed swap, where (i) the purpose of the quanto equity swap is to transfer exposure to the return of a security or security index without transferring exposure to any currency or exchange rate risk; and (ii) any exchange rate or currency risk exposure incurred by the dealer due to a difference in the currency denomination of the quanto equity swap and of the underlying security or security index is incidental to the quanto equity swap and arises from the instrument(s) the dealer chooses to use to hedge the quanto equity swap and is not a direct result of any expected payment obligations by either party under the quanto equity swap.657 By contrast, in a compo equity swap, the parties assume exposure to, and the total return is calculated based on, both the performance of specified foreign stocks and the change in the relevant exchange rate.658 Because the counterparty initiating a transaction can choose to avoid currency exposure by entering into a quanto equity swap, the currency exposure obtained via a compo equity swap is not incidental to the equity exposure for purposes of determining mixed swap status. In fact, investors seeking synthetic exposure to foreign securities via a TRS may also be seeking exposure to the exchange rate between the currencies, as evidenced by the fact that a number of mutual funds exist in both hedged and unhedged versions to provide investors exposure to the same foreign securities with or without the attendant currency

659See, e.g., Descriptive Brochure: The Tweedy, Browne Global Value Fund II—Currency Unhedged at 1, available at http://www.tweedy.com/resources/ gvf2/TBGVF-II_verJuly2011.pdf (last visited May 4,
2012) (comparing the Tweedy, Browne Global
Value Fund II—Currency Unhedged and the Tweedy, Browne Global Value Fund (which hedges its currency exposure) and stating that ‘‘[t]he only material difference [between the funds] is that the Unhedged Global Value Fund generally does not hedge currency risk [and] is designed for long-term value investors who wish to focus their investment exposure on foreign stock markets, and their associated non-U.S. currencies’’ and ‘‘[b]y establishing the Tweedy, Browne Global Value Fund II—Currency Unhedged, we were acknowledging that many investors may view exposure to foreign currency as another form of diversification when investing outside the U.S., and/or may have strong opinions regarding the future direction of the U.S. dollar.’’). See also the PIMCO Foreign Bond Fund (Unhedged) Fact Sheet at 1 (stating that ‘‘[t]he fund seeks to capture the returns of non-U.S. bonds including potential returns due to changes in exchange rates. In a declining dollar environment foreign currency appreciation may augment the returns generated by investments in foreign bonds.’’), available at http://investments.pimco.com/Shareholder Communications/External%20Documents/Foreign %20Bond%20Fund%20(Unhedged)%20 Institutional.pdf last visited May 4, 2012 and the PIMCO Foreign Bond Fund (U.S. Dollar-Hedged) INSTL Fact Sheet at 1 (stating that ‘‘[t]he fund seeks to capture the returns of non-U.S. bonds but generally hedges out most currency exposure in order to limit the volatility of returns.’’), available at http://investments.pimco.com/Shareholder Communications/External%20Documents/Foreign %20Bond%20Fund%20(U.S.%20Dollar-Hedged) %20Institutional.pdf (last visited May 4, 2012). 660Such swaps are examples of swaps with payments that ‘‘incorporate additional elements that create additional * * * currency exposures

• • • unrelated to the financing of the security￾based swap * * * that may cause the security￾based swap to be a mixed swap.’’ See Proposing
      Release at 29842.
      661See infra note 667 and accompanying text. 662 Depending on the facts and circumstances loans may be notes or evidences of indebtedness that are securities. See section 3(a)(10) of the Exchange Act. In this section, the Commissions address only groups or indexes of loans that are not securities. 663See CEA section 1a(35), 7 U.S.C. 1a(35), and
      section 3(a)(55) of the Exchange Act, 15 U.S.C.
      78c(a)(55).
      664The same would be true with respect to swaps (e.g., options, CFDs, NDFs), other than LTRS or loan index credit default swaps, on two or more loans that are not securities. 665See July LSTA Letter; Letter from David Lucking, Allen & Overy LLP, dated May 26, 2011 (‘‘Allen & Overy Letter’’); and SIFMA Letter. 666See SIFMA Letter. 667See Allen & Overy Letter and July LSTA Letter. 668See SIFMA Letter. 669 Id. 670 Id. SIFMA added that such a determination could require market participants to determine whether a specific interest rate or spread referenced in the TRS is sufficiently in line with market rates to constitute a financing leg of a transaction under the proposed test. SIFMA continues by noting that there are a number of examples where a TRS can provide for some interest rate or currency exposure incidental to the primary purpose of the TRS, describing a quanto equity swap as an example. 671To the extent a market participant is uncertain as to the results of such an analysis, it may seek informal guidance from the Commissions’ staffs or use the process established in this release, see infra
      part VI, for seeking formal guidance from the
      Commissions as to the nature of a Title VII instrument as a swap, security-based swap or mixed swap. 672For example, the Commissions would expect a dealer perceived by the market to constitute a higher counterparty risk to have higher funding costs generally, which might affect its TRS financing costs. To the extent such a dealer passed through its higher TRS financing costs to its TRS counterparty, such a pass-through simply would reflect the dealer’s specific circumstances, and would not transform the TRS from a security-based swap into a mixed swap. exposure.659 Consequently, a compo equity swap is a mixed swap.660 In response to comments,661 the Commissions also are providing an interpretation with respect to the treatment of loan TRS (‘‘LTRS’’) on two or more loans. As noted above, the second prong of the security-based swap definition includes a swap that is based on ‘‘a single security or loan, including any interest therein or on the value thereof.’’ Thus, an LTRS based on a single loan, as mentioned above, is a security-based swap. The Commissions believe, however, that an LTRS based on two or more non-security loans are swaps, and not security-based swaps.662 An LTRS on a group or index of such non-security loans is not covered by the first prong of the security-based swap definition—swaps based on a narrow￾based security index—because the definition of the term ‘‘narrow-based security index’’ in both the CEA and the Exchange Act only applies to securities, and not to non-security loans.663 An LTRS, moreover, is not covered by the third prong of the security-based swap definition because it is based on the total return of such loans, and not events related thereto. Accordingly, an LTRS on two or more loans that are non￾security loans is a swap and not a security-based swap.664 Comments The Commissions received three comments with respect to the interpretation provided on TRS in the Proposing Release.665 One of these commenters addressed the Commissions’ interpretation on security-based TRS.666 The other two commenters requested that the Commissions clarify the treatment of LTRS on two or more loans.667 One commenter asserted that the terms of a TRS that create interest rate or currency exposures incidental to the primary purpose of the TRS should not cause a transaction that otherwise would be deemed to be a security-based swap to be characterized as a mixed swap.668 This commenter agreed with the Commissions that the scope of the mixed swap category of Title VII instruments is intended to be narrow and that, when variable interest rates are used for financing purposes incidental to counterparties’ purposes, and risks assumed, in entering into a TRS, the TRS is a security-based swap and not a mixed swap.669 This commenter also opined that the Commissions’ interpretation that ‘‘where such payments incorporate additional elements that create additional interest rate or currency exposures * * * unrelated to the financing of the [TRS], or
      otherwise shift or limit risks that are related to the financing of the [TRS], those additional elements may cause the [TRS] to be a mixed swap’’ could be seen as requiring a quantitative analysis to determine whether a reference to interest rates or currencies in a TRS is solely for financing purposes or creates additional exposure that might be construed as extending beyond those purposes.670 The Commissions are clarifying that a quantitative analysis is not necessarily required in order to determine whether a TRS is a mixed swap. Any analysis, quantitative or qualitative, clearly demonstrating the nature of a payment (solely financing-related, unrelated to financing or a combination of the two) can suffice.671 The Commissions also are clarifying that market participants are not necessarily required to compare their financing rates to market financing rates in order to determine whether the financing leg of a TRS is merely a financing leg or is sufficient to render the TRS a mixed swap. Because a number of factors can influence how a particular TRS is structured,672 the Commissions cannot provide an interpretation applicable to all situations. If the financing leg of a TRS reflects the dealer’s financing costs on a one-to-one basis, the Commissions would view such leg as a financing leg. Adding a spread would not alter that conclusion if the spread is consistent with the dealer’s course of dealing generally, with respect to a particular type of TRS or with respect to a particular counterparty. The Commissions believe that this would be the case even if the spread is ‘‘off￾market,’’ if the deviance from a market spread is explained by factors unique to the dealer (e.g., the dealer has high financing costs), to the TRS (e.g., the underlying securities are highly illiquid, so financing them is more costly than would be reflected in a ‘‘typical’’ market spread for other TRS) or to then-current market conditions (e.g., a share repurchase might make shares harder

673The Commissions expect that dealers know their financing costs and can readily explain the components of the financing leg paid by their TRS counterparties. 674 Id. SIFMA distinguished quanto equity swaps from the examples of mixed swaps that the Commissions provided in the Proposing Release, characterizing them as ‘‘very different.’’ 675See Allen & Overy Letter and July LSTA Letter. 676See Allen & Overy Letter. Allen & Overy notes that a Title VII Instrument that references two securities is a security-based swap. It believes that treating an LTRS on two or more loans as a swap would result in functionally and potentially economically similar products being treated in an arbitrarily different way, contrary to the spirit of the Dodd-Frank Act. 677The Commissions address the comments regarding loan index credit default swaps below. See infra note 768 and accompanying text. 678See Proposing Release at 29843. 679See infra note 689 and accompanying text. 680Section 3(a)(68)(A)(ii)(II) of the Exchange Act, 15 U.S.C. 78c(a)(68)(A)(ii)(II). The first prong of the security-based swap definition is discussed below. See infra part III.G. 681Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15 U.S.C. 78c(a)(68)(A)(ii)(III). 682The Commissions understand that in the context of credit derivatives on asset-backed securities or MBS, the events include principal writedowns, failure to pay principal and interest shortfalls. 683The Commissions understand that some single-name CDS now trade with fixed coupon payments expressed as a percentage of the notional amount of the transaction and payable on a periodic basis during the term of the transaction. See Markit, ‘‘The CDS Big Bang: Understanding the Changes to the Global CDS Contract and North American Conventions,’’ 3, available at http:// www.markit.com/cds/announcements/resource/ cds_big_bang.pdf. The Commissions are restating their view that the existence of such single-name CDS does not change their interpretation. 684See Proposing Release at 29843. 685See infra note 689 and accompanying text. 686See infra note 691. 687The security-based swap definition further defines ‘‘index to include an ‘‘index or group of securities.’’ See section 3(a)(68)(E) of the Exchange Act, 15 U.S.C. 78c(a)(68)(E). for a dealer to procure in order to hedge its obligations under a TRS to pay its counterparty the capital appreciation of a security, resulting in higher financing costs due to the decrease in shares outstanding, assuming demand for the shares does not change). If the spread is designed to provide exposure to an underlying reference other than securities, however, rather than to reflect financing costs, such a TRS is a mixed swap. Market participants are better positioned than are the Commissions to determine what analysis, and what supporting information and materials, best establish whether the nature of a particular payment reflects financing costs alone, or something more. Moreover, the Commissions expect that a
dealer would know if the purpose of the payment(s) in question is to cover its cost of financing a position or a related hedge.673 In such cases, a detailed analysis should not be necessary. One commenter noted the nature of quanto equity swaps as TRS and maintained that such a transaction ‘‘is equivalent to a financing of a long position in the underlying non-U.S. equity index[]’’ and that the currency protection is incidental to the financing element, which is the primary purpose of the TRS.674 As discussed above, the Commissions have provided a final interpretation regarding the appropriate classification of Title VII instruments that are quanto equity swaps and compo equity swaps. Two commenters requested that the Commissions clarify the status of LTRS on two or more loans.675 Both commenters stated that while the statutory definition of the term ‘‘security-based swap’’ provides that swaps based on a single loan are security-based swaps, it does not explicitly provide whether swaps on indexes of loans are security-based swaps.676 They requested clarification regarding the treatment of loan based swaps, including both LTRS and loan index credit default swaps.677 The Commissions have provided the final interpretation discussed above regarding LTRS based on two or more loans that are not securities. The Commissions acknowledge that this interpretation results in different treatment for an LTRS on two non￾security loans (a swap), as opposed to a Title VII instrument based on two securities (a security-based swap). This result, however, is dictated by the statute. D. Security-Based Swaps Based on a Single Security or Loan and Single￾Name Credit Default Swaps The Commissions provided an interpretation in the Proposing Release regarding security-based swaps based on a single security or loan and single￾name CDS 678 and are restating such interpretation with certain modifications in response to commenters.679 The second prong of the statutory security-based swap definition includes a swap that is based on ‘‘a single security or loan, including any interest therein or on the value thereof.’’ 680 The Commissions believe that under this prong of the security￾based swap definition, a single-name CDS that is based on a single reference obligation would be a security-based swap because it would be based on a single security or loan (or any interest therein or on the value thereof). In addition, the third prong of the security-based swap definition includes a swap that is based on the occurrence of an event relating to a ‘‘single issuer of a security,’’ provided that such event ‘‘directly affects the financial statements, financial condition, or financial obligations of the issuer.’’ 681 This provision applies generally to event-triggered swap contracts. With respect to a CDS, such events could include, for example, the bankruptcy of an issuer, a default on one of an issuer’s debt securities, or the default on a non￾security loan of an issuer.682 The
Commissions believe that if the payout on a CDS on a single issuer of a security is triggered by the occurrence of an event relating to that issuer, the CDS is a security-based swap under the third prong of the statutory security￾based swap definition.683 In relation to aggregations of transactions under a single ISDA Master Agreement,684 the Commissions are revising the example that was included in the Proposing Release referring to single-name CDS to clarify that the interpretation regarding aggregations of transactions is non-exclusive and thus not limited to either CDS or single￾reference instruments.685 The Commissions believe that each transaction under an ISDA Master Agreement would need to be analyzed to determine whether it is a swap or security-based swap. For example, the Commissions believe that a number of Title VII instruments that are executed at the same time and that are documented under one ISDA Master Agreement, but in which a separate confirmation is sent for each instrument, should be treated as an aggregation of such Title VII instruments, each of which must be analyzed separately under the swap and security-based swap definitions.686 The Commissions believe that, as a practical and economic matter, each such Title VII instrument would be a separate and independent transaction. Thus, such an aggregation of Title VII instruments would not constitute a Title VII instrument based on one ‘‘index or group’’ 687 under the security-based swap definition but instead would constitute multiple Title VII instruments. The Commissions find that this interpretation is an appropriate way to address CDS, TRS or other Title VII instruments referencing a single security or loan or entity that is documented under a Master Agreement or Master Confirmation and is designed to reduce the cost associated with determining

688See supra part I, under ‘‘Overall Economic Considerations’’. 689See July LSTA Letter. 690 Id. 691See Letter from Richard M. McVey, Chairman and Chief Executive Officer, MarketAxess Holdings, Inc. (‘‘MarketAxess’’), July 22, 2011 (‘‘MarketAxess Letter’’). 692The Commissions believe, based on the July LSTA Letter, that the ‘‘Master Confirmation’’ structure the commenter described is the same general structure as the aggregation of single-name CDS the Commissions provided as an example in the Proposing Release, but that a ‘‘Master Confirmation’’ structure may not be limited to single-reference instruments or to CDS and instead may be used for a broader range of instruments. See July LSTA Letter. The Commissions note that the following are examples of ‘‘Master Confirmation’’ structure to which the interpretive guidance would apply: 2009 Americas Master Equity Derivatives Confirmation Agreement, Stand-alone 2007 Americas Master Variance Swap Confirmation Agreement, and 2004 Americas Interdealer Master Equity Derivatives Confirmation Agreement and March 2004 Canadian Supplement to the Master Confirmation. The Commissions believe the broader example in this release provides the clarification the commenter requested. 693See Proposing Release at 29843–44. 694 Id. 695See infra note 718 and accompanying text. 696See rule 1.3(bbbb) under the CEA and rule 3a68–5 under the Exchange Act. 697A security future is defined in both the CEA and the Exchange Act as a futures contract on a single security or a narrow-based security index, including any interest therein or based on the value thereof, except an exempted security under section 3(a)(12) of the Exchange Act, 15 U.S.C. 78c(a)(12), as in effect on the date of enactment of the Futures Trading Act of 1982 (other than any municipal security as defined in section 3(a)(29) of the Exchange Act, 15 U.S.C. 78c(a)(29), as in effect on the date of enactment of the Futures Trading Act of 1982). The term security future does not include any agreement, contract, or transaction excluded from the CEA under sections 2(c), 2(d), 2(f), or 2(g) of the CEA, 7 U.S.C. 2(c), 2(d), 2(f), or 2(g), as in effect on the date of enactment of the Commodity Futures Modernization Act of 2000 (‘‘CFMA’’) or Title IV of the CFMA. See section 1a(44) of the CEA, 7 U.S.C. 1a(44), and section 3(a)(55) of the Exchange Act, 15 U.S.C. 78c(a)(55). 698 Depending on the underlying reference of the futures contract, though, such swaps could be SBSAs. For example, a swap on a future on the S&P 500 index would be an SBSA. 699See Proposing Release at 29843. 700Specifically, rule 3a12–8 under the Exchange Act requires as a condition to the exemption that the foreign government debt securities not be registered under the Securities Act (or be the subject of any American depositary receipt registered under the Securities Act) and that futures contracts on such foreign government debt securities ‘‘require delivery outside the United States, [and] any of its
possessions or territories, and are traded on or through a board of trade, as defined in [section 2 of the CEA, 7 U.S.C. 2].’’ See rules 3a12–8(a)(2) and 3a12–8(b) under the Exchange Act, 17 CFR 240.3a12–8(a)(2) and 240.3a12–8(b). These conditions were ‘‘designed to minimize the impact of the exemption on securities distribution and trading in the United States.

• • *’’ See Exemption for Certain Foreign
    Government Securities for Purposes of Futures Trading, 49 FR 8595 (Mar. 8, 1984) at 8596–97 (citing Futures Trading Act of 1982). 701See rule 3a12–8(a)(1) under the Exchange Act (designating the debt securities of the governments of the United Kingdom, Canada, Japan, Australia, France, New Zealand, Austria, Denmark, Finland, the Netherlands, Switzerland, Germany, Ireland, Italy, Spain, Mexico, Brazil, Argentina, Venezuela, Belgium, and Sweden). 702The Commissions note, by contrast, that a Title VII instrument that is based on the price or value of, or settlement into, a futures contract on the debt securities of one of the 21 enumerated foreign governments and that also has the potential to settle directly into such debt securities would be a security-based swap and, depending on other features of the Title VII instrument, possibly a mixed swap. 703Rule 3a12–8(b) under the Exchange Act defines ‘‘qualifying foreign futures contracts’’ as ‘‘contracts for the purchase or sale of a designated foreign government security for future delivery, as ‘future delivery’ is defined in 7 U.S.C. 2, provided such contracts require delivery outside the United States, any of its possessions or territories, and are traded on or through a board of trade, as defined at 7 U.S.C. 2.’’ 17 CFR 240.3a12–8(b). 704See supra note 700. whether such instruments are swaps or security-based swaps.688 Comments The Commissions received two comments regarding the interpretation regarding aggregation of Title VII instruments under a single ISDA Master Agreement. One commenter requested that the Commissions clarify that the interpretation applies to other types of instruments, such as TRS, in addition to CDS.689 The commenter also stated that the interpretation should be helpful with respect to use of a ‘‘Master Confirmation’’ structure, which the commenter described as use of general terms in a ‘‘Master Confirmation’’ that apply to a number of instruments with separate underlying references but for which a separate ‘‘Supplemental Confirmation’’ is sent for each separate component.690 A second commenter agreed with the Commissions’ interpretation that a number of single-name CDS that are executed at the same time and that are documented under one ISDA Master Agreement, but in which a separate confirmation is sent for each CDS, should not be treated as a single index CDS and stated that this approach is consistent with market practice.691 As discussed above, in response to comments the Commissions are expanding the example so it is clear that it applies beyond just CDS.692 E. Title VII Instruments Based on Futures Contracts The Commissions proposed an interpretation in the Proposing Release regarding the treatment, generally, of swaps based on futures contracts.693 The Commissions are restating the interpretation they provided in the Proposing Release without modification. The Commissions also discussed in the Proposing Release the unique circumstance involving certain futures
    contracts on foreign government debt securities and requested comment as to how Title VII instruments on these futures contracts should be treated.694 In response to commenters,695 the Commissions are adopting a rule regarding the treatment of Title VII instruments on certain futures contracts on foreign government debt securities.696 A Title VII instrument that is based on a futures contract will either be a swap or a security-based swap, or both (i.e., a mixed swap), depending on the nature of the futures contract, including the underlying reference of the futures contract. Thus, a Title VII instrument where the underlying reference is a security future is a security-based swap.697 In general, a Title VII instrument where the underlying reference is a futures contract that is not a security future is a swap.698 As the Commissions noted in the Proposing Release,699 Title VII instruments involving certain futures contracts on foreign government debt securities present a unique circumstance, which is discussed below. Rule 3a12–8 under the Exchange Act exempts certain foreign government debt securities, for purposes only of the offer, sale, or confirmation of sale of futures contracts on such foreign government debt securities, from all provisions of the Exchange Act which by their terms do not apply to an ‘‘exempted security,’’ subject to certain conditions.700 To date, the SEC has enumerated within rule 3a12–8 the debt securities of 21 foreign governments solely for purposes of futures trading (‘‘21 enumerated foreign governments’’).701 The Commissions recognize that as a result of rule 3a12–8, futures contracts on the debt securities of the 21 enumerated foreign governments that satisfy the conditions of rule 3a12–8 are subject to the CFTC’s exclusive jurisdiction and are not considered security futures. As a result, applying the interpretation above to a Title VII instrument that is based on a futures contract on the debt securities of these 21 enumerated foreign governments would mean that the Title VII instrument would be a swap.702 The Commissions note, however, that the conditions in rule 3a12–8 were established specifically for purposes of the offer and sale of ‘‘qualifying foreign futures contracts’’ (as defined in rule 3a12–8) 703 on the debt securities of the 21 enumerated foreign governments,704 not Title VII instruments based on futures contracts on the debt securities

705See Proposing Release at 29844.
706See infra note 718 and accompanying text. 707See supra note 703. 708See, e.g., rule 405 under the Securities Act, 17 CFR 230.405. 709See supra note 700. 710 Id. 711See infra part III.H. 712See Proposing Release at 29844. 713See section 2(a)(3) of the Securities Act, 15 U.S.C. 77b(a)(3), as amended by the Dodd-Frank Act. 714See section 5 of the Securities Act, 15 U.S.C. 77e, as amended by the Dodd-Frank Act. of the 21 enumerated governments. Further, the Commissions note that the Dodd-Frank Act did not exclude swaps on foreign government debt securities generally from the definition of the term ‘‘security-based swap.’’ Accordingly, a Title VII instrument that is based directly on foreign government debt securities, including those of the 21 enumerated governments, is a security￾based swap or a swap under the same analysis as any other Title VII instruments based on securities. The Commissions indicated in the Proposing Release that they would evaluate whether Title VII instruments based on futures contracts on the debt securities of the 21 enumerated foreign governments that satisfy the conditions of rule 3a12–8 should be characterized as swaps, security-based swaps, or mixed swaps.705 In response to commenters,706 the Commissions are adopting rule 1.3(bbbb) under the CEA and rule 3a68–5 under the Exchange Act, which address the treatment of these Title VII instruments. The final rules provide that a Title VII instrument that is based on or references a qualifying foreign futures contract on the debt securities of one or more of the 21 enumerated foreign governments is a swap and not a security-based swap, provided that the Title VII instrument satisfies the following conditions:

• The futures contract on which the
  Title VII instrument is based or that is referenced is a qualifying foreign futures contract (as defined in rule 3a12–8) 707 on the debt securities of any one or more of the 21 enumerated foreign governments that satisfies the conditions of rule 3a12–8;
• The Title VII instrument is traded
  on or through a board of trade (as defined in section 1a(6) of the CEA);
• The debt securities on which the
  qualifying foreign futures contract is based or referenced and any security used to determine the cash settlement amount pursuant to the fourth condition below are not covered by an effective registration statement under the Securities Act or the subject of any American depositary receipt covered by an effective registration statement under the Securities Act;
• The Title VII instrument may only
  be cash settled; and
• The Title VII instrument is not
  entered into by the issuer of the securities upon which the qualifying foreign futures contract is based or referenced (including any security used to determine the cash payment due on settlement of such Title VII instrument), an affiliate (as defined in the Securities Act and the rules and regulations thereunder) 708 of the issuer, or an underwriter with respect to such securities. Under the first condition, the final rules provide that the futures contract on which the Title VII instrument is based or referenced must be a qualifying foreign futures contract that satisfies the conditions of rule 3a12–8 and may only be based on the debt of any one or more of the enumerated 21 foreign governments. If the conditions of rule 3a12–8 are not satisfied, then there cannot be a qualifying foreign futures contract, the futures contract is a security future, and a swap on such a security future is a security-based swap. The second condition of the final rules provides that the Title VII instrument on the qualifying foreign futures contract must itself be traded on or through a board of trade because a qualifying foreign futures contract on the debt securities of one or more of the 21 enumerated foreign governments itself is required to be traded on a board of trade. The Commissions believe that swaps on such futures contracts should be traded subject to rules applicable to such futures contracts themselves. The third condition of the final rules provides that the debt securities on which the qualifying foreign futures contract is based or referenced and any security used to determine the cash settlement amount pursuant to the fourth condition cannot be registered under the Securities Act or be the subject of any American depositary receipt registered under the Securities Act. This condition is intended to prevent circumvention of registration and disclosure requirements of the Securities Act applicable to foreign government issuances of their securities. This condition is similar to a condition included in rule 3a12–8.709 The fourth condition of the final rules provides that the Title VII instrument must be cash settled. Although, as the Commissions recognize, rule 3a12–8 permits a qualifying foreign futures contract to be physically settled so long as delivery is outside the United States, any of its possessions or territories,710 in the context of Title VII instruments, only cash settled Title VII instruments based on qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments will be considered swaps. The Commissions believe that this condition is appropriate in order to provide consistent treatment of Title VII instruments based on qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments with the Commissions’ treatment of swaps and security-based swaps generally.711 The fifth condition of the final rules provides that for a Title VII instrument to be a swap under such
  rules, it cannot be entered into by the issuer of the securities upon which the qualifying foreign futures contract is based or referenced (including any security used to determine the cash payment due on settlement of such Title VII instrument), an affiliate of the issuer, or an underwriter of the issuer’s securities. The Commissions have included this condition to address the concerns raised by the SEC in the Proposing Release that the characterization of a Title VII instrument that is based on a futures contract on the debt securities of one of the 21 enumerated foreign governments may affect Federal securities law provisions relating to the distribution of the securities upon which the Title VII instrument is based or referenced.712 The Dodd-Frank Act included provisions that would not permit issuers, affiliates of issuers, or underwriters to use security-based swaps to offer or sell the issuers’ securities underlying a security-based swap without complying with the requirements of the Securities Act.713 This provision applies regardless of whether the Title VII instrument allows the parties to physically settle any such security-based swap. In addition, the Dodd-Frank Act provided that any offer or sale of security-based swaps to non￾ECPs would have to be registered under the Securities Act.714 For example, if a Title VII instrument that is based on a futures contract on the debt securities of one of the 21 enumerated foreign governments is characterized as a swap, and not a security-based swap, then the provisions of the Dodd-Frank Act enacted to ensure that there could not be offers and sales of securities made without compliance with the Securities Act, either by issuers, their affiliates, or underwriters or to non-ECPs, would not apply to such swap transactions. Only those Title VII instruments that are based on qualifying foreign futures contracts on the debt securities of the 21

715The Commissions note that the final rules provide consistent treatment of qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments and Title VII instruments based on qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments unless the Title VII instrument is entered into by the issuer of the securities upon which the qualifying foreign futures contract is based or referenced (including any security used to determine the cash payment due on settlement of such Title VII instrument), an affiliate of the issuer, or an underwriter with respect to such securities. 716For the quarter that ended December 31, 2011, the trading volume reported to the CFTC of qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments made available for trading by direct access from the U.S. on foreign trading venues granted direct access no-action relief by the CFTC that exceeded 100,000 contracts per quarter from the U.S. were as follows: (i) 7,985,959 contracts for 3 Year Treasury Bond Futures on the Australian Securities Exchange’s ASX Trade24 platform; (ii) 1,872,592 contracts for 10-Year Government of Canada Bond Futures on the Bourse de Montreal; (iii) 47,874,911 contracts for Euro Bund Futures on Eurex Deutschland (‘‘Eurex’’); (iv) 26,434,713 contracts for Euro Bobl Futures on Eurex; (v) 30,489,427 contracts for Euro Schatz Futures on Eurex; and (vi) 8,292,222 contracts for Long Gilt Futures on the NYSE LIFFE. 717See supra note 712 and accompanying text. 718See CME Letter and SIFMA Letter. 719 Id. Both commenters stated their belief that the range of factors considered by the SEC in designating the debt securities of the 21 enumerated foreign governments as exempted securities indicated that there is sufficient disclosure about the 21 enumerated foreign governments and their securities such that the further disclosure should not be necessary. Both commenters also indicated that subjecting futures contracts on the debt securities of the 21 enumerated foreign governments to CFTC regulation, while subjecting Title VII instruments based on these futures contracts to SEC regulation, would be problematic. Id. 720See Proposing Release at 29845. 721This interpretation relates solely to the determination regarding whether a Title VII instrument is a swap or security-based swap. The Commissions are not expressing a view regarding whether such Title VII instrument would be a security-based swap agreement. 722However, to the extent the fixed term or condition is set at a future date or at a future value or level of a security, rate, or other commodity rather than the value or level of such security, rate, or other commodity at the time of execution of the Title VII instrument, the discussion above would not apply, and the nature of the security, rate, or other commodity used in determining the terms or conditions would be considered in evaluating
whether the Title VII instrument is a swap or security-based swap. enumerated foreign governments and that satisfy these five conditions will be swaps, not security-based swaps. The Commissions note that the final rules are intended to provide consistent treatment (other than with respect to method of settlement) of qualifying foreign futures contracts and Title VII instruments based on qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments.715 The Commissions understand that many of the qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments trade with substantial volume through foreign trading venues under the conditions set forth in rule 3a12–8 716 and permitting swaps on such futures contracts subject to similar conditions would not raise concerns that such swaps could be used to circumvent the conditions of rule 3a12– 8 and the Federal securities laws concerns that such conditions are intended to protect.717 Further, providing consistent treatment for qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments and Title VII instruments based on futures contracts on the debt securities of the 21 enumerated foreign governments will allow trading of these instruments through designated contract markets on which such futures are listed. The Commissions recognize that the rules may result in a different characterization of a Title VII instrument that is based directly on a foreign government debt security and one that is based on a qualifying foreign futures contract on a debt security of one of the 21 enumerated foreign governments. However, the Commissions note that this is the case today (i.e., different treatments) with respect to other instruments subject to CFTC regulation and/or SEC regulation, such as futures on broad-based security indexes and futures on a single security or narrow-based security index. Comments Commenters did not address the interpretation as it applied to Title VII instruments based on futures contracts generally. Two commenters addressed Title VII instruments based on futures contracts on debt securities of the 21 enumerated foreign governments.718 Both commenters requested that the Commissions treat these Title VII instruments as swaps.719 The Commissions agree that these instruments should be treated as swaps under certain conditions and, therefore, are adopting rule 1.3(bbbb) under the CEA and rule 3a68–5 under the Exchange Act as discussed above to treat Title VII instruments based on qualifying foreign futures contracts on the debt securities of the 21 enumerated foreign governments as swaps, provided such Title VII instruments satisfy certain conditions. F. Use of Certain Terms and Conditions in Title VII Instruments The Commissions provided an interpretation in the Proposing Release regarding the use of certain fixed terms in Title VII instruments and are restating that
interpretation without modification.720 The Commissions are aware that market participants’ setting of certain fixed terms or conditions of Title VII instruments may be informed by the value or level of a security, rate, or other commodity at the time of the execution of the instrument. The Commissions believe that, in evaluating whether a Title VII instrument with such a fixed term or condition is a swap or security-based swap, the nature of the security, rate, or other commodity that informed the setting of such fixed term or condition should not itself impact the determination of whether the Title VII instrument is a swap or a security-based swap, provided that the fixed term or condition is set at the time of execution and the value or level of that fixed term or condition may not vary over the life of the Title VII instrument.721 For example, a Title VII instrument, such as an interest rate swap, in which floating payments based on three-month LIBOR are exchanged for fixed rate payments of five percent would be a swap, and not a security-based swap, even if the five percent fixed rate was informed by, or quoted based on, the yield of a security, provided that the five percent fixed rate was set at the time of execution and may not vary over the life of the Title VII instrument.722 Another example would be where a private sector or government borrower that issues a five-year, amortizing $100 million debt security with a semi￾annual coupon of LIBOR plus 250 basis points also, at the same time, chooses to enter into a five-year interest rate swap on $100 million notional in which this same borrower, using the same amortization schedule as the debt security, receives semi-annual payments of LIBOR plus 250 basis points in exchange for five percent fixed rate payments. The fact that the specific terms of the interest rate swap (e.g., five￾year, LIBOR plus 250 basis points, $100 million notional, fixed amortization
schedule) were set at the time of
execution to match related terms of a debt security does not cause the interest rate swap to become a security-based swap. However, if the interest rate swap contained additional terms that were in fact contingent on a characteristic of the debt security that may change in the future, such as an adjustment to future interest rate swap payments based on the future price or yield of the debt security, then this Title VII instrument would be a security-based swap that would be a mixed swap.

723See ISDA Letter.
724See infra part III.G.5(a).
725See Proposing Release at 29845–58. 726See Proposing Release at 29845–48. 727Sections 3(a)(55)(B) and (C) of the Exchange Act, 15 U.S.C. 78c(a)(55)(B) and (C), include a definition of ‘‘narrow-based security index’’ in the same paragraph as the definition of security future. See also sections 1a(35)(A) and (B) of the CEA, 7 U.S.C. 1a(35)(A) and (B). A security future is a contract for future delivery on a single security or narrow-based security index (including any interest therein or based on the value thereof). See section 3(a)(55) of the Exchange Act, 15 U.S.C. 78c(a)(55), and section 1a(44) of the CEA, 7 U.S.C. 1a(44). 728See section 3(a)(55)(B) of the Exchange Act, 15 U.S.C. 78c(a)(55)(B). See also sections 1a(35)(A) and (B) of the CEA, 7 U.S.C. 1a(35)(A) and (B). 729The narrow-based security index definition in the CEA and Exchange Act also excludes from its scope security indexes that satisfy certain specified criteria. See sections 3(a)(55)(C)(i)–(vi) of the Exchange Act, 15 U.S.C. 78c(a)(55)(C)(i)–(vi), and sections 1a(35)(B)(i)–(vi) of the CEA, 7 U.S.C. 1a(35)(B)(i)–(vi). 730See Joint Order Excluding Indexes Comprised of Certain Index Options From the Definition of Narrow-Based Security Index, 69 FR 16900 (Mar. 31, 2004) (‘‘March 2004 Index Options Joint Order’’). 731See section 1a(35)(B)(vi) of the CEA, 7 U.S.C. 1a(35)(B)(vi), and section 3(a)(55)(C)(vi) of the Exchange Act, 15 U.S.C. 78c(a)(55)(C)(vi). 732See March 2004 Index Options Joint Order. 733See Joint Final Rules: Application of the Definition of Narrow-Based Security Index to Debt Securities Indexes and Security Futures on Debt Securities, 71 FR 39434 (Jul. 13, 2006) (‘‘July 2006 Debt Index Release’’). Comments One commenter agreed with the Commissions’ interpretation generally, but believed that the Commissions should broaden the interpretation to allow a swap to reflect ‘‘resets,’’ or changes in the referenced characteristic of a security, where those ‘‘resets’’ or changes are ‘‘intended to effect a purpose other than transmitting the risk of changes in the characteristic itself,’’ without causing a Title VII instrument that is not a security-based swap to become a security-based swap.723 The Commissions are not expanding the interpretation to allow ‘‘resets’’ of a fixed rate derived from a security. The interpretation is consistent with the statutory swap and security-based swap definitions. The Commissions believe that a Title VII instrument based on a rate that follows a security, and that may ‘‘reset’’ or change in the future based on changes in that security, is a security-based swap. Further, any amendment or modification of a material term of a Title VII instrument would result in a new Title VII instrument and a corresponding reassessment of the instrument’s status as either a swap or a security-based swap.724 G. The Term ‘‘Narrow-Based Security Index’’ in the Security-Based Swap Definition

1. Introduction
   As noted above, a Title VII instrument in which the underlying reference of the instrument is a ‘‘narrow-based security index’’ is a security-based swap subject to regulation by the SEC, whereas a Title VII instrument in which the underlying reference of the instrument is a security index that is not a narrow-based security index (i.e., the index is broad￾based) is a swap subject to regulation by the CFTC. The Commissions proposed an interpretation and rules regarding usage of the term ‘‘narrow-based security index’’ in the security-based swap definition, including:

• The existing criteria for determining
  whether a security index is a narrow￾based security index and the applicability of past guidance of the Commissions regarding those criteria to Title VII instruments;
• New criteria for determining
  whether a CDS where the underlying reference is a group or index of entities or obligations of entities (typically referred to as an ‘‘index CDS’’) is based on an index that is a narrow-based security index;
• The meaning of the term ‘‘index’’;
• Rules governing the tolerance
  period for Title VII instruments on security indexes traded on DCMs, SEFs, foreign boards of trade (‘‘FBOTs’’), security-based SEFs, or NSEs, where the security index temporarily moves from broad-based to narrow-based or from narrow-based to broad-based; and
• Rules governing the grace period for
  Title VII instruments on security indexes traded on DCMs, SEFs, FBOTs, security-based SEFs, or NSEs, where the security index moves from broad-based to narrow-based or from narrow-based to broad-based and the move is not temporary.725 As discussed below, the Commissions are restating the interpretation set forth in the Proposing Release with certain further clarifications and adopting the rules as proposed with certain modifications.

2. Applicability of the Statutory Narrow￾Based Security Index Definition and
   Past Guidance of the Commissions to Title VII Instruments The Commissions provided an interpretation in the Proposing Release regarding the applicability of the statutory definition of the term ‘‘narrow￾based security index’’ and past guidance of the Commissions relating to such term to Title VII instruments.726 The Commissions are restating the interpretation set out in the Proposing Release without modification. As defined in the CEA and Exchange Act,727 an index is a narrow-based security index if, among other things, it meets any one of the following four criteria:

• It has nine or fewer component
  securities;
• A component security comprises
  more than 30 percent of the index’s weighting;
• The five highest weighted
  component securities in the aggregate comprise more than 60 percent of the index’s weighting; or
• The lowest weighted component
  securities comprising, in the aggregate, 25 percent of the index’s weighting have an aggregate dollar value of average daily trading volume of less than $50,000,000 (or in the case of an index with more than 15 component securities, $30,000,000), except that if there are two or more securities with equal weighting that could be included in the calculation of the lowest weighted component securities comprising, in the aggregate, 25 percent of the index’s weighting, such securities shall be ranked from lowest to highest dollar value of average daily trading volume and shall be included in the calculation based on their ranking starting with the lowest ranked security.728 The first three criteria apply to the number and concentration of the ‘‘component securities’’ in the index. The fourth criterion applies to the average daily trading volume of an index’s ‘‘component securities.’’ 729 This statutory narrow-based security index definition focuses on indexes composed of equity securities and certain aspects of the definition, in particular the evaluation of average daily trading volume, are designed to take into account the trading patterns of individual stocks.730 However, the Commissions, pursuant to authority granted in the CEA and the Exchange Act,731 previously have extended the definition to other categories of indexes but modified the definition to take into account the characteristics of those other categories. Specifically, the Commissions have previously provided guidance regarding the application of the narrow-based security index definition to futures contracts on volatility indexes 732 and debt security indexes.733 Today, then, there exists guidance for determining what constitutes a narrow-based security index. Volatility indexes are indexes composed of index options. The Commissions issued a joint order in

734 15 U.S.C. 78f(a). 735See March 2004 Index Options Joint Order. In 2009, the Commissions issued a joint order that provided that, instead of the index options having to be listed on an NSE, the index options must be listed on an exchange and pricing information for the index options, and the underlying index, must be computed and disseminated in real time through major market data vendors. See Joint Order To Exclude Indexes Composed of Certain Index Options From the Definition of Narrow-Based Security Index, 74 FR 61116 (Nov. 23, 2009) (expanding the criteria necessary for exclusion under the March 2004 Index Options Joint Order to apply to volatility indexes for which pricing information for the underlying broad-based security index, and the options that compose such index, is current, accurate, and publicly available). 736Under the rules, debt securities include notes, bonds, debentures or evidence of indebtedness. See rule 41.15(a)(1)(i) under the CEA, 17 CFR 41.15(a)(1)(i) and rule 3a55–4(a)(1)(i) under the Exchange Act, 17 CFR 240.3a55–4(a)(1)(i). See also July 2006 Debt Index Release. 737 15 U.S.C. 78m or 78o(d). 738 15 U.S.C. 78c(a)(12). 739See July 2006 Debt Index Rules. The July 2006 Debt Index Rules also provided that debt securities in the index must satisfy certain minimum outstanding principal balance criteria, established certain exceptions to these criteria and the public information availability requirement, and provided for the treatment of indexes that include exempted securities (other than municipal securities). 740See sections 3(a)(55)(B) and (C) of the Exchange Act, 15 U.S.C. 78c(a)(55)(B) and (C). See also sections 1a(35)(A) and (B) of the CEA, 7 U.S.C. 1a(35)(A) and (B). 741The statutory definition of the term ‘‘narrow￾based security index’’ for equities, and the Commissions’ subsequent guidance as to what constitutes a narrow-based security index with respect to volatility and debt indexes, is applicable in the context of distinguishing between futures contracts and security futures products. 742See March 2004 Index Options Joint Order. 743See July 2006 Debt Index Rules. 744See infra part III.G.3. 745 7 U.S.C. 1a(35) and 15 U.S.C. 78c(a)(55). 746See infra part III.G.3. 2004 to define when a volatility index is not a narrow-based security index. Under this joint order, a volatility index is not a narrow-based security index if the index meets all of the following criteria:

• The index measures the magnitude
  of changes (as calculated in accordance with the order) in the level of an underlying index that is not a narrow￾based security index pursuant to the statutory criteria for equity indexes discussed above;
• The index has more than nine
  component securities, all of which are options on the underlying index;
• No component security of the index
  comprises more than 30 percent of the index’s weighting;
• The five highest weighted
  component securities of the index in the aggregate do not comprise more than 60 percent of the index’s weighting;
• The average daily trading volume of
  the lowest weighted component securities in the underlying index (those comprising, in the aggregate, 25 percent of the underlying index’s weighting) have a dollar value of more than $50,000,000 (or $30,000,000 in the case of an underlying index with 15 or more component securities), except if there are 2 or more securities with equal weighting that could be included in the calculation of the lowest weighted component securities comprising, in the aggregate, 25 percent of the underlying index’s weighting, such securities shall be ranked from lowest to highest dollar value of average daily trading volume and shall be included in the calculation based on their ranking starting with the lowest ranked security;
• Options on the underlying index
  are listed and traded on an NSE registered under section 6(a) of the Exchange Act; 734 and
• The aggregate average daily trading
  volume in options on the underlying index is at least 10,000 contracts calculated as of the preceding 6 full calendar months.735 With regard to debt security indexes, the Commissions issued joint rules in 2006 (‘‘July 2006 Debt Index Rules’’) to define when an index of debt securities 736 is not a narrow-based security index. The first three criteria of that definition are similar to the statutory definition for equities and the order regarding volatility indexes in that a debt security index would not be narrow-based if:
• It is comprised of more than nine
  debt securities that are issued by more than nine non-affiliated issuers;
• The securities of any issuer
  included in the index do not comprise more than 30 percent of the index’s weighting; and
• The securities of any five non￾affiliated issuers in the index do not
  comprise more than 60 percent of the index’s weighting. In the July 2006 Debt Index Rules, instead of the statutory average daily trading volume test, however, the Commissions adopted a public information availability requirement. Under this requirement, assuming the aforementioned number and concentration criteria were satisfied, a debt security index would not be a narrow-based security index if the debt securities or the issuers of debt securities in the index met any one of the following criteria:
• The issuer of the debt security is
  required to file reports pursuant to
  section 13 or section 15(d) of the
  Securities Exchange Act of 1934; 737
• The issuer of the debt security has
  a worldwide market value of its outstanding common equity held by non-affiliates of $700 million or more;
• The issuer of the debt security has
  outstanding securities that are notes, bonds, debentures, or evidence of indebtedness having a total remaining principal amount of at least $1 billion;
• The security is an exempted
  security as defined in section 3(a)(12) of the Securities Exchange Act of 1934 738 and the rules promulgated thereunder; or
• The issuer of the security is a
  government of a foreign country or a political subdivision of a foreign country.739 In the Dodd-Frank Act, Congress included the term ‘‘narrow-based security index’’ in the security-based swap definition, and thus the statutory definition of the term ‘‘narrow-based security index’’ 740 also applies in distinguishing swaps (on security indexes that are not narrow-based, also known as ‘‘broad-based’’) and security￾based swaps (on narrow-based security indexes).741 The Commissions have determined that their prior guidance with respect to what constitutes a narrow-based security index in the context of volatility indexes 742 and debt security indexes 743 applies in determining whether a Title VII instrument is a swap or a security-based swap, except as the rules the Commissions are adopting provide for other treatment with respect to index CDS as discussed below.744 To make clear that the Commissions are applying the prior guidance and rules to Title VII instruments, the Commissions are adopting rules to further define the term ‘‘narrow-based security index’’ in the security-based swap definition. Under paragraph (1) of rule 1.3(yyy) under the CEA and paragraph (a) of rule 3a68–3 under the Exchange Act, for purposes of the security-based swap definition, the term ‘‘narrow-based security index’’ has the same meaning as the statutory definition set forth in section 1a(35) of the CEA and section 3(a)(55) of the Exchange Act,745 and the rules, regulations, and orders issued by the Commissions relating to such definition. As a result, except as the rules the Commissions are adopting provide for other treatment with respect to index CDS as discussed below,746 market participants generally may use the Commissions’ past guidance in determining whether certain Title VII instruments based on a security index are swaps or security￾based swaps. The Commissions also are providing an interpretation and adopting additional rules establishing criteria for indexes composed of securities, loans, or issuers of securities referenced by an

747 Id.
748See infra part III.G.4.
749See infra part III.G.5.
750See Proposing Release at 29847–48. 751See, e.g., Markit, ‘‘Markit CDX’’ (describing the Markit CDX indexes and the number of ‘‘names’’ included in each index), available at http:// www.markit.com/en/products/data/indices/credit￾and-loan-indices/cdx/cdx.page; Markit, ‘‘Markit iTraxx Indices,’’ (stating that the ‘‘Markit iTraxx indices are comprised of the most liquid names in the European and Asian markets’’) (emphasis added), available at http://www.markit.com/en/ products/data/indices/credit-and-loan-indices/ itraxx/itraxx.page . Examples of indexes based on securities include the Markit ABX.HE and CMBX indexes. See Markit, ‘‘Markit ABX.HE,’’ (describing the Markit ABX.HE index as ‘‘a synthetic tradeable index referencing a basket of 20 subprime mortgage￾backed securities’’), available at http:// www.markit.com/en/products/data/indices/ structured-finance-indices/abx/abx.page; and Markit, ‘‘Markit CMBX,’’ (describing the Markit CMBX index as ‘‘a synthetic tradeable index referencing a basket of 25 commercial mortgage￾backed securities’’), available at http:// www.markit.com/en/products/data/indices/ structured-finance-indices/cmbx/cmbx.page. 752Similarly, an option to enter into a single￾name CDS or a CDS referencing a narrow-based security index as described above would be a security-based swap, while an option to enter into a CDS on a broad-based security index or the issuers of securities in a broad-based security index would be a swap. Index CDS where the underlying reference is a broad-based security index would be SBSAs. The SEC has enforcement authority with respect to swaps that are SBSAs, as discussed further in section V., infra. 753See July 2006 Debt Index Rules. 754Section 3(a)(68)(A)(ii)(III) of the Exchange Act, 15 U.S.C. 78c(a)(68)(A)(ii)(III). 755Section 3(a)(68)(A)(ii)(I) of the Exchange Act, 15 U.S.C. 78c(a)(68)(A)(ii)(I). 756Because they apply only with respect to index CDS, the definitions of ‘‘issuers of securities in a narrow-based security index’’ and ‘‘narrow-based security index’’ as adopted do not apply with respect to other types of event contracts, whether analyzed under the first or third prong. 757For example, if the reference entities included in one index are the same as the issuers of securities included in another index, application of the two definitions should result in both indexes being either broad-based or narrow-based. 758See Proposing Release at 29848. 759The discussion throughout this section refers to ‘‘reference entities’’ and ‘‘issuers’’ in discussing the final rules. The term ‘‘reference entity’’ is defined in paragraph (c)(3) of rule 1.3(zzz) under the CEA and rule 3a68–1a under the Exchange Act and the term ‘‘issuer’’ is defined in paragraph (c)(3) of rule 1.3(aaaa) under the CEA and rule 3a68–1b under the Exchange Act. The final rules provide that the term ‘‘reference entity’’ includes: (i) An issuer of securities; (ii) an issuer of securities that is an issuing entity of asset-backed
securities is a reference entity or issuer, as applicable; and (iii) an issuer of securities that is a borrower with respect to any loan identified in an index of borrowers or loans is a reference entity. The final rules provide that the term ‘‘issuer’’ includes: (i) An issuer of securities; and (ii) an issuer of securities that is an issuing entity of asset-backed securities is a reference entity or issuer, as applicable. See paragraph (c)(3) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and rule 3a68–1a and 3a68–1b under the Exchange Act. index CDS.747 The interpretation and rules also address the definition of an ‘‘index’’ 748 and the treatment of broad￾based security indexes that become narrow-based and narrow-based indexes that become broad-based, including rule provisions regarding tolerance and grace periods for swaps on security indexes that are traded on CFTC-regulated trading platforms and security-based swaps on security indexes that are traded on SEC-regulated trading platforms.749 These rules and interpretation are discussed below.
3. Narrow-Based Security Index Criteria
for Index Credit Default Swaps (a) In General The Commissions provided an interpretation in the Proposing Release regarding the narrow-based security index criteria for index CDS and are restating it without modification.750 While the Commissions understand that the underlying reference for most cleared CDS is a single entity or an index of entities rather than a single security or an index of securities, the underlying reference for CDS also could be a single security or an index of securities.751 A CDS where the underlying reference is a single entity (i.e., a single-name CDS), a single obligation of a single entity (e.g., a CDS on a specific bond, loan, or asset-backed security, or any tranche or series of any bond, loan, or asset-backed security), or an index CDS where the underlying reference is a narrow-based security index or the issuers of securities in a narrow-based security index is a security-based swap. An index CDS where the underlying reference is not a narrow-based security index or the issuers of securities in a narrow-based security index (i.e., a broad-based index) is a swap.752 The statutory definition of the term ‘‘narrow-based security index,’’ as explained above, was designed with the U.S. equity markets in mind.753 Thus, the statutory definition is not necessarily appropriate for determining whether an index underlying an index CDS is broad or narrow-based. Nor is the guidance that the Commissions have previously issued with respect to the narrow-based security index definition discussed above necessarily appropriate, because that guidance was designed to address and was uniquely tailored to the characteristics of volatility indexes and debt security indexes in the context of futures. Accordingly, the Commissions are clarifying that the guidance that the Commissions have previously issued with respect to the narrow-based security index definition discussed above does not apply to index CDS. Instead, the Commissions are adopting rules as discussed below that include separate criteria for determining whether an index underlying an index CDS is a narrow-based security index. The Commissions are further defining the term ‘‘security-based swap,’’ and the use of the term ‘‘narrow-based security index’’ within that definition, to modify the criteria applied in the context of index CDS in assessing whether the index is a narrow-based security index. The third prong of the security-based swap definition includes a Title VII instrument based on the occurrence of an event relating to the ‘‘issuers of securities in a narrow-based security index,’’ provided that such event directly affects the ‘‘financial statements, financial condition, or financial obligations of the issuer.’’ 754 The first prong of the security-based swap definition includes a Title VII instrument that is based on a narrow￾based security-index.755 Because the third prong of the security-based swap definition relates to issuers of securities, while the first prong of
such definition relates to securities, the Commissions are further defining both the term ‘‘narrow-based security index’’ and the term ‘‘issuers of securities in a narrow￾based security index’’ in the context of the security-based swap definition as applied to index CDS. The Commissions believe it is important to further define both terms in order to assure consistent analysis of index CDS.756 While the wording of the two definitions as adopted differs slightly, the Commissions expect that they will yield the same substantive results in distinguishing narrow-based and broad￾based index CDS.757 (b) Rules Regarding the Definitions of ‘‘Issuers of Securities in a Narrow-Based Security Index’’ and ‘‘Narrow-Based Security Index’’ for Index Credit Default Swaps The Commissions proposed rules to further define the terms ‘‘issuers of securities in a narrow-based security index’’ and ‘‘narrow-based security index’’ in order to provide appropriate criteria for determining whether an index composed of issuers of securities referenced by an index CDS and an index composed of securities referenced by an index CDS are narrow-based security indexes.758 The Commissions are adopting rules 1.3(zzz) and 1.3(aaaa) under the CEA and rules 3a68–1a and 3a68–1b under the Exchange Act as proposed with certain modifications.759 In formulating the criteria in the final rules, and consistent with the guidance and rules the Commissions have

760See discussion of July 2006 Debt Index Rules. 761The Commissions note that the language of the rules is intended, in general, to be consistent with the criteria developed for debt indexes discussed above. Certain changes from the criteria developed for debt indexes are necessary to address differences between futures on debt indexes and index CDS. Certain other changes are necessary because the rules for debt indexes define under what conditions an index is not a narrow-based security index, whereas the rules for index CDS define what is a narrow-based security index. For example, an index is not a narrow-based security index under the rule for debt indexes if it is not a narrow-based security index under either subparagraph (a)(1) or paragraph (a)(2) of the rule. See July 2006 Debt Index Rules. Under the rules for index CDS, however, an index is a narrow-based security index if it meets the requirements of both of the counterpart paragraphs in the rules regarding index CDS (paragraphs (1)(i) and (1)(ii) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and paragraph (a)(1) and paragraph (a)(2) of rules 3a68–1a and 3a68–1b under the Exchange Act), even though the criteria in the debt index rules and the rules for index CDS include generally the same criteria and structure. 762See infra note 768 and accompanying text. 763 If the loans underlying the index of loans are securities, the index CDS would be analyzed in the same manner as any other index CDS based on an index of securities. 764An index CDS referencing loans also may be based on events relating to the borrower, such as bankruptcy, and to defaults on any obligation of the borrower. 765See ISDA Letter and MarketAxess Letter. 766See MarketAxess Letter. This commenter stated that ‘‘The Proposed Rules layout an exceedingly complex process for determining whether an index CDS is broad-based or narrow￾based.’’ Id. 767See ISDA Letter. 768See Allen & Overy Letter; July LSTA Letter; and SIFMA Letter. 769See Allen & Overy Letter. 770 Id. 771 Id. 772See July LSTA Letter. This commenter noted that prong (III) of the statutory security-based swap definition does not clearly reference borrowers of loans or indexes of borrowers. However, this commenter noted that because most borrowers that are named as reference entities in loan CDS transactions are corporate entities that issue equity interests to one or more shareholders (although they may not issue public securities or become subject to public reporting requirements), this commenter believes that prong (III) can be interpreted to include swaps that reference a single borrower or borrowers of loans in an index. Id. 773See SIFMA Letter. 774The Commissions also are providing guidance with respect to TRS based on two or more loans that are not securities. See supra part III.C. previously issued and adopted regarding narrow-based security indexes in the context of security futures, the Commissions believe that there should be public information available
about a predominant percentage of the reference entities included in the index, or, in the case of an index CDS on an index of securities, about the issuers of the securities or the securities underlying the index, in order to reduce the likelihood that non-narrow-based indexes referenced in index CDS or the component securities or issuers of securities in that index would be readily susceptible to manipulation, as well as to help prevent the misuse of material non-public information through the use of CDS based on such indexes. To satisfy these objectives, the Commissions are adopting rules that are based on the criteria developed for debt indexes discussed above 760 but that tailor these criteria to address index CDS.761 These criteria are included solely for the purpose of defining the terms ‘‘narrow-based security index’’ and ‘‘issuers of securities in a narrow￾based security index’’ in the first and third prongs of the security-based swap definition with respect to index CDS and will not affect any other interpretation or use of the term ‘‘narrow-based security index’’ or any other provision of the Dodd-Frank Act, the CEA, or the Exchange Act. Further, in response to commenters,762 the Commissions are clarifying that if an index CDS is based on an index of loans that are not securities,763 an event relating to a loan in the index, such as a default on a loan, is an event ‘‘relating to’’ the borrower.764 To the extent that the borrower is an issuer of securities, the index CDS based on such index of loans will be analyzed under the third prong of the security-based swap definition in the same manner as any other index CDS. Comments The Commissions received two general comments requesting that the proposed rules further defining the terms ‘‘issuers of securities in a narrow￾based security index’’ and ‘‘narrow￾based security index’’ be simplified.765 One commenter believed that the rules were exceedingly complicated.766 Another commenter thought that the criteria should allow transactions to be readily and transparently classifiable as a swap or security-based swap.767 The commenters did not provide analysis supporting their comments or recommend language changes. The Commissions are adopting the rules regarding index CDS essentially as proposed with certain modifications to address commenters’ concerns. While the final rules contain a number of elements that are similar or identical to elements contained in the statutory narrow-based security index definition, in order to enable the narrow-based security index definition to apply appropriately to index CDS, the final rules contain some alternative tests to those set forth in the statutory definition. The Commissions also recognize the diversity of Title VII instruments. While the final rules for index CDS are based on the July 2006 Debt Index Rules, the substantive differences between the final rules in the index CDS and the equity or debt security contexts are intended to reflect the
particular characteristics of the CDS marketplace, in which, for example, index components may be entities (issuers of securities) as well as specific equity and debt securities. The Commissions also received three comments requesting clarification regarding the applicability of the index CDS rules to CDS based on indexes of loans.768 One commenter noted that the Commissions did not address in the Proposing Release the question of whether an index composed exclusively of loans should be treated as a narrow￾based security index.769 This commenter noted that because the first and third prongs of the statutory security-based swap definition do not explicitly reference loans, the statutory definition does not expressly categorize Title VII instruments based on more than one loan, or contingent on events that occur with respect to more than one loan borrower, unless such borrowers are also ‘‘issuers of securities.’’ 770 Based on this commenter’s view of the statutory definition, this commenter requested that the Commissions clarify the treatment of indexes composed exclusively of loans.771 Another commenter provided similar comments and also requested clarification regarding the treatment of CDS based on indexes of loans.772 A third commenter stated its view that the third prong of the statutory security-based swap definition implies that Title VII instruments on a basket of loans are security-based swaps if the lenders would satisfy the criteria for issuers of a ‘‘narrow-based security index’’ and encouraged the Commissions to clarify this issue.773 The Commissions agree with commenters that an index CDS based on an index of loans that are not securities is analyzed under the third prong of the statutory security-based swap definition and, therefore, are clarifying the treatment of these Title VII instruments above.774 (i) Number and Concentration Percentages of Reference Entities or Securities The Commissions believe that the first three criteria of the debt security index test (which are based on the statutory narrow-based security index definition) discussed above (i.e., the number and concentration weighting requirements) are appropriate to apply to index CDS,

775See infra notes 792 and 793 and accompanying text. 776See paragraphs (a)(1)(i)–(iii) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and rules 3a68–1a and 3a68–1b under the Exchange Act. 777See infra note 804 and accompanying text. 778See infra notes 795 and 796 and accompanying text. 779 15 U.S.C. 78c(a)(68)(A)(ii)(III). 780These rules refer to the ‘‘effective notional amount’’ allocated to reference entities or securities in order to address potential situations in which the means of calculating payout across the reference entities or securities is not uniform. Thus, if one or more payouts is leveraged or enhanced by the structure of the transaction (i.e., 2x recovery rate), that amount would be the ‘‘effective notional amount’’ for purposes of the 30 percent and 60 percent tests in paragraphs (1)(i)(B) and (1)(i)(C) of rules 1.3(zzz) and 1.3(aaaa) and paragraphs (a)(1)(ii) and (a)(1)(iii) of rules 3a68–1a and 3a68–1b. Similarly, if the aggregate notional amount under a CDS is not uniformly allocated to each reference entity or security, then the portion of the notional amount allocated to each reference entity or security (which may be by reference to the product of the aggregate notional amount and an applicable percentage) would be the ‘‘effective notional amount.’’ 781 15 U.S.C. 78c(a)(68)(A)(ii)(I). 782See infra part III.G.3(b)(ii), for a discussion of the affiliation definition applicable to calculating the number and concentration criteria. As noted above, the Commissions are modifying the method of calculating affiliation for purposes of these criteria. whether CDS on indexes of securities or indexes of issuers of securities.775 Accordingly, the Commissions are adopting the first three criteria of rule 1.3(zzz) under the CEA and rule 3a68– 1a under the Exchange Act as proposed with certain modifications in response to commenters’ concerns.776 These rules contain the same number and concentration criteria as proposed, but modify the method of calculating affiliation among issuers and reference entities in response to commenters.777 Further, in response to commenters,778 the Commissions are providing an additional interpretation with respect to the application of these criteria to two particular types of CDS, commonly known as ‘‘nth-to-default CDS’’ and ‘‘tranched CDS.’’ The first three criteria provide that, for purposes of determining whether an index CDS is a security-based swap under section 3(a)(68)(A)(ii)(III) of the Exchange Act,779 the term ‘‘issuers of securities in a narrow-based security index’’ includes issuers of securities identified in an index (including an index referencing loan borrowers) in which:

• Number: There are nine or fewer
  non-affiliated issuers of securities that are reference entities included in the index, provided that an issuer of securities shall not be deemed a reference entity included in the index unless (i) a credit event with respect to such reference entity would result in a payment by the credit protection seller to the credit protection buyer under the index CDS based on the related notional amount allocated to such reference entity; or (ii) the fact of such credit event or the calculation in accordance with clause (i) above of the amount owed with respect to such credit event is taken into account in determining whether to make any future payments under the index CDS with respect to any future credit events;
• Single Component Concentration:
  The effective notional amount allocated to any reference entity included in the index comprises more than 30 percent of the index’s weighting; or
• Largest Five Component
  Concentration: The effective notional amount allocated to any five non￾affiliated reference entities included in the index comprises more than 60 percent of the index’s weighting.780 Similarly, the Commissions are adopting as proposed the first three criteria of rule 1.3(aaaa) under the CEA and rule 3a68–1b under the Exchange Act. These three criteria provide that, for purposes of determining whether an index CDS is a security-based swap under section 3(a)(68)(A)(ii)(I) of the Exchange Act,781 the term ‘‘narrow￾based security index’’ includes an index in which essentially the same criteria apply, substituting securities for issuers. Under these criteria, the term ‘‘narrow￾based security index’’ would mean an index in which:
• Number: There are nine or fewer
  securities, or securities that are issued by nine or fewer non-affiliated issuers, included in the index, provided that a security shall not be deemed a component of the index unless (i) a credit event with respect to the issuer of such security or a credit event with respect to such security would result in a payment by the credit protection seller to the credit protection buyer under the index CDS based on the related notional amount allocated to such security, or (ii) the fact of such credit event or the calculation in accordance with clause (i) above of the amount owed with respect to such credit event is taken into account in determining whether to make any future payments under the index CDS with respect to any future credit events;
• Single Component Concentration:
  The effective notional amount allocated to the securities of any issuer included in the index comprises more than 30 percent of the index’s weighting; or
• Largest Five Component
  Concentration: The effective notional amount allocated to the securities of any five non-affiliated issuers included in the index comprises more than 60 percent of the index’s weighting. Thus, the applicability of the final rules depends on conditions relating to the number of non-affiliated reference entities or issuers of securities, or securities issued by non-affiliated issuers, as applicable, included in an index and the weighting of notional amounts allocated to the reference entities or securities included in the index, as applicable. These first three criteria of the final rules evaluate the number and concentration of the reference entities or securities included in the index, as applicable, and ensure that an index with a small number of reference entities, issuers, or securities or concentrated in only a few reference entities, issuers, or securities is narrow￾based, and thus where such index is the underlying reference of an index CDS, the index CDS is a security-based swap. Further, as more fully described below,782 the final rules provide that a reference entity or issuer of securities included in an index and any of that reference entity’s or issuer’s affiliated entities (as defined in the final rules) that also are included in the index are aggregated for purposes of determining whether the number and concentration criteria are met. Specifically, the final rules provide that an index meeting any one of certain identified conditions would be a narrow-based security index. The first condition in paragraph (1)(i)(A) of rule 1.3(zzz) under the CEA and paragraph (a)(1)(i) of rule 3a68–1a under the Exchange Act is that there are nine or fewer non-affiliated issuers of securities that are reference entities in the index. An issuer of securities counts toward this total only if a credit event with respect to such entity would result in a payment by the credit protection seller to the credit protection buyer under the index CDS based on the notional amount allocated to such entity, or if the fact of such a credit event or the calculation of the payment with respect to such credit event is taken into account when determining whether to make any future payments under the index CDS with respect to any future credit events. Similarly, the first condition in paragraph (1)(i)(A) of rule 1.3(aaaa) under the CEA and paragraph (a)(1)(i) of rule 3a68–1b under the Exchange Act provides that a security counts toward the total number of securities in the index only if a credit event with respect to such security, or the issuer of such security, would result in a payment by the credit protection seller to the credit

783This requirement is generally consistent with the definition of ‘‘narrow-based security index’’ in
section 1a(35)(A) of the CEA, 7 U.S.C. 1a(35)(A),
and section 3(a)(55)(B) of the Exchange Act, 15 U.S.C. 78c(a)(55)(B), and the July 2006 Debt Index Rules. 784 Id. 785See infra note 795 and accompanying text. 786An ‘‘nth-to-default CDS’’ is a CDS in which the payout is linked to one in a series of defaults (such as first-, second- or third-to-default), with the contract terminating at that point. See SIFMA Letter. 787See infra note 796 and accompanying text. 788A ‘‘tranched CDS’’ is a CDS in which the counterparties agree to buy and sell credit protection on only a portion of the potential losses that could occur on an underlying portfolio of reference entities. The portion is typically denoted as a specified percentage range of aggregate losses (e.g., 2 percent to 5 percent, meaning the credit protection seller would not make payments until aggregate losses exceed 2 percent of the notional of the transaction, and would no longer be obligated to make payments after aggregate losses reach 5 percent). See SIFMA Letter. 789See July 2006 Debt Index Rules. 790As noted above, the Commissions are modifying the method of calculating affiliation for purposes of the number and concentration criteria. See infra part III.G.3(b)(ii). 791See ISDA Letter. According to this commenter, the ‘‘operational complexity’’ of the number and concentration criteria will increase costs and compliance risks. Id. 792See 15 U.S.C. 78c(a)(55)(B) and 7 U.S.C. 1a(35). 793See July 2006 Debt Index Rules. 794See infra part III.G.3(b)(ii). 795See ISDA Letter and SIFMA Letter. One of these commenters noted that such an approach also made sense for nth-to-default CDS because they are typically based on baskets of less than 10 securities. See ISDA Letter. 796See Markit Letter and SIFMA Letter. One of these commenters stated that classifying tranches underlying index CDS according to attachment or detachment points is not appropriate because it is impossible to know for certain at inception of the CDS the number of credit events that will ultimately affect actual payments, which typically depend on the severity of loss associated with each credit event. See SIFMA Letter. protection buyer under the index CDS based on the notional amount allocated to such security, or if the fact of such a credit event or the calculation of the payment with respect to such credit event is taken into account when determining whether to make any future payments under the index CDS with respect to any future credit events. These provisions are intended to ensure that an index concentrated in a few reference entities or securities, or a few reference entities that are affiliated (as defined in the final rules) or a few securities issued by issuers that are affiliated, are within the narrow-based security index definition.783 These provisions also are intended to ensure that an entity is not counted as a reference entity included in the index, and a security is not counted as a security included in the index, unless a credit event with respect to the entity,
issuer, or security affects payout under a CDS on the index.784 Further, as this condition is in the alternative (i.e., either there must be a credit event resulting in a payment under the index CDS or a credit event is considered in determining future CDS payments), the tests encompass all index CDS. For example, and in response to a commenter,785 the test would cover an nth-to-default CDS,786 in which default with respect to a specified component of an index (such as the first default or fifth default) triggers the CDS payment, even if the CDS payment is not made with respect to such particular credit event. As another example, and in response to another commenter,787 the test applies to a tranched CDS 788 if the payments are made on only a tranche, or portion, of the potential aggregate notional amount of the CDS (often expressed as a percentage range of the total notional amount of the CDS) because the CDS payment takes into account a credit event with respect to an index component, even if the credit event itself does not result in such a payment. The second condition, in paragraphs (1)(i)(B) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and paragraphs (a)(1)(ii) of rules 3a68–1a and 3a68–1b under the Exchange Act, is that the effective notional amount allocated to any reference entity or security of any issuer included in the index comprises more than 30 percent of the index’s weighting. The third condition, in paragraphs (1)(i)(C) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and paragraphs (a)(1)(iii) of rules 3a68–1a and 3a68–1b under the Exchange Act, is that the effective notional amount allocated to any five non-affiliated reference entities, or to the securities of any five non-affiliated issuers, included in the index comprises more than 60 percent of the index’s weighting. Given that Congress determined that these concentration percentages are appropriate to characterize an index as a narrow-based security index, and the Commissions have determined they are appropriate for debt security indexes in the security futures context,789 the Commissions believe that these concentration percentages are appropriate to apply to the notional amount allocated to reference entities and securities in order to apply similar standards to indexes that are the underlying references of index CDS. Moreover, with respect to both the number and concentration criteria, the markets have had experience with these criteria with respect to futures on equity indexes, volatility indexes, and debt security indexes.790 Comments One commenter expressed its view that the Commissions should increase the percentage test in the largest five component concentration.791 The Commissions are adopting the number and concentration criteria as proposed. The statutory definition of the term ‘‘security-based swap’’ references the definition of the term ‘‘narrow-based security index’’ contained in the Exchange Act and the CEA,792 which includes the same number and concentration
percentages as the Commissions are adopting in this release. The Commissions are not modifying the statutory definition to change the percentages. The statutory definition included the concentration percentages, which the Commissions understand are intended to assure that a security index could not be used as a surrogate for the underlying securities in order to avoid application of the Federal securities laws. The Commissions also previously determined to retain these statutory percentages in connection with rules relating to debt security indexes in the security futures context.793 The Commissions believe that these percentages are similarly appropriate to apply to indexes on which index CDS are based. Moreover, with respect to the number and concentration criteria, as these are in the statutory definition of the term ‘‘narrow-based security index’’ applicable to security futures, market participants have experience in analyzing indexes, including equity, volatility and debt security indexes, to determine compliance with these criteria. As discussed below,794 though, the Commissions are modifying the affiliation definition used in analyzing the number and concentration criteria for an index. Two commenters requested clarification regarding nth-to-default CDS, stating their view that such CDS should be treated as security-based swaps to reflect their single-entity triggers.795 Two commenters requested clarification regarding tranched index CDS, including whether the CDS would be classified based on the underlying index.796 As discussed above, the Commissions are providing an interpretation on the applicability of the first three criteria of the rules to nth-to￾default CDS and tranched CDS. As noted above, the Commissions believe the rules encompass all index CDS, regardless of the type or payment

797See infra note 804 and accompanying text. 798See paragraph (c)(4) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and rule 3a68–1a and 3a68–1b under the Exchange Act. 799See paragraph (c)(1) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and rules 3a68–1a and 3a68–1b under the Exchange Act. 800See paragraph (c)(2) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and rules 3a68–1a and 3a68–1b under the Exchange Act. 801See Proposing Release at 29849. 802See infra note 804 and accompanying text. The Commissions note that another alternative would have been to include a requirement that the entities satisfy the 20 percent control threshold and also be consolidated with each other in financial statements. The Commissions did not include a requirement that the entities be consolidated with each other in financial statements because they do not believe that the scope of the affiliation definition should be exposed to the risk of future changes in accounting standards. Further, the use of a majority ownership control threshold (more than 50 percent) is generally consistent with consolidation under generally accepted accounting principles. See FASB ASC section 810–10–25, Consolidation—Overall—Recognition (stating that consolidation is appropriate if a reporting entity has a controlling financial interest in another entity and a specific scope exception does not apply). 803 In such a case, as noted by commenters, the affiliated entities are viewed as part of group for which aggregation of these entities is appropriate. See infra note 806 and accompanying text. 804See ISDA Letter (requesting a threshold of at least 50 percent); Markit Letter (requesting a threshold of at least 50 percent); and SIFMA Letter (requesting a threshold of majority ownership, or 51 percent). One commenter also requested that the Commissions clarify the application of the affiliation definition. See Markit Letter. The Commissions have provided above and in infra part III.G.3(b)(ii), several examples illustrating the application of the affiliation definition in response to this commenter. 805 Id. 806See SIFMA Letter. The ISDA Letter provides a similar rationale that ‘‘the control threshold was too low and potentially disruptive when viewed against entities that the swap markets now trade as separate entities. In the CDS market, for example, entities that share ownership ties of substantially more than 20 percent trade quite independently. These entities may have completely disparate characteristics for the purpose of an index grouping of one sort or another.’’ See ISDA Letter. 807See SIFMA Letter. structure, such as whether there is a single-entity payment based on credit events of other index components or whether the payment is based on a specific entity. (ii) Affiliation of Reference Entities and Issuers of Securities With Respect to Number and Concentration Criteria The Commissions are adopting the affiliation definition that applies when calculating the number and concentration
criteria with certain modifications from the proposal to address commenters’ concerns.797 The final rules provide that the terms ‘‘reference entity included in the index’’ and ‘‘issuer of the security included in the index’’ include a single reference entity or issuer of securities included in an index, respectively, or a group of affiliated reference entities or issuers included in an index, respectively.798 For purposes of the rules, affiliated reference entities or issuers of securities included in an index or securities included in an index issued by affiliated issuers will be counted together for determining whether the number and concentration criteria are met. However, with respect to asset-backed securities, the final rules provide that each reference entity or issuer of securities included in an index that is an issuing entity of an asset-backed security is considered a separate reference entity or issuer, as applicable, and will not be considered affiliated with other reference entities or issuers of securities included in the index. The final rules provide that a reference entity or issuer of securities included in an index is affiliated with another reference entity or issuer of securities included in the index if it controls, is controlled by, or is under common control with, that other reference entity or issuer.799 The final rules define control, solely for purposes of this affiliation definition, to mean ownership of more than 50 percent of a reference entity’s or issuer’s equity or the ability to direct the voting of more than 50 percent of a reference entity’s or issuer’s voting equity.800 The affiliation definition in the final rules differs from the definition included in the proposal, which provided for a control threshold of 20 percent ownership.801 This change is based on the Commissions’ consideration of comments received.802 By using a more than 50 percent (i.e., majority ownership) test rather than a 20 percent ownership test for the control threshold, there is a greater likelihood that there will be an alignment of economic interests of the affiliated entities that is sufficient to aggregate reference entities or issuers of securities included in an index for purposes of the number and concentration criteria.803 As the affiliation definition is applied to the number criterion, affiliated reference entities or issuers of securities included in an index will be viewed as a single reference entity or issuer of securities to determine whether there are nine or fewer non-affiliated reference entities included in the index or securities that are issued by nine or fewer non-affiliated issuers. Similarly, as the affiliation definition is applied to the concentration criteria, the notional amounts allocated to affiliated reference entities included in an index or the securities issued by a group of affiliated issuers of securities included in an index must be aggregated to determine the level of concentration of the components
of the index for purposes of the 30-percent and 60-percent concentration criteria. Comments Three commenters requested that the Commissions revise the affiliation definition that applies when calculating the number and concentration criteria to increase the control threshold from 20 percent ownership to majority ownership.804 These commenters noted that majority ownership is consistent with current market practice, including the definition of affiliate included in the 2003 ISDA Credit Derivatives Definitions.805 One commenter also stated its belief that affiliated entities should only be aggregated where the reference entities’ credit risks are substantially similar and credit decisions are made by the same group of individuals.806 This commenter stated its view that 20 percent ownership is too low and that majority ownership is necessary for credit risk and credit decisions to be aligned enough as to warrant collapsing two issuers into one for purposes of the number and concentration criteria.807 As stated above, the Commissions are modifying the affiliation definition that applies when calculating the number and concentration criteria in response to commenters to use an affiliation test based on majority ownership. Based on commenters’ letters, the Commissions understand that the current standard CDS documentation and the current approach used by certain index providers for index CDS with respect to the inclusion of affiliated entities in the same index use majority ownership rather than 20 percent ownership to determine affiliation. The Commissions are persuaded by commenters that, in the case of index CDS only it is more appropriate to use majority ownership because majority-owned entities are more likely to have their economic interests aligned and be viewed by the market as part of a group. The Commissions believe that revising the affiliation definition in this manner for purposes of calculating the number and concentration criteria responds to commenters’ concerns that the percentage control threshold may inadvertently include entities that are not viewed as part of a group. Thus, as revised, the affiliation definition will include only those reference entities or issuers included in an index that satisfy the more than 50 percent (i.e., majority ownership) control threshold. The

808See supra note 765 and accompanying text. 809See Proposing Release at 29850. 810See infra notes 845, 847, 849 and 867 and accompanying text. 811See paragraphs (a)(1)(iv)(A)–(G) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and rule 3a68–1a and 3a68–1b under the Exchange Act. 812 17 CFR 240.12g3–2(b). 813See July 2006 Debt Index Rules (noting that issuers having worldwide equity market capitalization of $700 million or more are likely to have public information available about them). 814 15 U.S.C. 78c(a)(77). 815See July 2006 Debt Index Rules (noting that issuers having at least $1 billion in outstanding debt are likely to have public information available about them). 816 15 U.S.C. 78c(a)12. 817 15 U.S.C. 78c(a)(77). 818See paragraph (b) of rules 1.3(zzz) and 1.3(aaaa) under the CEA and rule 3a68–1a and 3a68–1b under the Exchange Act. 819Most of the thresholds in the public information availability test are similar to those the Commissions adopted in their joint rules regarding the application of the definition of the term ‘‘narrow-based security index’’ to debt security indexes and security futures on debt securities. See July 2006 Debt Index Rules. The July 2006 Debt Index Rules also included an additional requirement regarding the minimum principal amount outstanding for each security in the index. The Commissions have not included this requirement in rule 1.3(zzz) under the CEA and rule 3a68–1a under the Exchange Act. That requirement was intended as a substitute criterion for trading volume because the trading volume of debt securities with a principal amount outstanding above that minimum amount was found to be generally larger than debt securities with a principal amount outstanding below that minimum amount. See July 2006 Debt Index Release. There is no similar criterion that would be applicable in the context of index CDS. The numerical thresholds also are similar to those the SEC adopted in other contexts, including in the existing definitions of ‘‘well-known seasoned issuer’’ and ‘‘large accelerated filer.’’ See rule 405 under the Securities Act, 17 CFR 230.405, and rule 12b–2 under the Exchange Act, 17 CFR 240.12b–2. Commissions believe that determining affiliation in this manner for purposes of calculating the number and concentration criteria responds to the commenters’ concerns. The Commissions also believe that the modified affiliation definition addresses commenters’ concerns noted above 808 that the rules further defining the terms ‘‘issuers of securities in a narrow-based security index’’ and ‘‘narrow-based security index’’ should be simplified. The modified affiliation definition enables market participants to make an affiliation determination for purposes of calculating the number and concentration criteria by measuring the more than 50 percent (i.e., majority ownership) control threshold. (iii) Public Information Availability Regarding Reference Entities and Securities In addition to the number and concentration criteria,
the debt security index test also includes, as discussed above, a public information availability test. The public information availability test is intended as the substitute for the average daily trading volume (‘‘ADTV’’) provision in the statutory narrow-based security index definition. An ADTV test is designed to take into account the trading of individual stocks and, because Exchange Act registration of the security being traded is a listing standard for equity securities, the issuer of the security being traded must be subject to the reporting requirements under the Exchange Act. Based on the provisions of the statutory ADTV test, the Commissions have determined that the ADTV test is not useful for purposes of determining the status of the index on which the index CDS is based because index CDS most commonly reference entities, which do not ‘‘trade,’’ or debt instruments, which commonly are not listed, and, therefore, do not have a significant trading volume. However, the underlying rationale of such provision, that there is sufficient trading in the securities and therefore public information and market following of the issuer of the securities, applies to index CDS. In general, if an index is not narrow￾based under the number and concentration criteria, it will be narrow￾based if one of the reference entities or securities included in the index fails to meet at least one of the criteria in the public information availability test. This test was designed to reduce the likelihood that broad-based debt security indexes or the component securities or issuers of securities in that index would be readily susceptible to manipulation. The fourth condition in the index CDS rules sets out a similar public information availability test that is intended solely for purposes of determining whether an index underlying a CDS is narrow-based.809 The Commissions are adopting the public information availability test essentially as proposed with certain modifications to address commenters’ concerns, including modifications to the definition of affiliation for purposes of satisfying certain criteria of the public information availability test.810 The Commissions are adopting final rules under which an index CDS will be considered narrow-based (except as discussed below) if a reference entity or security included in the index does not meet any of the following criteria: 811

• The reference entity or the issuer of
  the security included in the index is required to file reports pursuant to the Exchange Act or the regulations thereunder;
• The reference entity or the issuer of
  the security included in the index is eligible to rely on the exemption provided in rule 12g3–2(b) under the Exchange Act; 812
• The reference entity or the issuer of
  the security included in the index has a worldwide market value of its outstanding common equity held by non-affiliates of $700 million or more; 813
• The reference entity or the issuer of
  the security included in the index (other than a reference entity or an issuer of the security included in the index that is an issuing entity of an asset-backed security as defined in section 3(a)(77) of the Exchange Act 814) has outstanding notes, bonds, debentures, loans, or evidences of indebtedness (other than revolving credit facilities) having a total remaining principal amount of at least $1 billion; 815
• The reference entity included in the
  index is an issuer of an exempted security, or the security included in the index is an exempted security, each as defined in section 3(a)(12) of the Exchange Act 816 and the rules promulgated thereunder (except a municipal security);
• The reference entity or the issuer of
  the security included in the index is a government of a foreign country or a political subdivision of a foreign country; or
• If the reference entity or the issuer
  of the security included in the index is an issuing entity of asset-backed securities as defined in section 3(a)(77) of the Exchange Act,817 such asset￾backed security was issued in a transaction registered under the Securities Act and has publicly available distribution reports. However, so long as the effective notional amounts allocated to reference entities or securities included in the index that satisfy the public information availability test comprise at least 80 percent of the index’s weighting, failure by a reference entity or security included in the index to satisfy the public information availability test will be disregarded if the effective notional amounts allocated to that reference entity or security comprise less than five percent of the index’s weighting.818 In this situation, the public information availability test for purposes of the index would be satisfied. The determination as to whether an index CDS is narrow-based is conditioned on the likelihood that information about a predominant percentage of the reference entities or securities included in the index is publicly available.819 For example, a reference entity or an issuer of securities

820 17 CFR 240.12g3–2(b).
821 It is important to note that the public information availability test is designed solely for purposes of distinguishing between index CDS that are swaps and index CDS that are security-based swaps. The proposed criteria are not intended to provide any assurance that there is any particular level of information actually available regarding a particular reference entity or issuer of securities. Meeting one or more of the criteria for the limited purpose here—defining the terms ‘‘narrow-based security index’’ and ‘‘issuers of securities in a narrow-based security index’’ in the first and third prongs of the security-based swap definition with respect to index CDS—would not substitute for or satisfy any other requirement for public disclosure of information or public availability of information for purposes of the Federal securities laws. 822See infra note 845 and accompanying text. 823See July 2006 Debt Index Release. 824See infra part III.G.3(b)(iv), for a discussion regarding the affiliation definition applicable to the public information availability test. As noted above, the Commissions are modifying the method of calculating affiliation for purposes of this test. 825Under this part of the public information availability test, all offerings of the asset-backed securities will have to be covered by a registration statement under the Securities Act, including all tranches, so that public information would exist for any tranche included in an index. However, as noted below, CDS that are offered to ECPs only may rely on alternatives to satisfy the public information test for asset-backed securities. 826See infra note 849 and accompanying text. 827See generally Asset-Backed Securities, 75 FR 23328 (May 3, 2010). 828See supra note 625 and accompanying text. included in the index that is required to file reports pursuant to the Exchange Act or the regulations thereunder makes regular and public disclosure through those filings. Moreover, a reference entity or an issuer of securities included in the index that does not file reports with the SEC but that is eligible to rely on the exemption in rule 12g3–2(b) under the Exchange Act (i.e., foreign private issuers) is required to make certain types of financial information publicly available in English on its Web site or through an electronic information delivery system generally available to the public in its primary trading markets.820 The Commissions believe that other reference entities or issuers of securities included in the index that do not file reports with the SEC, but that have worldwide equity market capitalization of $700 million or more, have at least $1 billion in outstanding debt obligations (other than in the case of issuing entities of asset-backed securities), issue exempted securities (other than municipal securities), or are foreign sovereign entities either are required to or are otherwise sufficiently likely, solely for purposes of the ‘‘narrow-based security-index’’ and ‘‘issuers
of securities in a narrow-based security index’’ definitions, to have public information available about them.821 In response to commenters,822 the Commissions are modifying the outstanding debt threshold criterion in the public information availability test to include any indebtedness, including loans, so long as such indebtedness is not a revolving credit facility. The Commissions believe that expanding the definition of indebtedness to include loans (other than revolving credit) for purposes of the debt threshold determination is consistent with the view that entities that have significant outstanding indebtedness likely will have public information available about them.823 As more fully described below,824 for purposes of satisfying one of these issuer eligibility criteria, the final rules provide that a reference entity or an issuer of securities included in an index may rely upon the status of an affiliated entity as an Exchange Act reporting company or foreign private issuer or may aggregate the worldwide equity market capitalization or outstanding indebtedness of an affiliated entity, regardless of whether such affiliated entity itself or its securities are included in the index. In the case of indexes including asset￾backed securities, or reference entities that are issuing entities of asset-backed securities, information about the reference entity or issuing entity of the asset-backed security will not alone be sufficient and, consequently, the rules provide that the public information availability test will be satisfied only if certain information also is available about the asset-backed securities. An issuing entity (whether or not a reference entity) of asset-backed securities will meet the public information availability test if such asset-backed securities were issued in a transaction for which the asset-backed securities issued (which includes all tranches) 825 were registered under the Securities Act and distribution reports about such asset-backed securities are publicly available. In response to commenters,826 the Commissions note that distribution reports, which sometimes are referred to as servicer reports, delivered to the trustee or security holders, as the case may be, are filed with the SEC on Form 10–D. In addition, because of the lack of public information regarding many asset￾backed securities, despite the size of the outstanding amount of securities,827 the rules do not permit such reference entities and issuers to satisfy the public information availability test by having at least $1 billion in outstanding indebtedness. Characterizing an index with reference entities or securities for which public information is not likely to be available as narrow-based, and thus index CDS where the underlying references or securities are such indexes as security-based swaps, should help to ensure that the index cannot be used to circumvent the Federal securities laws, including those relating to Securities Act compliance and the
antifraud, antimanipulation and insider trading prohibitions with respect to the index components or the securities of the reference entities. As noted above, if an index is not narrow-based under the number and concentration criteria, it will be narrow￾based if one of the reference entities or securities included in the index fails to meet at least one of the criteria in the public information availability test. However, even if one or more of the reference entities or securities included in the index fail the public information availability test, the final rules provide that the index will not be considered ‘‘issuers of securities in a narrow-based security index’’ or a ‘‘narrow-based security index,’’ so long as the applicable reference entity or security that fails the test represents less than five percent of the index’s weighting, and so long as reference entities or securities comprising at least 80 percent of the index’s weighting satisfy the public information availability test. An index that includes a very small proportion of reference entities or securities that do not satisfy the public information availability test will be treated as a broad-based security index if the other elements of the definition, including the five percent and 80 percent thresholds, are satisfied prior to execution, but no later than when the parties offer to enter into the index CDS.828 The five-percent weighting threshold is designed to provide that reference entities or securities not satisfying the public information availability test comprise only a very small portion of the index, and the 80- percent weighting threshold is designed to provide that a predominant percentage of the reference entities or securities in the index satisfy the public information availability test. As a result, these thresholds provide market participants with flexibility in constructing an index. The Commissions believe that these thresholds are appropriate and that providing such flexibility is not likely to increase the likelihood that an index that satisfies these provisions or the component securities or issuers of securities in that index would be readily susceptible to manipulation or that there would be misuse of material non￾public information about the component