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DEFINING THE MARKET: ENTITY AND 

PRODUCT CLASSIFICATIONS UNDER TITLE 

VII OF THE DODD-FRANK WALL STREET 

REFORM AND CONSUMER PROTECTION ACT

HEARING

BEFORE THE

COMMITTEE ON AGRICULTURE 

HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

MARCH 31, 2011

Serial No. 112–7

(

Printed for the use of the Committee on Agriculture 

agriculture.house.gov 

COMMITTEE ON AGRICULTURE 

FRANK D. LUCAS, Oklahoma, Chairman 

BOB GOODLATTE, Virginia, 

Vice Chairman 

TIMOTHY V. JOHNSON, Illinois 

STEVE KING, Iowa 

RANDY NEUGEBAUER, Texas 

K. MICHAEL CONAWAY, Texas 

JEFF FORTENBERRY, Nebraska 

JEAN SCHMIDT, Ohio 

GLENN THOMPSON, Pennsylvania 

THOMAS J. ROONEY, Florida 

MARLIN A. STUTZMAN, Indiana 

BOB GIBBS, Ohio 

AUSTIN SCOTT, Georgia 

STEPHEN LEE FINCHER, Tennessee 

SCOTT R. TIPTON, Colorado 

STEVE SOUTHERLAND II, Florida 

ERIC A. ‘‘RICK’’ CRAWFORD, Arkansas 

MARTHA ROBY, Alabama 

TIM HUELSKAMP, Kansas 

SCOTT DESJARLAIS, Tennessee 

RENEE L. ELLMERS, North Carolina 

CHRISTOPHER P. GIBSON, New York 

RANDY HULTGREN, Illinois 

VICKY HARTZLER, Missouri 

ROBERT T. SCHILLING, Illinois 

REID J. RIBBLE, Wisconsin 

COLLIN C. PETERSON, Minnesota, Ranking 

Minority Member 

TIM HOLDEN, Pennsylvania 

MIKE MCINTYRE, North Carolina 

LEONARD L. BOSWELL, Iowa 

JOE BACA, California 

DENNIS A. CARDOZA, California 

DAVID SCOTT, Georgia 

HENRY CUELLAR, Texas 

JIM COSTA, California 

TIMOTHY J. WALZ, Minnesota 

KURT SCHRADER, Oregon 

LARRY KISSELL, North Carolina 

WILLIAM L. OWENS, New York 

CHELLIE PINGREE, Maine 

JOE COURTNEY, Connecticut 

PETER WELCH, Vermont 

MARCIA L. FUDGE, Ohio 

GREGORIO KILILI CAMACHO SABLAN, 

Northern Mariana Islands 

TERRI A. SEWELL, Alabama 

JAMES P. MCGOVERN, Massachusetts 

PROFESSIONAL STAFF

NICOLE SCOTT, Staff Director 

KEVIN J. KRAMP, Chief Counsel 

TAMARA HINTON, Communications Director 

ROBERT L. LAREW, Minority Staff Director 

(II) 

(III)

C O N T E N T S 

Page 

Lucas, Hon. Frank D., a Representative in Congress from Oklahoma, opening 

statement .............................................................................................................. 1

Submitted letter ................................................................................................ 73

Peterson, Hon. Collin C., a Representative in Congress from Minnesota, opening statement ........................................................................................................ 2

WITNESSES

Gensler, Hon. Gary, Chairman, Commodity Futures Trading Commission, 

Washington, D.C. ................................................................................................. 3

Prepared statement .......................................................................................... 5

Submitted questions ......................................................................................... 159

Allison, James C., Gas and Power Risk Manager, North America, 

ConocoPhillips, Houston, TX; on behalf of Working Group of Commercial 

Energy Firms ........................................................................................................ 32

Prepared statement .......................................................................................... 34

Supplemenatry material .................................................................................. 73

Cvrkel, Mark J., Chief Financial Officer, Susquehanna Bank, Lititz, PA .......... 38

Prepared statement .......................................................................................... 40

Field, James M., Senior Vice President and Chief Financial Officer, Deere 

& Company, Moline, IL ....................................................................................... 42

Prepared statement .......................................................................................... 44

Submitted question .......................................................................................... 164

McMahon, Jr., Richard F., Vice President, Finance and Energy Supply, Edison Electric Institute, Washington, D.C.; on behalf of American Gas Association; Electric Power Supply Association ........................................................ 46

Prepared statement .......................................................................................... 48

Trakimas, Ann E., Chief Operating Officer, CoBank, Greenwood Village, CO; 

on behalf of Farm Credit Council ....................................................................... 55

Prepared statement .......................................................................................... 56

Submitted question .......................................................................................... 165

(1)

DEFINING THE MARKET: ENTITY AND 

PRODUCT CLASSIFICATIONS UNDER TITLE 

VII OF THE DODD-FRANK WALL STREET 

REFORM AND CONSUMER PROTECTION ACT 

THURSDAY, MARCH 31, 2011

HOUSE OF REPRESENTATIVES, 

COMMITTEE ON AGRICULTURE, 

Washington, D.C. 

The Committee met, pursuant to call, at 2:14 p.m., in Room 

1300, Longworth House Office Building, Hon. Frank D. Lucas 

[Chairman of the Committee] presiding. 

Members present: Representatives Lucas, Goodlatte, Johnson, 

King, Neugebauer, Conaway, Fortenberry, Schmidt, Thompson, 

Rooney, Stutzman, Gibbs, Austin Scott of Georgia, Fincher, Tipton, 

Southerland, Crawford, Roby, DesJarlais, Gibson, Hultgren, 

Hartzler, Schilling, Peterson, Holden, McIntyre, Boswell, Baca, 

David Scott of Georgia, Cuellar, Costa, Kissell, Owens, Courtney, 

Welch, Sewell, and McGovern. 

Staff present: Tamara Hinton, John Konya, Kevin Kramp, Josh 

Mathis, Ryan McKee, Matt Schertz, Debbie Smith, Liz Friedlander, 

Clark Ogilvie, and Jamie Mitchell. 

OPENING STATEMENT OF HON. FRANK D. LUCAS, A 

REPRESENTATIVE IN CONGRESS FROM OKLAHOMA 

The CHAIRMAN. This hearing of the Committee on Agriculture, 

entitled, Defining the Market: Equity and Product Classifications 

Under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, will come to order. 

Today the Committee will continue its efforts in a series of hearings to review the implementation of the derivatives provisions of 

the Dodd-Frank Wall Street Reform Act. Already we have heard 

from diverse market participants, from farmer cooperatives to manufacturers to global financial institutions. Rarely does Congress 

consider an issue that has an impact on such diverse segments of 

the economy. That is why the oversight role of this Committee is 

so important, and that is why I am deeply concerned with the 

speed at which CFTC is crafting a new regulatory regime for a 

marketplace that is important all the way from the countryside to 

Wall Street, and for the U.S. economy as a whole. 

Under the current time frame, the CFTC can’t possibly comprehend the cumulative impact that over 40 proposed regulations 

will have on the markets, on the economy, or adequately evaluate 

and weigh the costs and the benefits of each rule. With an economy 

2

that is still fragile and under a directive from the American public 

that job growth should be our top priority, we simply cannot impose a wave of new regulations that are rushed and poorly vetted. 

I have no doubt that today’s hearing will identify potential consequences of a rushed rulemaking process. Dodd-Frank requires 

several new regulatory designations that will define the market 

and, very importantly, shape the ability for end-users across the 

country to affordably hedge their risk. While Congress gave CFTC 

broad discretion in defining key terms, it also directed the CFTC 

to provide exemptions where appropriate, to avoid imposing unjustified and unnecessary costs on market participants. 

Yet, what we are seeing, and what we are going to hear today, 

is that CFTC has proposed very broad, far-reaching definitions, but 

very narrow interpretations of the exemptions Congress authorized. 

The result of this approach will be a spectrum of market participants subject to a new and sweeping regulatory regime that far exceeds the risks those entities pose to the financial system or to 

their counterparties. 

One of Congress’ principal objectives in Title VII was to mitigate 

risk to the financial system and to prevent another financial crisis. 

Yet, entities that do not come close to threatening the financial stability and who had no role in the financial crisis may be regulated 

in the same way that those that do. That simply doesn’t make 

sense, and that is not what Congress intended. 

Now we need to be cautious. The derivatives markets serve an 

important risk mitigation role across the economy and we cannot 

create significant economic disincentives to using those markets, 

especially for end-users and smaller entities that can least afford 

the cost of new regulation. We need to make sure we are not eliminating these tools for commercial hedgers, shifting more of the 

trading volume to the largest financial players, or sending activity 

to our competitors overseas. 

I look forward to hearing our witnesses today.

PREPARED STATEMENT OF HON. FRANK D. LUCAS, A REPRESENTATIVE IN CONGRESS

FROM OKLAHOMA

Today, this Committee continues its series of hearings to review the implementation of the derivatives provisions in the Dodd-Frank Wall Street Reform Act. Already, we’ve heard from diverse market participants, from farmer cooperatives to 

manufacturers to global financial institutions. Rarely does Congress consider an 

issue that has an impact on such diverse segments of the economy. 

That is why the oversight role of this Committee is so important. And, that is why 

I’m deeply concerned at the speed with which the CFTC is crafting a new regulatory 

regime for a marketplace that’s important from the countryside to Wall Street, and 

for the U.S. economy as a whole. 

Under the current timeframe, the CFTC can’t possibly comprehend the cumulative impact over 40 proposed regulations will have on the markets and the economy, or adequately evaluate and weigh the costs and the benefits for each rule. 

With an economy that is still fragile, and under a directive from the American public that job growth should be our top priority, we simply cannot impose a wave of 

new regulations that are rushed and poorly vetted. 

I have no doubt that today’s hearing will identify potential consequences of a 

rushed rulemaking process. Dodd-Frank requires several new regulatory designations that will define the market, and very importantly—shape the ability for endusers across the country to affordably hedge their risks. And while Congress gave 

the CFTC broad discretion in defining key terms, it also directed the CFTC to provide exemptions where appropriate to avoid imposing unjustified and unnecessary 

costs on market participants. 

3

Yet what we’re seeing, and what I think we’re going to hear today, is that the 

CFTC has proposed very broad and far-reaching definitions, but very narrow interpretations of the exemptions Congress authorized. 

The result of this approach will be a spectrum of market participants subject to 

a new and sweeping regulatory regime that far exceeds the risks those entities pose 

to the financial system or their counterparties. 

One of Congress’ principal objectives in Title VII was to mitigate risks to the financial system and to prevent another financial crisis. Yet entities that do not come 

close to threatening financial stability and who had no role in the financial crisis 

may be regulated in the same way as those that do. That simply doesn’t make 

sense, and it’s not what Congress intended. 

We need to be cautious. The derivatives markets serve an important risk mitigation role across the economy, and we cannot create significant economic disincentives to using these markets—especially for end-users and smaller entities that can 

least afford the costs of new regulation. We need to make sure we’re not eliminating 

these tools for commercial hedgers, shifting more of the trading volume to the largest financial players, or sending activity to our competitors overseas. 

I look forward to hearing from our witnesses today.

The CHAIRMAN. And with that, the chair would recognize the 

Ranking Member, Mr. Peterson, for his opening statement. 

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A 

REPRESENTATIVE IN CONGRESS FROM MINNESOTA 

Mr. PETERSON. Thank you, Mr. Chairman, for holding today’s 

hearing. And Chairman Gensler, welcome back to the Committee. 

We are here again reviewing the provisions of Title VII of the 

Dodd-Frank Act. When writing this legislation, the Committee’s 

goal was to bring greater transparency and accountability to the 

derivatives marketplace. For too long, the over-the-counter swap 

market operated in darkness, and as a consequence, the actions of 

some financial institutions contributed to the worst recession our 

country has seen since the Great Depression. The Dodd-Frank Act 

gave regulators new tools to monitor derivatives trading. To accomplish this, we had to identify the market activities and participants 

that merited greater oversight. 

However, we also worked very hard to ensure that those not responsible for the financial collapse, such as end-users using the 

market to mitigate risk, would not bear the burden of further oversight. After all, as was mentioned, they weren’t the ones that got 

us into this mess in the first place. 

Given that these markets have been hidden for so long, the challenge was to distinguish the products and the persons to which regulation should apply and to those to which it should not. I have 

heard from a lot of folks their concerns about how the CFTC proposed rules, or lack thereof, classifying certain entities and products could potentially impact them. I am sympathetic to those concerns, since they have been coming from groups that were not responsible for the financial crisis. We need to look closely at the situation before us to make sure that this is not the case. 

However, I am equally concerned that some of the big financial 

firms whose irresponsible behavior Dodd-Frank seeks to address 

are looking at ways to use the end-user concerns to create loopholes 

for themselves. While I am not a big fan of regulation, the requirements under Title VII are necessary to ensure we don’t get into another situation where the American taxpayer has to bail out large 

financial firms. 

4

I hope the second panel of witnesses will speak to how their concerns can be addressed in a manner that precludes the possibility 

of inadvertently creating a loophole that renders the law obsolete. 

Additionally, I would like to remind everyone that the process of 

implementing a law has to have a starting point. While not everybody may like where the CFTC is starting, these are proposed 

rules, not final rules. 

Interested parties, and even Members of Congress, have and will 

continue to share their thoughts with the CFTC both in person and 

through the comment process. I have some optimism that at the 

end of the day, the resulting rules are going to be acceptable. If 

they aren’t, it will definitely be an area for the Committee to address. 

Again, I want to thank the chair for holding today’s hearing and 

I look forward to hearing from our witnesses. 

The CHAIRMAN. Absolutely. 

The chair would request that other Members submit their opening statements for the record so the witnesses might begin their 

testimony to ensure there is ample time. 

With that, I would like to welcome our first witness to the table, 

the Honorable Gary Gensler, Chairman of the Commodity Futures 

Trading Commission in Washington, D.C., a gentleman who has 

shown great patience in working with our schedule and timing for 

the hearing. 

Now, Chairman Gensler, we have a series of votes beginning. I 

would ask perhaps with your agreement, you provide your opening 

testimony and then we will break for our series of votes and then 

return to begin the questioning, if that is agreeable, Mr. Chairman. 

STATEMENT OF HON. GARY GENSLER, CHAIRMAN,

COMMODITY FUTURES TRADING COMMISSION,

WASHINGTON, D.C. 

Mr. GENSLER. I thank you, Mr. Chairman, and that is certainly 

agreeable, anything that helps you do your work and vote. 

Chairman Lucas, Ranking Member Peterson, and Members of 

the Committee I thank you. Good afternoon. 

I am pleased to testify on behalf of the Commodity Futures Trading Commission regarding our progress thus far on a number of 

rules you asked us to chat about. This is about the entity and product definitions and the end-user exception. 

The Dodd-Frank Act was actually very detailed with regard to 

entity and product definitions as well as the exemption from clearing for the end-users. But Congress did direct the CFTC and the 

SEC, working together and jointly consulting with the Federal Reserve, to further define these entity and product definitions, though 

they were quite detailed in statute. 

So the CFTC and SEC first put out what is called an advanced 

notice of proposed rulemaking, a list of questions, in essence. We 

received 80 comments, very helpful. Based on that and based on 

the statute, in December, we put out a joint rule on entity definitions. We received about 180 comments, some of them coming in 

after the comment period. Even this hearing, in essence, is a comment on those proposals, which will be very helpful. 

5

The proposed swap dealer definition closely followed the criteria 

laid out by Congress. That criteria included whether an entity 

makes a market in swaps or it holds itself out as a swap dealer, 

is commonly referred to as a swap dealer, regularly enters into 

swaps in the ordinary course of business. I am actually reading 

statutory text. That is what Congress said. 

So we have tried to further give some guidance to the market. 

Those 180 comments will be taken into consideration. The final 

rule will change from the proposal based on those comments. 

The Dodd-Frank Act also defines something called a major swap 

participant. It was really an entity that was not a swap dealer but 

otherwise might prove to have systemic ramifications if it failed. So 

we put in the proposed rule various numbers and criteria trying to 

follow Congress’ will that it would be a very small handful. And, 

in fact, the major swap participant category would be measured in 

the single digits. And so that proposed rule is out and we are waiting to think through. We are not going to move forward until we 

can summarize all the comments, we can get Commissioner input, 

other regulatory input and so forth. 

We also put out a rule in December on the end-user exception. 

The Dodd-Frank Act is very clear, the intent of Congress is very 

clear, that if you are a nonfinancial entity hedging a commercial 

risk, you don’t have to use a clearinghouse. 

We have also said that even though we have not yet put out a 

rule on margin and capital; that when we do so, we are going to 

follow Congressional intent there as well, and the same nonfinancial end-users will not have to post or receive margin. I just 

want to cover that point because I know it is an important one. 

The proposed rule went out in December. We have gotten 1,300 

comments on that. It will take us a little longer to summarize those 

comments, but I think they are very helpful. 

Last, I know you wanted me to chat a little bit about product 

definitions. Based upon the 80 comments to that advanced notice 

of proposed rulemaking, the SEC and CFTC are working on a product definition rule. The statute is very clear. Interest rate swaps, 

currency swaps, a swap, credit default swaps and so forth, these 

are swaps. But we are sorting through comments to make sure that 

people understand, as Congress intended, that insurance is not a 

swap, for instance, or commercial loans are not swaps. And very 

importantly to the community that you all oversee, that forwards 

and options embedded in forwards, just as they have been excluded 

from the definition of futures for many, many decades, they are 

also to be excluded from the definition of swap. And this is a very 

important point to the agriculture community and the energy community. And we will put that together in this proposal, but consistent with what the Congress has done. 

I thought I would, for one moment, just say that on timing, we 

know that the Congress did say that we were supposed to complete 

this task in 360 days. But we are right now at a pause. We are 

analyzing all the comments. 

We have two important rules still to propose: margin and capital 

and the product definitions. We are not moving forward on any 

final rules until we adequately summarize all the comments, get 

Commissioner feedback, get regulatory feedback. So, realistically 

6

we will start doing some final rules this spring. But the final rules 

will fall well into the Fall of this year. We are human; even that 

may change. But we are committed not to do anything until we actually can summarize the comments, summarize the cost-benefit 

analyses, get the feedback that is so important, and move forward. 

Congress did give us some authorities on implementation phasing. Phasing of the effective dates is really important as well, to 

look at the whole mosaic of rules so that we can lower the cumulative cost. A rule might be finalized this summer, but you gave us 

the latitude that it might not have an effective date until much 

later. And we are looking at having effective dates for some of the 

rules to only go effective after other rules are effective; for instance, 

until a product definition rule is finalized, maybe some other rules 

shouldn’t be effective. That would be one example. Or that for 

clearing and other transaction mandates, that they happen for the 

swap dealers early on, and then other market participants, hedge 

funds and the like and asset managers maybe a little later. Of 

course, there is no clearing mandate on the true end-users, the 

commercial end-users. 

So with that I would be happy to take any questions after your 

break to go take a vote. 

[The prepared statement of Mr. Gensler follows:]

PREPARED STATEMENT OF HON. GARY GENSLER, CHAIRMAN, COMMODITY FUTURES

TRADING COMMISSION, WASHINGTON, D.C. 

Good morning, Chairman Lucas, Ranking Member Peterson, and Members of the 

Committee. I thank you for inviting me to today’s hearing on the Commodity Futures Trading Commission’s (CFTC) progress thus far on rules relating to entity and 

product definitions under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. I am pleased to testify on behalf of the CFTC. I also thank 

my fellow Commissioners for their hard work and commitment on implementing the 

legislation. 

The Dodd-Frank Act for the first time brought oversight to the swaps market. By 

bringing comprehensive regulation to swap dealers and mandating that standardized swaps be brought to clearing and transparent trading, the Dodd-Frank Act 

helps lower risk to the American public and bring transparency, openness and competition to these markets. 

The Dodd-Frank Act was very detailed with regard to entity and product definitions as well as the exception from clearing for nonfinancial end-users. Congress did 

direct the CFTC, however, working with the Securities and Exchange Commission 

(SEC) and in consultation with the Federal Reserve, to further define those entities 

and products. The Dodd-Frank Act further provides the CFTC with authority to 

write rules with regard to the nonfinancial end-user clearing exception. 

This afternoon I will discuss the joint rule on entity definitions that was proposed 

last fall, the CFTC’s and SEC’s work to propose a product definitions rulemaking 

and the CFTC’s proposed rule with regard to the nonfinancial end-user exception 

from clearing. I also will briefly discuss the CFTC’s rule-writing process and authority to phase effective dates of final rules. The CFTC and the SEC jointly released 

an advance notice of proposed rulemaking in September to seek public comment on 

entity and product definitions. Those comments informed both agencies as we 

worked to propose a joint rule on entity definitions and as we continue to work on 

a product definitions proposed rulemaking. 

Entity Definitions Rulemaking 

The Dodd-Frank Act defined two categories of market participants that would be 

subject to comprehensive regulation by the CFTC: swap dealers and major swap 

participants. This comprehensive regulation includes capital and margin requirements, business conduct standards and record-keeping and reporting requirements. 

On December 1, 2010, the CFTC proposed a rule jointly with the SEC to fulfill 

Congress’s direction to further define the terms ‘‘swap dealer,’’ ‘‘major swap participant,’’ ‘‘security-based swap dealer,’’ ‘‘security-based major swap participant’’ and 

7

‘‘eligible contract participant.’’ The comment period ran through February 22, 2011. 

There are presently 180 comments in the comment file, including those that were 

received after the comment period closed. The Commission is considering all of these 

comments. 

The proposed swap dealer definition closely follows the criteria laid out by Congress. These criteria include whether an entity makes a market in swaps, holds 

itself out as a swap dealer, is commonly referred to as a swap dealer or regularly 

enters into swaps in the ordinary course of business. 

The proposed rule identified characteristics to be considered in determining 

whether persons are swap dealers, including whether they tend to accommodate demand for swaps from other parties; are generally available to enter into swaps to 

facilitate other parties’ interest; tend not to request that other parties propose the 

terms of swaps; tend to enter into swaps on their own standard terms or on terms 

they arrange in response to other parties’ interest; and tend to be able to arrange 

customized terms for swaps upon request, or to create new types of swaps at their 

own initiative. 

The Dodd-Frank Act and the proposed joint rule provide an exclusion for an insured depository institution ‘‘to the extent it offers to enter into a swap with a customer in connection with originating a loan with that customer.’’ The exclusion in 

the proposed rule would apply to swaps that are connected to the financial terms 

of the loan itself. 

The Dodd-Frank Act and the Commissions’ joint proposed rule provide an exemption for a person who ‘‘engages in a de minimis quantity of swap dealing in connection with transactions with or on behalf of its customers.’’

The Dodd-Frank Act also defined another category of market participants that 

would be subject to comprehensive regulation, called major swap participants. These 

entities were defined as those that are not otherwise swap dealers and whose failure 

would have systemic ramification given their substantial participation in the swaps 

market. 

The major swap participant definition relies on Congress’s three-prong test. In 

each of the three prongs, the Dodd-Frank Act spoke to an entity that has a substantial position in swaps or substantial counterparty exposure. The proposed rule focuses on net uncollateralized current exposure and potential future exposure. Therefore, it takes into consideration entities’ uncleared versus cleared swaps as well as 

any netting or collateral arrangements that they may have with their 

counterparties. 

Under the statute and the proposed rule, the major swap participant category is 

very clearly limited only to those non-swap dealer entities that have risk large 

enough to pose a threat to the U.S. financial system. It is likely that, under the joint 

proposed rule, this category will include only a handful of entities. 

The joint proposed rule includes two changes to the definition of eligible contract 

participant (ECP). First, the proposed rule explicitly includes swap dealers and 

major swap participants within the definition of ECP. Second, the rule proposes 

clarifications to how certain commodity pools use retail foreign exchange products. 

These commodity pools must meet certain specific requirements of the current ECP 

definition. 

Product Definitions 

The Dodd-Frank Act was very specific in defining derivatives products that will 

be required to be regulated. The Act covers the entire swaps marketplace—both bilateral and cleared—and the entire product suite, including interest rate swaps, currency swaps, commodity swaps, equity swaps and credit default swaps. 

The CFTC is working closely with the SEC on a proposed rule to further define 

swaps, security-based swaps, mixed swaps and security-based swap agreements, 

which are defined terms in the Dodd-Frank Act. We hope to jointly propose the 

products definitions rule in the near future. 

In preparing the proposed rule, staff has been working to address the more than 

80 comments that were submitted by the public in response to the joint advance notice of proposed rulemaking on definitions. Many of the commenters asked that the 

Commissions specifically provide guidance on what is not a swap or security-based 

swap. 

Though staff is yet to make a formal recommendation to the two Commissions, 

I would like to address some thoughts on three areas. 

Under the Commodity Exchange Act, the CFTC does not regulate forward contracts. Over the decades, there has been a series of orders, interpretations and cases 

that market participants have come to rely upon regarding the exception from futures regulation for forwards and forwards with embedded options. Consistent with 

that history, the Dodd-Frank Act excluded from the definition of swaps ‘‘any sale 

8

of a nonfinancial commodity or security for deferred shipment or delivery, so long 

as the transaction is intended to be physically settled.’’ I believe it would be appropriate to interpret that exclusion in a manner that is consistent with the Commission’s previous history of the forward exclusion from futures regulation, including 

the Commission’s treatment of bookouts. 

Further, commenters have expressed the view that Congress did not intend that 

the swap definition include state or federally regulated insurance products that are 

provided by regulated insurance companies. The staffs of the Commissions are 

working to address these comments in a way that clarifies what products are insurance and therefore would not be considered swaps. In addition, commenters have 

suggested that the Commissions clarify that certain consumer and commercial arrangements that historically have not been considered swaps, such as consumer 

mortgage rate locks, contracts to lock the price of home heating oil and contracts 

relating to inventory or equipment, also should not be considered within the swap 

definition. The staffs of the Commissions also are working to address these comments in a way that clarifies that these products are not swaps. 

End-User Exception 

A central component of the Dodd-Frank Act is its provision to lower risk in the 

financial system by generally requiring the clearing of standardized swaps through 

regulated clearinghouses. Central clearing has been a feature of the U.S. futures 

markets since the late-19th century. Clearinghouses have functioned both in clear 

skies and during stormy times—through the Great Depression, numerous bank failures, two world wars and the 2008 financial crisis—to lower risk to the economy. 

Congress excepted swaps transactions involving nonfinancial end-users from the 

clearing requirement because they do not pose the same risk as transactions between two financial entities. 

The CFTC proposed a rule on December 9, 2010 relating to the end-user exception. We have received 1,039 comments in response to the proposal. In essence, the 

proposal says that, if a nonfinancial company is using a swap to hedge an asset, 

liability, input or service that it currently has or uses or anticipates having or using, 

it would qualify for the end-user exception. In addition, the proposal says that if 

a swap meets generally accepted accounting principles as a hedge or if it is used 

for bona fide hedging, then the transaction would qualify for the end-user exception. 

Non-financial entities would be able to hedge interest rate risk, currency risk, physical commodity risk or other types of risk. 

The proposed rule does, however, say that if an entity is taking a position to speculate, the transaction would not qualify for the end-user exception. 

The Dodd-Frank recognized that swaps transactions involving nonfinancial endusers do not pose the same risk as transactions between two financial entities. 

Thus, the CFTC does not intend to impose margin requirements with regard to 

these transactions. 

CFTC Rule-Writing Process 

At this point in the process, the CFTC has come to a natural pause as we have 

now promulgated proposals in most of the areas required by the Dodd-Frank Act. 

As we receive comments from the public, we are looking at the whole mosaic of rules 

and how they interrelate. We will begin considering final rules only after staff can 

analyze, summarize and consider public comments, after the Commissioners are 

able to discuss the comments and provide direction to staff, and after the Commission consults with fellow regulators on the rules. We hope to move forward in the 

spring, summer and fall with final rules. 

Phasing of Implementation 

The Dodd-Frank Act gave the CFTC flexibility as to setting implementation or effective dates of the rules to implement the Dodd-Frank Act. For example, even if 

we finish finalizing rules in a particular order, that doesn’t mean that the rules will 

be required to become effective in that order. Effective dates and implementation 

schedules for certain rules may be conditioned upon other rules being finalized, 

their effective dates and the associated implementation schedules. For instance, the 

effective dates of some final rules may come only after the CFTC and SEC jointly 

finalize the entity or product definitions rules. 

The Commission has the authority to phase implementation dates based upon a 

number of factors, including asset class, type of market participant and whether the 

requirement would apply to market platforms, like clearinghouses, or to specific 

transactions, such as real time reporting. For example: a rule might become effective for one asset class or one group of market participants before it is effective for 

other asset classes or other groups of market participants. We are looking to phase 

in implementation, considering the whole mosaic of rules. We look forward to hearVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00012 Fmt 6633 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
9

ing from market participants and regulators, both in the U.S. and abroad, regarding 

the phasing of implementation. 

Regardless of the eventual effective dates of the swaps rules, to provide regulatory 

certainty to the market, rules relating to mandatory clearing, real time reporting, 

the trading requirement, margin and business conduct standards will apply only 

prospectively to those transactions that are executed after the rules go into effect. 

Conclusion 

I again thank you again for inviting me to testify today. I’d be happy to take questions.

The CHAIRMAN. Thank you, Chairman Gensler, and the Committee now stands in recess until the conclusion of these two votes. 

[Recess.] 

The CHAIRMAN. The Committee will reconvene. A number of our 

colleagues are still proceeding back from the floor. They will be 

here shortly and join us in a timely fashion. 

With that, the Chairman having concluded his opening statement, we will now turn to questions, and it gives me the great 

honor and privilege of beginning. 

Mr. Chairman, in a recent speech, you put forth a timetable for 

the finalization of the rules that would have them completed by 

early fall. No similar indication has come from the Securities and 

Exchange Commission. Do you intend to move forward, Mr. Chairman, with the final rules even if the SEC is not on your timetable? 

Mr. GENSLER. We have been working very closely with the Securities and Exchange Commission. And, in fact, our staffs even had 

a meeting yesterday about some of those schedules, both sequencing final rules and then implementation and phasing of the rules 

into the effective dates. Where we have joint rules, naturally we 

would work together with the Securities and Exchange Commission. Their agenda is much busier than ours, so we might finalize 

some rules before they do because they have a lot of other topics 

they are dealing with. But what we are trying to do in working 

with them is to align the effective dates and the phasing in of these 

in a consistent manner. 

The CHAIRMAN. Let’s talk for a moment, Chairman, about the—

in your testimony you noted you had received 180 comments on the 

proposed definitions. And I would like to highlight some of those 

comments and then give you a chance to respond. 

From the Coalition of Derivative End-Users, ‘‘The Commission’s 

interpretation of the swap dealer and security-based swap dealer 

definitions could sweep a large number of derivative end-users into 

these categories.’’

Another quote from a letter signed by the Farm Bureau, the Soybean Association, the Wheat Growers, the National Cattlemen’s 

Beef Association, the Corn Growers, the Farmers Cooperatives, the 

Grain and Feed Association, the Milk and Pork Producers: ‘‘We are 

concerned that the proposed definition of swap dealer is overly 

broad and would capture entities that were never intended by Congress to be regulated as swap dealers. If regulatory requirements 

intended for large financial firms are applied to those that offer 

risk management products to farmers, those tools would become 

less available and more expensive.’’

And then one final quote, and then your response, of course, 

Chairman, from the National Association of Regulatory Utility 

Commissioners, ‘‘We are concerned that if regulated utilities are 

10

swept into the swap dealer definition, this will result in unnecessary increases in consumer cost and reduce the capital available for 

essential investments’’. 

Chairman, can you respond to these concerns from the comments? 

Mr. GENSLER. The 180 comment letters are very helpful. We are 

trying to summarize them now. They have been in for a few weeks 

now. And you are correct on those three comment letters. 

If I might just take the middle one as an example, the farm cooperatives, we have been working very closely and meeting with a 

number of the different cooperatives. We are hoping to have additional meetings with them. Whether it be—because of the very nature of these farm cooperatives as they deal almost exclusively with 

their members, and in some cases how they almost act as the farmers themselves, on their behalf, to get the feed and grain, and, in 

this case, risk management done—we are seeking a way to think 

through with them under the statute and consistent with what 

Congress did, this swap dealer definition. I think that we are working along with them to try to take those comments in line. 

With regard to the energy participants—and they were in the 

first and the third category—tens of thousands of people use these 

products and need to use these products as end-users, and they are 

not swap dealers. There may be some handful of energy companies 

that actually do provide services very similar to Wall Street, and 

they may be swap dealers as Congress has defined it. But we are 

working closely with energy companies, we even have a meeting tomorrow with a group of energy companies, again on this very topic, 

the swap dealer definition. 

The CHAIRMAN. But you would acknowledge that the concerns 

brought up by these three comments of the 180 comments that you 

mentioned in your testimony, there is the potential, then, for some 

of these entities to be defined as swap dealer, and their concerns 

are legitimate. 

Mr. GENSLER. Well, it depends on their activities, because Congress had four tests in the statute about what is a swap dealer. We 

have given some further clarification on that, but it is really the 

test of whether you are making markets in swaps, whether it be 

interest rate swaps or oil swaps, if you are making a market in 

these swaps, and if you are known in the trade as dealing in these 

swaps and the like. I think that that is not a large group of companies, but there are companies that we are working very closely 

with and hearing their concerns. And we are not going to move forward on a final rule until we can adequately hear from them and 

work through this with our Commission. 

The CHAIRMAN. Chairman Gensler, before my time expires, when 

should we anticipate the proposed rule on margin and capital? 

Mr. GENSLER. I would anticipate in the next few weeks. This is 

one that we have been working very closely with the bank regulators as well, and the statute says, ‘‘To the greatest extent possible’’—but it might have said to the maximal extent possible we 

are supposed to be consistent. So we are looking to try to do this 

in mid-April. 

The CHAIRMAN. So then, when I follow that with a question along 

the line of what you have just addressed, will the rules proposed 

11

by CFTC and the Fed be similar in nature, your response would 

be? 

Mr. GENSLER. Yes. Yes. Not identical, because we also have—and 

this is important—we have nonbank parties that might be dealers 

and they might even be nonfinancial entities, and so we have been 

really sorting through this in a way so that we don’t just apply 

bank capital rules to companies that might be nonbanks. 

The CHAIRMAN. You have made helpful comments, but you don’t 

intend to apply margin transactions to transactions involving nonfinancial end-users. If the Fed does propose to impose margin 

transactions involving nonfinancial end-users, how will the agencies resolve that inconsistency? 

Mr. GENSLER. I can’t speak for the Federal Reserve, but I can 

speak for the Commodity Futures Trading Commission. We are not 

going to have a rule proposed that either requires a swap dealer 

to pay or collect margin, either direction, from these nonfinancial 

end-users. We think that is consistent with what Congress directed 

us. 

The CHAIRMAN. My time has expired. I now turn to the Ranking 

Member for his questions. 

Mr. PETERSON. Thank you, Mr. Chairman. 

Chairman Gensler, welcome back again. The first question I have 

is, have you watched the movie Inside Job?

Mr. GENSLER. I am under oath, so I have to say no, I have not 

had the opportunity to see it. 

Mr. PETERSON. I was hoping we could get a movie review here, 

but you need to watch it. 

Mr. GENSLER. All right. I will commit to you to watch it before 

I appear to testify before you the next time. And I will try to open 

my statement with a review. 

Mr. PETERSON. I imagine you have been a little busy. 

Some of the witnesses in the next panel will ask Congress to 

push back the implementation date now scheduled for mid-July, because they believe that you need more time to consider views, and 

they need more time to see the whole picture of the new regulatory 

framework. 

Do you need more time? 

Mr. GENSLER. I don’t think Congress needs to push back the 

date, but we are going to take more time. We are not going to move 

forward with these final rules and finish them all by July. We have 

already proposed 28 of the topic areas, but for two very important 

topic areas we have yet to propose, so we would not finalize those, 

at the earliest, until this fall. And you have already given us great 

latitude to phase the implementation dates. 

But, the regulatory framework is largely out there, and it helps 

lower regulatory uncertainty that people see this whole mosaic. 

And they are commenting on it, obviously, right now. 

Mr. PETERSON. That was my other question. So you think that 

the flexibility is there for you to do this in the right way and——

Mr. GENSLER. Yes. I am told by General Counsel of the CFTC 

that you all won’t have me sent to jail if we miss the July deadline; 

maybe for other reasons, but not that. 

12

Mr. PETERSON. And on the uncertainty issue, if Congress did 

push back this date with legislation, how much will this impact the 

regulatory uncertainty? Can you speculate about that? 

Mr. GENSLER. Well, we have heard from many commenters about 

the specifics, but a broad overview as people want us to get on 

with—thoughtfully, just thoughtfully—get on with the job and then 

give them time to implement, and Congress gave us a lot of latitude to give time to implement. 

But there was a crisis in 2008, and there also are a lot of people 

that want to bring greater transparency to the market, and the 

core of the statute is to bring greater transparency to these markets. 

Mr. PETERSON. We have heard many complaints about the Commission not putting forth its proposed further definition of several 

terms, including swap and mixed swap. Congress directed you to 

further define these terms in conjunction with the SEC. I think you 

maybe touched on this a little bit, but how is that working with 

the SEC in terms of are you able to—are they bogging you down, 

or is that——

Mr. GENSLER. Let me say it has been an interesting process. But 

it is constructive. We are getting very close. I think that we are—

I would say probably within 6 weeks that we will have something 

to propose. The most important thing, we had a lot of people commenting, and they wanted further clarification that insurance 

wasn’t a swap. Well, we didn’t think it was, but you have to write 

that all up—or that commercial loans aren’t swaps—we had to 

write that all up—and forwards, and this is very important to the 

agriculture community, that forwards aren’t swaps, just like they 

aren’t futures. And I know you had a colloquy on this on the floor, 

I think other Members did, and we are following those colloquies 

and so forth. 

Mr. PETERSON. Are the disagreements between the agencies the 

cause for this delay or is that what—you say it is an interesting 

process. Is it just you are not, you guys, there is just not agreement 

between you and the SEC? 

Mr. GENSLER. We are now down to one small issue in a document that is over 100 pages long. So I am focusing forward. A lot 

of the delay has been that the 80 comments that came in asked for 

a lot of bright line tests and clarifications on these insurance 

issues, these forward issues, and these commercial loan issues. 

People asked questions on some very specific issues that we are 

trying to provide guidance on. 

Mr. PETERSON. I think I recall that there was—this was something that kind of got in there at the end—but I think initially our 

position was that you were going to make this definition by yourself, and not the SEC. So I assume the answer, if we would have 

stuck with that and if it was you, you would have been given the 

responsibility for defining these terms, it would probably be done 

by now. 

Mr. GENSLER. Well, you are kind to compliment us like that. But, 

it is going to be a very strong product and it is benefited by the 

SEC and CFTC sorting it through together. So it has taken a little 

longer, but it will be hopefully a good product and it will benefit 

from hundreds of public comments as well. 

13

Mr. PETERSON. Thank you. Thank you, Mr. Chairman. 

The CHAIRMAN. The chair now recognizes the gentleman from Illinois, Mr. Johnson, for 5 minutes. 

Mr. JOHNSON. Thank you, Mr. Chairman. 

Let me preface my comments, Mr. Gensler, by saying there is a 

relatively small number of people I would suggest who truly understand the nuances and the details of not only this bill but of its 

progeny. I, quite frankly, am not one of them, so you will forgive 

me if I ask questions that appear to be a little amateurish, but I 

will do the best I can here. 

The first is, speaking as a Member of Congress, when we enacted 

this legislation a bit ago, I don’t think anybody intended that endusers would be designated as swap dealers. 

Under your proposed definition, is it possible for an end-user to 

be a swap dealer? 

Mr. GENSLER. I don’t think that an end-user will be a swap dealer. But there may be some nonbanks that are swap dealers, and 

Congress anticipated that because it gave the CFTC some authority over those, but it will be a very small number. 

Mr. JOHNSON. You also in the past and otherwise have focused—

and it is good—on the de minimis exception of the swap dealer definition. And you have also indicated that you are receiving and have 

received public comment since you last testified. 

I can’t speak for other Members of the Committee, but I don’t 

think the Committee has heard from any entity that would actually 

qualify for the de minimis exception. Does that impact your 

thought and your analysis of this definition and the issue? 

Mr. GENSLER. We did get comments. Congress asked us to have 

a de minimis exception. We made a proposal. It had three tests to 

it. I suspect, just as with many things, it will change; that the final 

rule will be reflective of many of the comments on the de minimis. 

This is particularly important in the farm co-op area. A number of 

the farm cooperatives have raised this and we are looking at that 

very closely. 

Mr. JOHNSON. A lot of us, in fact a majority of Members of this 

Committee, represent districts that have a lot of small or mid-sized 

banks. Is it your intention, as you look forward, to exempt those 

small farm credit banks and credit unions, community banks, from 

the mandatory clearing requirement, as we authorized you to do? 

Mr. GENSLER. Congress did ask us to consider it. We asked the 

public for some comments. We received about 15 comments on that, 

and so what we are doing now is working with the bank regulators, 

the Farm Credit Administration—I saw Russell here earlier with 

Lee Strom and his folks, and Debbie Matz over at the credit union. 

So we are working with them and sorting this through and looking 

to see how to best fulfill what Congress asked us to do. 

Mr. JOHNSON. Just anticipating, without knowing that the second panel, very distinguished individuals like yourself, are going to 

have some significant concerns about their designation as swap 

dealers, specifically the Farm Credit Bank, the community bank. 

As you were here at the last Committee meeting, and I am quoting 

you as best I can, you indicated that the small—again, I am 

quoting specifically now, ‘‘The small entities, by and large, are not 

14

swap dealers. There may be one or two exceptions; I doubt many 

of them are swap dealers.’’ Is that still your attitude? 

Mr. GENSLER. It is still my understanding. I am not—there may 

be some out there, but I am not aware of community banks that 

have concerns—they haven’t knocked on our door, and they have 

been focused, as your earlier question, on the clearing exception. 

But I haven’t heard many community banks come in. 

And in fact, Congress provided something in the statute explicitly, that if you are doing swaps in connection with originating a 

loan, just because you were doing a swap in connection with originating a loan, that does not make you a swap dealer. And it is 

something we included in our proposed rule in December. We have 

gotten some very thoughtful comments on the specificity of that exclusion, and like many things, we will probably change a little bit 

because of those comments. 

Mr. JOHNSON. Let me just conclude because my time is running 

short here. Let me just conclude by making an observation more 

than a question. 

Oftentimes we enact legislation that is implemented very differently than we intended it to be implemented. Quite frankly, 

sometimes we enact legislation that gets implemented the way we 

wrote the language of the bill, but not our intention. 

There is a lot of impact that this legislation and your Commission is going to have on the future of the country and certainly of 

rural America. And I would just urge you to use good common 

sense, practicality, and good business sense in how you implement; 

because if you don’t, the ramifications of what we did and what you 

do are going to be felt for a long, long time. 

Mr. GENSLER. I appreciate that and I will try to do my best to 

follow that guideline. 

The CHAIRMAN. The gentleman’s time has expired. And the chair 

now recognizes the gentleman from Connecticut, Mr. Courtney, for 

5 minutes. 

Mr. COURTNEY. Thank you, Mr. Chairman and thank you Chairman Gensler for your testimony today. I think all your comments 

about the fact that we have to be smart about implementing the 

Wall Street Reform Act are to me just common sense. And I don’t 

envy your job. This is a big task ahead of you. But on the other 

hand, it is also important to remember that not acting swiftly 

enough, aside from exposing us to what happened in 2008, frankly, 

there are things happening out there in the economy right now 

where not acting, is already causing real trouble. 

And I would just again focus on energy contracts right now, 

which again the timeline has slipped in terms of limiting position 

limits on energy contracts. 

We have a situation, I am going to give you a really small example, but I think it is connected to this. In New London County, 

Connecticut, right now oil dealers are refusing to do any lock-in 

contracts for next winter’s home heating oil, because the market 

right now is just completely out of control. And these are guys who 

follow this stuff like a box score. Every day they follow what is 

going on in Cushing, Oklahoma, and I am just going to read you 

a quote from an oil dealer, Wilcox Fuel, Dave Foster: ‘‘We don’t 

15

have a clue anymore. It is really driven by media news and Wall 

Street and it is disconnected from supply and demand.’’

They are, again, are calling folks like me and they just are apoplectic about the fact that we have not recognized that there are 

forces in the market there that have nothing to do with them being 

able to run a real business. And so I just want to share that with 

you, that there are folks out there, they are not asking me about 

when are these rules going to be issued; they are asking me when 

are these rules going to be enforced. 

And I would like, first, to give you an opportunity to give us an 

update in terms of where you are with that. Again, this affects consumer confidence all through the economy, by the way. I think this 

is bigger than New London County. 

Mr. GENSLER. If I am allowed to, this is very much like what 

Congressman Johnson was saying, maybe from a different perspective. I think that what Congress has done is basically said this very 

large market, this swaps market, that is seven times the size of the 

futures market, should have the transparency, and so that the public, that fuel oil company in Connecticut, or anyone in rural America could have the confidence in these markets. Because at the 

core, if they don’t have confidence in the markets, they might not 

use them as much. 

These products are actually critical to our economy. They are 

critical to lock in a price and gain certainty so you can focus on 

what you are good at in your business, whether it is planting the 

crops or buying the oil or refining the oil, or just being a retailer. 

Mr. COURTNEY. The irony is that these are the guys for whom 

this market was supposed to operate so they could hedge a risk and 

actually do a long-term contract and use it. 

Mr. GENSLER. So realistically, if we are able to finish the rule 

sometime this fall—and we might slip from that too—but if we are 

able to, this marketplace will start to get more transparency in 

2012. It won’t all happen at once, because we do plan to use the 

authority you gave us to phase this. There will be some phasingin on this. 

Mr. COURTNEY. Again, there are folks that are really looking to 

you, frankly, very seriously for assistance. 

The other point I just want to make real quick. My other committee is Armed Services. Secretary Mabus of the Navy was testifying before us the other day, and he pointed out that every $10 

increase in a barrel of oil costs the U.S. Navy’s annual fuel bill 

$300 million. Now society in general is calculating that speculation 

accounts for $20 of the price per barrel. I don’t know if that is right 

or wrong, but I just throw that out there. It is a fairly credible 

source. 

When we look at your budget and what is being proposed in 

terms of the H.R. 1 and the savings just to the Navy—Air Force 

uses even more fuel. Stabilizing in a rational market, fuel costs is 

not just for consumers out there, it is also for the taxpayer. And, 

again, we should hopefully put that in perspective about the importance of your agency and its mission. 

Mr. GENSLER. I thank you. Our $168 million budget and what the President asked for in this year’s budget of $261 million, or 

next year’s budget of $308 million, I think is a good investment to 

16

the American public. I know it is a hard thing to ask for more 

money, but I know it is a good investment. 

Mr. COURTNEY. Well we are going to pay for it, again in our DOD 

costs, which is the number one consumer of fossil fuels in the 

world, if we don’t have a market that actually functions the way 

they can count on. With that, I yield back. 

The CHAIRMAN. The gentleman yields back. The chair now turns 

to the gentleman from Texas, Mr. Conaway, to be recognized for 

his 5 minutes. 

Mr. CONAWAY. Thank you, Mr. Chairman. 

Chairman Gensler, welcome. Given the extensive comments on 

the swap dealer definition, do you have any intention of re-proposing that rule before you go final with it in order to make sure 

you get it right? 

Mr. GENSLER. We are taking those comments in. We are going 

to be working with the Securities and Exchange Commission and 

our goal is to try to finalize this amongst one of the earlier rules, 

because a great many people in the market look for that. Again, 

Congress was very detailed in what a swap dealer was. We will 

modify——

Mr. CONAWAY. On the four tests, Mr. Gensler, do you have to 

beat all four tests? Because the last one says if you are just dealing, if you enter into swap transactions of a certain volume that 

captures you as a dealer. Is that your attitude that—we had a milk 

co-op sit there last time, after you left, and said they fall under the 

definition. And they simply do swap-like—some dealer-like stuff for 

their members. And so if the four tests include just doing it on behalf of yourself and your members, how do you get out from under 

the swap? 

Mr. GENSLER. You are right. The Congressional statute was an 

or not an and and it is the fourth test. You are correct, it has this 

term about in the ordinary business or something. And so then we 

were trying to give some more meaning to that, to limit it in a 

sense, to give more clarity to that. But we have continued to meet 

with the farm co-ops, not just in dairy but in grain as well, because 

I think that——

Mr. CONAWAY. The idea, though, just to make sure you get it 

right. You mentioned earlier in the conversation that you are going 

to implement these rules in over a period of time. Will you expose 

that implementation scheme that you put in place, as you understand how these things roll out, for public comment to see that you 

have the wisdom of the collective group? I know that would be fully 

under your authority, but it would make some sense to me if you 

would expose that implementation scheme to the general public for 

some period of comment so that we will have a chance to——

Mr. GENSLER. That is something we are looking at. In each of 

our rules, we have asked for implementation phasing—or implementation dates from people. We have had a lot of people come in. 

We are looking at whether to have some public roundtables or, as 

you say, exploring how best to expose it. 

Mr. CONAWAY. I do think it would be helpful for all of us to see 

what your team had proposed from an implementation issue to 

make sure that there wasn’t something that you all are blind to 

that the rest of us might see. 

17

We had some conversation the last time we were here about the 

cost-benefit analysis that you do, either under the CMA Act or 

under the President’s Executive Order and all that kind of good 

stuff, but in one of your recent rulemakings on the cost-benefit, the 

statement was: For costs the Commission has determined that the 

cost to market participants and the public, if not adopted, are substantial. But then on the benefits you said: The Commission is determined that the benefits of the proposed rule are many and substantial. 

Pretty casual swipe at a really important piece. Now many laws 

where agencies, not just yours, but other agencies who have done 

a cavalier approach to cost-benefit analysis, have been challenged 

in court. Can you help us understand that there is more depth to 

the cost-benefit analysis under these rules than just they are substantial, and if we don’t do them or if we do do them, pretty cavalier comments just on the way you phrased it. 

Mr. GENSLER. Well, one of the best ways of getting comments 

from the public is a hearing. And each of our teams summarizing 

public comments, one of the things they are specifically doing is 

summarizing all of the cost-benefit comments from the public, so 

that the Commissioners can take those into consideration, and 

whether it be qualitative or quantitative, that we can include that 

before we go to any final rule, and as you say, to include anything 

that we have heard from the public with that regard. 

Mr. CONAWAY. There are some pretty dramatic differences between your cost—your expected cost to participants and folks that 

deal—in what they themselves see under these proposed rules. So 

making sure that we have not done something that costs way too 

much money versus the benefit that we get, would be helpful. 

And one final comment. As you roll out this entire scheme when 

we get it in place, can we do an interim final rule for the whole 

package so that the industry, the participants, everyone can see 

how all of this matrix of new regulations fit together to make sure 

we get it right? I understand going at it a piece at a time, but it 

seems to me beneficial to the agency, as well as those who try to 

comply with your rules, if they saw the whole matrix at some final 

point, it would still allow for some fine-tuning, so to speak. 

Mr. GENSLER. We have nearly completed all the proposals. There 

are these two that I think will be out to the public, capital and 

margin, hopefully in the next few weeks, and the product definition 

may be a few weeks after that. We don’t plan to move on any final 

rules in April. There may be some very noncontroversial, small 

rules that we start to move on in May. We have the discretion to 

continue to take public comment and include it in public comment 

files, and have done so. We have used that discretion very liberally. 

This meeting right here, this Committee meeting, will be part of 

our public comment file as well. So the mosaic will be out there 

really before we move on final rules of any substance. 

Mr. CONAWAY. Thank you, Mr. Chairman, I yield back. 

The CHAIRMAN. The gentleman’s time has expired. 

The chair now recognizes the gentleman from Pennsylvania, Mr. 

Holden. 

Mr. HOLDEN. Thank you, Mr. Chairman. 

18

Chairman Gensler, it is nice to see you again. I had two issues 

I wanted to raise, but you more or less have addressed them; so 

I will just make a couple of comments about agreeing with my colleagues that we are, on this Committee, hearing a great deal from 

the agriculture sector and the energy sector, particularly public 

utilities, about the definition. So I am glad to hear you are going 

to be working with them. 

And following up on Mr. Johnson’s comments about the exemption for small banks, Farm Credit System, and credit unions, I 

would just encourage you to stay engaged and listen to their concerns, because it is my understanding that the overwhelming majority, over 90 percent of the swap dealing, is in the hands of 25 

entities or fewer. So you will have to be very careful with smaller 

banks. 

As a matter of fact, on the next panel, Mr. Cvrkel from Susquehanna Bank, headquartered in Pennsylvania, will be testifying. It 

is a bank of about $14 billion in assets, I believe, and I will ask 

him when he is testifying or taking questions. In the last 3 or 4 

years, they have only done about 54 swaps compared to the overwhelming majority. I think you need to be careful that these are 

useful instruments in smaller banks and other entities, but at the 

same time if we are too burdensome on them, they are not going 

to participate. 

So I just would encourage you to stay at the table and listen to 

what they have to say. Thank you. I yield back. Do you want to 

comment? 

Mr. GENSLER. No. I appreciate the comment. I read the testimony and look forward to working not just with Susquehanna but 

many banks of similar ilk. 

Mr. HOLDEN. Well, this is a Pennsylvania interest here. 

The CHAIRMAN. The gentleman yields back. 

The chair turns to the gentleman from Texas, Mr. Neugebauer. 

Mr. NEUGEBAUER. I thank you, Mr. Chairman. 

Chairman Gensler, thank you for being here. Yesterday you and 

I talked—just a while ago, one of your cohorts, Ms. Sommers, testified before my hearing that I had on the Financial Services Committee. She said some things that were very concerning to me. 

Kind of one of the things that she alluded to here, she says that 

we are voting on proposals containing a very short, boilerplate, 

cost-benefit analysis section. And she referred to the President’s 

Executive Order, although it does not apply to your agency, and 

taking into account both quantitative and qualitative issues and 

the cost and the benefits of those. And one of the things that she 

brought up was an interesting point, is that when you do a better 

job of those cost-benefit analyses, and as you quantify those various 

proposed regulations and you put numbers onto them, that she 

feels like, she said, that she thinks Commissioners make better decisions. I think we would all agree that that would be hopefully the 

goal of every agency is that when we put people to serve in the capacity of Commissioners, that they avail themselves of every opportunity to make the best decisions. 

And as I didn’t get to hear all of my friend from Texas’ testimony, but what we are talking about with Dodd-Frank is we are 

19

not talking about just a little tweaking here of the financial markets. 

We are talking about a major change in those financial markets 

and maybe even influencing the way capital moves and how capital 

is priced and how capital is distributed in this country, which 

equates to jobs. Basically, the way we create jobs in this country 

is people have an idea and they find the capital to do that, or they 

have a business and they expand it. And these markets have become a very effective tool for many of the people that use them. 

They have created jobs and they have created more certainty in 

their companies. 

And so I am a little concerned. What would be your response to 

Ms. Sommers’ response, that you all aren’t doing a good job over 

there doing your cost-benefit analysis? 

Mr. GENSLER. I am very proud of the work of the staff and the 

five Commissioners. We are in compliance with the Commodities 

and Exchange Act, section 15(a), which Commissioner Sommers 

also said yesterday, and we are looking very closely at the comments that people have put forward on cost-benefit analysis. I can 

assure you we are not going to move forward on final rules until 

they are summarized and Commissioners get to deliberate with 

each other about that and with the staff. 

I think that what the Dodd-Frank Act does at its core is it brings 

transparency to these markets and lowers risk in these markets, 

and competition and open competition in these markets will lower 

some of the barriers to entry to many banks. If a small bank wanted to actually enter the market in a way, right now this is a highly 

concentrated market where the information advantages are more 

towards the financial community in New York than to the tens of 

thousands of users, whether they be in Texas, my home State of 

Maryland or elsewhere. 

And I think you all in passing the Act tried to tip that balance 

a little bit to most of the corporations that use these products. 

Mr. NEUGEBAUER. I don’t think she said that you weren’t in compliance, but she said compliance is, to that particular section, is a 

relatively interpretive term. You can be in compliance or you can 

do a good job. I think what she was saying is that somehow within 

the agency, you all have come to the conclusion, hey, we are complying with that section. 

But, as she said, as complicated and as important as many of 

these things are and with the speed with which they are coming 

out, that there is really not any way that the kind of comprehensive analysis that should be done for the potential impact and the 

consequences that these changes could make on the market. And 

as you say, I don’t think anybody here disagrees with the fact that 

markets should operate with integrity and transparency. 

But many of the rules that you are putting out will actually determine the people who can use some of these tools and how they 

can use them, and whether they can afford to use them and whether those tools continue to be advantageous to their organization. 

And so I would just say that I think Mr. Bachus and I wrote all 

of you a letter here recently and said, Do you know what? We are 

not interested in speed here. We are interested in doing the right 

thing. 

20

And if a lot of people think that Dodd-Frank is the right thing 

to do, I think all those same people who voted for it would probably 

also, without speaking on their behalf, would say, yes, we voted for 

it but we hope it does what we intended for it to do. We hope that 

the consequences and the outcome has been measured, and we 

know what we are getting before we go down that road. And some 

people say, well, Mr. Frank said today, ‘‘Well, we will fix it if we 

made a mistake.’’

The problem is when you start changing the behavior in a lot of 

these markets, then going back and trying to, ‘‘fix it,’’ has even 

more dire consequences than taking a little extra time to make 

sure that we get this right. 

And so what you are going to continue to hear from me is that 

I am concerned about the speed, I am concerned about the sequence, and I am certainly concerned about the analysis and 

thought that is going in in this rulemaking process. 

With that, Mr. Chairman, I yield back. 

The CHAIRMAN. The gentleman’s time has expired. 

The chair now turns to the gentlelady from Alabama, Ms. Sewell, 

and recognizes her for 5 minutes. 

Ms. SEWELL. Thank you so much. 

First, welcome, Mr. Chairman. I admire what you are doing and 

really feel that the Commission has been charged with a very special duty, and I know it is to get it done in a timely fashion is what 

we all want, as well as to be fair. 

I have one question really. Where are you in the decision making 

process when it comes to determining whether to exempt the Farm 

Credit System institutions from the definition of end-user?

Mr. GENSLER. We asked the public for some comments. We received about 15 comments on this. And now we are working with 

the Farm Credit Administration, as well as the banking regulators 

and the credit union folks, as to how to piece this together. 

If we were to move forward, we would have to do a proposal 

under the statute and get further public comments on that. But 

right now we are in—similar to the rules, we are sort of taking the 

comments that we received and are working with the other regulators on how to craft something. 

Ms. SEWELL. Where do you think you will come out on that? 

Mr. GENSLER. I don’t want to get ahead of the process and my 

fellow Commissioners. But we take seriously what Congress said, 

that we shall consider this, so I take it seriously in the entire statute, but this was the direction from Congress. 

Ms. SEWELL. Absolutely. Thank you. I yield back the rest of my 

time. 

The CHAIRMAN. The chair now turns to the gentleman from Alabama, Mr. Goodlatte, for his 5 minutes. 

Mr. GOODLATTE. Except I am going to stay in Virginia. 

The CHAIRMAN. Virginia. Virginia. Very good point. 

Mr. GOODLATTE. I thank you, Mr. Chairman. I thank you for 

holding this hearing. And, Mr. Gensler, I thank you for participating today. 

I understand that my colleague, Mr. Peterson, asked you if you 

had seen the movie, Inside Job. And you said you hadn’t seen it 

yet. I recommend you see it. 

21

And let me just ask you a question about my main concern here, 

why I voted against Dodd-Frank, and why I am concerned about 

where you are headed. I think that what we should be doing is 

clearly defining what you can and can’t do and throwing the book 

at the bad guys who do what they are told they can’t do, and not 

going into the amount of regulations that you are imposing on people who are trying to conduct a legitimate business and making it 

all that more difficult to do that. 

So my first question is, one of the things revealed in that interesting documentary is the fact that apparently a number of the 

major investment banking firms sold various derivatives to their 

customers at the same time they were betting against their customers themselves. 

What can you tell us about that? And what is being done to cure 

that? 

Mr. GENSLER. Your question and much of what happened in that 

was in credit default swaps. Some of that jurisdiction will be at the 

Securities and Exchange Commission, but I will speak more broadly. Because what Congress gave the Securities and Exchange Commission and the Commodity Futures Trading Commission is new 

authorities on anti-manipulation and to protect the markets from 

abusive practices. And I don’t know how the Securities and Exchange Commission will deal with that on these single name and 

these basket of credit default swaps where a lot of that, you are 

right, occurred. 

What we are doing at the CFTC is we have proposed a new antimanipulation standard which is consistent with what Congress did. 

Congress gave us a new anti-manipulation standard, and that is 

out for comment. We would like to finalize that to make sure that 

we can pursue actions in this marketplace. 

Mr. GOODLATTE. One of the issues that—I don’t know how related to that is—but attempting to cure some of this is—the categories of swap dealer and major swap participant are mutually exclusive. If an entity is a swap dealer, that entity may not be a 

major swap participant. This makes sense, because swap dealers 

are the sell-side of swaps and major swap participants are the buyside, basically the largest customers. Sellers and buyers should not 

be in the same regulatory category, and Dodd-Frank appropriately 

provides for that. 

Do your regulatory proposals take this basic difference into account? 

Mr. GENSLER. Yes. I would think that there would be only, at 

most, a handful of major swap participants; that somebody who is 

not a swap dealer, but yet for some reason is so large or substantial—is what Congress used the term—that their failure would 

have a systemic effect on the economy. 

And I should say on your first question, we do also have authorities on business conduct standards for selling swaps to pension 

funds and municipalities. And Congress asked us to be very focused on the sales practices in that regard as well. 

Mr. GOODLATTE. I know that some have expressed concerns that 

swap dealers and major swap participants will be regulated the 

same. Do you propose to regulate them the same, even though one 

is the seller and one is the buyer? And why should buyers and sellVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00025 Fmt 6633 Sfmt 6601 I:\DOCS\112-07\65892.TXT BRIAN
22

ers be subject to the same sales practice rules, when the buyers are 

not indeed sellers? 

Mr. GENSLER. You raise a very good question, and I am going to 

go back and think about that and ask about that on the sales practices. But the basic answer is because the statute did not differentiate between the two. Once one is designated a major swap participant, one of these handful of companies that are so large, the statute just regulates them the same. But you raise a very good question about sales practices. 

Mr. GOODLATTE. So are you suggesting that we need to take further legislative action because your hands are tied; or are you able 

to make a difference there? 

Mr. GENSLER. Could I get back to you on that in terms of the 

sales practices for major swap participants? 

Mr. GOODLATTE. My time is limited, so let me go on to another 

question. 

I have heard from some businesses that they are uncertain about 

how they will be designated and which rulemaking will apply to 

them. Is there any documentation that provides various market entities, and specifically end-users, guidance regarding which of the 

various rulemakings are applicable to them? 

Mr. GENSLER. Well, for the vast majority of end-users, they are 

not going to be swap dealers, they are not going to have to use a 

clearinghouse unless they choose to, and they will benefit from the 

transparency in the marketplace. There will be changes in the marketplace, of course, because the financial companies will be using 

these clearinghouses, but they will be out of it. 

Mr. GOODLATTE. With the leave of the Chairman, I will ask you 

one more question. 

I am concerned that the CFTC is putting out rules piecemeal for 

comment. Many of these regulations are highly interdependent, 

and I am concerned that we will not get to see the full picture of 

how they work together or a meaningful analysis of the cost and 

the impact of the regulations. Would you be willing to put forward 

a full package of proposed regulations for comment before they are 

all adopted, or at least put them in packages so that we and market participants are able to fully appreciate their cost and their impact? 

Mr. GENSLER. I think, actually, that is nearly what we have 

done. We haven’t finalized anything and we have two major rules 

left, which we will probably do in the next 4 to 6 weeks. 

Mr. GOODLATTE. Will those rules be out and evaluated before the 

first rules you issued take effect? 

Mr. GENSLER. Yes. 

Mr. GOODLATTE. That is helpful. 

Thank you, Mr. Chairman. I appreciate it 

The CHAIRMAN. With that, the gentleman’s time has expired. The 

chair will now try in a more accurate fashion to turn to the gentleman from Iowa, Mr. Boswell, and recognize him for his 5 minutes. 

Mr. BOSWELL. Thank you, Mr. Chairman. 

Just briefly, I wasn’t here for all that you have been through already, but thank you for coming. You have a big job. And I am 

wondering if you want to comment on are we giving you the tools 

23

to do what you have to do. Have you got the tools to follow 

through? 

Mr. GENSLER. Well, you are kind to ask. We have the tools to 

write the rules and excellent staff, but we do not have the tools to 

oversee the market. We have estimated that we need about 45 percent more people to oversee a market that is seven times the size 

of what we——

Mr. BOSWELL. We have talked about this before. Can you give us 

some kind of a figure—dollars, number of people? 

Mr. GENSLER. The President has put forward a budget of $308 million for our agency for 2012, and $261 million for this year. We 

are currently funded at $168 million. In terms of people, we have 

about 675 people now, and the President has put forward 983 people. We only spend $31 million on technology a year. We have asked 

to go up to about double that. That is less than about 1 day of technology spending for some of the biggest Wall Street banks. 

Mr. BOSWELL. So what happens if we are going to have to—you 

can’t do the job, you don’t have the tools, you don’t have the personnel if we continue with this; or do we back off and we don’t do 

the regulation, or what happens? 

Mr. GENSLER. I think the challenge for the agency is if we even 

kept flat on funding, is that we will have to shift resources that 

currently oversee the futures market, or even agricultural futures 

and energy futures, over to some of these financial swaps. The mission is, right now, far broader. The market is seven times its size 

and far more complex. And so we will not be able to pursue the 

Ponzi schemes. We will not be able to promote the transparency in 

the markets that I think the public deserves. 

Mr. BOSWELL. Well, I will yield back, Mr. Chairman, in just a 

moment. But it just seems to me like we have to lay this out in 

broad daylight and decide what we want to do with it, whether we 

are going to give up the oversight, or whatever. I don’t know. I 

don’t envy your job here. I am not sure what we are going to do. 

Thank you. I yield back. 

The CHAIRMAN. The gentleman yields back. 

The chair now turns to the gentlelady from Ohio, Mrs. Schmidt, 

for 5 minutes. 

Mrs. SCHMIDT. Thank you, Mr. Chairman. And thank you, Mr. 

Gensler, for coming. 

I want to focus a little bit on farm credit and community banks. 

Is it your intention to extend the insured deposit institution’s 

swaps in connection with loans exemption to the farm credit 

banks? 

Mr. GENSLER. I know that a number of comment letters have 

come in on this. The statute speaks of insured depository institutions and did not speak in a broader way, so I am familiar with 

the comments that have come in. I know that our staff and General 

Counsel’s office is taking a close look at it because the statute actually just uses the term insured deposit institutions. 

Mrs. SCHMIDT. So you don’t know how you are going to handle 

that? 

Mr. GENSLER. I don’t know. I am apprised of it. I know that staff 

is looking very closely at it. 

24

Mrs. SCHMIDT. Because I believe during the last hearing when 

you appeared before the Committee, you were asked about small 

banks and farm credit institutions. And I believe you said that the 

small entities, by and large, are not swap dealers; there may be 

one or two exceptions. And you further said you couldn’t speak for 

thousands. And then you said, I doubt that many of them are swap 

dealers. 

And in light of the fact that we have a farm credit bank and a 

community bank here today that have expressed concerns in their 

testimony—or will be expressing concerns, because we have received the written testimony—about being designated as swap 

dealer, what would you say in light of that response? 

Mr. GENSLER. My answer was trying to answer a question about 

banks smaller than $10 billion. I think the banks you are hearing 

from today are $14 billion and maybe—I am sure they can tell you 

how large, $50 or $60 billion. 

Mrs. SCHMIDT. You think $14 billion is a large bank? 

Mr. GENSLER. Congress actually defined it in the statute. They 

used the term small bank, and then right below it it said $10 billion or less. So I was using a Congressional term. 

Mrs. SCHMIDT. So do you think we should change that benchmark? 

Mr. GENSLER. I am just using it——

Mrs. SCHMIDT. Because, sir, I come from a banking background, and $14 billion is not a large bank. I don’t know why $10 billion 

was the threshold. That would be a very small bank, in my opinion, 

but it is certainly not a large bank. So should we change the benchmark, the definition? 

Mr. GENSLER. I think the statute is a strong statute; I am not 

asking Congress for any changes. 

Mrs. SCHMIDT. Okay. And then I just want to go back to the 

swap issue. We have heard concerns, and I know you have received 

public comments, that active trading in the swap market by itself 

could make an entity a swap dealer. Is that your intention? 

Mr. GENSLER. What we have put forward is a rule that further 

defines what Congress laid out, four provisions for what a swap 

dealer is, and so we are taking those comments in. But the statutory language was, ‘‘if you make a market in swaps, or you are 

commonly known as a ‘swap’.’’

And then the fourth prong, which was one that talked about in 

the ordinary course, is where we thought there was some need for 

further definition. But in essence, if you are accommodating demand or facilitating customers in swaps, it would be sort of part 

of the facts and circumstances. 

Mrs. SCHMIDT. So again, back to this Act that you are now trying 

to implement rulemaking on, it appears there is a lot more ambiguity or questions that arise from the Act itself, and maybe we 

should revisit the Act. 

Let me go on again. In the definition of security-based swap dealer, the SEC plans to adopt their dealer trade distinction with respect to who must register as a security-based swap dealer. The 

CFTC appears to have rejected this distinction for the swap dealer

definition, and now again there seems to be some sort of tension. 

Can you clarify this? 

25

Mr. GENSLER. Yes. We did not, as our markets are different. 

They have in that definition, that dealer and trader definition, they 

talk about inventory and the like; inventory of securities, which is 

not easily or readily adaptable to the interest rate swap market; 

what is the inventory of interest rates, for instance? Or even, for 

instance, in the oil markets, which is not like an inventory of securities. So there are some challenges just because of the specificity 

in their rule. 

Mrs. SCHMIDT. I yield back, but——

Mr. HOLDEN. Will the gentlewoman yield on her point about $10 

billion for me to ask the Chairman a question? 

Mrs. SCHMIDT. Yes, please. 

Mr. HOLDEN. I thank the gentlewoman. 

Chairman, you do have the authority to exempt above $10 billion, correct? It is just below $10 billion you must? 

Mr. GENSLER. Again, as I understand, the statute asked us that 

we shall consider exempting from the clearing requirement the 

small banks, and then it lists banks under $10 billion, credit 

unions under $10 billion, and of course farm credit institutions 

under $10 billion. 

Mr. HOLDEN. But you have the authority above $10 billion as 

well. 

Mr. GENSLER. I am just speaking to what—I mean, Congress directed us to take this up. We are taking it up right now, working 

with the institutions. I believe that the Congresswoman’s question 

about swap dealers, what I said earlier and I will say now, I am 

not aware of institutions less than $10 billion. There may be some 

out there, but I am not aware of them. They haven’t been knocking 

on our doors, that say they would be a swap dealer or anything like 

that. 

Mrs. SCHMIDT. May I have just an additional 30 seconds? 

The CHAIRMAN. The gentlelady reclaims her time. The gentlelady 

has an additional 30 seconds. 

Mrs. SCHMIDT. Sir, you said that $10 billion was the threshold. 

I believe you said it is a suggestion, not an absolute benchmark of 

$10 billion. And I believe you have the authority to go above that, 

the way this law was written. 

So, again, there is a lot of ambiguity in this Act, but $10 billion 

was not the absolute benchmark. You could go above that to $14 

or $15 billion. 

I yield back. 

The CHAIRMAN. The gentlelady’s time has expired. 

The chair now recognizes the gentleman from California, Mr. 

Costa, for 5 minutes. 

Mr. COSTA. Thank you very much, Mr. Chairman. 

I want to first kind of revisit a subject that we discussed the last 

time you testified, as it related to the potential of regulating of foreign currency swaps. My understanding is that the Secretary of the 

Treasury is considering or leaning toward a decision that foreign 

currency swaps should be regulated. We are all following very 

closely what is happening with the Euro and a number of countries 

within the EU, and of course situations with China and other foreign currencies that obviously impact our trade. 

26

And so I guess my question, my first question, is what impact 

would such a decision have, if any, on producing a definition of a 

swap, or any other rulemaking that is already underway, if we 

start to regulate foreign currency swaps? 

Mr. GENSLER. I think we have contemplated that in our rulemaking and are contemplating it in the product side as well, that 

Congress gave the Secretary the determination; he could determine 

that foreign currency swaps are out, but we have sort of contemplated that in our rulemaking. 

Mr. COSTA. Can that occur on a separate track? 

Mr. GENSLER. I believe it can in terms of our rulemaking. We 

would take it into consideration in terms of phasing implementation. For instance, there is not a swap data repository for foreign 

currency right now. There are swap data repositories, for instance, 

in credit default swaps. That is one of the things we are taking into 

consideration. It might just take more time to stand up, for instance, some of the infrastructure. 

Mr. COSTA. Can you tell us this afternoon, at this time, what you 

think you are going to do? 

Mr. GENSLER. Well, it is the Secretary of the Treasury’s determination. 

Mr. COSTA. I understand. 

Mr. GENSLER. No. I don’t believe it would be prudent for me——

Mr. COSTA. Not before its time, right? 

Mr. GENSLER. It wouldn’t be prudent for me to——

Mr. COSTA. Following up on Mr. Boswell’s line of questioning on 

resources, under the Dodd-Frank law there are a host of issues 

that we have discussed here this afternoon, from applications for 

new swap execution facilities, designated clearing organizations 

and swap data repositories, swaps to see if clearing mandates 

should apply, requests for exemptions to the law’s provisions, and 

other requests from the business community. 

You made a comment earlier on your current resources available 

and your fine staff and what your capabilities are today. When you 

go down that list that I just stated, what gets included or excluded 

based upon how much your budget is? 

Mr. GENSLER. It really depends on where the budget is. If we 

were cut, a lot of it goes away; we can’t even oversee the futures 

market much. If we just stay flat, we will have to start reallocating 

people. We did have a very real crisis in 2008. These markets are 

not as transparent as Congress has wished them to be. We would 

be relying on the markets to be complying with Dodd-Frank, but 

we wouldn’t be able to actually examine for it and oversee the markets with regard to swaps, as you have directed us to. 

Mr. COSTA. Well, to use a medical terminology, first, do no harm, 

when a surgeon is in ER, on a serious case they triage, and so they 

deal with the most urgent matters first. So on that list, I assume 

that when you do get a chance to sit down on a Friday afternoon 

with your staff and figure out, now that we have these rules almost 

presented and we are moving to the next stage, where are your priorities going to be? 

Mr. GENSLER. Well, the biggest priority is to increase our technology budget so we can aggregate the data and actually make it 

public. We have proudly put out, every Friday, Commitments of 

27

Traders Report in the futures market. We would like to do something similar in the swaps market if we could actually have the 

technology and aggregate data. 

For the hundreds of applications that will come in, we would like 

to be responsive. We would like to have a professional on the end 

of the phone to answer the questions and try to walk people 

through some very new rules and give them regulatory guidance. 

I don’t see how we will be able to do that. 

Mr. COSTA. So if you get the President’s full request, you can do 

all of the above? 

Mr. GENSLER. I think that if we get the President’s full request 

we can grow into it, and it will take a couple of years to grow into 

it. But, yes, the President’s request helps us grow into these responsibilities. 

Mr. COSTA. And if you get half of it or something less, you will 

have to do the prioritization. 

Mr. GENSLER. That is correct. That is correct. And if we are cut 

from where we are now, at some point I would have to tell this 

Committee we could not fulfill our mission. We certainly could not 

fulfill it if we were cut back to 2008 funding levels. 

Mr. COSTA. Well, I think that needs to be clear. And you should 

also tell this Committee if it is something less, half or less, what 

you can do and what you can’t do. I think that is an area—when 

you try to create an expectation for a transparency level and for all 

elements of these derivatives, I just think people need to know 

what they can expect and what they can’t. 

Mr. GENSLER. Part of the investment in an agency like ours is 

it is like investing, and you don’t know when—to use your medical 

analogy, it is like the doctor saying, ‘‘Stay on a diet and maybe 

don’t smoke or something.’’

I can’t tell you that in 2012 there will be a crisis. But we know 

in 2008 there was a crisis and swaps were part of it. And Congress 

reacted appropriately. We are trying to implement the law consistent with the intent, but if we don’t oversee this market, the 

American public is prone to risk. 

Mr. COSTA. I would like to quickly, before my time expires, move 

over to another area. You touched upon it, Mr. Conaway touched 

upon it. When we are dealing with some of the various commodities, whether we talk about wheat, soybean, milk, others—

anecdotally, and I have nothing to base this on because I don’t deal 

with these trades, but I get complaints from a lot of my farmers 

that there is a lack of transparency, there is a lack of activity, that 

it seems to be an in-house game. 

It is hard from my perspective to really determine whether or not 

these anecdotal stories really—to what degree they are accurate. 

Have you got any sense, based upon getting back to the whole purpose on why this was created, going back to the 1930s—not the exotic sorts of mechanisms that you deal with today—but getting 

back to what is important out on the farm to see what is going on 

in Chicago and see what is going on elsewhere for our farmers and 

ranchers? 

Mr. GENSLER. Well, hedgers meet speculators in a marketplace. 

If a farmer needs to lock in a price at harvest time, it is usually 

a speculator on the other side of that transaction. 

28

But it is true that over the decades that the markets have been—

the percent has gone up that are financial actors or speculators in 

that marketplace. And it is why people want the transparency, so 

they can still have the confidence that the price they get for their 

corn or wheat or soy or milk, as you said, is actually reflective of 

supply and demand, and that there is integrity in the market. 

Mr. COSTA. A lot of my dairymen complain, they just think there 

is a total lack of transparency, that it is an in-house deal, and they 

have little way to really get a sense that prices aren’t set without 

their ability to have the input. 

Thank you. 

The CHAIRMAN. The gentleman’s time has expired. 

The chair now turns to the gentleman from Colorado, Mr. Tipton, 

to be recognized for 5 minutes. 

Mr. TIPTON. Thank you, Mr. Chairman. Thank you, Mr. Gensler, 

for being here. 

I just have a few questions that I would like to get some clarification on. 

You commented earlier that you are seeking to work with the 

various entities in terms of some of the resolution in regards to the 

rulemaking. Can you describe what it means to be working with 

them? Is it just taking the comment; they put out an idea and you 

say, well, here is the problem? Is there that give-and-take going 

back and forth, or is it just receiving comment; we will consider it 

and we will make up our own mind. 

Mr. GENSLER. If I might, there is some of both. We have had well 

over 600 meetings. I had one on the end here with the good gentleman at ConocoPhillips that is about to testify that we will put 

on our website as well. So he will be able to answer you whether 

there was give-and-take, but it is some of both, if I want to be——

Mr. TIPTON. Well, I appreciate that. I guess one of the big concerns that I always have—small business guy—and we are probably hearing that in terms of an underlying theme through some 

of the questioning that is going on—is really some of the cost-benefit analysis that is really going in that. Can you describe for me 

how you approached cost-benefit analysis in this process? 

Mr. GENSLER. Many years ago in our statute a section you will 

hear about, it is called 15(a) was added, and it has five criteria, five 

characteristics we have to look at. And it talks about the integrity 

of the market and the price discovery function and the lowering of 

risk. So it is around those things that somewhat inherently are 

qualitative. Commenters have come in with some quantitative figures as well. And so we try to take all of that into consideration. 

One thing for me, as one Commissioner, is trying to find what 

Congress asks us to do in a way that lessens the burden or cumulative cost, because there are things in the statute that will cost 

money, that is true. But then there is a way to find a least-cost 

way, or find a way that we can spread it out and have it phased 

in terms of implementation, to take into consideration the cost as 

well. 

Mr. TIPTON. Can you maybe just tie that in just a little closer 

here? Like an electric utility, as a swaps dealer being designated, 

how are you going to approach the cost-benefit analysis on that? 

29

Mr. GENSLER. The swap dealer definition is very precise in the 

statute. So many electric utilities wouldn’t be; but if they were, 

then it is really trying to walk through with them what are the 

capital margining requirements—because we are supposed to set 

the capital and margin regime for these nonbanks. And it doesn’t 

have to be the same as the banks. The statute says that to the 

maximum extent practical we have to be consistent, but it didn’t 

say we have to be the same. 

It is walking through the business conduct standards and how 

they might apply to some of these nonbank swap dealers, whether 

it is phasing the timing or whether they apply differently, to try 

to walk that through. 

Mr. TIPTON. It sounds a little iffy to me in terms of setting some 

of those capital requirements. It just sounds a little iffy to me in 

terms of how you are trying to define those capital requirements 

for entities that are nonbanks. 

Mr. GENSLER. Well, one of the challenges is that those capital 

rules have been done for banks, insurance companies, broker-dealers, and so Congress gave us a task and it was specific to 

nonbanks. We are hoping to propose that in the next few weeks. 

We are very much looking forward to public comment on it, because we will be assisted by that public comment. We have already 

been assisted by many of the meetings we have had with industry 

people. 

Mr. TIPTON. Okay. And I appreciate that assistance. 

I want to go back to an earlier question that was raised in regards to the packaging, the entire package. Did I understand you 

correctly that you are willing to be able to bring that back as a 

package for comment? Because I deeply respect the comments of do 

no harm, and unintended consequences.

Mr. GENSLER. Well, I just want to be precise. We have already 

put out rules on 28 of the 30 topic areas. There are two significant 

ones. There is capital and margin, there is a product definition, 

which will be out in a number of weeks. We don’t intend to move 

on any final rules in April. So the mosaic is largely out there and 

will be, in essence, out there before we move on any major rule. 

There might be one or two very small rules that we move on—an 

example is the definition of agricultural commodity. This is one 

rule we might move on early, but it is not the same category. 

Mr. TIPTON. I guess my point on this is it is not so much how 

I am viewing it as mosaic, as impressionistic art. When we are up 

close, we aren’t really seeing it, it is coming in in little bits and 

pieces; when we step back, we see the whole picture. Being able to 

come back in and revisit these, once we then have that interaction 

with industry, the actual impacts that are going to be there. 

Mr. GENSLER. We have used the discretion we have under the 

Administrative Procedures Act to continue to consider comments, 

just like this hearing is a comment. And we have gotten many comments we have put in even after it is out there. 

With all respect, industry does know Dodd-Frank is a full mosaic 

itself, and now we are almost there; that we have finalized this 

proposal stage, and then we will move to the finalization stage. 

Mr. TIPTON. Thank you, Mr. Chairman. Thank you, Mr. Gensler. 

The CHAIRMAN. The gentleman’s time has expired. 

30

The chair turns to the gentleman from Pennsylvania, Mr. 

Thompson, for 5 minutes. 

Mr. THOMPSON. Thank you, Mr. Chairman. 

Chairman Gensler, thank you for being here and for your testimony. 

My question has to do with the National Futures Association’s 

petition to the CFTC to narrow the Rule 4.5 exemptions provided 

in mutual funds, among others, from the definition of the commodity pool operator. Now, the petition was based on the activities 

of three firms, yet your recent Rule 4.5 proposal would capture 

large swaps of mutual funds and subject them to duplicative and 

potentially conflicting CFTC regulation, when mutual funds are already highly regulated by the SEC. 

Now this rule proposal seemed to have nothing to do with DoddFrank. And at a time when the CFTC has extensive new responsibilities under Dodd-Frank and is before Congress asking for additional financial resources to meet its new regulatory burden, why 

would the CFTC attempt to drastically expand its regulatory jurisdiction and extensive new responsibilities over mutual funds when 

the SEC already regulates this? 

Mr. GENSLER. We have for decades regulated or overseen something called, ‘‘commodity pool operators.’’ The public might just call 

them hedge funds, or the public might call them money managers 

and so forth. Commodity pool operators pool money and invest in 

futures. They can invest in other things. The SEC, for the first 

time in the Dodd-Frank Act, has reporting for hedge funds. Some 

of those hedge funds are also commodity pool operators. So the 

statute actually said we should do a joint rule with the Securities 

and Exchange Commission on information that would go to the 

SEC. 

So we did choose to propose that joint rule in January. We did 

a sister rule—the one I think to which you are referring—on commodity pools that wouldn’t necessarily be reporting to the SEC, to 

try to align that with what we are doing in that joint rule at the 

SEC. So that is why we took it off, because of Congress’ mandate 

on this joint rule and trying to align some of that which we have 

done in these commodity pools. But I would be glad to come and 

see you one on one, and try to dig more into some of these issues, 

because I have to remind myself of all the details of each rule too. 

Mr. THOMPSON. Well, Chairman Gensler, I appreciate it. 

Mr. Chairman, I yield back the balance of my time. 

Mr. CONAWAY. Would the gentleman yield his minute for one follow-up? 

The CHAIRMAN. The gentleman—yes. 

Mr. CONAWAY. Mr. Gensler, does the Administrative Procedures 

Act have any kind of a bright line requirement as to major changes 

to a proposed rule that would in effect require you to re-propose it; 

or is that fully within your discretion as to how much change 

drives going from proposed to final versus a re-proposal? 

Mr. GENSLER. I think you are probably beyond my personal 

knowledge base and I have to ask my General Counsel. 

Mr. CONAWAY. If you wouldn’t mind providing that for the 

record. 

31

Mr. GENSLER. What I am led to believe is if we are proposing 

something completely new, it hasn’t been considered, it is not questioned and so forth, we might need to re-propose. But if we have 

laid out enough predicate, enough in the proposal, we don’t need 

to re-propose. And often what is happening is we are getting comments from people that want us to narrow something and so forth. 

I am just being handed a note, it says, ‘‘If it is a logical outgrowth’’—those are the key words—‘‘a logical outgrowth of the proposal.’’

Mr. CONAWAY. So there is some standard by which to judge what 

you would go final with, as to whether or not you would go final 

or re-propose? 

Mr. GENSLER. Yes. 

Mr. CONAWAY. Thank you, Mr. Chairman. I yield back. 

The CHAIRMAN. The gentleman yields back. 

And as the Chairman of the CFTC would know, there are sometimes, anymore, not a lot of pleasures that go with being Chairman 

of anything. But in my regard, I have the ability to control the time 

and I have a couple more questions for you, sir, if you don’t mind. 

That is one of the few pleasures of this job these days. 

As you know, Chairman Gensler, I recently joined Chairman 

Bachus and Chairman Kline in writing you and Chairman 

Schapiro and Secretary Solis about the potential conflict among the 

three agencies’ regulatory proposals that could be detrimental to 

pension plans. Swaps are an important risk management tool for 

pension plans, and we need to take every caution not to jeopardize 

the benefits they provide to ensuring the retirement security of millions of Americans. In fact, when you appeared before the Committee last, you were asked if CFTC would take every precaution 

not to impose significant and additional new costs on pension 

funds. And you said, ‘‘Well, I think we are.’’

Yet shortly thereafter, we heard testimony from the American 

Benefits Council that the business conduct standards rules proposed by CFTC conflict with the DOL rule to the point that they 

would require a swap dealer to perform an illegal action or refrain 

from entering into a swap with a plan. In short, this would make 

it impossible for pensions to engage in swaps at all. 

If the business conduct standards are finalized before this conflict is clearly and officially resolved, there would be significant and 

potentially harmful consequences for our pension system. Can you 

assure me that this conflict will be publicly resolved before the 

business conduct standards are finalized? 

Mr. GENSLER. We have been meeting with the Department of 

Labor to harmonize the two. So to Congressman Tipton, who asked 

me earlier about how we are working together, this one we are 

really working together with the Department of Labor. I think they 

are going to be able to assist us and assist this Committee to harmonize that our business conduct standards, which Congress in essence said—the key to this, Mr. Chairman, is that Congress said 

that swap dealers have to, on a daily basis, value the swaps with 

their counterparties. Just because they value that swap on the 

other side’s pension fund shouldn’t make them a fiduciary. 

And we are working with the Department of Labor to ensure 

that this Congressional mandate that we embedded in our business 

32

conduct doesn’t somehow make somebody, solely because of that, a 

fiduciary under this Department of Labor rule. So we are working 

to harmonize it and get clear input from the Department of Labor 

that we can share publicly. 

The CHAIRMAN. Thank you. 

One other question. You recently traveled to Europe and spoke 

publicly about the need for international cooperation. Specifically 

you said, ‘‘Effective reform cannot be achieved by one nation alone.’’ 

You also stated before this Committee that you are working very 

closely with foreign regulators to ensure as best we can—another 

quote again—‘‘that we are consistent in our regulatory treatment.’’

In addition, you made remarks in Europe that it was important 

for them to pursue reforms that were consistent with Dodd-Frank 

in order for CFTC to recognize comparable regulatory regimes. 

And I would like to submit for the record a copy of a letter submitted to the CFTC by the Financial Services Authority in the U.K. 

Seeing no objection, so ordered. 

[The document referred to is located on p. 73.] 

The CHAIRMAN. In the letter, the FSA expresses concern that 

CFTC’s proposal to set a $50 million cap on the amount of capital 

clearinghouses can require of potential clearing members could actually increase risk to the system. 

So I guess, Chairman, can you respond to the concerns expressed 

from a foreign regulator that your proposal would inject more risk 

into the system? 

Mr. GENSLER. I am familiar with the letter. I think that currently the clearinghouses in the futures industry are well managed 

and they do not have the limits in the swap market. The swap 

marketplace, frankly, has been an exclusionary practice where they 

say you have to have $5 billion of capital or $1 trillion of swaps 

before you are a member of the clearinghouse. 

We proposed in December that there be different limits, that it 

foster competition and not just be exclusively these large swap 

dealers. And we will take into consideration the FSA’s letter, we 

will take it into consideration like all other letters. But what we 

think Congress was trying to do was have open access to this clearing and open access to these markets, and not have it so exclusive 

as it has been today. 

The CHAIRMAN. And I am going to be brave with the time and 

ask one more question: Where else are there significant differences 

between your approach and the approach under consideration in 

Europe? 

Mr. GENSLER. Europe is moving forward. In their European Parliament I was honored to be in front of a committee—the Economic 

Committee of the European Parliament. They are likely to move 

forward this summer on clearing, on the dealer regime, on data repositories. And it is not going to be identical, but it is quite similar. 

Their timing on the real-time reporting and on the transparency 

that is brought forward in trading platforms called swap execution 

facilities, they are taking up in a reform later in the fall. And just 

as any legislative process, when something is a little later, it is a 

little less certain. They are committed to try to get their implementing rules done by next summer, the summer of 2012. 

33

The CHAIRMAN. With that, the time for questions has expired. I 

wish to thank the Chairman of the CFTC once again for his time 

and his patience, and note that I am quite confident we will have 

several more visits before this year is over. 

Mr. GENSLER. I look forward to it. I think these are helpful. 

The CHAIRMAN. Absolutely, Chairman Gensler. Thank you. 

I would like to now welcome our second panel of witnesses to the 

table as they prepare for their testimony. 

Mr. James C. Allison, Gas and Power Risk Manager, North 

America, ConocoPhillips, on behalf of the Working Group of Commercial Energy Firms, Houston, Texas. 

Mr. Mark J. Cvrkel, Chief Financial Officer of Susquehanna 

Bank, Lititz, Pennsylvania. 

Mr. James M. Fields, Senior Vice President and Chief Financial 

Officer, Deere & Company, Moline, Illinois. 

Mr. Richard J. McMahon, Vice President, Finance and Energy 

Supply, Edison Electric Institute Washington, D.C. 

Ms. Ann Trakimas, Chief Operating Officer, CoBank, on behalf 

of the Farm Credit Council, Greenwood Village, Colorado. 

Whenever you are ready, Mr. Allison, you may begin. 

STATEMENT OF JAMES C. ALLISON, GAS AND POWER RISK 

MANAGER, NORTH AMERICA, CONOCOPHILLIIPS, HOUSTON, TX; 

ON BEHALF OF WORKING GROUP OF COMMERCIAL ENERGY 

FIRMS 

Mr. ALLISON. Chairman Lucas, Ranking Member Peterson, Members of the Committee, thank you for inviting me to discuss certain 

key implementation issues regarding Title VII of the Dodd-Frank 

Act. 

I am Jim Allison, North American Gas and Power Risk Manager 

for ConocoPhillips. I am appearing today on behalf of the Working 

Group of Commercial Energy Firms. The Working Group is a diverse group of commercial energy firms whose primary business activity is the physical delivery of energy commodities to others. 

My testimony today reflects the positions of the Working Group. 

It does not necessarily reflect the positions of ConocoPhillips or any 

individual member of the Working Group. My oral comments are 

a summarization of the written testimony, and I would like, if the 

Committee will allow me, to have that be part of the record. 

The Working Group supports the policy goals of the Dodd-Frank 

Act, but is concerned that several of the CFTC’s proposed rules will 

have significant unintended consequences. These include concentration of commodity market activity among large financial dealers—

many of which have been considered too big to fail—increased market volatility, increased liquidity risk, increased cost for commercial 

firms and regulations that will ultimately lead to higher costs for 

energy consumers. Before I discuss these areas of concern, I would 

like to briefly describe how and why commercial energy firms use 

swaps. 

Members of the Working Group are engaged in many aspects of 

the energy business, including electricity generation, oil and natural gas production, refining, storage and transportation, and merchandising and trading energy commodities. These activities expose 

the Working Group’s members to many commercial risks. FortuVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00037 Fmt 6633 Sfmt 6601 I:\DOCS\112-07\65892.TXT BRIAN
34

nately, commodity derivatives give us the ability to manage some 

of these risks. 

For example, we can buy or sell necessary feedstocks and endproducts at predictable prices. They provide us with greater certainty around the income from our capital investments. We can 

take market positions where we are active, physical market participants, and it gives us the ability to increase our economic investments in U.S. energy infrastructure. 

Managing the commercial risks enables delivery of energy at stable and affordable prices. The Working Group believes it was the 

intent of Congress to preserve this ability and to avoid market disruptions that would subject consumers to higher energy prices. The 

Working Group highlights three areas of concern where the CFTC’s 

implementation efforts may run counter to Congressional intent. 

First, the CFTC’s proposed definitions of swap dealer and major 

swap participant are unnecessarily broad. As proposed, these definitions would impose costly regulation on many firms that do not 

pose a risk to the U.S. financial system. In response to these costs, 

firms will be faced with a choice to either pass the costs on to consumers or scale back business activities. 

Second, overly broad entity definitions may deny commercial 

firms the benefits of the mandatory clearing exemption that was 

created by Congress to protect them. While clearing will reduce 

counterparty risk for these firms, it will increase liquidity risk. 

Third, the CFTC’s sequencing of proposed regulations is causing 

significant uncertainty for farms that are trying to determine the 

impact of and potential requirements for compliance with the proposed regulations. 

We believe these concerns can be avoided. First, the CFTC 

should use the available statutory tools to avoid unnecessary regulation of commercial firms as swap dealers. This can be done by, 

first, adopting a distinction between the terms dealer and trader

that is similar to the distinction adopted by the SEC; and second, 

implementing the de minimis exception in a way that recognizes 

the statutory distinction between customer and counterparty with 

a meaningful threshold that allows for a reasonable amount of customer-facing activity. 

Second, the CFTC should adopt the definition of major swap participant that includes only those firms that truly threaten the U.S. 

financial system. Both dollar thresholds and assessments of firm 

exposure based on a percent of market value can be used to make 

those determinations. 

Third, it is imperative that companies have an opportunity to 

evaluate in the aggregate the complex set of rules proposed by the 

CFTC. As of today, final rules defining swap dealer and major 

swap participant have not been issued, and the CFTC has not 

issued even a proposed rule defining swap, a critical definition 

needed to understand the impact of all the proposed rules. 

The CFTC should ensure that rulemakings are logically 

sequenced and that effective dates for final rules provide firms adequate time to identify and implement the extensive systems 

changes that will be needed to ensure compliance. 

I have highlighted today particular issues that may create unintended consequences, ultimately resulting in increased energy costs 

35

for consumers. The Working Group is confident that there are solutions for these issues, and we look forward to continuing to work 

with the CFTC to implement these solutions. 

I thank the Committee for the opportunity to present this testimony on behalf of the Working Group of Commercial Energy 

Firms, and I would be pleased to answer any questions. 

[The prepared statement of Mr. Allison follows:]

PREPARED STATEMENT OF JAMES C. ALLISON, GAS AND POWER RISK MANAGER, 

NORTH AMERICA, CONOCOPHILLIPS, HOUSTON, TX; ON BEHALF OF WORKING GROUP

OF COMMERCIAL ENERGY FIRMS

I. Introduction 

Chairman Lucas, Ranking Member Peterson, and Members of the Committee; 

thank you for this opportunity to discuss certain key issues regarding the implementation of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection 

Act and the regulation of commodity derivatives, including the regulation of entities 

and products in commodity derivatives markets. 

I am Jim Allison, North America Gas & Power Risk Manager for ConocoPhillips 

Company, and I am appearing today on behalf of the Working Group of Commercial 

Energy Firms. The Working Group is a diverse group of commercial firms in the 

energy industry whose primary business activity is the physical delivery of energy 

commodities to others, including industrial, commercial, and residential consumers. 

My testimony and statements made today reflect the positions of the Working 

Group, and do not necessarily reflect the positions of ConocoPhillips or any individual member of the Working Group. 

The Working Group supports the policy goals of the Dodd-Frank Act to promote 

the financial stability of the United States by improving accountability and transparency in the financial system and to reduce systemic risk. However, achieving 

these goals without imposing excessive costs and burdens on the economy is contingent on successful implementation of a regulatory framework that accommodates 

the differences among the new entities, products, and markets that the CFTC will 

regulate under Title VII. Implementation of such regulations will be successful only 

if those regulations do not result in costs that are greater than the public benefit 

of the Dodd-Frank Act, and if those regulations are developed in a logical and prudent manner. 

Among the Working Group’s specific concerns with the CFTC’s proposed rules regarding regulation of commodity derivatives markets are (1) the vagueness and potential breadth of the definitions of ‘‘swap dealer,’’ ‘‘major swap participant,’’ and 

‘‘swap,’’ and (2) the challenges posed by the CFTC’s ongoing rulemaking process, including the sequencing of the issuance of proposed rules, the interdependent nature 

of many of those rules, and the limited amount of time stakeholders will have to 

analyze and plan for the effects of those rules. If these concerns are not appropriately addressed, they are likely to decrease the ability of commercial firms to use 

commodity derivatives to manage commercial risks, and, in the case of energy markets, are highly likely to result in increased costs for the ultimate consumers of energy products and decreased job opportunities. This reduction or elimination of involvement by commercial firms in commodity derivatives markets is likely to result 

in reduced competition in those markets. In the short-term, this reduction in competition would create decreased liquidity in commodity derivatives markets as commercial firms reduce their participation in those markets. In the long-term, this reduction in competition would create concentration of commodity derivatives transactions among the financial entities that have traditionally been recognized as swap 

dealers. Many of these are the firms that have been considered ‘‘too big to fail.’’

II. How and Why Commercial Firms Use Swaps 

Members of the Working Group are engaged in many aspects of the energy business, including: (1) the basic creation or manufacturing processes, such as exploring 

for, producing, and marketing crude oil and natural gas; refining feedstocks into 

gasoline and other products, and marketing those products; and generating and 

marketing electricity, including electricity from renewable projects such as wind and 

solar; (2) the logistical activities that are fundamental to the energy business, including storing energy commodities and moving energy commodities by tanker, pipeline, transmission line, or other means from source to market or from one market 

to another; and (3) the associated merchandising and trading of energy commodities. 

36

All of these activities expose the Working Group’s members to a wide array of 

commercial risks, including risks that are similar to those experienced by any commercial firm engaged in manufacturing or logistics, such as operational risk, market 

risk, and credit risk. Like agricultural firms, the Working Group’s members differ 

from some manufacturing firms in that their basic energy products are commodities 

around which financial derivatives have been developed. Those derivatives allow 

each Working Group member to manage the level of commercial risk to which it is 

exposed, scaling the commercial risk that has been created through its primary 

business activity up or down to achieve the level of exposure to that risk that the 

firm believes is appropriate for its stakeholders. For example, commercial energy 

firms can use commodity derivatives to:

• Buy or sell necessary commodity products, including feedstocks, end products, 

and inventories, at predictable prices;

• Provide greater certainty for future cash flow from investments;

• Take market positions in the commodities in which they are active physical 

market participants; and

• Increase the ability to make economic investments in U.S. energy infrastructure 

and the development of energy resources. 

III. Specific Issues 

A. The CFTC’s Proposed Definition of ‘‘Swap Dealer’’ Could Result in Regulation of 

Commercial Energy Firms as Swap Dealers Where There Is No Public Benefit 

1. The CFTC’s Proposed Rule Does Not Recognize a Distinction Between Swaps 

Used for ‘‘Dealing’’ and ‘‘Trading’’ Purposes 

The Dodd-Frank Act definition of ‘‘swap dealer’’ is based on four categories of activity that are comparable to the types of activities used to define ‘‘dealer’’ in the 

Securities Exchange Act of 1934. Based on that ‘‘dealer’’ definition, the SEC has applied a long-standing and well-known Dealer/Trader Distinction Rule. In general, 

the SEC’s Dealer/Trader Distinction Rule recognizes that certain activities involving 

securities may at first appear to be dealing activities but are, in fact, trading activities, and that market participants engaging in such trading activities should not be 

regulated as dealers. There are significant similarities between the Dodd-Frank Act 

definition of ‘‘swap dealer’’ and the Securities Exchange Act of 1934 definition of 

‘‘dealer’’; however, the CFTC’s proposed definition of ‘‘swap dealer’’ specifically rejects making a distinction between dealers and traders in commodity derivatives 

markets. The CFTC rejects the application of a dealer/trader distinction to these 

markets, which increases the likelihood of commercial energy firms being regulated 

as swap dealers, despite the fact that such firms use commodity derivatives to manage risks associated with their primary business activity of delivering physical energy commodities to others. The Working Group strongly recommends that the 

CFTC implement a framework that distinguishes between dealers and market participants that use commodity derivatives for their own hedging or trading purposes. 

2. The CFTC’s Proposed De Minimis Exception Is So Narrow That It Will Be Unavailable to Commercial Energy Firms That Do Engage in a Relatively Small 

Amount of Dealing Activity 

The Working Group believes Congress intended the de minimis exception to apply 

to any person that would otherwise be a swap dealer but for the fact that it engages 

in limited amounts of swap dealing or whose notional amount of exposure is small. 

The CFTC’s proposed de minimis exemption included in the definition of ‘‘swap dealer’’ is so narrow that commercial firms that may engage in a relatively small 

amount of transactions in a swap dealing capacity will be unable to claim the exemption and will be subject to full regulation as swap dealers. As noted above, there 

is no public benefit to regulating such firms as swap dealers. The CFTC’s proposal 

inexplicably provides that any entity who enters annually into more than twenty 

swaps, has more than fifteen counterparties, or enters into swaps with more than 

$100 million in notional amount is a swap dealer regardless of its regular business. 

Such interpretation essentially makes every market participant in the swap markets a swap dealer and renders the express statutory definition superfluous. The 

CFTC has proposed this limited de minimis exception even when data indicates that 

the largest 25 bank holding companies control more than 90 percent of the U.S. 

swaps market. An appropriate interpretation of ‘‘de minimis’’ would provide a meaningful exception for entities other than these traditional financial institutions. It 

was not the intent of Congress to create a de minimis exception that applies to no 

one. 

37

3. An Unnecessarily Broad Definition of ‘‘Swap Dealer’’ Will Harm Commodity Derivatives Markets 

The Working Group is concerned that an unnecessarily broad definition of ‘‘swap 

dealer’’ will harm the liquidity and efficiency of commodity derivatives markets. Efficiency requires that regulations be designed to result in the least-cost approach to 

achieve a regulatory objective, and to ensure that the public benefit of those regulations is greater than the costs of those regulations. These costs include the costs for 

individual market participants to comply with regulations, public costs to implement 

and enforce the regulations, and the public and private costs created by the impact 

of the regulation on the regulated market and participants in that market. 

Classification of commercial energy firms that use commodity derivatives as swap 

dealers would have significant implications for those firms, including:

• Applying capital and margin requirements that could consume or divert resources that might otherwise be available for infrastructure investment, including investment in the production of new energy resources; and

• Denying those firms the benefits of the end-user exception from mandatory (1) 

clearing and (2) on-facility execution of swaps.

Further, the excessive breadth of the definition of ‘‘swap dealer’’ will impose substantial additional and unnecessary burdens on regulators. A broad definition of 

‘‘swap dealer’’ that results in regulation of commercial firms as swap dealers will 

result in a dilution of the CFTC’s resources that will necessarily result in less oversight of large traditional swap dealers. 

Commercial energy firms have not traditionally been considered swap dealers, do 

not cause systemic risk, and were not a cause of the financial crisis. The Working 

Group believes the CFTC has not justified the cost, relative to the public benefit, 

of a broad definition of ‘‘swap dealer,’’ and should adopt a final definition of ‘‘swap 

dealer’’ that is tailored to regulate only those firms that truly function as swap dealers and not those firms that simply use commodity derivatives to manage commercial risks associated with their primary business activity of delivering physical commodities to others. 

B. The CFTC’s Proposed Definition of ‘‘Major Swap Participant’’ Could Result in 

Regulation of Commercial Energy Firms Even When Those Firms Do Not Create 

Systemic Risk 

The CFTC’s proposed definition of ‘‘Major Swap Participant’’ is overly broad and 

is likely to result in companies that are not systemically risky being unnecessarily 

subject to prudential regulation. Despite the Dodd-Frank Act’s limitation on the definition of ‘‘major swap participant’’ to entities that are ‘‘systemically important or 

can significantly impact the financial system of the United States,’’ the CFTC has 

chosen to classify companies as major swap participants based upon fixed exposure 

thresholds that the Working Group believes fall well below levels that actually pose 

a risk to the U.S. financial system. Importantly, these thresholds do not appear to 

have any direct relationship to systemic risk and will not adjust to changing market 

prices. Even if one could assume that the current CFTC-proposed thresholds are 

reasonable in the present market, over time, as commodity prices fluctuate, the 

CFTC will have to routinely revisit these thresholds to make sure they comply with 

Congressional intent. The effort to monitor and adjust these thresholds will be another unnecessary use of the CFTC’s resources. If commodity prices increase as they 

have over the past several months, more and more companies will reach these fixed 

thresholds despite the fact that the relative market positions of these companies 

would have largely remained unchanged. Because of these effects, the Working 

Group respectfully suggests that the CFTC should test the systemic risk of companies in ways that account for current market conditions. Evaluating exposures as 

a percentage of market value rather than by relying on fixed thresholds is one way 

to do this. Given that regulation of major swap participants is very similar to regulation of swap dealers, many of the negative effects of a definition of ‘‘swap dealer’’ 

that unnecessarily results in regulation of commercial firms would also apply to unnecessary regulation of those firms categorized as major swap participants. 

C. Mandatory Clearing Will Not Reduce Risk—It Will Only Transform Counterparty 

Risk into Liquidity Risk 

The Working Group believes that mandatory clearing will only succeed in transforming counterparty risk into liquidity risk. One benefit of the end-user exception 

to mandatory clearing is that commercial firms will be protected from this liquidity 

risk. However, if the definitions of ‘‘swap dealer’’ and ‘‘major swap participant’’ are 

unnecessarily broad and result in commercial firms being regulated as swap dealers 

38

or major swap participants, then those firms will be fully exposed to this liquidity 

risk. 

Clearing reduces counterparty risk by requiring every party to a transaction to 

provide (1) full cash margin on the change in the value of the cleared portfolio every 

day and (2) initial margin sufficient to cover the potential movement in value between daily margin calls. Daily margin calls must be settled in cash, on very strict 

and short deadlines, and they apply to changes in value caused by ordinary market 

movement and those caused by extraordinary market events. 

When the financial system is functioning smoothly, a commercial firm can manage 

liquidity requirements caused by ordinary market movement through capital reserves and access to lines of credit. However, liquidity requirements caused by extraordinary market events may require a diversion of capital from other uses. This 

admittedly is an extreme scenario, but it is precisely these extreme scenarios that 

must be analyzed to understand how the CFTC’s proposed rules affect risk in the 

financial system. 

When combined with the vagueness and potential breadth of the definitions of 

‘‘swap dealer’’ and ‘‘major swap participant,’’ the transformation of counterparty risk 

to liquidity risk and the exposure of commercial firms to this liquidity risk may actually thwart the policy goals of the Dodd-Frank Act. The CFTC can avoid this by 

appropriately tailoring the definitions of ‘‘swap dealer’’ and ‘‘major swap participant’’ 

and not unnecessarily including commercial firms in either category of regulated entities. 

D. The CFTC’s Rulemaking Process Does Not Allow Stakeholders to Properly Consider the Interaction of the Rules Required for Regulation of Commodity Derivatives Under Title VII of the Dodd-Frank Act 

Title VII represents a fundamental redesign of the regulatory regime applicable 

to commodity derivative markets, especially the commodity derivatives used by the 

Working Group’s members to manage the risks associated with their primary business activity of delivering physical energy commodities to others. A threshold element of this redesign is the determination of which products and market participants will be regulated by the CFTC. Notwithstanding the CFTC’s aggressive efforts 

to adopt all final rules required by the Dodd-Frank Act, as of March 29, 2011, the 

CFTC has not issued final rules defining ‘‘swap dealer’’ and ‘‘major swap participant,’’ and it has not issued even a proposed definition of ‘‘swap.’’ A direct result 

of the lack of final rules defining these key terms is that more than 8 months after 

passage of the Dodd-Frank Act, market participants still do not know with any certainty the universe of entities and products that will be subject to regulation under 

Title VII’s provisions relating to commodity derivatives. Without full knowledge of 

which entities will be regulated as swap dealers and major swap participants and 

which products will be regulated as swaps, the Working Group’s members and other 

commercial energy firms are not able to determine the impact of these rules on their 

businesses. This uncertainty is likely to result in disruption of energy markets and 

could have negative consequences on the broader economy, including, but not limited to, increased prices for ultimate consumers of those products. Such consequences are avoidable. Given the complexity of the rulemaking process, the Working Group believes it is imperative that the CFTC allow interested parties a period 

of time to analyze and comment on all of the rules proposed under Title VII of the 

Dodd-Frank Act in the aggregate. Further, once the CFTC issues final rules, the 

Working Group believes market participants should be given adequate time to 

evaluate their compliance obligations, and to design and implement measures to 

meet such obligations in an efficient manner. Many of these rules will require timeconsuming and expensive changes to systems and processes, so reasonable compliance deadlines are critical. 

IV. Conclusion 

In closing, the Working Group restates its support for the policy goals of the 

Dodd-Frank Act to promote the financial stability of the United States by improving 

accountability and transparency in the financial system and to reduce systemic risk. 

Under Title VII of the Dodd-Frank Act, the CFTC has been asked to take on a significant amount of new regulatory oversight for derivative markets and derivative 

market participants. The Working Group appreciates the diligent efforts of the 

CFTC and its staff to understand our businesses and the markets in which we operate. However, if the CFTC’s rules to implement Title VII of the Dodd-Frank Act are 

not designed to appropriately regulate commodity derivatives markets and if those 

rules are not implemented in a coordinated and prudent manner, commercial energy 

firms may either be subject to unnecessary and costly regulation or will reduce their 

39

use of commodity derivatives to manage commercial risks, each of which could ultimately result in increased energy costs for consumers. 

I thank the Committee for the opportunity to present this testimony on behalf of 

the Working Group of Commercial Energy Firms and I will be pleased to answer 

any questions.

The CHAIRMAN. Thank you very much. 

STATEMENT OF MARK J. CVRKEL, CHIEF FINANCIAL OFFICER, 

SUSQUEHANNA BANK, LITIZ, PA 

Mr. CVRKEL. Chairman Lucas, and Members of the Committee, 

I appreciate the opportunity to testify today. 

My name is Mark Cvrkel. I am a Chief Financial Officer of Susquehanna Bank, headquartered in Lititz, Pennsylvania. 

Susquehanna Bank is a commercial bank with assets of approximately $14 billion, deposits of more than $9 billion, and more than 

3,000 employees in 221 locations. At Susquehanna, we are committed to building the economic strength of the communities we 

serve in Pennsylvania, New Jersey, Maryland, and West Virginia. 

As is the case with hundreds of community and regional banks, 

Susquehanna Bank’s risk management strategy involves using interest rate derivatives to prudently manage risks that are inherent 

to the business of commercial banking. Additionally, we enter into 

certain interest rate and foreign exchange derivatives with commercial banking customers to facilitate their risk management 

needs. 

My comments today stem from concerns that certain proposed 

rules released by the Commodity Futures Trading Commission 

could unnecessarily jeopardize our ability to manage risk, provide 

the services our clients demand, and remain competitive against 

much larger financial institutions. 

I would like to focus today on four issues: the swap dealer definition; the potential exemption for small banks; the eligible contract 

participant definition; and the process and timing of rulemaking. 

Several community and regional banks have expressed concern 

that the swap dealer definition in the CFTC’s proposed rule could 

capture hundreds of community and regional banks that offer risk 

management products to commercial customers. This would hamper the ability for smaller banks to compete with larger financial 

institutions without any appreciable benefit in terms of enhanced 

market oversight or reduction in systemic risk. 

Congress provided an exemption from the swap dealer definition 

for any swap offered by a bank to a customer in connection with 

originating a loan with that customer; however, the CFTC’s proposed rule interpreting this exemption is very narrow. 

In addition, we are concerned that the CFTC’s proposed thresholds for the so-called ‘‘de minimis exception’’ from the swap dealer

definition are extremely low. These low thresholds could have the 

effect of either subjecting many small banks to the substantial regulatory burden imposed on swap dealers, or causing them to cease 

offering certain risk management services to their customers. 

We urge regulators to compare the thresholds for the de minimis

exception against the volume of dealing done by large financial institutions that control the vast majority of the OTC derivatives 

market. Even an extremely conservative analysis of available data 

40

suggests that the CFTC could substantially increase the thresholds 

without running afoul of Congressional intent. 

Congress provided the regulators with the authority to exempt 

small banks from the financial entity definition. If such an exemption were granted, these small banks still would have to meet certain conditions required for end-user exception to the clearing requirement. 

Moreover, small banks already are subject to existing regulations, including rules that require adequate capital to be held 

against all assets, including derivatives. In addition, existing regulations allow examiners to take certain actions to prevent default 

or to limit bank losses in the event of default. These protections 

adequately mitigate risks associated with an exception for toosmall banks. We respectfully ask that the Committee urge the regulators to exercise the authority to exempt small banks from the 

financial entity definition. 

We appreciate Congress’ efforts to ensure that OTC derivatives 

are not marketed to unsophisticated customers. However, we would 

urge the regulators to clarify that smaller, sophisticated firms 

could continue to enter into hedges over-the-counter, providing that 

they meet specific criteria already established by the CFTC and observed by market participants for more than 20 years. 

Finally, community and regional banks are concerned with the 

aggressive pace of rulemaking. We would urge Congress to extend 

the statutory effective date for Title VII and set a sequence for 

rulemaking that supports thorough cost-benefit analysis and productive public comment. 

Community and regional banks are essential to support job creation at small, middle-market businesses that forms the foundation 

for any economic recovery. We caution against finalizing rules that 

would place undue burdens on small banks that had nothing to do 

with the financial crisis, do not pose systemic risk, and collectively 

engage in a fraction of the derivatives traded by the large dealers. 

Thank you for the opportunity to testify today, and I will answer 

any questions that you may have. 

[The prepared statement of Mr. Cvrkel follows:]

PREPARED STATEMENT OF MARK J. CVRKEL, CHIEF FINANCIAL OFFICER, SUSQUEHANNA BANK, LITITZ, PA 

Chairman Lucas, Ranking Member Peterson, and Members of the Committee, I 

appreciate the opportunity to testify today on the key definitions in Title VII of the 

Dodd-Frank Act. My name is Mark Cvrkel and I am the Chief Financial Officer of 

Susquehanna Bank (‘‘Susquehanna’’). 

Headquartered in Lititz, PA, Susquehanna is a commercial bank with assets of approximately $14 billion, deposits of more than $9 billion and more than 3,000 employees in 221 locations. At Susquehanna we are committed to building the economic strength of the communities we serve in Pennsylvania, New Jersey, Maryland 

and West Virginia. 

As is the case with hundreds of community and regional banks, Susquehanna’s 

risk management strategy involves using interest rate derivatives to prudently manage risks that are inherent to the business of commercial banking. We do not use 

credit default swaps or use derivatives for speculation. At Susquehanna, we use derivatives to add stability to our interest income and expense and to modify the duration of specific assets and liabilities. In short, we use derivatives to manage exposure to fluctuations in interest rates over which we have no control. 

Additionally, we enter into a relatively small amount of interest rate and foreign 

exchange derivatives with commercial banking customers to facilitate their risk 

management needs. For example, we are able to offer a borrower a competitive longVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00044 Fmt 6633 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
41

1Please refer to page 1 of the report at: http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq410.pdf. 2Please refer to pages 3–4 of the comment letter submitted by Susquehanna Bank and 18 

other community and regional banks to the CFTC for examples. 3 Note that the Secretary of the Department of the Treasury has the authority to make a written determination exempting certain FX derivatives from certain regulatory requirements. Such 

a determination has not been made as of the writing of this statement. 4Please refer to pages 5 and 6 of the comment letter submitted by Susquehanna Bank and 

18 other community and regional banks to the CFTC for additional comparative data: http://

www.chathamfinancial.com/wp-content/uploads/2011/02/Coalition-Comments-SmallBanks.pdf. 

term financing at a fixed rate by pairing a variable-rate loan with an interest rate 

swap—thereby providing the customer with the fixed rate they desire without taking on any incremental interest rate risk at the bank. As another example, we may 

have a middle-market customer that sells its products in Canada. We can offer to 

enter into an FX forward with the customer so that when they are paid in Canadian 

dollars, they can fix the exchange rate and know the exact amount they will receive 

in U.S. dollars. 

Neither our use nor our customers’ use of derivatives poses systemic risk. As was 

shown during the financial crisis, systemic risk in the derivatives market is concentrated among a few very large and interconnected financial institutions. According to the Office of the Comptroller of the Currency’s Quarterly Report on Bank 

Trading and Derivatives Activities, while more than 1,000 banks in the U.S. use derivatives, 96% of the notional and 86% of the credit exposure is held at the top five 

banks in the U.S.1

My comments today stem from concerns that certain proposed rules released by 

the Commodity Futures Trading Commission (‘‘CFTC’’)—including those relating to 

the key definitions in Title VII—could unnecessarily jeopardize our ability to manage risk, provide the services our clients demand and remain competitive against 

much larger financial institutions. 

I would like to focus today on four issues: the swap dealer definition, the potential 

exemption from the financial entity definition for small banks, the eligible contract 

participant definition and the process and timing for rulemaking. 

(1) Swap Dealer Definition 

Several community and regional banks have expressed concern that the swap 

dealer definition in the CFTC’s proposed rule could capture hundreds of community 

and regional banks that offer risk management products to commercial customers. 

This would hamper the ability for many smaller banks to compete with larger financial institutions without any appreciable benefit in terms of enhanced market oversight or reduction in systemic risk. 

Congress provided an exemption from the swap dealer definition for any swap offered by a bank to a customer in connection with originating a loan with that customer; however, the CFTC’s proposed rule interpreting this exemption is very narrow. While not required by Title VII, the CFTC is considering whether to limit the 

exemption to swaps offered contemporaneously with origination of the loan. As it is 

very common for a borrower to enter into an interest rate swap before or after origination of the corresponding loan, the exemption should not be limited to any swap 

entered into contemporaneously with a loan. In addition, we would urge the CFTC 

to consider excluding from the swap dealer definition swaps offered by a bank in 

connection with syndications, participations and bond issuances that are facilitated 

by the bank.2

In addition we are concerned that the CFTC’s proposed thresholds for the socalled ‘‘de minimis exception’’ from the swap dealer definition are extremely low. For 

example, if a bank were to offer just 21 FX hedges 3 to customers in one year, they 

would be required to register as a swap dealer. These low thresholds could have the 

effect of either subjecting many small banks to the substantial regulatory burden 

imposed on swap dealers, or causing them to cease offering certain risk management services to customers. 

We urge regulators to compare the thresholds for the de minimis exception 

against the volume of dealing done by the large financial institutions that control 

the vast majority of the OTC derivatives market. For example, while executing more 

than 20 trades with customers in one year would require a bank to register as a 

swap dealer, it is known that Lehman Brothers had 900,000 trades in place at the 

time of its bankruptcy. Available data 4 suggests that the CFTC could substantially 

increase the thresholds without running afoul of congressional intent. We do not believe the benefit of regulatory oversight over smaller financial institutions engaged 

42

5Firms that are not eligible contract participants will only be permitted to enter into derivatives on regulated exchanges. In addition to other criteria, corporations and partnerships that 

have at least $10 million in assets or are hedging and have $1 million in net worth qualify as 

eligible contract participants under the Commodity Exchange Act. 6 Certain firms have been able to enter into over-the-counter hedges if they meet the criteria 

set forth in the CFTC’s 1989 Policy Statement Concerning Swaps Transactions. 

in a relatively infinitesimal level of dealing activity outweighs the cost associated 

with registration and compliance for such firms. 

(2) Potential Exemption for Small Financial Institutions 

Congress provided the regulators with the authority to exempt small banks from 

the financial entity definition. If such an exemption were granted, these small banks 

still would have to meet the same conditions required for the end-user exception to 

the clearing requirement. Moreover, small banks already are subject to existing regulations, including rules that require adequate capital to be held against all assets, 

including derivatives. In addition, existing regulations allow examiners to take certain actions to prevent default, or to limit bank losses in the event of default. These 

protections adequately mitigate risks associated with an exception for small banks. 

We respectfully ask that the Committee urge the regulators to exercise the authority to exempt small banks from the financial entity definition. 

(3) Eligible Contract Participant Definition 

Section 723 of Title VII includes a Limitation of Participation provision prohibiting any firm that is not an ‘‘eligible contract participant’’ from entering into a 

hedge over-the-counter.5 We appreciate Congress’ efforts to ensure that OTC derivatives are not marketed to unsophisticated customers; however, many community 

and regional banks are concerned that certain customers—including small businesses and other firms that execute hedges out of pass-through entities—may not 

be able to use the customized, OTC derivatives that they require for risk management purposes. We would urge the regulators to clarify that smaller, sophisticated 

firms could continue to enter into hedges over-the-counter, providing that they meet 

specific criteria already established by the CFTC and observed by market participants for more than 20 years.6

(4) Process and Timing 

Finally, while the regulatory agencies are to be commended for running an open 

and transparent rulemaking process, community and regional banks are very concerned with the aggressive pace of rulemaking. We would urge Congress to extend 

the statutory effective date for Title VII and set a sequence for rulemaking that supports thorough cost-benefit analysis and productive public comment. We would recommend a sequence for rulemaking that defines entity and product definitions and 

other key terms first, duties and obligations second and then the specific regulatory 

requirements that apply based on these terms, duties and obligations. Additionally, 

we would recommend that the regulators permit market participants to consider the 

entirety of the proposed rules for all of Title VII, once they are available, and provide additional comment before finalizing any of the proposed rules. 

Conclusion 

Community and regional banks are essential to support the job creation at small 

and middle-market businesses that forms the foundation of any economic recovery. 

We applaud the work of the regulators to strengthen the OTC derivatives market, 

but we urge caution against finalizing rules that would place undue burdens on 

small banks that had nothing to do with the financial crisis, do not pose systemic 

risk and collectively engage in a fraction of the derivatives traded by the large dealers. It is critical to get these definitions right in order to ensure that regulation of 

the derivatives market is effective and unintended consequences are minimized. I 

thank you for the opportunity to testify today, and I am happy to answer any questions that you may have.

The CHAIRMAN. Thank you. Mr. Field. 

STATEMENT OF JAMES M. FIELD, SENIOR VICE PRESIDENT 

AND CHIEF FINANCIAL OFFICER, DEERE & COMPANY,

MOLINE, IL 

Mr. FIELD. Good afternoon. My name is Jim Field. I am the Senior Vice President and Chief Financial Officer of Deere & Company, 

perhaps better known as John Deere. 

43

I am pleased to have this opportunity to share our perspectives 

on the implementation of Title VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act. 

As with most major multinational companies, the new law will 

impact many aspects of our business, especially our captive finance 

business. Through our captive finance business, John Deere Financial Services, Inc., we provide literally tens of millions of dollars of 

liquidity into rural America each and every day. We provide essential financing to agricultural producers, construction contractors, 

commercial landscapers, and foresters seeking to purchase highquality John Deere equipment. This source of financing is essential 

to our customers’ success and directly contributes to the growth 

and prosperity of local economies across this country. 

As the Committee knows, derivatives are an essential tool for 

companies like Deere to manage commercial risks inherent in our 

business, such as interest rate risk and foreign exchange risk. We 

do not use the derivatives for speculative purposes at Deere. The 

prudent use of derivatives supports our ability to provide highquality products and services to U.S. farmers and other customers 

around the world. 

John Deere worked closely with the Congress on the derivatives 

reform legislation and commends this Committee for its leadership 

on that important title. While we believe the statutory direction is 

generally clear, the current rulemaking process has not yet adequately settled several implementation issues and concerns. I 

would like to highlight several areas for the Committee, all of 

which are subject to ongoing rulemaking proceedings. 

Congress provided an exception for captive finance companies 

from the major swap definition. This exception—often referred to 

as the 90:90 exception—is explicitly provided for in the statute. 

However, we are concerned that the statutory language is imprecise and could be interpreted in a manner to inadvertently preclude 

many end-users for whom this exception was or is intended. 

We are currently seeking guidance to clarify the application of 

the captive finance provision to ensure it reflects how we operate 

and practice. For instance, as a captive finance company, we facilitate the sale of all products sold by the parent and its dealers, not 

just those manufactured by the parent or another subsidiary. For 

instance, we may finance an implement manufactured by another 

company, along with one of our tractors, as part of an entire sales 

package. 

We also facilitate the financing for parts and services on John 

Deere equipment. For example, we provide financing for significant 

overhauls on Deere equipment. This work is done at a John Deere 

dealership for a John Deere customer using both Deere and nonDeere parts. A significant portion of the finance covers the labor 

cost or the technician’s hours. We interpret the exception to include 

the full value of these notes, but others might interpret this differently. 

We are seeking more clarity that reflects the legislative intent 

while not adding burdensome requirements. Regulations that provides either a broader exception or additional clarity reflecting ordinary business activities are necessary. 

44

In addition to the major swap participant exemption for captive 

finance companies, the CFTC proposed a rulemaking to include an 

exemption for a captive finance company. We want to ensure that 

the definition of a captive finance company, as it applies to the 

clearing exemption, is consistent with the definition of a captive finance company as it applies to the major swap participant exemption. 

A second area of concern relates to the exemption from mandatory clearing requirements for derivatives end-users such as Deere. 

While it appears that this exemption would apply to our trades, a 

regulatory requirement on swap dealers and major swap participants to collect margins from end-users could effectively eliminate 

the benefits of the clearing exemption. Hence, we strongly support 

a statutory provision that prohibits regulatory agents from requiring swap dealers or major swap participants to post or collect capital or margin on trades that are executed with a financial or nonfinancial end-user counterparty. 

If John Deere is required to clear swaps, independently or post 

margin through our transactions with a major swap participant, we 

would need to divert working capital to comply with this requirement. Furthermore, the requirements of posting margin on a daily 

basis could create additional costs and administrative burdens. 

We are also seeking clarification that unintended parties are not 

defined as a swap dealer or major swap participant. The CFTC and 

the SEC propose to consider the economic reality of transactions 

between wholly-owned affiliates, including whether the swaps and 

security-based swaps simply represent an allocation of risks within 

a corporate group. John Deere supports this interpretation and 

would note further that the regulator should not limit an interpretation of inter-affiliate transactions to those between wholly-owned 

affiliates. 

Transactions between commonly controlled affiliates, as well as 

swap transactions done by one corporate treasury entity to hedge 

the commercial risk of another entity in the same corporate group, 

merely represent the shifting or hedging of risk within a corporate 

group, and do not pose any more or any less risk to the economy 

as a whole. Including such inter-affiliate swaps or affiliate riskhedging swaps for purposes of calculating the major participant 

definitions would effectively ‘‘double count’’ the same swaps. 

Last, John Deere wishes to emphasize the importance of getting 

this regulation right for all derivatives end-users. We recognize the 

substantial efforts being made by the regulatory agents to advance 

several concurrent rulemakings in order to meet the timelines provided by Congress. However, given the complexity of the business 

issues involved, the number of potentially affected market participants, and the potential disruption to legitimate risk mitigation 

strategies, we believe that an extension of the date by which the 

rules must be promulgated, as well as a workable implementation 

schedule, should be considered. 

Let me again reiterate John Deere’s appreciation for the opportunity to appear before this Committee today. 

[The prepared statement of Mr. Field follows:]

45

PREPARED STATEMENT OF JAMES M. FIELD, SENIOR VICE PRESIDENT AND CHIEF

FINANCIAL OFFICER, DEERE & COMPANY, MOLINE, IL 

Good afternoon. 

My name is Jim Field, and I am Senior Vice President and Chief Financial Officer 

of Deere & Company. 

I am pleased to have this opportunity to share Deere & Company’s perspectives 

on the implementation of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Deere & Company is also a member of the Coalition for Derivatives End-Users who share our perspective. As with most major multi-national 

companies, the new law will impact many aspects of our business, especially our 

captive finance business. 

Deere & Company is a leading global manufacturer of agricultural, construction, 

forestry and turf care equipment, and provides advanced products and services, including financial services, to customers whose work is linked to the land—those who 

cultivate, harvest, transform, enrich and build upon the land to meet the world’s 

dramatically increasing need for food, fuel, shelter and infrastructure. We are 

headquartered in Moline, Illinois, with sales in over 100 countries and employing 

over 56,000 people. Since 1837, John Deere has delivered innovative products of superior quality built on a tradition of integrity. 

Through our captive finance business, John Deere Financial Services, Inc., we 

provide literally tens of millions of dollars of liquidity into rural America each and 

every day. We provide essential financing to agricultural producers, construction 

contractors, commercial landscapers and foresters seeking to purchase high-quality 

John Deere equipment. This source of financing is essential to our customers’ success and directly contributes to the growth and prosperity of local economies across 

the country. 

My testimony today will focus on the impacts of Title VII on derivatives end-users 

and, in particular, the End-Use Exception and Captive Finance Provision that were 

added to the Commodity Exchange Act through the Dodd-Frank Act. 

As the Committee knows, derivatives are an essential tool for companies like John 

Deere to manage commercial risks inherent in our business, such as interest rate 

and foreign exchange risks. We do not use derivatives for speculative purposes. The 

prudent use of derivatives supports our ability to provide high-quality products and 

services to U.S. farmers and to customers around the world. 

We provide financing for our customers on a significant percentage of our sales 

in both good and bad economic times. Our financial services operations have over 

$25 billion in assets. We offer fixed and variable rate financing to meet the various 

long and short-term financing needs of our customers. We issue debt in the commercial paper, medium term note, and asset-backed securitization markets to fund our 

loan and lease portfolios. Institutional debt investors purchase the majority of our 

debt securities, and the demand for these securities varies as economic conditions 

change. Derivatives enable us to match the interest rate characteristics of the funding available in the capital markets with the financing needs of our customers. This 

was especially critical during the credit crisis. John Deere’s volume of new loans to 

customers and dealers increased during the credit crisis as we were able to provide 

product financing when other financial institutions curtailed lending. During the 

crisis, we were able to issue long-term fixed rate notes in the capital markets and 

use interest rate swaps to match the fixed and floating rate loans and leases that 

we provided to our customers. We employ this strategy of issuing longer-termed 

debt even in good economic times to reduce our refunding risk. 

For a swap to be effective, it must match the timing and amount of the cash flows 

of the hedged exposure. Therefore, the terms of our interest rate swaps are customized to match the terms of the debt we issue. They will match the currency, 

principal or notional amount, interest rates, and maturity dates. Standardized contracts with predetermined terms would be a far less effective tool for hedging our 

risk exposure. 

Derivatives provide stability to our business. At the end of our most recent first 

quarter, John Deere had over $15 billion notional amount of derivative transactions 

outstanding. That is a large number, but it corresponds to the more than $25 billion 

of credit we have extended to our customers and dealers to purchase the equipment 

they need to help drive the economy. The fair value of these derivatives, which represents the price to terminate or settle the positions, was approximately $253 million, and was a receivable for John Deere—our counterparties would owe us that 

amount if we terminated the derivatives. 

John Deere worked closely with the Congress on the derivatives reform legislation 

and commends this Committee for its leadership on that important title. While we 

believe the statutory direction is generally clear, the current rulemaking process has 

46

not yet adequately settled several implementation concerns. I would like to highlight several areas for the Committee, all of which are subject to ongoing rulemaking proceedings. 

Congress provided an exception for captive finance companies from the major 

swap participant definition. This exception is defined as:

‘‘entities whose primary business is providing financing and use derivatives for 

the purpose of hedging underlying commercial risks related to interest rate and 

foreign currency exposures, 90 percent or more of which arise from financing 

that facilitates the purchase or lease of products, 90 percent or more of which 

are manufactured by the parent company or another subsidiary of the parent 

company.’’

We are concerned that the statutory language is imprecise and could be interpreted in a manner to inadvertently preclude many end-users, for whom the exception is intended, from qualifying. 

We are currently seeking guidance to clarify the application of the captive finance 

provision to ensure it reflects how we operate in practice. For instance, as a captive 

finance company we facilitate the sale of all products sold by the parent and its 

dealers, not just those that are manufactured by the parent or another subsidiary. 

We may finance an implement manufactured by another company along with one 

of our tractors as part of the entire sale. We also facilitate the financing for parts 

and service on John Deere equipment. For instance, we provide financing for significant overhauls on pieces of equipment. This work is done at a John Deere dealership, for a John Deere customer, using both Deere and non-Deere parts. A significant portion of the financing covers the labor costs. We interpret the full value of 

these notes to fall under the exception, but others might interpret this differently. 

We are seeking further clarity that reflects Congress’ intent while not adding burdensome requirements. Regulations that provide either a broader exception or additional clarity reflecting ordinary business activities are necessary. 

In addition to the major swap participant exemption for captive finance companies, the Commodity Futures Trading Commission (CFTC) proposed a rulemaking 

to include a mandatory clearing exemption for a captive finance company. We want 

to ensure that the definition of a captive finance company as it applies to the mandatory clearing exemption is consistent with the definition of a captive finance company as it applies to the major swap participant exemption. 

A second area of concern relates to the exemption from mandatory clearing requirements for derivatives end-users, such as John Deere. While it appears that the 

exemption would apply to our trades, a regulatory requirement on swap dealers and 

major swap participants to collect margin from end-users could effectively eliminate 

the benefits of the clearing exemption. Hence, we strongly support a statutory provision that prohibits regulatory agencies from requiring swap dealers or major swap 

participants to post or collect capital or margin on trades that are executed with 

a financial or nonfinancial end-user counterparty. 

If John Deere is required to clear swaps independently or post margin through 

our transactions with a swap dealer or major swap participant, we would need to 

divert working capital to comply with this requirement. Furthermore, the requirements of posting margin on a daily basis could create additional costs and administrative burdens on an end-user engaged in derivatives primarily to manage risk. 

We are also seeking clarification that unintended parties are not defined as a 

swap dealer or major swap participant. The CFTC and SEC propose to consider the 

‘‘economic reality’’ of transactions between wholly-owned affiliates, ‘‘including 

whether the swaps and security-based swaps simply represent an allocation of risk 

within a corporate group.’’ John Deere supports this interpretation and would note 

further that the regulators should not limit an interpretation of inter-affiliate transactions to those between wholly-owned affiliates. 

Transactions between commonly-controlled affiliates, as well as swap transactions 

done by one corporate treasury entity to hedge the commercial risk of another entity 

in the same corporate group, merely represent the shifting or hedging of risk within 

a corporate group and do not pose any more or any less risk to the economy as a 

whole. Including such inter-affiliate swaps or affiliate risk-hedging swaps for purposes of calculating the major participant definitions would effectively ‘‘doublecount’’ the same swaps, as swaps subsequent to the market-facing transaction simply transfer a swap’s risk-mitigation qualities to affiliated entities. 

We also have some concerns with potentially conflicting rules from the U.S. Department of Labor regarding utilization of swaps by pension plans that could, unintentionally, restrict the ability of ERISA-covered plans like John Deere’s from utilizing derivative markets to manage risks. 

47

Last, John Deere wishes to emphasize the importance of getting this regulation 

right for all derivative end-users. We recognize the substantial efforts being made 

by the regulatory agencies to advance several concurrent rulemakings, in order to 

meet the timelines provided by Congress. However, given the complexity of the business issues involved, the number of potentially affected market participants, and the 

potential disruption to legitimate risk mitigation strategies, we believe that an extension of the date by which rules must be promulgated, as well as a workable implementation schedule, should be considered. 

Let me again reiterate John Deere’s appreciation for this opportunity to appear 

before the Committee today. I would be pleased to answer your questions. 

Thank you.

The CHAIRMAN. The gentleman has been very thorough. 

Mr. McMahon. 

STATEMENT OF RICHARD F. MCMAHON, JR., VICE PRESIDENT,

FINANCE AND ENERGY SUPPLY, EDISON ELECTRIC

INSTITUTE, WASHINGTON, D.C.; ON BEHALF OF AMERICAN 

GAS ASSOCIATION; ELECTRIC POWER SUPPLY ASSOCIATION 

Mr. MCMAHON. Chairman Lucas and Members of the Committee, 

I am Richard McMahon, Vice President of Energy Supply and Finance for the Edison Electric Institute. I am testifying on behalf of 

EEI, AGA, and EPSA. Together, our members serve most of our 

nation’s electric and gas consumers. 

Thank you for this opportunity to discuss the role of OTC derivatives markets in helping our utilities and our customers, and specifically our implementation concerns with Title VII of the DoddFrank Act. 

Our members’ goal is to provide our customers with reliable and 

affordable electric and gas service. Therefore, it is essential to manage the significant price volatility inherent in wholesale commodity 

markets for natural gas and electricity. The derivatives market is 

an extremely effective tool in insulating our customers from this 

price volatility. Our members are the quintessential commercial 

end-users of swaps and in no way contribute to systemic risk. 

Utilities and energy companies are financially stable and highly 

creditworthy. As a result, utilities and their customers get a significant cost-benefit from little or no margin collateral requirements 

for their OTC derivatives transactions. 

Exchanges and clearinghouses demand expensive cash margin 

deposits from all participants, irrespective of their credit standing. 

A margin requirement on all OTC swaps for utilities would have 

an average annual cash flow impact of between $250 million and 

$400 million per company. If our members were forced to post margin on all their OTC swaps, or their transaction costs go up significantly for other reasons, we will have three equally undesirable 

choices—redirect dollars from our core infrastructure capital spending programs, or borrow the money and pass that cost through to 

our customers and rates, or curtail our derivatives hedging programs and pass the commodity price volatility through to our customers. 

We were pleased to hear Chairman Gensler today regarding margin and end-users. It is essential that this approach be fully implemented. However, we are concerned that our transaction costs may 

go up significantly as a result of other aspects of Dodd-Frank implementation. For example, the yet-to-be-promulgated rulemaking 

on capital and margin requirements for bank and nonbank swap 

48

dealers could impose incremental capital requirements on those 

dealers that engage in non-cleared OTC swaps with end-users. Undoubtedly, swaps dealers would pass along this additional cost to 

end-users, thereby more or less nullifying any benefit of having an 

end-user exemption from clearing margin. 

Dodd-Frank left many important issues to be resolved by regulators and set impractically tight deadlines on rulemakings. To further complicate matters, many of the complex issues raised by 

scores of rulemakings are interrelated. As a result, interested parties are unable to provide meaningful comments to the proposed 

rules because they do not know the full effect of the complete universe of proposed rules. 

For instance, the CFTC has not yet issued the proposed rules on 

the definition of swap. This definition is critical to many of the current rulemakings of Dodd-Frank and could significantly expand the 

reach and impacts of these regulations. 

For the end-user exception provision of the Dodd-Frank Act, the 

CFTC’s proposed rule would require an end-user to report roughly 

a dozen items of information to the CFTC each and every time it 

elects to rely on the end-user clearing exemption for a swap. The 

CFTC does not need such representations from end-users about 

each and every one of their non-cleared swaps to prevent abuse of 

the end-user clearing exemption. 

We request that the Committee emphasize to CFTC that it 

should implement the end-user clearing exemption by streamlining 

their proposed requirements in the following ways: by requiring 

end-users to represent to the CFTC, once, that they intend to rely 

on the end-user clearing exemption, and by informing the CFTC, 

once, how they generally intend to meet their financial obligations 

associated with entering into non-cleared swaps, and by maintaining a record showing that an appropriate committee of the board 

of directors—assuming they are a public company—has reviewed 

and approved their overall decision not to clear. 

We are also concerned with how the CFTC plans to define swaps 

dealer. CFTC’s proposed rule includes very expansive language 

about the types of activities that the CFTC views as dealing. At the 

same time, the Commission has proposed to implement the not as 

part of a regular business and de minimis exceptions in a very restrictive manner. The result could be that commercial end-users 

are inappropriately miscast as dealers. 

Since the enactment of Dodd-Frank, the CFTC has promulgated 

dozens of proposed rules. Commercial end-users like our members 

have struggled mightily just to keep pace and have filed comments 

in more than 17 different Dodd-Frank rulemakings to date. We do 

not believe that the end-user clearing exemption was intended to 

result in this burdensome outcome. 

We believe that under the current timetable, it is impossible for 

the CFTC to promulgate workable rules; therefore, we ask that the 

Congress extend the statutory deadline for the promulgation of derivatives rules of Dodd-Frank under Title VII. We also urge Congress to direct the regulatory agencies to promulgate those rules so 

that the basic definitions are issued prior to other rules that they 

rely upon. 

I am happy to answer any questions. Thank you. 

49

[The prepared statement of Mr. McMahon follows:]

PREPARED STATEMENT OF RICHARD F. MCMAHON, JR., VICE PRESIDENT, FINANCE

AND ENERGY SUPPLY, EDISON ELECTRIC INSTITUTE, WASHINGTON, D.C.; ON

BEHALF OF AMERICAN GAS ASSOCIATION; ELECTRIC POWER SUPPLY ASSOCIATION

Chairman Lucas, Ranking Member Peterson, and Members of the Committee, 

thank you for this opportunity to discuss the role of over-the-counter (OTC) derivatives markets in helping utilities and energy companies insulate our customers from 

the volatility of commodity price risk, and specifically our implementation concerns 

regarding the entity and product classifications under Title VII of the Dodd-Frank 

Wall Street Reform and Consumer Protection Act (Dodd-Frank), about which there 

remains great uncertainty. 

I am Richard McMahon, Vice President of Energy Supply and Finance for the Edison Electric Institute (EEI). EEI is the trade association of U.S. shareholder-owned 

electric utilities, with international affiliates and industry associates worldwide. 

EEI’s U.S. members serve 95 percent of the ultimate electricity customers in the 

shareholder-owned segment of the industry, and represent approximately 70 percent 

of the total U.S. electric power industry. 

I also am testifying on behalf of the American Gas Association (AGA) and the 

Electric Power Supply Association (EPSA). AGA represents 199 local energy companies that deliver clean natural gas throughout the United States. There are more 

than 70 million residential, commercial and industrial natural gas customers in the 

U.S., of which 91 percent receive their gas from AGA members. EPSA is the national trade association representing competitive power suppliers, including generators and power marketers. 

Utilities and Energy Companies Hedge Risk 

Wholesale natural gas and electric power are, and have been historically, two of 

the most volatile commodity groups. Our members use natural gas extensively as 

a fuel to generate electric power, and distribute natural gas to consumers in their 

homes. Additionally, utilities generate and purchase wholesale electricity from generators and marketers to meet consumer demand. 

The goal of our members is to provide their customers with reliable service at affordable and stable rates. Therefore, it is essential to manage the price volatility inherent in wholesale commodity markets for natural gas and electric power. Our 

members purchase fuel and sell power at thousands of delivery points throughout 

the U.S. They need the ability to use OTC swaps because existing futures contracts 

cover only a limited number of natural gas and electricity delivery points. The derivatives market has proven to be an extremely effective tool in insulating our customers from this risk and price volatility. Utilities and energy companies use exchange-traded and OTC natural gas and electric power swaps to hedge commercial 

risk. About 40% of our gas swaps and about 1⁄3 of our power swaps are traded on 

exchanges. 

In sum, our members are the quintessential commercial end-users of swaps. 

Why the Margin Issue Is Critically Important 

Utilities and energy companies are financially stable and highly creditworthy. On 

average, EEI’s members are rated BBB. As a result, utilities and their customers 

get a significant cost benefit from low- or no-collateral requirements for their OTC 

derivatives transactions. In some cases, our members provide a letter for credit or 

a lien on assets as collateral to support their obligations on swaps. Exchanges and 

clearinghouses are generally blind to the financial health of their participants and 

demand cash margin deposits, both initial and variation margin. 

Our industry is in the midst of a major capital spending program to enhance the 

electric grid, make our generation fleet cleaner and bring new technologies to our 

customers. Last year, shareholder-owned electric utilities’ capital expenditures 

(CAPEX) were $83 billion, while gas distribution utilities’ CAPEX was $5 billion. 

We expect this pace of capital investment to continue throughout the decade. The 

capital investments of all of our members are contributing to our nation’s economic 

recovery and job growth. 

A margin requirement on all utility OTC swaps would have an average annual 

cash flow impact of between $250 million and $400 million per company for EEI 

members. This ‘‘dead capital’’ tied up in margin accounts at clearinghouses would 

need to be funded by our retail customers. 

If our members are forced to post margin on all of our OTC transactions, we have 

three equally undesirable choices:

50

• Re-direct dollars from our core infrastructure capital spending programs to margin accounts at clearinghouses;

• Borrow the money to post in margin accounts and pass that cost through to our 

customers in rates; or

• Curtail our derivatives hedging programs and pass the commodity price volatility in natural gas and electricity through to our customers.

Because of these undesirable consequences, the National Association of Regulatory Utility Commissioners (NARUC) passed a resolution in support of the industry’s goal of maintaining our ability to use OTC derivatives without cash margining 

requirements (see attached). 

We were very pleased to hear Commodity Futures Trading Commission (CFTC) 

Chairman Gensler’s recent testimony earlier this month before Congress in which 

he stated, ‘‘Proposed rules on margin shall focus on transactions between financial 

entities rather than those transactions that involve nonfinancial end-users.’’ It is essential that this now unambiguous direction from the CFTC Chairman be carried 

through fully in implementation of the Dodd-Frank Act. We believe this was the 

clear intent of the Congress, and it was confirmed in the Dodd-Lincoln letter, which 

was drafted as part of the conference committee to clarify the intent of Congress 

to fully exempt end-users from margining and burdensome CFTC compliance obligations. (see attached). 

However, there remains significant concern that our transaction costs may go up 

significantly as the result of Dodd-Frank implementation. For example, the yet-tobe promulgated rulemaking on capital and margin requirements for bank and 

nonbank swap dealers could impose incremental capital requirements on those dealers that engage in non-cleared OTC swaps with end-users. Undoubtedly, swap dealers would pass this additional cost along to end-users, thereby nullifying any benefit 

of having an end-user exemption from clearing margin. 

Need for a Proper Sequencing and an Extension of the Implementation 

Timetable 

We support the overarching goals of the Dodd-Frank Act to bring greater transparency and oversight to derivatives markets and to address systemic risk to the 

economy. Additionally, we compliment the CFTC Chairman, Commissioners and 

staff for their hard work and openness in seeking input from different market participants during the implementation process. But, like the CFTC and other market 

participants, we are overwhelmed by the pace and scope of rulemakings. 

Since the enactment of Dodd-Frank, the CFTC has established 30 rulemaking 

teams and has promulgated dozens of proposed rules. Energy swaps are a small 

fraction of the more than $650 trillion swaps market. We believe that, under the 

current timetable, it is impossible for the CFTC to adequately understand the energy swaps market, the other segments of the commodity-based swaps (metals and 

agriculture) market, and the much larger other classes of swaps (rates and credit), 

and to promulgate workable rules. 

Therefore, we ask that Congress extend the statutory deadline for the promulgation of derivatives rules set forth in section 712 of the Dodd-Frank Act. Also, we 

urge Congress to direct the regulatory agencies to promulgate these rules so that 

the basic definitions are issued prior to other rules that rely upon them. 

The Dodd-Frank Act left many important issues to be resolved by regulators and 

set impractically tight deadlines on rulemakings by the agencies charged with implementation. To further complicate matters, many of the complex issues raised by 

scores of rulemakings are interrelated. As a result, interested parties are unable to 

comment on the proposed rules in a meaningful way, because they cannot know the 

full effect of the complete universe of proposed rules. For example, it is very difficult 

to comment on the proposed swap dealer definition, position limits, and record-keeping and reporting rules for swaps before the proposed definition of a swap has been 

issued. 

Commercial end-users like our members have struggled mightily just to keep 

pace, and have been compelled, because of the aforementioned uncertainty, to file 

comments in more than 17 different Dodd-Frank rulemakings in the past 6 months. 

We do not believe that the end-user clearing exemption was intended to result in 

this burdensome outcome. 

Concerns Regarding Entity Designation and Implementation Burdens on 

End-Users 

In a provision of the Dodd-Frank Act known as the ‘‘end-user clearing exception,’’ 

Congress gave our members and other end-users of swaps the flexibility to elect not 

to clear swaps that they use to hedge commercial risk. 

51

The CFTC’s proposed rule implementing this provision would require an end-user 

to report roughly a dozen items of information to the CFTC every time it elects to 

rely on the end-user clearing exception for a swap. The required information for 

each swap includes representations that:

• it is a nonfinancial entity,

• the swap is hedging commercial risk,

• it has certain credit arrangements in place, and

• in the case of publicly-traded companies like most of our members, that an appropriate committee of the board of directors (or equivalent body) has reviewed 

and approved its decision not to clear.

The CFTC does not need repeated representations from our members and other 

end-users about every one of their non-cleared swaps to prevent abuse of the enduser clearing exception. Our members and other end-users understand that knowingly providing the CFTC with inaccurate information is a very serious violation of 

the Commodity Exchange Act (CEA). That is more than sufficient incentive for endusers to rely on the end-user clearing exception only when they are authorized to 

do so. 

We request that the Committee emphasize to the CFTC that it can implement the 

end-user clearing exception, consistent with Congress’s intent, by requiring endusers to:

• represent once that they will only rely on the end-user clearing exception for 

swaps that hedge commercial risk;

• inform the Commission once how they generally meet their financial obligations 

associated with entering into non-cleared swaps (coupled with an obligation to 

provide notice of material changes); and

• in the case of publicly-traded companies, maintain a record that shows that an 

appropriate committee of the board of directors (or equivalent body) has reviewed and approved their decision not to clear.

In addition to our concerns about the CFTC’s proposed implementation of the enduser clearing exception, we have serious concerns about how the CFTC plans to define ‘‘swap dealer.’’ The CFTC’s proposed rule includes very expansive language 

about the types of activity—including ‘‘accommodating’’ the demand of third parties 

for swaps—that the CFTC views as dealing activity. At the same time, the Commission has proposed to implement the ‘‘not as part of a regular business’’ and ‘‘de minimis’’ exceptions to the definition of ‘‘swap dealer’’ in a very restrictive manner. The 

result could be that commercial end-users are inappropriately miscast as swap dealers. If our members, who primarily engage in hedging activities, are caught within 

the definition of ‘‘swap dealer,’’ they will face not only the costs of registration and 

margin requirements, but they also will be subject to additional capital requirements (not yet defined by the CFTC), cost of IT systems for additional record-keeping and reporting, and other costly requirements not appropriate for end-users. 

The CEA, prior to the passage of the Dodd-Frank Act, excluded physical forward 

transactions from the CFTC’s jurisdiction over futures contracts. The definition of 

swap in the Dodd-Frank Act includes options for the purchase or sale of commodities, but excludes ‘‘any sale of a nonfinancial commodity . . . so long as the transaction is intended to be physically settled.’’ The CFTC has issued proposed rules on 

swap position reporting and commodity options that indicate the CFTC intends to 

regulate options that, when exercised, require the delivery or receipt of physical 

commodities as swaps or ‘‘swaptions.’’ The end-user community is concerned about 

the CFTC’s proposal because many contracts for the delivery of power in the electric 

industry, such as capacity and requirements contracts, include price, volume or 

other optionality. Including these end-user to end-user contracts in the definition of 

swap would greatly expand the scope of the CFTC’s regulation over the electric utility industry, conflict with the jurisdiction of the Federal Energy Regulatory Commission, and potentially would subject end-users to a number of burdensome regulatory requirements. We urge Congress to restrain CFTC’s regulatory authority in 

this critical area of our business. 

Conclusion 

Thank you for your leadership and interest in implementation of the Dodd-Frank 

Act. We appreciate your role in helping to ensure that shareholder-owned and community-owned utilities and energy suppliers can continue to use OTC derivatives to 

cost-effectively help protect our nation’s consumers from volatile wholesale natural 

gas and power commodity prices. We ask that the Congress extend the statutory 

deadline for the promulgation of derivatives rules set forth in section 712 of the 

52

Dodd-Frank Act. Also, we urge Congress to direct the regulatory agencies to promulgate these rules in a logical order so that the basic definitions are issued prior to 

other rules that rely upon them. 

Again, I appreciate the opportunity to testify and would be happy to answer any 

questions. 

ATTACHTMENTS

Resolution on Financial Reform Legislation Affecting Over-the-Counter Risk 

Management Products and Its Impacts on Consumers 

Whereas, There is a diverse group of end-users, consisting of electric and natural 

gas utilities, suppliers, customers, and other commercial entities who rely on overthe-counter (‘‘OTC’’) derivative products and markets to manage electricity and natural gas price risks for legitimate business purposes, thereby helping to keep rates 

stable and affordable for retail consumers; and

Whereas, The United States Congress is considering financial reform legislation 

with the goal of ensuring that gaps in regulation, oversight of markets and systemic 

risk do not lead to economic instability; and

Whereas, Previous NARUC resolutions support Federal legislative and regulatory 

actions that fully accommodate legitimate hedging activities by electric and natural 

gas utilities; and

Whereas, The proposed legislation would, among other things, provide the Commodity Futures Trading Commission (CFTC) with oversight of OTC risk management products, including mandatory centralized clearing and exchange trading of all 

OTC products; and

Whereas, Mandatory centralized clearing of all OTC contracts will increase expenses associated with hedging activity, and ultimately end-user prices, due to increased margin requirements; and

Whereas, A report by the Joint Association of Energy End-Users stated that the 

effect of margin requirements resulting from mandatory clearing for electric utilities 

would have the unintended effect of reducing or eliminating legitimate hedging 

practices and could jeopardize or reduce investments in Smart Grid technology; and 

for natural gas utilities and production companies could reduce capital devoted to 

infrastructure and natural gas exploration; and

Whereas, The laudable goals of reform that ensure market transparency and adequate regulatory oversight can be accomplished by means other than mandatory 

clearing of OTC risk management contracts and the anticipated extra expense. For 

example, a requirement that natural gas and electric market participants engaging 

in legitimate hedging report all OTC derivative transactions to a centralized data 

repository, like the CFTC, provides sufficient market transparency without the costs 

associated with mandatory clearing; and

Whereas, Proposed reforms would cause regulatory uncertainty with regard to 

the oversight of Regional Transmission Organizations (RTOs) and Independent System Operators (ISOs), where such uncertainty and/or overlapping jurisdiction can 

lead to negative impacts on liquidity, market confidence and reliability; and

Whereas, The Federal Energy Regulatory Commission (FERC), and the Public 

Utility Commission of Texas (PUCT) for Texas/ERCOT, as the regulators with the 

necessary expertise and statutory mandates to oversee electricity and natural gas 

markets to protect the public interest and consumers, should not be preempted by 

the financial reform legislation from being able to continue exercising their authority to ensure reliable, just and reasonable service and protect consumers; and

Whereas, Energy markets currently regulated by FERC or the PUCT (for Texas/

ERCOT) under accepted tariffs or rate schedules should continue to be subject to 

FERC’s and the PUCT’s (for Texas/ERCOT) exclusive Federal jurisdiction, including 

jurisdiction over physical and financial transmission rights, and market oversight; 

and should themselves not be subject to CFTC jurisdiction as a clearinghouse due 

to the financial and other settlement services they provide those transacting in regional electricity markets; now, therefore be it

Resolved, That the Board of Directors of the National Association of Regulatory 

Utility Commissioners, convened at its 2010 Winter Committee Meetings in Washington, D.C., supports passage of financial reform legislation ensuring that electric 

and natural gas market participants continue to have access to OTC risk management products as tools in their legitimate hedging practices to provide more predictable and less volatile energy costs to consumers; and be it further

53

Resolved, That new financial legislation being considered by Congress should 

weigh the costs of potential end-user utility rate increases versus the benefits of new 

standards for the clearing of OTC risk management contracts used by natural gas 

and electric utilities for legitimate hedging purposes; and be it further

Resolved, That any Federal legislation addressing OTC risk management products should provide for an exemption from mandatory clearing requirements for legitimate hedging activity in natural gas and electricity markets; and be it further

Resolved, That any exemption to the mandatory clearing requirement for OTC 

derivatives be narrowly tailored as to not allow excessive speculation in natural gas 

and electricity markets; and be it further

Resolved, That the FERC, and the PUCT for Texas/ERCOT, charged with the 

statutory obligation to protect the public interest and consumers, should continue 

to be the exclusive Federal regulators with authority to oversee any agreement, contract, transaction, product, market mechanism or service offered or provided pursuant to a tariff or rate schedule filed and accepted by the FERC, or the PUCT for 

Texas/ERCOT; and be it further

Resolved, That NARUC authorizes and directs the staff and General Counsel to 

promote with the Congress, the Commodity Futures Trading Commission and other 

policymakers at the Federal level, policies consistent with this statement.

Sponsored by the Committee on Gas, Consumer Affairs, and Electricity Adopted by 

the NARUC Board of Directors February 17, 2010.

June 30, 2010

Hon. BARNEY FRANK, Chairman,

House Committee on Financial Services, 

Washington, D.C.;

Hon. COLLIN C. PETERSON, Chairman,

House Committee on Agriculture, 

Washington, D.C.

Dear Chairmen Frank and Peterson:

Whether swaps are used by an airline hedging its fuel costs or a global manufacturing company hedging interest rate risk, derivatives are an important tool businesses use to manage costs and market volatility. This legislation will preserve that 

tool. Regulators, namely the Commodity Futures Trading Commission (CFTC), the 

Securities and Exchange Commission (SEC), and the prudential regulators, must 

not make hedging so costly it becomes prohibitively expensive for end-users to manage their risk. This letter seeks to provide some additional background on legislative 

intent on some, but not all, of the various sections of Title VII of H.R. 4173, the 

Dodd-Frank Act. 

The legislation does not authorize the regulators to impose margin on end-users, 

those exempt entities that use swaps to hedge or mitigate commercial risk. If regulators raise the costs of end-user transactions, they may create more risk. It is imperative that the regulators do not unnecessarily divert working capital from our 

economy into margin accounts, in a way that would discourage hedging by end-users 

or impair economic growth. 

Again, Congress clearly stated in this bill that the margin and capital requirements are not to be imposed on end-users, nor can the regulators require clearing 

for end-user trades. Regulators are charged with establishing rules for the capital 

requirements, as well as the margin requirements for all uncleared trades, but rules 

may not be set in a way that requires the imposition of margin requirements on 

the end-user side of a lawful transaction. In cases where a Swap Dealer enters into 

an uncleared swap with an end-user, margin on the dealer side of the transaction 

should reflect the counterparty risk of the transaction. Congress strongly encourages 

regulators to establish margin requirements for such swaps or security-based swaps 

in a manner that is consistent with the Congressional intent to protect end-users 

from burdensome costs. 

In harmonizing the different approaches taken by the House and Senate in their 

respective derivatives titles, a number of provisions were deleted by the Conference 

Committee to avoid redundancy and to streamline the regulatory framework. However, a consistent Congressional directive throughout all drafts of this legislation, 

and in Congressional debate, has been to protect end-users from burdensome costs 

associated with margin requirements and mandatory clearing. Accordingly, changes 

54

made in Conference to the section of the bill regulating capital and margin requirements for Swap Dealers and Major Swap Participants should not be construed as 

changing this important Congressional interest in protecting end-users. In fact, the 

House offer amending the capital and margin provisions of Sections 731 and 764 

expressly stated that the strike to the base text was made ‘‘to eliminate redundancy.’’ Capital and margin standards should be set to mitigate risk in our financial 

system, not punish those who are trying to hedge their own commercial risk. 

Congress recognized that the individualized credit arrangements worked out between counterparties in a bilateral transaction can be important components of 

business risk management. That is why Congress specifically mandates that regulators permit the use of non-cash collateral for counterparty arrangements with 

Swap Dealers and Major Swap Participants to permit flexibility. Mitigating risk is 

one of the most important reasons for passing this legislation. 

Congress determined that clearing is at the heart of reform—bringing transactions and counterparties into a robust, conservative and transparent risk management framework. Congress also acknowledged that clearing may not be suitable for 

every transaction or every counterparty. End-users who hedge their risks may find 

it challenging to use a standard derivative contracts to exactly match up their risks 

with counterparties willing to purchase their specific exposures. Standardized derivative contracts may not be suitable for every transaction. Congress recognized that 

imposing the clearing and exchange trading requirement on commercial end-users 

could raise transaction costs where there is a substantial public interest in keeping 

such costs low (i.e., to provide consumers with stable, low prices, promote investment, and create jobs.) 

Congress recognized this concern and created a robust end-user clearing exemption for those entities that are using the swaps market to hedge or mitigate commercial risk. These entities could be anything ranging from car companies to airlines or energy companies who produce and distribute power to farm machinery 

manufacturers. They also include captive finance affiliates, finance arms that are 

hedging in support of manufacturing or other commercial companies. The end-user 

exemption also may apply to our smaller financial entities—credit unions, community banks, and Farm Credit institutions. These entities did not get us into this crisis and should not be punished for Wall Street’s excesses. They help to finance jobs 

and provide lending for communities all across this nation. That is why Congress 

provided regulators the authority to exempt these institutions. 

This is also why we narrowed the scope of the Swap Dealer and Major Swap Participant definitions. We should not inadvertently pull in entities that are appropriately managing their risk. In implementing the Swap Dealer and Major Swap 

Participant provisions, Congress expects the regulators to maintain through rulemaking that the definition of Major Swap Participant does not capture companies 

simply because they use swaps to hedge risk in their ordinary course of business. 

Congress does not intend to regulate end-users as Major Swap Participants or Swap 

Dealers just because they use swaps to hedge or manage the commercial risks associated with their business. For example, the Major Swap Participant and Swap 

Dealer definitions are not intended to include an electric or gas utility that purchases commodities that are used either as a source of fuel to produce electricity 

or to supply gas to retail customers and that uses swaps to hedge or manage the 

commercial risks associated with its business. Congress incorporated a de minimis

exception to the Swap Dealer definition to ensure that smaller institutions that are 

responsibly managing their commercial risk are not inadvertently pulled into additional regulation. 

Just as Congress has heard the end-user community, regulators must carefully 

take into consideration the impact of regulation and capital and margin on these 

entities. 

It is also imperative that regulators do not assume that all over-the-counter transactions share the same risk profile. While uncleared swaps should be looked at 

closely, regulators must carefully analyze the risk associated with cleared and 

uncleared swaps and apply that analysis when setting capital standards for Swap 

Dealers and Major Swap Participants. As regulators set capital and margin standards on Swap Dealers or Major Swap Participants, they must set the appropriate 

standards relative to the risks associated with trading. Regulators must carefully 

consider the potential burdens that Swap Dealers and Major Swap Participants may 

impose on end-user counterparties—especially if those requirements will discourage 

the use of swaps by end-users or harm economic growth. Regulators should seek to 

impose margins to the extent they are necessary to ensure the safety and soundness 

of the Swap Dealers and Major Swap Participants. 

Congress determined that end-users must be empowered in their counterparty relationships, especially relationships with swap dealers. This is why Congress explicVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00058 Fmt 6633 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
55

itly gave to end-users the option to clear swaps contracts, the option to choose their 

clearinghouse or clearing agency, and the option to segregate margin with an independent third party custodian. 

In implementing the derivatives title, Congress encourages the CFTC 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 Commodity Exchange Act and 

the CFTC’s established policy and orders on this subject, including situations where 

commercial parties agree to ‘‘book-out’’ their physical delivery obligations under a 

forward contract. 

Congress recognized that the capital and margin requirements in this bill could 

have an impact on swaps contracts currently in existence. For this reason, we provided legal certainty to those contracts currently in existence, providing that no contract could be terminated, renegotiated, modified, amended, or supplemented (unless 

otherwise specified in the contract) based on the implementation of any requirement 

in this Act, including requirements on Swap Dealers and Major Swap Participants. 

It is imperative that we provide certainty to these existing contracts for the sake 

of our economy and financial system. 

Regulators must carefully follow Congressional intent in implementing this bill. 

While Congress may not have the expertise to set specific standards, we have laid 

out our criteria and guidelines for implementing reform. It is imperative that these 

standards are not punitive to the end-users, that we encourage the management of 

commercial risk, and that we build a strong but responsive framework for regulating the derivatives market. 

Sincerely,

Hon. CHRISTOPHER DODD,

Chairman,

Senate Committee on Banking, Housing, and Urban Affairs;

Hon. BLANCHE L. LINCOLN,

Chairman,

Senate Committee on Agriculture, Nutrition, and Forestry.

The CHAIRMAN. Thank you. 

Ms. Trakimas. 

STATEMENT OF ANN E. TRAKIMAS, CHIEF OPERATING

OFFICER, COBANK, GREENWOOD VILLAGE, CO; ON BEHALF 

OF FARM CREDIT COUNCIL 

Ms. TRAKIMAS. Thank you. Good afternoon, Chairman Lucas, 

Ranking Member Peterson, and Members of the Committee. Thank 

you for your leadership in overseeing the CFTC’s implementation 

of the derivatives title of the Dodd-Frank Act and for the opportunity to testify today. 

My name is Ann Trakimas and I am the Chief Operating Officer 

of CoBank. I am testifying today on behalf of the Farm Credit System. New derivatives regulation has the potential to affect the 

Farm Credit System’s ability to offer cost-effective, dependable financing to farmers, farm-related businesses, rural home buyers 

and rural energy, water and communications companies. 

Farm Credit supports Congress’ goal of making the U.S. financial 

system safer and more transparent. We believe, however, that 

some of the new proposed regulations would impose unwarranted 

costs on Farm Credit institutions, ultimately increasing the cost of 

credit to our customers without making the financial system safer. 


11201007 11201008
56

The provisions on derivatives in the Dodd-Frank Act were designed to reduce and control systemic risk in the financial system. 

In passing the Act, Congress made clear its view that Farm Credit 

institution derivative activities do not pose a systemic threat. As a 

result, we believe Congress’ intent is for new regulation to be focused on institutions that engage in derivatives activity that do 

create systemic risk. 

Farm Credit institutions should be exempt from the mandatory 

swap clearing requirements of the Act. System institutions are endusers and use them solely for hedging the risks inherent in making 

loans to their customers and in managing their liquidity and funding costs. Farm Credit institutions primarily use plain vanilla, 

fixed for floating interest rate, swaps and caps. We do not use 

swaps to speculate; we are not market makers, and we do not use 

the credit default swaps that contributed to the financial crisis. 

The System’s swaps are an extremely small portion of the overall 

derivatives market. We have robust procedures in place today, 

closely overseen by our Federal regulator, that ensures our swaps 

post no significant risk to us or to our counterparties. 

The recent global financial crisis conclusively demonstrated that 

Farm Credit’s strong risk controls effectively limited our exposure 

to financial stress resulting from derivatives activities. Congress 

recognized all of this in the Dodd-Frank Act when it directed CFTC 

to consider exempting small banks, credit unions, and Farm Credit 

institutions for mandatory swap clearing. 

The CFTC’s final regulations in this area should provide an exemption from mandatory swap clearing for derivatives activities 

that do not possess systemic risk. 

In addition, no Farm Credit institution should be considered a 

swap dealer. Only one Farm Credit institution, CoBank, offers 

swaps to its customers. 

CoBank does a limited number of these transactions each year, 

and all of these transactions are executed in conjunction with loans 

made to our customers. All of our customers’ derivative transactions are nonspeculative, and we offset the risk associated with 

each. These customer transactions pose no systemic risk and are 

critical to helping our customers economically manage the risks inherent in their loans. 

Additionally, because CoBank is the only lender to many of its 

borrowers, we may be the only counterparty able to enter into a 

swap with that customer, because we already hold the customer’s 

collateral via our loan agreements. 

Congressional intent in this area is clear: The Dodd-Frank Act 

specifically gives CFTC the authority to exclude these types of customer swap transactions from the swap dealer definition. CoBank’s 

customer derivatives are the same as the customer derivatives that 

commercial banks provide to their customers, and Congress has exempted commercial banks from designation as a swap dealer. 

There is no reason that the same exemption should not apply to 

the Farm Credit System. 

On behalf of the members of the Farm Credit System, thank you 

for holding this hearing and for considering our views on this important topic. 

The CHAIRMAN. Thank you. 

57

1Pub. L. No. 111–203, 124 Stat. 1376 (2010). 

Ms. TRAKIMAS. Can I just complete? Farm Credit institutions 

rely on the safe use of derivatives to manage our interest rate liquidity and balance sheet risks. These instruments in turn help us 

provide cost-effective, dependable financing to farmers, ranchers, 

ag co-ops and other farm-related and rural infrastructure businesses that serve rural America. It is essential that in implementing Dodd-Frank, the CFTC does not impose unwarranted, duplicative, and costly regulations on the Farm Credit System. Mandatory clearing or swap dealer regulation would increase our borrowers’ financing costs. 

We look forward to working with the Committee as well as the 

CFTC to strike the appropriate balance between improving the 

safety of the financial system and preserving rural America’s access to credit. 

Thank you, Mr. Chairman. And I would be very happy to answer 

any questions that you or the Committee have. 

[The prepared statement of Ms. Trakimas follows:]

PREPARED STATEMENT OF ANN E. TRAKIMAS, CHIEF OPERATING OFFICER, COBANK, GREENWOOD VILLAGE, CO; ON BEHALF OF FARM CREDIT COUNCIL

Good afternoon, Chairman Lucas, Ranking Member Peterson, and Members of the 

Committee. I appreciate the opportunity to testify today on behalf of the Farm Credit System, and I commend the Committee for its leadership in overseeing the rulemaking process as the Commodity Futures Trading Commission (‘‘CFTC’’) implements the derivatives title of the Dodd-Frank Wall Street Reform and Consumer 

Protection Act (‘‘Dodd-Frank’’).1

I am the Chief Operating Officer of CoBank, a member bank of the Farm Credit 

System. Before joining CoBank, I served as a director of the Federal Farm Credit 

Banks Funding Corporation, the entity that issues debt securities that CoBank and 

other Farm Credit banks use to fund loans to farmers and ranchers, farm-related 

businesses, agricultural cooperatives, and rural electric, water, and communications 

providers. 

As you know, the Farm Credit System provides 40% of agricultural lending in the 

United States. New derivatives regulation has the potential to affect the Farm Credit System’s ability to offer cost-effective, dependable financing to farmers, farm-related businesses, and rural America. The Farm Credit System supports Congress’s 

goal of making the financial system safer. We believe, however, that new regulation 

should not impose unwarranted costs on Farm Credit System institutions, which 

would ultimately raise the costs of loans to our member-borrowers and diminish 

rural America’s access to credit, without making the financial system safer. 

In explaining how proposed regulations will affect the Farm Credit System and 

what steps we believe the CFTC should take in implementing Dodd-Frank, I would 

like to make three points: 

First, the Farm Credit System already has in place important protections for safety, soundness, and consumer protection. These attributes illustrate that many of 

Dodd-Frank’s regulatory concerns do not apply with equal force to the Farm Credit 

System. In passing the Act, Congress concluded that the Farm Credit System did 

not pose a systemic threat and specifically excluded them from oversight by the new 

systemic risk regulatory agency. 

Second, Farm Credit System banks and associations should qualify for the enduser exemption to Dodd-Frank’s clearing requirement. Congress authorized and instructed the CFTC to consider exempting Farm Credit System institutions, regardless of size, from mandatory clearing since they do not pose a systemic risk to the 

financial system and they were not the cause of the problems that resulted in the 

recent financial crisis. Imposing higher costs, through unnecessary derivatives regulations, on Farm Credit System institutions ultimately leads to higher credit costs 

for farmers and ranchers, their agricultural cooperatives, rural infrastructure providers and others in rural America. While Dodd-Frank places special emphasis on 

exempting institutions with less than $10 billion in assets, Congress also made it 

clear that it should not be viewed as a limit by CFTC. If the CFTC adopts an asset 

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2 12 U.S.C. § 2001(a). 3 Id. § 2001(b). 4 Id. § 2252(a)(10). 

test, it must be applied in a manner that appropriately recognizes the unique cooperative structure of the Farm Credit System to ‘‘look through’’ Farm Credit Banks 

to the smaller Farm Credit associations that own them. Alternatively, the CFTC 

should adopt a risk-based approach to mandatory clearing in a manner similar to 

the definition of major swap participant. 

Third, no Farm Credit System institution should be considered a swap dealer. 

Farm Credit System institutions enter into customer derivative transactions that 

are linked to the financial terms of the loans they issue. All customer derivative 

transactions are non-speculative in nature with risk immediately eliminated 

through appropriate risk management activities and controls. These customer derivative transactions pose no systemic risk to the financial system and are critical to 

helping our customers economically manage interest rate and foreign currency risk. 

In this way, the Farm Credit System’s customer derivatives activity is the same as 

the same sort of customer derivatives activity of commercial banks, which Congress 

has exempted from designation as a swap dealer. There is no reason that the same 

exemption should not apply to the Farm Credit System. 

Background 

I would like to begin with an overview of the Farm Credit System, which comprises five banks and 84 cooperative lending associations. As you know, Congress 

created the Farm Credit System ‘‘to accomplish the objective of improving the income and well-being of American farmers and ranchers by furnishing sound, adequate, and constructive credit and closely related services to them, their cooperatives, and to selected farm-related businesses necessary for efficient farm operations.’’ 2 Congress also intended ‘‘to encourage farmer- and rancher-borrowers participation in the management, control, and ownership of a permanent system of 

credit for agriculture which will be responsive to the credit needs of all types of agricultural producers having a basis for credit.’’ 3 Today, the Farm Credit System is 

safe, sound, and responsive to its customer-owners. This is due, in part, to the following aspects of the Farm Credit System. 

The Farm Credit System uses safe, non-speculative swaps and already effectively 

addresses counterparty credit risk. Farm Credit System institutions primarily use 

plain vanilla, fixed-for-floating interest rate swaps, and virtually all of our derivatives qualify for hedge accounting treatment. Farm Credit System institutions do 

not use swaps to speculate, and do not use the credit default swaps that contributed 

to the financial crisis. And Farm Credit System institutions already effectively manage counterparty credit risk. We deal with counterparties that have an investment 

grade or better long-term credit rating, and we monitor the credit standing of and 

levels of exposure to individual counterparties. Substantially all of our derivative 

contracts are supported by credit support agreements requiring the two-way posting 

of collateral in the event certain dollar thresholds of exposure are reached. These 

thresholds are small relative to the Farm Credit System capital. As of December 31, 

2010, the net uncollateralized exposure of Farm Credit System institutions to swap 

dealers was only $232 million. As of that same date, Farm Credit Bank capital stood 

at $12.3 billion. 

Farm Credit System institutions are regulated by the Farm Credit Administration, an independent Federal agency that effectively mitigates the risk of Farm 

Credit System institutions to the United States financial system. The Farm Credit 

Act gives the Farm Credit Administration broad powers ‘‘for the purpose of ensuring 

the safety and soundness of System institutions.’’ 4 These powers include suspending 

or removing directors or officers of Farm Credit System institutions who engage in 

unsafe or unsound practices, and the ability to place unsafe or unsound institutions 

in conservatorship or receivership. 

The Farm Credit Administration also effectively oversees the capital adequacy 

and derivatives activity of Farm Credit System institutions. The Farm Credit Administration sets minimum capital standards and rates the safety and soundness 

of each Farm Credit System institution, and it requires Farm Credit System institutions to limit their exposure to single or related counterparties and to establish policies that ensure that counterparty risks are consistent with the institution’s riskbearing capacity. 

The Farm Credit System is not so interconnected with other financial entities to 

raise systemic risk concerns. Because Farm Credit System institutions do not take 

deposits, Farm Credit System banks and associations cannot experience a ‘‘run on 

the bank.’’ And the Systemwide Debt Securities used to fund the Farm Credit SysVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00062 Fmt 6633 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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5Pub. L. No. 111–203, § 723(a)(3), 124 Stat. at 1680 (CEA § 2(h)(7)(C)(ii)). 

tem are (1) insured by the Farm Credit System Insurance Corporation, a government-controlled, independent entity, that administers a more than $3 billion insurance fund paid by premiums imposed on System institutions, and (2) issued by the 

five Farm Credit System banks, which are jointly and severally liable for these Systemwide debt obligations. In short, these layers of investor protection ensure that 

the Farm Credit System will not cause a run on the funding of other entities. 

The Farm Credit System is a cooperative enterprise. Farm Credit System associations are cooperatives owned by their borrowers, and Farm Credit System banks are 

cooperatives primarily owned by their affiliated associations and other borrowers organized as cooperatives. Borrowers purchase equity in the institutions with which 

they do business, and Farm Credit System institutions return a portion of their 

earnings to their borrower-owners in the form of patronage distributions. Farm 

Credit Administration regulations further govern our standard of conduct, requiring, 

among other things, that Farm Credit System institutions monitor and avoid conflicts of interest. 

Finally, Farm Credit System institutions are uniquely well suited to provide derivatives to their customers. To the extent that a System institution is a customer’s 

only lender, that customer will likely be unable to enter into a swap with another 

party that would not have access to the loan collateral. New regulation would raise 

the costs of derivatives to the Farm Credit System’s customers and could cause System institutions to stop offering these products. This would deprive some farmers, 

farm-related businesses, and rural America of the ability to manage risk, and drive 

others to Wall Street swap dealers that are less familiar with their unique needs. 

In sum, Farm Credit System institutions are safe and sound, and they operate 

with high standards of conduct for their customers. Before determining that new 

regulation is warranted, regulators must therefore consider the Farm Credit Administration’s effective current regulation of safety and soundness, the low risk profile 

of Farm Credit System institutions, and the unique relationship those institutions 

have with their borrower-owners. 

With these principles in mind, I would like to discuss two significant areas of potential new regulation: (1) whether Farm Credit System institutions will qualify for 

the end-user exemption as we believe Congress, and this Committee, intended; and 

(2) whether Farm Credit System institutions will be designated as swap dealers, 

which we believe Congress, and this Committee did not intend and if it occurred 

would be unfair and unnecessary. 

End-User Exemption 

As you know, Dodd-Frank provides an exemption to mandatory clearing for endusers entering into swaps to hedge or mitigate commercial risk. Although DoddFrank generally defines end-users as nonfinancial entities, Congress also directed 

the CFTC to ‘‘consider whether to exempt small banks, savings associations, farm 

credit system institutions, and credit unions.’’ 5 Because the Farm Credit System is 

already safe and sound, and because our derivatives are already collateralized, we 

believe Congress gave the CFTC broad authority to permit Farm Credit System institutions, including those with total assets of more than $10 billion, to use the enduser exemption. We have urged the CFTC to clarify in its final rules that Farm 

Credit System institutions will qualify for the end-user clearing exemption. 

First, we have asked the CFTC to provide the maximum flexibility to adopt an 

equitable solution for exempting Farm Credit institutions from mandatory swaps 

clearing if they do not pose a systemic risk to the U.S. financial institutions. Consistent with what we believe to be Congress’s intent, the Dodd-Frank Act authorizes 

CFTC to exempt any-sized Farm Credit System institution from mandatory clearing 

requirements, which is appropriate given Farm Credit System institutions’ derivatives use does not pose a systemic risk to the financial system. More troubling to 

us is the CFTC may take a more narrow approach, particularly with respect to how 

it interprets the Dodd-Frank Act’s reference to the $10 billion asset limit, which 

would make even more critical that it at least recognize the unique cooperative 

structure of the Farm Credit System where the cooperative district banks are generally owned by cooperative lending associations, which engage in most of the System’s retail lending. Under this structure, the cooperative lending associations are 

smaller than their affiliated banks that provide them funding and use derivatives 

to manage liquidity and other balance-sheet risks. For example, AgriBank, FCB, is 

the largest district bank, and its assets exceed $10 billion. But the 17 associations 

that own 99% of AgriBank have average assets of $3.6 billion. This is well below 

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6 As the Farm Credit Council noted in its February 22 comment on the CFTC’s proposed enduser exception rules, although the majority of Farm Credit System associations have assets of 

less than $10 billion, the few associations with greater assets do not present risk requiring mandatory clearing. Even the failure of a large association would have no material impact on the 

Farm Credit System’s ability to meet its debt obligations because the five Farm Credit System 

banks are jointly and severally liable for the System’s notes and bonds. Thus, no association 

is so large that it would impact System debt holders if it were placed in receivership. By contrast, if a standalone bank fails, its bondholders will likely face losses. 

the $10 billion threshold that some have suggested.6 Congress did not intend the 

$10 billion as a size limitation for exempting Farm Credit institutions from mandatory clearing. If, however, CFTC decides to implement an exemption test that included size, the agency must then also recognize the unique cooperative structure 

of the Farm Credit System and ‘‘look through’’ Farm Credit Banks to the smaller 

Farm Credit associations that own them. One consequence of our unique structure 

is that each bank centrally funds loans for its district. Centralized funding enables 

the associations to benefit from lower administrative and operational costs. Swaps 

that hedge risk on behalf of Farm Credit System associations are executed by the 

district bank to gain hedge accounting, to minimize administrative costs, and to 

minimize counterparty credit risk and margin requirements via district-wide netting 

of offsetting exposures. This is more cost effective and strengthens the liquidity of 

the System. As a result, Farm Credit System associations have a lower risk profile 

than the small commercial banks. 

We believe the increased costs of mandatory clearing will ultimately be borne by 

farmers and ranchers because of the higher cost of credit, and will put our cooperative lending associations at a disadvantage with respect to the small commercial 

banks with which they compete. The increased costs of mandatory clearing will be 

passed on from the banks to their associations, reducing their capital and liquidity, 

which in turn will either reduce the funds available for loans or increase borrowing 

costs. That result would be unfair and unnecessary given that Congress intended 

to give regulators maximum flexibility in implementing the end-user exemption. 

Second, we have asked the CFTC to consider the risk of an institution’s derivatives activity instead of simply its total assets. To the extent clearing is designed 

to address credit risk, large institutions may in fact be less risky than smaller institutions. Risk is a function of the type and amount of derivative activity after netting 

offsetting positions and collateral, not simply of total assets. Accordingly, we have 

urged the CFTC to consider a risk-based measure of which financial entities should 

be eligible for the end-user clearing exemption. 

One such approach could draw on the framework proposed by the CFTC and the 

Securities and Exchange Commission (‘‘SEC’’) for determining whether an entity has 

a ‘‘substantial position’’ in a major swaps category warranting regulation as a major 

swap participant. A similar test measuring uncollateralized current exposure or current exposure plus potential future exposure would also be appropriate for determining which financial institutions pose enough risk to warrant mandatory clearing. 

Specifically, we have proposed that current uncollateralized exposure of $2 billion 

in rate swaps and $1 billion in other categories of swaps—or current 

uncollateralized exposure and potential future exposure of $3 billion for rate swaps 

or $1 billion for other swaps—would be appropriate. These proposed thresholds, 

which are lower than the thresholds the CFTC has proposed for identifying major 

swap participants, would address risk among financial entities and would more accurately capture financial institutions whose swap exposure poses risk to the financial system. We are convinced that implementing a risk-based test using current 

and potential exposures is more equitable and appropriate way to determine when 

financial institution derivative activities, including Farm Credit System institutions, 

may pose a systemic risk to the financial system and, therefore, require mandatory 

clearing of derivative transactions. 

Alternatively, the CFTC could adopt a test based on an institution’s 

uncollateralized exposure to swaps as a percentage of capital. The Farm Credit System has suggested to the CFTC that appropriate risk limits would be current 

uncollateralized exposure to swaps of 10% of capital, or current uncollateralized exposure plus potential future exposure to swaps of 20% of capital. These limits would 

appropriately identify which small financial institutions pose systemic risk warranting mandatory clearing. 

In the end, it is critically important that Farm Credit System banks, associations, 

and their members can make use of the end-user clearing exemption. Clearing will 

raise costs for Farm Credit System institutions that will ultimately be borne by our 

agricultural borrowers in the form of higher interest rates. We do not believe that 

new costs on agricultural borrowers are justified. 

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7 156 Cong. Rec. S5922 (daily ed. July 15, 2010) (statement of Sen. Lincoln) (‘‘The definition 

of swap dealer was adjusted in a couple of respects so that a community bank which is hedging 

its interest rate risk on its loan portfolio would not be viewed as a Swap Dealer. In addition, 

we made it clear that a bank that originates a loan with a customer and offers a swap in connection with that loan shouldn’t be viewed as a swap dealer. It was never the intention of the Senate Agriculture Committee to catch community banks in either situation. We worked very hard 

to make sure that this understanding came through in revised statutory language which was 

worked out during conference.’’). 8Pub. L. No. 111–203, § 721(a)(21), 124 Stat. at 1670 (adding CEA § 1a(49)(A)). 

Swap Dealer Regulation 

Finally, I would like to address the issue of whether any Farm Credit System institution will be defined as a ‘‘swap dealer’’ and therefore will be forced to register 

with the CFTC and comply with potentially costly new capital, margin, and business 

conduct standards. 

Farm Credit System institutions do not use swaps speculatively and we are not 

market makers. CoBank does, however, enter into swaps with customers as a service that enables them to modify or reduce their interest rate and foreign currency 

risk related to their loans with the bank or its related associations. For example, 

a floating-rate loan agreement may require the customer to hedge fluctuations in 

interest rates. The most efficient way for the customer to do so is to enter into an 

interest rate swap or cap. By requiring the customer to hedge against changing interest rates and by providing the customer a swap for that hedge, CoBank reduces 

the risk that higher interest rates may cause excessive interest expense that the 

customer cannot afford. Thus, the hedging requirement mitigates risk for both the 

bank and the customer. 

All of the Farm Credit System’s customer derivatives transactions are non-speculative, and Farm Credit System institutions offset the risk associated with them. 

For example, CoBank concurrently enters into offsetting agreements with approved 

counterparties, and customer derivatives are secured under the related loan agreements with CoBank or its related association. CoBank’s customers—which include 

agricultural cooperatives; rural energy, communications, and water companies; 

farmer-owned financial institutions including agricultural credit associations; and 

other businesses that serve rural America—depend on these swaps to hedge risk 

and allow them to access credit. Indeed, because CoBank is the only lender to many 

of its borrowers, it may be the only counterparty able to enter into a swap backed 

by the loan collateral. 

We believe that Congress intended to clarify that ‘‘community banks aren’t swap 

dealers or major swap participants’’ 7—at least not when they enter into a swap 

with a customer that is linked to the financial terms of the customer’s loan. To accomplish this objective, Dodd-Frank states that ‘‘in no event shall an insured depository institution be considered to be a swap dealer to the extent it offers to enter 

into a swap with a customer in connection with originating a loan with that customer.’’ 8 Although the statute says ‘‘insured depository institution,’’ we believe Congress intended to exclude swaps offered in connection with loans and did not intend 

to confer a peculiar market advantage on commercial banks. To effectuate the intent 

that community banks not be designated swap dealers, the members of the Farm 

Credit System have urged the CFTC to clarify that this exemption applies equally 

to Farm Credit System institutions when they offer derivatives to customers in connection with loans, even though our institutions do not accept deposits. 

First, the Farm Credit System’s customer interest rate derivatives are identical 

to swaps offered by community banks in connection with loans. For example, 

CoBank customizes customer swaps to match the terms of loans and to ensure that 

the customer is effectively hedged against changes in interest rates. Because the 

swaps are connected to the financial terms of the loan, CoBank’s customer interest 

rate swaps are consistent with the CFTC’s preliminary interpretation of the community banks exemption. 

Second, Farm Credit System institutions are subject to similar regulatory requirements as insured depository institutions. As an example, the Farm Credit Administration uses the same FIRS, or CAMELS, rating system for Farm Credit System institutions that the Federal Deposit Insurance Corporation uses for commercial 

banks. 

Third, although Farm Credit System institutions do not accept deposits, the Systemwide Debt Securities they use to finance loans are insured, just as deposits of 

commercial banks are insured. If a bank cannot pay principal or interest on an insured debt obligation, the investors are paid from an independently administered insurance fund supported by premiums paid by Farm Credit System institutions. In 

the event that the entire insurance fund is exhausted, investors have further reVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00065 Fmt 6633 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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course to the five Farm Credit System banks, which are jointly and severally liable 

for Systemwide Debt Securities. All of the Farm Credit System’s debt financing is 

insured in this manner. 

Finally, unless Farm Credit System institutions were able to use it, the community bank exemption would give commercial banks an unwarranted competitive advantage in the market for agricultural lending. In determining whether an entity 

is a swap dealer, the rules currently proposed by the CFTC and the SEC do just 

that. The proposed rules exempt derivatives offered by commercial banks, while 

counting the same derivatives offered by the Farm Credit System, simply because 

System institutions do not accept deposits. This is unfair, and we do not believe that 

Congress intended this result in exempting community banks from additional regulation. Accordingly, we have urged the CFTC to provide this same exemption to the 

Farm Credit System in its final rules. 

* * * * *

On behalf of the members of the Farm Credit System, I thank the Committee for 

holding for this hearing and for considering our views on these very important 

issues. Farm Credit System institutions rely on the safe use of derivatives to manage interest rate, liquidity, and balance sheet risk. These instruments, in turn, help 

us to provide cost-effective, dependable financing to farmers, farm-related businesses, and rural America. It is essential that, in implementing Dodd-Frank, the 

CFTC does not impose unwarranted, duplicative, and costly regulation on the Farm 

Credit System. Mandatory clearing or swap dealer regulation would raise costs of 

financing for our borrowers. We look forward to working with the Committee, as 

well as with the CFTC, to strike the appropriate balance between improving the 

safety of the financial system and preserving rural America’s access to credit. Again, 

I thank the Committee for its leadership on these important matters.

The CHAIRMAN. Thank you again. 

I now recognize myself for 5 minutes. 

Mr. Allison, if ConocoPhillips were no longer providing swaps to 

its physical customers because of the cost associated with regulation as a swap dealer due to that activity, how do you anticipate 

the demand for those swaps would be met? If you can’t do it, what 

is going to happen? 

Mr. ALLISON. The customers that were unable to acquire swaps 

from us would either have to increase the risk they were willing 

to bear, or they would go to an entity that I would think of—probably one of the big financial firms. The well-known financial firms 

are the biggest swap dealers in the energy space as in the other 

derivatives markets, and that would be the most likely firm to pick 

up any business that we weren’t doing. 

The CHAIRMAN. So they simply expose themselves to more risk, 

or they increase their cost by finding some entity that would? 

Mr. ALLISON. Yes. 

The CHAIRMAN. Mr. Fields, Mr. McMahon, how would you respond to the assertion that central clearing shifts the informational 

advantage from Wall Street to the end-users and that the result 

from end-users of a central clearing mandate would be better pricing? How do you respond to that comment by some people? 

Mr. MCMAHON. I will start first. Our members utilize exchanges 

and central clearing for some of their transactions in electric swap 

transactions and electric power and natural gas. So it is not that 

we don’t use clearing in exchanges, but only where it makes sense. 

Oftentimes there are a lot of customized transactions that need to 

be done that don’t lend themselves to central clearing. So we need 

the ability to utilize all the options. 

I think that for us, that is the key, having that flexibility and 

also where it makes sense; because of our credit standing, oftenVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00066 Fmt 6633 Sfmt 6601 I:\DOCS\112-07\65892.TXT BRIAN
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times we don’t need to post any margin, and that benefit flows directly to our customers. 

The CHAIRMAN. Mr. Field? 

Mr. FIELD. I would reply to that in the sense that when we are 

bidding a transaction, we will have a very, very transparent and 

a very significant process where we are getting lots of market information from many different Wall Street banks. And so we feel that 

actually it is very, very transparent from our perspective today and 

we don’t see that advantage. In fact, we see an advantage where 

oftentimes the banks are bidding very aggressively for our business, because they like a swap with a nonfinancial institution, a 

non-Wall Street bank. They like having us as the counterparty. 

The CHAIRMAN. Mr. Cvrkel, Ms. Trakimas, as the bankers at the 

table, how is the credit profile of a potential borrower impacted by 

whether or not they are hedging their exposure to risk? I know it 

is a simple question but it is one of those things we need to point 

out and discuss in public. 

Ms. TRAKIMAS. I guess I will start. Our customers typically borrow in the floating rate market, and essentially they use interest 

rate swaps to cap the interest rate risk on that floating rate loan. 

So to the extent that we do not offer this product because of increased costs and regulation, they will be increasing their risk profile to us and themselves. So it is a disadvantage. 

Mr. CVRKEL. When we look at our customers, one thing we need 

to evaluate credit risk exposure is fixed-debt service cost so the cost 

will be consistent over the next 5 years or 10 years. If we are unable to offer those customers that fixed-rate debt service cost, 

chances are we would not make any loans greater than 10 years. 

That would be out. Lending would be shut off. 

The CHAIRMAN. I suspected that was the case, and thank you for 

pointing that out. 

Mr. Field, one last question. Does your pension fund engage in 

swaps and are you concerned about the CFTC’s business conduct 

rules? 

Mr. FIELD. Yes, we do engage in swaps and we are concerned 

about the rule. Let me, if you can indulge me for a minute. 

The CHAIRMAN. Please. 

Mr. FIELD. John Deere has a defined benefit plan that covers 

more than 40,000 participants. And we are very, very proud that 

we are able to provide a defined benefit plan in this environment; 

and in fact, as you all know, that is the minority of companies that 

do that anymore. 

And we use swaps basically to discharge our fiduciary duty to reduce the risk to manageable levels. So we have a payment obligation to our beneficiaries that has a very long tail on it. And what 

we are trying to do is go out and get assets that match up against 

that long tail. And the only way that we can do that cost effectively 

is through the use of swaps. So we are very concerned about this. 

The CHAIRMAN. It is an important issue. 

My time has expired. 

I now turn to the gentleman from Pennsylvania, Mr. Holden, and 

recognize him for 5 minutes. 

Mr. HOLDEN. Thank you, Mr. Chairman. 

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Mr. Cvrkel and Ms. Trakimas, following up on the Chairman’s 

question, basically if you are not exempted, the services you provide your customers now, you will not do in the future because of 

the regulation and because of the costs; or is more staff needed to 

comply. 

Mr. CVRKEL. The way I look at it is we started swaps in 2007; 

we have done 54 transactions. And currently with the additional 

regulation come on us, we don’t have the staff nor would I get the 

staff. So chances are we would stop using swaps to fix our debt 

service cost and help our customers. And that lending opportunity 

would go away. 

Mr. HOLDEN. They would have to go to larger entities? 

Mr. CVRKEL. That is correct. 

Ms. TRAKIMAS. From our perspective, it is clear that the costs to 

our customers will increase and the potential negative there is that 

the availability of credit will also diminish. We would be looking 

at higher capital requirements and higher margin requirements. 

The other issue to think about here is that our customers may 

not have access to another swap counterparty because our swaps 

are made in connection with the loans that we make to them and 

we hold the collateral against those loans. So from a collateral perspective, the customers posting to us collateral on our loan, which 

we also use to collateralize our swap position. So the marketplace 

is not prepared to, and our customers are not prepared to, technically and operationally post collateral to anyone else other than 

their lender. 

Mr. HOLDEN. To the extent that such exemptions are granted, 

could such exemptions be based on the same standard regardless 

of the type of entity? Suppose the CFTC determines that an exemption is warranted for Farm Credit banks with less than $20 billion 

in assets, could the CFTC set a different threshold for small banks 

and credit unions? 

Ms. TRAKIMAS. Yes. From our perspective, it is not the size of the 

institution that is the question; the question to us is what is the 

risk in the transaction. And also all swaps are not created equal. 

Some are more risky than others. And the type of swaps that we 

use are plain vanilla, interest-rate swaps that are risk mitigation 

tools. 

And from our perspective, you could be a very large institution 

and have very small swap exposure. And I would probably put us 

in that category. We are a good-sized institution, but the size of our 

portfolio of swaps from a risk perspective is just very, very small. 

On the other hand, you could be a small institution with a very, 

very high volatility swaps portfolio. 

So to us, it is not necessarily the size that counts. 

If I just might. To the extent that that is the way the rules will 

be written, however, we do—a lot of our lending associations are 

small. When you look at the System on a combined basis, we are 

large. So if it does come down to a numbers, a size perspective, we 

do think that we would appreciate a sizeable threshold so our lending associations could be excluded. 

Mr. HOLDEN. Do you care to comment, Mr. Cvrkel? 

Mr. CVRKEL. I think one thing you have to look at is even the 

size of the organization. For instance, for banks under $10 billion, 

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they have .04 percent of the swap market; for banks of $30 billion 

and under, that goes up to .1 percent. The top five banks in the 

country have 96 percent of the notional value of the swap portfolio. So the risk is not into smaller banks. It is not banks of $14 billion or $20 billion. That is not where the risk exposure is. 

Also when you look at swap risk, I think it is somewhat mis- leading, everyone is looking at the big numbers of the $600 billion 

market; that is not the risk exposure. The risk exposure is the 

uncollateralized portion of that swap. When we do a swap, and if 

it is an asset to our counterparty, we have to post collateral. So the 

risk is the difference that is not posted. 

And one thing, one comment I want to make, too, as I mentioned 

we made 54 transactions since 2007. When Lehman Brothers went 

bankrupt they had 900,000 transactions compared to 54. Why 

should we get regulated like them? 

Mr. HOLDEN. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman’s time has expired. The chair now 

recognizes the gentleman from Illinois for 5 minutes, Mr. Johnson. 

Mr. JOHNSON. Thank you, Mr. Chairman. 

Let me just say I don’t expect any of you to comment on my comment, but the fact that you have to be here today and subject yourself not only to questions but also to this whole incredibly complicated labyrinthine process is an indication to me how Congress 

overreaches in regard to a problem and then causes innumerable 

problems as a result of it. So that is just my parenthetical. I don’t 

expect Members of the Committee or you to respond, but this is a 

good example of bureaucracy run amok and over-regulation and 

over-legislation run amok. So take that as you will. 

I wish Mr. Gensler were still here, but since he isn’t let me direct 

this question to Mr. Cvrkel. And I don’t mean—this is not an adversarial question to you. I remember in response to one of my 

questions, that he indicated that they hadn’t received any public 

comment in regard to one particular area. 

I am specifically now directing you—maybe you don’t have 

awareness of this—to a letter of February 22nd of this year, in 

which at some point in the letter—this is a letter that Susquehanna signed and a number of other entities signed. I am quoting, 

‘‘These low thresholds, especially when coupled with narrow interpretation of the statutory exclusion for IDIs, could have the effect 

of either subjecting many small banks to the substantial regulatory 

burden imposed on swap dealers or causing them to cease offering 

certain risk management services to customers.’’

I think I heard him correctly. The Chairman, maybe he overlooked this letter, indicated he hadn’t received any input in that regard. 

Would you agree with me that this is a pretty definitive letter 

from you and your coalition? 

Mr. CVRKEL. That is correct. 

Mr. JOHNSON. And that maybe the Chairman just overlooked this 

public input? 

Mr. CVRKEL. Apparently he has. 

Mr. JOHNSON. Mr. Field, you are a corporate citizen of my State 

of Illinois, and we are very happy and proud to have you, and I 

know Congressman Schilling who represents your district just does 

66

an extraordinary job of advocating on your behalf and your employees’ behalf. 

But let me just ask you specifically whether you think that the 

captive finance exemption that we have referenced in questions in 

response, was intended for a business like yours. And a follow-up 

question is: What would be the impact of your specific ability to 

lend to farmers and others if they don’t qualify for that exemption? 

Mr. FIELD. Well, first let me thank you for the comments about 

Deere, and I am very privileged to be here and represent Deere, 

and we are privileged to be in the great State of Illinois. 

Mr. JOHNSON. Even though we are trying to tax you and Caterpillar and everybody else out of the state, in the state legislature. 

But that is another issue. 

Mr. FIELD. Yes. We believe that the captive finance exemption 

is—and the legislative intent was clearly to capture companies like 

Deere. And as we mentioned, we were very active in the process. 

And the reason why we are active in the process is because this 

is a critically important offering for us and for our customers. 

And the reason why it is critically important is because the farm 

sector isn’t always the world’s most favorite sector in the world. 

And neither is the construction sector. But we are there through 

thick and thin. We are in the finance business not to be in the finance business; we are in the finance business to help sell pieces 

of John Deere equipment. And if we did not have that exemption, 

well, one thing for sure is that there would be an increased cost, 

increased regulatory, burdensome requirements for us, and ultimately impacted in the wallets of our farmer customers, or through 

us by having to take costs out of the system somewhere else. Because we need to be in the finance business and we need to be 

there through thick and thin. 

Mr. JOHNSON. Let me just encourage you to continue to communicate with us specifically through Congressman Schilling, who is 

your advocate here, and we hope to be responsive to what you want 

us to do. 

One last question for Ms. Trakimas. 

Ms. TRAKIMAS. Yes. 

Mr. JOHNSON. Can you give me some examples, I have only 

about 20 seconds, so your 20 second examples of some of the particular swaps that you provide to customers, and why you think 

that should be distinguished from swaps dealing in general? 

Ms. TRAKIMAS. Our swaps are what we call plain vanilla swaps 

fixed or floating, and caps. And essentially this is just to manage 

the interest rate risk that we as lenders have on our balance sheet. 

It helps us manage our liquidity and our costs. And we also provide 

these swaps to our customers. These are extremely low-volatility 

swaps and they are merely there to cap the interest rate risk that 

is either connected with our loans or our customers’ loans. 

Mr. JOHNSON. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman’s time has expired. The chair now 

recognizes the gentleman from Texas, Mr. Conaway, for 5 minutes. 

Mr. CONAWAY. Thank you, Mr. Chairman. And, panel, thank you 

for sitting here all afternoon. 

You all heard Chairman Gensler’s comments to our questions, 

several different directions in trying to understand his idea of a 

67

swap dealer. Can any of you say with any degree of certainty how 

you are classified under these new rules? Just right down the list. 

Mr. Allison. 

Mr. ALLISON. I don’t think I can say with certainty how we ought 

to be classified. I think I know where Chairman Gensler thinks we 

are, but I don’t know that that is the outcome necessarily dictated 

by the rules. 

I will not claim to understand fully how all of the rules work. 

But, I know where Chairman Gensler thinks the answer is for us. 

Mr. CONAWAY. Okay. Mr. Cvrkel. 

Mr. CVRKEL. I think we would be considered a swap dealer. 

Mr. CONAWAY. Okay. Mr. Field. 

Mr. FIELD. I don’t think we could say with a level of certainty 

that I would be comfortable answering. 

Mr. CONAWAY. Mr. McMahon. 

Mr. MCMAHON. I don’t think any of our members should be classified as swaps dealers; but, again, there was a question asked 

about utilities, and the Chairman answered that question to say 

that most aren’t, but some may be. So that would be my interpretation of what he said. 

Ms. TRAKIMAS. We really have no idea. But to the extent that we 

are like commercial banks and our business is like commercial 

banks, we think we should be treated like commercial banks and 

be exempt. 

Mr. CONAWAY. The point being is that that level of uncertainty 

and/or certainty is pervasive across the folks you represent, your 

members or whatever, and so that is a pretty telling indication that 

we don’t have a lot of granularity yet. We made a big deal about 

the cost-benefit analysis that we think has not been done at CFTC. 

At least the comments included in their proposed rules are pretty 

cavalier with respect to the decision making process. 

Can you comment on what the estimates that the CFTC has said 

you will bear in terms of cost versus your own internal analysis of 

what you think it is going to cost to comply as you understand the 

rules today, Mr. Allison? 

Mr. ALLISON. In certain of the rulemakings, the Working Group 

has been able to do fairly detailed comparisons of our estimate 

versus the CFTC’s estimate, and our perspective is that the costs 

we would expect to bear are very, very, very much larger than 

what the CFTC has. 

Mr. CONAWAY. A factor of what? 

Mr. ALLISON. Up to a factor of 100, depending on exactly what 

costs element you are looking at. 

Mr. CONAWAY. Thank you. Mr. Cvrkel. 

Mr. CVRKEL. Yes. As far as if it goes the way it is written now, 

we would be out of the swap business. We would not take on the 

added cost, and we would not be able to provide long-term fixed 

rate debt service cost to our customers. 

Mr. CONAWAY. Okay. Mr. Field. 

Mr. FIELD. We have not done a detailed analysis, but suffice to 

say that our presence here today is because we believe the cost is 

quite significant to Deere. 

Mr. CONAWAY. Significant beyond what the estimate that the 

CFTC is providing? 

68

Mr. FIELD. No. No. Not beyond. 

Mr. CONAWAY. So you think the CFTC got it right as to what it 

would cost you? 

Mr. FIELD. Let me get back to you on that. 

Mr. CONAWAY. It is a leading question. 

Mr. FIELD. We haven’t done a comparison. 

Mr. CONAWAY. Okay, thank you. Mr. McMahon. 

Mr. MCMAHON. I am not aware of an estimate in terms of the 

impact on the utility industry. But what I will say, as I pointed out 

in my statement, is assuming that we are end-users, this transactional approach that they appear to be going in terms of the enduser exemption would be costly in and of itself, and it shouldn’t be 

like that for end-users. 

Mr. CONAWAY. But the information in the proposed rule, does it 

give you enough information to be able to—for your members to 

guess at what their implementation cost would be? 

Mr. MCMAHON. Again, if some of them fall into this category of 

swaps dealer, it would be profound. And, we don’t have all the information we will need at this point because there is reporting and 

a lot of different things and systems changes and governance 

changes. So there are a lot of issues. 

Mr. CONAWAY. Any indication you have in the proposed rules 

that they are getting it right; or is it just a broad statement you 

think understated what the costs will be? 

Mr. MCMAHON. We just feel that the costs are going to be very 

significant. 

Mr. CONAWAY. Ms. Trakimas. 

Ms. TRAKIMAS. We have attempted to make an estimate of the 

costs, but the rules are so vague that we, with no confidence or accuracy, can come up with a number. But it is clear that costs will 

go up, and credit availability to our customers will decline and 

farmers and ranchers will suffer. 

Mr. CONAWAY. Okay. Just for the record, does anybody think 

those are good results, that costs go up and services go down? Just 

official. 

Mr. ALLISON. For the record, no. 

Mr. CONAWAY. Mr. Field? 

Mr. Cvrkel? 

Mr. CVRKEL. No. 

Mr. CONAWAY. The transcriber can’t put down nods of the head, 

so I need you to say in the record. Mr. Field. 

Mr. FIELD. No. 

Mr. CONAWAY. Mr. McMahon. 

Mr. MCMAHON. No. 

Ms. TRAKIMAS. No. 

Mr. CONAWAY. Mr. Chairman, I yield back. 

The CHAIRMAN. The gentleman yields back the balance of his 

time. I now turn to the gentleman from Illinois, for 5 minutes, Mr. 

Schilling. 

Mr. SCHILLING. Thank you, Chairman. First and foremost I 

would like to welcome you all here, and I am with Representative 

Johnson and we have a lot better things that we could be doing 

right now. And I am part of the freshman class, the 87 that were 

69

swept in, and I come here basically for the same reason that I believe that you folks might be here, is the over-regulating. 

You know, I look at Mr. Field’s company which is in the 17th 

Congressional District. It has been the backbone of our district for 

over 100 years. I believe we have close to 60,000 employees there. 

And the thing that we are finding in Illinois is because of over-regulating and overtaxing, we are losing lots of people from our great 

state. And people are finally rising up to that challenge. 

But I just have a couple of questions for Mr. Field specifically. 

Could you just comment maybe on the timing sequencing and the 

analysis of the SEC and the CFTC on their proposed rulemaking? 

Mr. FIELD. Yes. Maybe I will answer that question a little bit 

more from—contrast it with at least how we would approach it 

from a business perspective, because I can’t sit here and be as presumptuous that I understand exactly all these regulatory processes 

as some of the folks that are very involved in it. But I would say 

from our perspective, when we are doing a product program, we always say never, ever put quality—put schedule, rather, ahead of 

quality. I think the analogy in this particular piece of legislation 

and rulemaking is dead-on. 

I think what we would like to see is, first of all, that we come 

out with a quality product that has the appropriate level of public 

conversation, discussion, and exposure prior to going into adoption. 

I think it is vitally important that we settle on these definitions 

first and foremost, and then we can start to see how this mosaic 

comes together, because we understand what definitions apply to 

who and what, and where we are going to be in this whole process. 

Right now, it is a little bit like from our perspective; and from others’ perspective, it is a little bit like trying to put your finger on 

a bead of mercury, because you might fall out of this one and then 

you are in here and then you are over here. So, getting buttoned 

down in aggregate and a holistic view of the definitions, so then we 

can start to understand what provisions apply to whom, would be 

very, very important. 

Mr. SCHILLING. So basically you would say that just let us know 

what our environment is, what cards are on the table, so we know 

what we are doing. 

Mr. FIELD. Yes. And let’s not shortchange this. This is a very, 

very sweeping piece of legislation for corporate America and for all 

that are involved in the financial process. I think from our perspective, we think it would be a grave injustice to put schedule ahead 

of quality here. 

Mr. SCHILLING. And then finally, and being one of the less senior 

people here, a lot of my questions get asked by the time it gets to 

me. So finally, do you think that the agencies will meet their 1 

year deadline or even should meet the 1 year deadline? 

Mr. FIELD. I think Chairman Gensler indicated that they most 

likely are not going to. And I would say that, from my perspective, 

is probably a good thing because at least it shows we are taking 

a little bit of time. But, having that 1 year deadline out there in 

terms of a sort of a backdrop is something that I think we might 

be better off if we were to remove that or suspend it. 

Mr. SCHILLING. Thank you, Mr. Field, and thank you all for what 

you do for your communities. And I yield back my time. 

70

The CHAIRMAN. The gentleman yields back. And the chair now 

recognizes the gentleman from Pennsylvania, Mr. Thompson, for 

the concluding 5 minutes. 

Mr. THOMPSON. Thank you, Mr. Chairman. Thanks to the panel, 

everyone on the panel for your testimony and weighing in on this. 

My first question actually really has to do more with the sequencing in the process by which the CFTC has used in rolling this 

out. And have the proposed rules impacted your ability to participate in the process, and how has it impacted your ability to evaluate how the proposed regulations will impact your business? 

Mr. ALLISON. The sequencing has, in fact, had a detrimental effect on our ability to evaluate the rules and respond sensibly to the 

CFTC with comments on them. The Working Group had filed with 

the CFTC, before the rulemakings came out, a letter proposing an 

order for the rules. The CFTC followed a different order. And we 

recently filed another comment with the CFTC about the sequence 

we think they should use from here, and I would be happy to get 

those added into the record if that would be helpful. 

Mr. THOMPSON. Thank you. 

Mr. CVRKEL. As far as when we look at the proposal, in my job 

I have multiple tasks to do other than this. So to spend my time 

to understand all the proposed regulations and go down that road 

is—I just really don’t have the time. The concern I have, it is going 

to affect our customers, and I believe if you are a bank you want 

to have good customer service, and that is how you keep your customers. And being defined as a swap dealer, we would have a disservice to our customers and also to economic growth in our region 

because credit will no longer be there for the long term. 

Mr. THOMPSON. Thank you. Mr. Field. 

Mr. FIELD. I think the sequencing has had an impact. I think, 

to my earlier comment, not having all the definitions as the starting point, speaks to that. I think earlier today a Member of Congress said, ‘‘You know, it would be nice to have all the pieces together so that we can see how this all interrelates rather than 

piecemeal at some point in time.’’

The CHAIRMAN. Mr. McMahon. 

Mr. MCMAHON. I would concur. I think the sequencing has had 

an impact and a negative impact. I would suggest that we should 

start with the fundamental definitions, particularly with a swap, 

and work our way out. Our view kind of coming in was that we 

would mostly be, we would be end-users and that we would only 

be engaged in one or two of these rulemakings, not 17 as we have 

to this point. So, yes, it has. 

Ms. TRAKIMAS. My response to your question is that I would encourage the CFTC to go back to what it was tasked with by Congress, and that is to ensure that systemic risk is reduced and controlled. How long that takes, if it is a year, clearly we don’t think 

they should be bound by a time frame, but we would really ask 

them to focus on the main purpose of what we are doing here 

today, and that is to control and reduce systemic risk. 

Mr. THOMPSON. I appreciate, actually, all of your thoughts not 

only on how it impacts your business, but specifically all the suggestions of how this could have been done in a better way to minimize negative impacts and the consequences. 

71

Mr. Cvrkel, why should community and regional banks receive 

different treatment under Title VII, and why is your derivative use 

distinguishable from those that are the target of the new regulation under Dodd-Frank? 

Mr. CVRKEL. I guess the way I look at it is, here again, banks 

like ours didn’t cause the meltdown. We don’t have any—the swaps 

we do are vanilla swaps. There is no additional risk exposure. And 

here again, there is some confusion on defining risk related to 

swaps. And the risks should be defined as the uncollateralized portion of that swap, not the notional. And under Dodd-Frank I don’t 

believe under the proposals, opinions of banks our size and how we 

use bank swaps with our customers were taken into consideration. 

Mr. THOMPSON. Very good. I would assume that most you would 

agree with the thoughts that this is actually a solution in search 

of a problem as it was proposed. 

Thanks, Mr. Chairman. 

The CHAIRMAN. The gentleman’s time has expired. The time for 

all questions has expired. 

Before we adjourn, I would like to thank our panel’s participation. Many times in this body we become so focused on grandiose 

pieces of legislation that we forget that there are dramatic effects 

on you, your customers, your businesses, your pensioners, on the 

entire economy as a whole. And that is why we need to hear from 

you in the straightforward fashion that you have come today to discuss the potential impact. 

With that, under the rules of the Committee, the record for today’s hearing will remain open for 10 calendar days to receive additional material and supplemental written responses from the witnesses to any question posed by a Member. 

This hearing of the Committee on Agriculture is adjourned. 

[Whereupon, at 5:20 p.m., the Committee was adjourned.] 

[Material submitted for inclusion in the record follows:] 

72

73

1 Committee on Payment and Settlement Systems (CPSS), International Organization of Securities Commissions (IOSCO). 2 CPSS IOSCO Principles for financial market infrastructures—consultative report 2011. 

3Federal Register Vol. 76, No. 13 page 3701. 4 CPSS IOSCO Principles for financial market infrastructures—consultative report 2011, Principle 18, Key consideration 1. 5Such as the Commission’s proposals 39.12(a)(1)(iv) ‘‘A derivatives clearing organization shall 

not require that clearing members must be swap dealers’’, ibid (v) ‘‘A derivatives clearing organization shall not require that clearing members maintain a swap portfolio of any particular 

size, or that clearing members meet a swap transaction volume threshold.’’, and ibid (2)(iii) ‘‘A 

derivatives clearing organization shall not set a minimum capital requirement of more than $50 

million.’’

SUPPLEMENTARY MATERIAL SUBMITTED BY HON. FRANK D. LUCAS, A

REPRESENTATIVE IN CONGRESS FROM OKLAHOMA

21 March 2011

DAVID A. STAWICK,

Secretary,

Commodity Futures Trading Commission, 

Washington, D.C.

Re: Re: Risk Management Requirements for Derivatives Clearing Organizations—Federal Register Vol. 76, No. 13 3698 (January 20, 2011) RIN 3038–

AC98

Dear Mr Stawick:

The Financial Services Authority (‘‘FSA’’) is submitting this letter in response to 

the request for comment in respect to the rule proposals by the Commodity Futures 

Trading Commission (‘‘the Commission’’) regarding risk management requirements 

for derivatives clearing organisations (‘‘DCOs’’). 

The FSA supports the September 2009 G20 commitment to improving the overthe-counter (‘‘OTC’’) derivatives markets and the clearing through central 

counterparties (‘‘CCPs’’) of standardised OTC derivative contracts. Regulatory authorities need to consider how existing market infrastructures can best play a role 

in meeting these commitments in an environment where CCPs are becoming increasingly systemically important. There is a clear need for stronger international 

standards for CCPs and the FSA is contributing to the work currently underway 

in developing such standards through, for example, the CPSS–IOSCO 1 work on 

principles for financial market infrastructure.2

Risk management standards for CCPs must be anchored in the characteristics of 

the products being cleared, and the FSA recognises that different product types may 

require different clearing models. This can extend to participant eligibility in models 

where the clearing members are required to perform specific actions to assist in a 

member default, for example Interest Rate Swap clearing models that include an 

obligation to bid for, or be allocated, portfolios from the defaulting clearing member. 

The Commission has requested comment on whether establishing a capital 

threshold on participants is an effective approach to promoting fair and open access 

to DCOs.3 The FSA supports transparent and non discriminatory rules, based on 

objective criteria, governing access to CCPs. We note the CPSS–IOSCO proposed 

principle that CCPs should allow ‘‘fair and open access to its services . . . based on 

reasonable risk-related participation requirements’’.4 However whilst capital thresholds or other participation eligibility threshold 5 limitations may be a potential tool 

to help ensure fair and open access to CCPs, to impose them on clearing arrangements for products that have complex or unique characteristics could lead to increased risk to the system in the short to medium term. 

Participation requirements sometimes need to be tailored to take into account the 

types of products being cleared by a CCP. For example the less liquid derivative 

markets typically require more complex default management processes that impose 

more onerous obligations on the participants than the exchange traded futures market. The ability of the surviving clearing members to meet their obligations in relation to default management is important in mitigating systemic risk in the event 

of a clearing member default. 

As noted by CPSS–IOSCO in its consultation, a CCP should ensure that its participants ‘‘have the requisite operational capacity, financial resources, legal powers, 

and risk-management expertise so that their activities do not generate unacceptable 

74

6 CPSS IOSCO Principles for financial market infrastructures—consultative report 2011, Principle 18, 3.18.1. 7 As well as adding legal and operational complexity at a time market stress, there is the risk 

that third parties might act differently than clearing members acting for themselves, given their 

different incentives. 8Federal Register Vol. 76, No. 13 39.12(a)(1)(iii). 

risk for the [CCP] and other participants’’.6 Capital requirements, the ‘‘swap dealer’’ 

criteria and portfolio size or volumes have previously served as proxies for establishing that a clearing member meets these criteria. If such criteria are to be excluded, then CCPs must develop alternative membership criteria that ensure the 

CCP’s own safety. Consideration should be given to the time required to develop 

such criteria. 

CCPs must therefore set appropriate risk based membership criteria that test a 

clearing member’s financial and operational ability to:

(i) manage the default of one of their own clients (i.e., to hedge and liquidate 

positions); and

(ii) participate in the CCPs default management process without introducing 

risk to the system (for example bid accurately in a default auction, hedge any 

portfolios acquired in a default auction, or manage any risks presented by the 

forced allocation of a portfolio in a default process).

Potential clearing members who lack the requisite operational capacity, financial 

resources, legal powers or risk-management expertise to participate in a default 

management process might consider that they could source these capabilities from 

a more experienced third party in the event of a default. Outsourcing the clearing 

member responsibility to partake in the default management process to a third 

party could present additional risk to the system 7 and increase the cost for the participant. 

A CCP may seek to reduce the relative impact of the default process on participants with lesser financial and operational ability by providing that their role in a 

default be proportional to the risk they introduce. As this would only limit the relative and not the absolute size of the risk (for example the size of portfolio that 

could be allocated to a clearing member in a default) this approach does not reduce 

the CCP’s need to set the appropriate membership criteria needed to gauge the ability of the clearing member to engage fully in the default management process (including loss allocation). 

Increasing the amount of margin called or contributions to the default fund does 

not compensate for the risk that a participant cannot participate in the default management process. Margin and default funds increase the time available to a CCP 

to liquidate its positions, but they do not directly assist the actual liquidation. 

We note that the Commission proposes that CCPs may exclude or limit certain 

types of market participant if the CCP can demonstrate that ‘‘the restriction is necessary to address credit risk or deficiencies in the participants’ operational capabilities that would prevent them from fulfilling their obligations as clearing members’’.8

If capital requirements, the ‘‘swap dealer’’ criteria and portfolio size or volumes are 

to be subject to limitation as criteria then we believe the Commission’s exclusion 

should specifically extend to address clearing members whose operational capabilities would prevent them from fulfilling their obligations to the CCP to participate 

in a default management process. 

The FSA therefore requests that when the Commission finalises its rules it takes 

into account that access should be based on proportionate risk-related participation 

requirements and that risks may be introduced into the system by universally prohibiting certain participant eligibility criteria. 

Yours sincerely,

ALEXANDER JUSTHAM,

Director, Market Division,

Financial Services Authority. 

SUPPLEMENTARY MATERIAL SUBMITTED BY JAMES C. ALLISON, GAS AND POWER RISK

MANAGER, NORTH AMERICA, CONOCOPHILLIPS, HOUSTON, TX; ON BEHALF OF

WORKING GROUP OF COMMERCIAL ENERGY FIRMS

February 22, 2011

DAVID A. STAWICK,

Secretary,

75

1 End-User Exception to Mandatory Clearing of Swaps, Notice of Proposed Rulemaking, 75 

FED. REG. 80747 (Dec. 23, 2010). 2Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111–203, 124 Stat. 

1376 (2010). 3 An ‘‘SEC Filer’’ refers to an issuer of securities that is registered under section 12 of the 

Securities Exchange Act of 1934 (15 U.S.C. 781) or that is required to file reports pursuant to 

Section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 780). 

Commodity Futures Trading Commission, 

Washington, D.C.

Re: End-User Exception to Mandatory Clearing of Swaps, RIN 3038–AD10

Dear Secretary Stawick: 

I. Introduction 

On behalf of the Working Group of Commercial Energy Firms (the ‘‘Working 

Group’’), Hunton & Williams LLP hereby submits these comments in response to the 

request for public comment set forth in the Commodity Futures Trading Commission’s (the ‘‘CFTC’’ or ‘‘Commission’’) Notice of Proposed Rulemaking, End-User Exception to Mandatory Clearing of Swaps (the ‘‘Proposed Rule’’), published in the Federal Register on December 23, 2010,1 which proposes to provide ‘‘non-financial entities,’’ i.e., commercial firms, with an exception from the mandatory clearing requirements (‘‘End-User Exception’’) pursuant to new Section 2(h)(7) of the Commodity Exchange Act (‘‘CEA’’), as established by Section 723 of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act of 2010 (the ‘‘Act’’).2

The Working Group considers and responds to requests for public comment regarding legislative and regulatory developments with respect to the trading of energy commodities, including derivatives and other contracts that reference energy 

commodities. The Working Group appreciates the opportunity to provide these comments in response to the Proposed Rule and respectfully requests that the Commission consider the comments set forth herein. The Working Group looks forward to 

working with the Commission to further develop and define the End-User Exception 

prior to the effective date of Title VII. 

II. Executive Summary 

The Working Group strongly supports the goals of the Act to enhance transparency and reduce systemic risk in the swap markets. To that end, the Working 

Group submits for the Commission’s consideration comments and recommendations 

it believes will assist the Commission in developing a final rule that preserves the 

integrity of the swap markets and serves the best interests of market participants. 

Specifically, the Working Group requests the Commission adopt the following recommendations: 

1. Revise Proposed CFTC Rule 39.6(b) to Require a Single, Omnibus Annual Notification Filing. The Working Group submits that requiring notification 

to the Commission each time a non-financial entity elects to use the End-User Exception is inconsistent with Section 2(h)(7)(A) of the Act. Additionally, such requirement is overly burdensome and will disrupt the trade execution process. In light of 

the foregoing, the Working Group strongly suggests that the Commission require a 

single, omnibus annual filing that reports such notification in the same prospective, 

narrative, and comprehensive form as the Commission’s current Form 40. 

2. Recognize Discretion Granted to the Board in Meeting its Obligation 

to Review and Approve Election to Use End-User Exception. Contrary to new 

CEA Section 2(j), which permits an appropriate committee of the board of directors 

(or equivalent governing body) (collectively, the ‘‘Board’’) broad discretion in meeting 

its obligation to review and approve the use of the End-User Exception by an SEC 

Filer,3 proposed CFTC Rule 39.6(b)(6)(ii) requires board review and approval on a 

transaction-by-transaction basis. As such, the Commission should reconcile the proposed rule with the clear and unambiguous new CEA Section 2(j) to permit the 

board (i) to adopt a single, continuing resolution approving any decision by an SEC 

Filer to use the End-User Exception and (ii) to delegate its obligation to appropriate 

supervisory personnel with direct knowledge and oversight responsibility of swap 

trading activities. 

3. Adopt a Definition of ‘‘Hedging’’ or ‘‘Mitigating Commercial Risk’’ that 

Appropriately Reflects Commonly Used Practices In Energy Markets. Because the unambiguous language of the proposed definition of ‘‘commercial risk’’ 

eliminates the need to adopt regulatory text identifying transactions that fall outside of the scope of this definition, proposed CFTC Rule 39.6(c)(2)(i) should be struck 

from any final rule adopted in this proceeding. Further, commercial energy firms 

do not generally execute swaps transactions to hedge a particular underlying physVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00079 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
76

4For instance, certain commercial firms in the energy sector use asset-based collateral arrangements (i.e., first liens in generating facilities). These collateral arrangements are accepted 

in energy markets as an appropriate form of credit support for liabilities and derivatives exposures. 5Proposed Rule at 80748. See Swap Data Recordkeeping and Reporting Requirements, Notice 

of Proposed Rulemaking, 75 FED. REG. 76574 (Dec. 8, 2010). 

ical trade. Indeed, in order to mitigate commercial risk, commercial energy firms 

hedge their underlying physical positions dynamically and on a portfolio basis, 

which do not involve the matching of hedges to specific underlying physical positions. Thus, any definition of ‘‘hedging’’ adopted by the Commission must contemplate such market practices. 

4. Exempt Inter-Affiliate Swap Transactions from Mandatory Clearing.

Because inter-affiliate transactions do not have any bearing on, or reflection of, 

swap markets, these transactions should be exempt from the mandatory clearing requirements. At a minimum, the Working Group recommends that the Commission 

confirm that otherwise qualified non-financial entities may engage in uncleared 

swap transactions with a swap dealer or major swap participant affiliate. 

III. Comments of the Working Group of Commercial Energy Firms 

The Working Group is a diverse group of commercial firms in the energy industry 

whose primary business activity is the physical delivery of one or more energy commodities to others, including industrial, commercial, and residential consumers. 

Members of the Working Group are energy producers, marketers, and utilities. As 

commercial firms, the Working Group members function primarily as principals, not 

intermediaries, by transacting futures and energy-related derivatives on a daily 

basis, among other things, to mitigate or hedge the commercial risk associated with 

their core businesses of delivering electricity, heating oil, crude oil, natural gas, propane, gasoline, and other energy commodities to U.S. consumers. 

The Working Group generally supports the intent of the Proposed Rule implementing new CEA Section (2)(h)(7). By exempting qualifying transactions involving 

‘‘non-financial entities’’ from the mandatory clearing requirements, this exception 

permits the continuation of a well-established and long-standing practice in the energy markets of accommodating the unique credit profiles of certain market participants. Unlike centralized clearing arrangements that demand uniformity in credit 

support based upon each underlying exposure, current practice in energy markets 

is for market participants to extend credit based on fundamental analysis of the 

ability of each counterparty to continue as a going concern, or through the use of 

alternative collateral support.4

The ability to transact swaps on an uncleared basis provides a significant cost 

benefit by permitting commercial energy firms to preserve capital and operating 

cash flow. This is particularly critical in such firms’ efforts to implement major capital spending programs designed to (i) enhance and expand energy infrastructure, 

(ii) develop and deploy technologies that promote energy independence, and (iii) 

comply with new environmental rules, regulations, and policies. More importantly, 

the ability of commercial energy firms to transact swaps on an uncleared basis is 

the most effective and efficient means to protect both themselves and consumers 

from the effects of volatility in physical energy markets. 

In recognition of the above factors, the Working Group respectfully recommends 

that the Commission adopt the revisions proposed herein to ensure that any final 

rule will promote efficient and orderly energy markets while ensuring transparency 

in accordance with the requirements of new CEA Section 2(h)(7). 

A. An Annual Filing Is Sufficient To Meet the Notice Requirement Regarding the Election To Use the End-User Exception 

New Section 2(h)(7)(A) of the CEA provides counterparties to a swap an exception 

from mandatory clearing if one of the counterparties ‘‘(i) is a non-financial entity; 

(ii) is using swaps to hedge or mitigate commercial risk; and (iii) notifies the Commission, in a manner set forth by the Commission, how it generally meets its financial obligations associated with entering into non-cleared swaps.’’ Proposed CFTC 

Rule 39.6(b) requires the ‘‘reporting counterparty’’ to provide notification of the manner in which the non-financial electing party expects to meet its financial obligations associated with the qualifying, non-cleared swap. 

Specifically, such notification must be submitted to a swap data repository 

(‘‘SDR’’) pursuant to the protocol for ‘‘reporting counterparties’’ set forth in the proposed rule for Swap Data Recordkeeping and Reporting Requirements (the ‘‘Proposed 

General Reporting Rule’’) 5 and must contain several items of information associated 

77

6See proposed CFTC Rule § 39.6(b). These items generally include: (1) the identity of the electing counterparty to the swap; (2) whether the electing counterparty is a ‘‘financial entity’’ as 

defined in new CEA Section 2(h)(7)(C)(i); (3) whether the electing counterparty is a finance affiliate meeting the requirements of new CEA Sections 2(h)(7)(C)(iii) or 2(h)(7)(D); (4) whether the 

swap is used by the electing counterparty to hedge or mitigate commercial risk as defined in 

proposed CFTC Rule § 39.6(c); (5) the method or mechanism by which the electing counterparty 

generally expects to meet its financial obligations associated with its non-cleared swaps; and (6) 

whether the electing counterparty is an issuer of securities registered under section 12 of, or 

is required to file reports under section 15(d) of, the Securities Exchange Act of 1934. 7 Unlike the Act, the Proposed Rule defines an issuer of securities to include a counterparty 

that is controlled by a person that is an issuer of securities. See Proposed Rule at 80750 n. 15. 

That is, the Proposed Rule broadens the definition of an issuer of securities as set forth in the 

Act to include subsidiaries. The Working Group submits that there is no policy or purpose that 

supports the expansion of the definition of issuer of securities beyond that which is provided 

under the Act. Indeed, while the Working Group acknowledges the Commission’s concern in ensuring proper Board oversight of a non-financial entity’s swap trading activity, the Commission 

required such only for an SEC Filer. If the Commission were seeking to accomplish such an objective, then it should have imposed the requirement on all non-financial entities that use swap 

trades. Because it did not, the Proposed Rule results in unreasonable disparate treatment of 

market participants. 8 In relevant part, the Proposed Rule states:

The Commission proposes in § 39.6(b) to require non-financial entities to notify the Commission each time the end-user clearing exception is elected by delivering specified information

to an SDR in the manner required by proposed rules for swaps data recordkeeping and reporting.

Proposed Rule at 80748 (emphasis added; footnote omitted). 

with a non-financial entity’s election to use the End-User Exception.6 Where the 

counterparty electing to use the End-User Exception is an SEC Filer,7 the notification must include two additional items of information: (i) the relevant SEC Central 

Index Key number for that counterparty; and (ii) whether the Board has reviewed 

and approved the decision not to clear the swap. 

The Proposed Rule states that the submission of information required by proposed 

CFTC Rule 39.6(b) must be submitted to an SDR on a transaction-by-transaction 

basis.8 Notwithstanding this requirement, the Proposed Rule requests comment on 

whether it would be difficult or prohibitively expensive for persons to report the information that must be included in the notification required by proposed CFTC Rule 

39.6(b). The Working Group submits that it would be prohibitively expensive for 

persons to do so and suggests a much less burdensome approach. 

1. A Single, Omnibus Annual Filing Is Consistent with, and in Furtherance of, the 

Statutory Objectives of New CEA 2(h)(7)(A) 

To maximize efficiency, minimize administrative burdens and costs, and ensure 

consistency with the express language of new CEA Section 2(h)(7)(A), the Working 

Group submits that this notification only be submitted annually and recommends 

that such notification should be reported in the same manner and form as the Commission’s current Form 40 applicable to large traders with reportable futures positions. Specifically, the Working Group envisions that the notification would be (i) 

prospective in nature (i.e., for the forthcoming calendar year beginning on January 

1), and (ii) provide all information required by proposed CFTC Rule 39.6(b) on a 

narrative and consolidated basis. 

Proposed CFTC Rule 39.6(a) requires submission of the notification of the election 

of the End-User Exception to be on a transaction-by-transaction basis. Moreover, the 

Proposed Rule interprets this provision to require market participants to determine 

whether a swap qualifies for the End-User Exception at the time of execution. As 

noted below, these requirements conflict with the plain language of new CEA Section 2(h)(7)(A). This apparent conflict should be reconciled by the Commission in 

any final rule issued in this proceeding. 

Proposed CFTC Rule 39.6(a) states, in relevant part:

(a) A counterparty to a swap (an ‘‘electing counterparty’’) may elect to use the 

exception to mandatory clearing under section 2(h)(7)(A)(iii) of the Act if the 

electing counterparty is not a ‘‘financial entity’’ as defined in section 2(h)(7)(C)(i) 

of the Act, is using the swap to hedge or mitigate commercial risk as defined 

in § 39.6(c), and provides or causes to be provided to a registered swap data repository or, if no registered swap data repository is available, the Commission, 

the information specified in § 39.6(b) . . . .

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9 Notwithstanding the statement in proposed CFTC Rule 39.6(a) that ‘‘a counterparty to a 

swap (the ‘electing counterparty’) may elect to use the exception to mandatory clearing under 

section 2(h)(7)(A)(iii) of the Act,’’ new CEA Section 2(h)(7)(A) is drafted in the conjunctive and, 

therefore, should be read in its entirety as the End-User Exception. The Commission’s reliance 

on new CEA Section 2(h)(7)(A)(iii) as the specific End-User Exception is misplaced. This interpretation effectively swallows the other statutory criteria that must be satisfied by a market 

participant to avail itself of the End-User Exception. The Working Group respectfully submits 

that new CEA Section 2(h)(7)(A)(iii) constitutes only the ‘‘notice’’ element of the End-User Exception that must be interpreted consistent with the express language of, and Congressional intent, 

underlying the other statutory elements. 10The Working Group believes that placing this obligation on the reporting counterparty is 

improper as it could create an inherent conflict of interest between the parties to a commercial 

transaction that should be avoided by the Commission. 11See 17 CFR § 21 (2010). 

(emphasis added).9

In contrast, new CEA Section 2(h)(7)(A) states:

(A) IN GENERAL.—The requirements of paragraph (1)(A) shall not apply to a 

swap if 1 of the counterparties to the swap—

(i) is not a financial entity; 

(ii) is using swaps to hedge or mitigate commercial risk; and

(iii) notifies the Commission, in a manner set forth by the Commission, 

how it generally meets its financial obligations associated with entering 

into non-cleared swaps.

(emphasis added).

The language of new CEA Section 2(h)(7)(A)(ii) and (iii), highlighted above, demonstrates a clear and unambiguous intent by Congress to permit a non-financial entity to make a general election to use the End-User Exception. Use of the singular 

form of the word ‘‘swap’’ in proposed CFTC Rule 39.6(a) is in direct conflict with 

the statutory use of ‘‘swaps’’ in CEA Section 2(h)(7)(A)(ii) and (iii). The conjunctive 

requirements of CEA Section 2(h)(7)(A) make clear that the election to use the EndUser Exception will not be required on a transaction-by-transaction basis. That is, 

this language cannot be reasonably construed by the Commission to require market 

participants to identify or provide notification that a particular swap qualifies for 

the End-User Exception at the time it is entered into. Consequently, since the election is not on a transaction-by-transaction basis, notification cannot be on a transaction-by-transaction basis unless the statute indicates otherwise. As stated above, 

however, new CEA Section 2(h)(7)(A)(iii) references ‘‘swaps’’ in the plural, which 

does not contemplate notification on a transaction-by-transaction basis. Accordingly, 

although new CEA Section 2(h)(7)(A)(iii) provides the Commission with the discretion to prescribe the manner (i.e., the form and format) in which such notification 

may be provided to it, the Commission must interpret this provision consistent with 

the express language of, and the Congressional intent underlying, new CEA Section 

2(h)(7)(A)(ii) and (iii), which clearly permits the use of the Working Group’s proposed annual omnibus notification in the form described above. 

2. Notification Should be Submitted by the Non-Financial Entity Electing to Use the 

End-User Exception 

The Working Group submits that it is not appropriate to impose an obligation on 

a ‘‘reporting counterparty,’’ as that term is defined in the General Reporting Rule,

to submit information to an SDR associated with a non-financial entity 

counterparty’s election to use the End-User Exception.10 In order to minimize the 

potential for administrative errors or conflicts between parties that could disrupt 

the trade execution process, proposed CFTC Rule 39.6(b) should be revised to require the counterparty electing to use the End-User Exception to submit any required information to an SDR, not the reporting counterparty. 

To the extent that the Commission has concerns regarding possible abuse of this 

exception, new CEA Section 2(h)(7)(F) provides it with the authority to request information from any non-financial entity claiming the use of the End-User Exception. 

The Commission may also solicit such information by issuing a formal special call 

pursuant to CFTC Rule 21.11 In addition, the Commission’s broad statutory enforcement authority under the CEA, as enhanced by the enactment of Title VII, is a 

strong deterrent to situations in which the End-User Exception could be abused 

through the knowing and willful submission of false information. 

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12See Proposed Rule at 80748, 80757 § 39.6(b)(6)(ii) (stating that the Commission must be notified ‘‘each time’’ the End-User Exception is elected, and where the non-financial party is an 

SEC Filer, such notification must include confirmation that the Board has approved the decision 

not to clear the swap).

B. Board Review and Approval of Use of End-User Exception by an SEC 

Filer 

As noted above, pursuant to proposed CFTC Rule 39.6(b)(6)(ii), the End-User Exception is only available to an SEC Filer if the Board has reviewed and approved 

its decision to enter into swap transactions subject to this exception. Further, this 

provision requires the notification submitted to an SDR relating to a counterparty’s 

election to use the End-User Exception to include confirmation that the required 

Board review and approval has been obtained. 

The scope and application of proposed CFTC Rule 39.6(b)(6)(ii) raises two concerns that should be addressed by the Commission in any final rule issued in this 

proceeding. First, the requirement for an SEC Filer to obtain Board review and approval each time a non-financial entity elects to use the End-User Exception is inconsistent with the statutory language of CEA Section 2(j) requiring a Board to review and approve the decision to enter into swaps, not each individual swap. Second, the Proposed Rule is not clear whether the Board review and approval requirement may be delegated to executive officers or other senior managers that have the 

direct corporate oversight responsibility for (i) stand-alone subsidiaries or affiliates 

of an SEC Filer engaged in swap trading activities, or (ii) functional business units 

of a corporate entity in which swap trading activities are organizationally housed. 

The Working Group’s concerns are discussed separately below. 

1. Board Review and Approval of an SEC Filer’s Decision to Use the End-User Exception 

Based upon the express language of proposed CFTC Rule 39.6(b)(6)(ii) and related 

interpretative guidance in the Proposed Rule, it appears that an SEC Filer must obtain on a transaction-by-transaction basis Board review and approval of each and 

every election to use the End-User Exception.12 Specifically, proposed CFTC Rule 

39.6(b)(6)(ii) states, in relevant part, as follows: 

(6) Whether the electing counterparty is an entity that is an issuer of securities registered under section 12 of, or is required to file reports under 15(d) of, 

the Securities Exchange Act of 1934, and if so: 

* * * * *

(ii) Whether an appropriate committee of the board of directors (or equivalent body) has reviewed and approved the decision not to clear the 

swap.

(emphasis added).

This language violates new CEA Section 2(j) which states:

(j) COMMITTEE APPROVAL BY BOARD.—Exemptions from the requirements of subsection (h)(1) to clear a swap and subsection (h)(8) to execute a swap through 

a board of trade or swap execution facility shall be available to a counterparty 

that is an issuer of securities that are registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required to file reports pursuant to section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o) 

only if an appropriate committee of the issuer’s board or governing body has reviewed and approved its decision to enter into swaps that are subject to 

such exemptions.

(emphasis added).

The use of the phrase ‘‘decision to enter into swaps,’’ namely, the singular form 

of ‘‘decision’’ and plural form of ‘‘swaps,’’ in new CEA Section 2(j) cannot be reasonably interpreted by the Commission to require Board review and approval of an SEC 

Filer’s decision to elect the End-User Exception on a transaction-by-transaction 

basis. In contrast, such language actually requires only that a Board review and approve an SEC Filer’s general decision to enter into multiple swaps qualifying for the 

End-User Exception. Accordingly, pursuant to new CEA Section 2(j), a Board of an 

SEC Filer may adopt a single, continuing resolution approving the decision to use 

the End-User Exception. 

The Working Group’s reading of new CEA Section 2(j) is supported by a statement 

in footnote 18 of the Proposed Rule that a ‘‘board committee could adopt policies and 

procedures to review and approve decisions not to clear swaps, on a periodic basis 

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13Proposed Rule at 80750 n. 18. 14See Proposed Rule at 80750 nn. 16 & 18. 15Further Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Participant’’ and ‘‘Eligible Contract Participant,’’ 75 FED. REG. 80174 (Dec. 21, 2010). 16The Working Group supports proposed CFTC Rule § 39.6(c)(1)(iii), which provides that a 

swap transaction hedges or mitigates commercial risk if such swap ‘‘qualifies for hedging treatment under Financial Accounting Standards Board Accounting Standards Codification Topic 

815, Derivatives and Hedging (formerly known as Statement No. 133).’’ Yet the Working Group 

submits that other accounting regimes exist and are used by market participants. As such, any 

final rule should include those in addition to the standards of the Financial Accounting Standards Board. 

or subject to other conditions deemed satisfactory to the board committee.’’13 Specifically, this statement demonstrates a recognition by the Commission that a Board 

may review and approve an SEC Filer’s decision to use the End-User Exception at 

its discretion. A transaction-by-transaction review and approval process is not required. Recognizing the importance of appropriate and diligent corporate oversight 

as required by applicable state laws, the Board may modify the proposed resolution 

upon determining that a material change in circumstances warrants such action. 

Accordingly, to eliminate any regulatory uncertainty created by the Proposed 

Rule, the Commission should reconcile and conform the language of proposed CFTC 

Rule 39.6(b)(6)(ii) with new CEA Section 2(j). In doing so, the Commission will ensure that proposed CFTC Rule 39.6(b)(6)(ii) is consistent with, and gives meaning 

to, the Congressional intent underlying new CEA Section 2(j). 

2. Delegation of Board Review and Approval Obligation To Duly Authorized Personnel Should Be Permitted 

The Commission should clarify that, for non-financial entities formed as a standalone subsidiary or affiliate of a parent holding company, the Board, for that subsidiary or affiliate, is permitted to review and approve the decision to use the EndUser Exception. That is, Board review and approval for that non-financial entity is 

sufficient to meet the requirements of proposed CFTC Rule 39.6(b)(6)(ii), and such 

review and approval need not be obtained from the Board of the parent holding company. 

The Commission should further clarify that, for any non-financial entity operating 

as a functional business unit within a single corporate entity, the obligation to review and approve the use of the End-User Exception under proposed CFTC Rule 

39.6(b)(6)(ii) may be delegated by the Board to duly authorized executive officers or 

other senior managers with direct oversight responsibility for swap trading activities. 

The delegation of the Board review and approval requirement in proposed CFTC 

Rule 39.6(b)(6)(ii) to such executive officers and other senior managers will ensure 

that duly authorized supervisory personnel with day-to-day knowledge of the operation of the relevant swap markets and their participants are in the position to review and approve a non-financial entity’s use of the End-User Exception. Furthermore, such delegation is supported by statements in footnotes 16 and 18 of the Proposed Rule, which expressly contemplate the review and approval of an SEC Filer’s 

decision to use the End-User Exception to be undertaken by duly authorized personnel.14 The exercise of such delegated authority may be guided by internal policies 

and procedures adopted pursuant to proposed CFTC Rule 39.6(b)(6)(ii) or other conditions established by the Board itself. 

C. Scope and Application of End-User Exception to Transactions Intended 

To Hedge ‘‘Commercial Risk’’

The Working Group supports the Commission’s proposed interpretation of the 

term ‘‘commercial risk’’ in proposed CFTC Rule 39.6(c)(1), and the consistency of 

this interpretation with the use of the same term in the pending joint rulemaking 

further defining ‘‘Major Swap Participant.’’ 15 However, to ensure regulatory certainty, the Commission should (i) strictly limit this definition to identifying those 

swaps that hedge or mitigate ‘‘commercial risk,’’ as defined in proposed CFTC Rule 

39.6(c)(1); and (ii) strike proposed CFTC Rule 39.6(c)(2)(i) from any final regulations 

implementing this definition.16 In addition, swaps that are executed to mitigate or 

hedge commercial risk on a dynamic or portfolio basis should unconditionally qualify 

for the End-User Exception. 

1. The Proposed Definition of Commercial Risk Obviates the Need for Proposed 

CFTC Rule 39.6(c)(2)(i) 

Proposed CFTC Rule 39.6(c)(2)(i) is unnecessary and excessive in light of the proper scope and specificity of the proposed definition of ‘‘commercial risk’’ in proposed 

81

17 Nowhere in Title VII do the terms ‘‘speculation,’’ ‘‘investing,’’ or ‘‘trading’’ appear together. 

Further, there are open questions about what activity constitutes ‘‘investing’’ or ‘‘trading.’’ Even 

if such terms were to be defined, it is unclear whether Title VII affords the same treatment 

for swaps used for investing and trading as it does for swaps entered into for speculation. 18The Working Group is particularly concerned that the word ‘‘trading’’ might impermissibly 

include the buying and selling of commodities by parties that are primarily in the business of 

producing, delivering, storing, marketing, and managing physical commodities. This is traditional ‘‘commercial activity.’’ Yet, it may also come within the meaning of ‘‘trading.’’ Swaps executed in connection with this trading likely would constitute bona fide hedging transactions. In 

other words, proposed CFTC Rule 39.6(c)(2)(i) would effectively nullify the force and effect of 

proposed CFTC Rule 39.6(c)(1)(ii), which cannot be the intention of the Commission. 19Proposed Rule at 80752 at n. 23.

CFTC Rule 39.6(c)(1). Any transaction that does not fall within the definition ‘‘commercial risk’’ cannot, by definition and in any way, qualify for the End-User Exception. The Working Group is concerned that, if adopted, the broad and vague regulatory text in proposed CFTC Rule 39.6(c)(2)(i) will dilute and weaken the proposed 

definition of ‘‘commercial risk’’ in proposed CFTC Rule 39.6(c)(1). 

In addition, the terms ‘‘investing’’ and ‘‘trading,’’ set forth in proposed CFTC Rule 

39.6(c)(2)(i) are beyond the scope of the CEA, as amended by Title VII of the DoddFrank Act. Moreover, these terms, as well as the term ‘‘speculation,’’ are not defined 

and are widely used in swap markets in a variety of contexts.17 In energy markets, 

for instance, the term ‘‘trading’’ is often used to describe activity involving both bona 

fide hedging as well as proprietary trading.18 Notwithstanding that the regulation 

of ‘‘investing’’ and ‘‘trading’’ is beyond the scope of the CEA, the adoption of regulatory text containing such undefined, yet commonly used, terms will lead to conflicting interpretations regarding the scope and application of the End-User Exception. Confusion as to what constitutes investing, trading, and speculation will inject 

unnecessary and harmful uncertainty into swap markets. 

The Working Group respectfully submits that such a result is neither in the public interest nor is it consistent with the Congressional intent underlying the new 

CEA Section 2(h)(7)(A). Because the clear and unambiguous language of the proposed definition of ‘‘commercial risk’’ eliminates the need to adopt regulatory text 

identifying transactions that fall outside of the scope of this definition, the Commission should strike proposed CFTC Rule 39.6(c)(2)(i) from the final regulations implementing the End-User Exception. 

2. Swaps Used to Offset Risks Associated with Underlying Position in Physical Commodity Markets Hedge or Mitigate ‘‘Commercial Risk’’

Interpretive guidance in the Proposed Rule creates uncertainty whether the Commission is attempting to create different categories of activity in physical commodity 

markets in order to distinguish whether a swaps transaction is hedging or mitigating commercial risk. Such uncertainty arises from interpretive guidance set forth 

in footnote 23 of the Proposed Rule:

The Commission preliminarily believes that swap positions that are held for the 

purpose of speculation or trading are, for example, those positions that are held 

primarily to take an outright view on the direction of the market, including positions held for short term resale, or to obtain arbitrage profits. Swap positions 

that hedge other positions that themselves are held for the purpose of speculation or trading are also speculative or trading positions.19

The Working Group seeks clarification that the highlighted language above is intended to apply to other swaps positions ‘‘that themselves are held for the purpose of speculation’’, and not any other position that would also include physical positions. Otherwise the Working Group is concerned that the Commission has adopted a preliminary view that certain exposures in physical commodity markets would 

not fall within the definition of ‘‘commercial risk’’ in proposed CFTC Rule 39.6(c)(1). 

This view is not supported by any policy rationale, is inconsistent with the proposed 

language under proposed CFTC Rule 39.6, and could lead to absurd results that 

would have material, adverse impacts on both physical commodity and swap markets. All physical market participants, from car manufacturers, to toy stores, to 

merchant energy companies, are in the business of trying to sell a commodity for 

more than the cost of producing or procuring the commodity. An energy company 

procuring supply in advance of the summer driving season, or a toy store stocking 

its shelves in advance of a holiday, are both arguably taking a position in a physical 

market to trade based on speculation that there will be increased demand. If the 

phrase ‘‘other positions’’ is interpreted as applying to physical market positions, it 

could have the perverse result of treating certain bona fide hedges of positions as 

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20The following provides an example of dynamic hedging of natural gas and power prices by 

a commercial energy firm in over-the-counter swap markets. The dynamic hedging transactions 

relate to the sale of power from a gas-fired, electric generating facility (the ‘‘Asset’’). The impact 

of the strategy set forth below is to hedge commercial risk associated with changing market conditions to (i) facilitate a cumulative improvement on the return of the Asset, and (ii) allow for 

a better economic allocation of the underlying physical commodities being used or generated by 

the Asset.

• Step 1: Power Prices Exceed Gas Prices; Asset Hedged to Lock in Positive Margin. The

commercial energy firm purchases fixed price swaps to fix the prices for natural gas

fuel supply and power output produced by the Asset (‘‘Initial Hedges’’). At the time the

Initial Hedges are entered into, power prices exceeded natural gas prices. This strategy

locks in a specified positive margin for the Asset.

• Step 2: Power Prices and Gas Prices Reverse; Asset Unhedged to Capture Additional

Positive Margin. At a later date, the relative prices of natural gas and power reversed

(i.e., gas prices exceeded power prices to the point where the natural gas was worth

more sold as gas than it would be if it was converted to electricity), the commercial

energy firm bought back the Initial Hedges to maximize the positive margin on the

Asset. The repurchase of the Initial Hedges left the Asset in an unhedged position. The

repurchase of the Initial Hedges made economic sense because it would have been uneconomic from the physical commodity pricing perspective to run the Asset. Specifically,

it allowed the commercial energy firm to earn an additional positive margin on the

Asset under the then-existing market conditions by mitigating lost opportunity costs associated with holding gas positions that were worth more than the power it could have

generated.

• Step 3: Power Prices and Gas Prices Reverse Again; Asset Re-Hedged to Capture Additional Positive Margin. As the relative prices of natural gas and power reverse again

a few months later it becomes economical to produce output from the Asset and enter

into new fixed price natural gas and power price hedges to lock in an additional positive

margin on the Asset. 

outright speculative swap positions. This interpretation is not consistent with the 

Congressional intent underlying new CEA Section 2(h)(7)(A). 

In light of the foregoing, the Working Group respectfully requests that the Commission clarify that the language in the interpretive guidance set forth in footnote 

23 of the Proposed Rule is the result of imprecise drafting that should be corrected 

in any final rule issued in this proceeding. As long as a swap transaction is intended 

to (i) offset the types of risks, or (ii) meet other qualifying criteria, identified in proposed CFTC Rule 39.6(c)(1), it should be viewed as hedging or mitigating ‘‘commercial risk.’’ To remedy the uncertainty created by the above-quoted text in footnote 

23 of the Proposed Rule, the Working Group requests that the Commission clarify 

that the phrase ‘‘other positions’’ is intended to mean ‘‘other swap positions.’’

3. Swaps that Hedge Commercial Risk on a Portfolio or Dynamic Basis Should Qualify for the End-User Exception 

The Working Group respectfully requests the Commission to recognize that, although participants in physical energy commodity markets use swaps and futures 

to hedge underlying physical positions, they do not, as a general matter, execute 

such transactions specifically for the purpose of hedging a specified underlying physical position only. With this in mind, the End-User Exception should not be interpreted by the Commission to implement a ‘‘one-size-fits-all’’ approach to hedging by 

requiring an entity claiming use of this exception to match a swap that hedges or 

mitigates commercial risk with a specified underlying physical commodity transaction only. 

In physical energy markets, the predominant risk management practice used by 

commercial firms is to hedge underlying physical assets and related positions on a 

portfolio or aggregate basis. In order to effectively and efficiently mitigate commercial risk associated with underlying physical assets and related positions, commercial energy firms will dynamically hedge their aggregate exposures on a regular and 

on-going basis. A commercial firm will normally hedge these exposures utilizing 

physical transactions, futures, and swaps, the exact combinations of which will be 

determined by various characteristics which may be unique to such firm. A prescriptive one-to-one matching requirement of each swap to a specific physical transaction 

or an asset position is contrary to the statutory language, and is unnecessary and 

overly burdensome. 

Another well-established practice used by commercial energy firms to mitigate 

commercial risk is to hedge dynamically to optimize the value of underlying physical 

assets or portfolios. A key aspect of dynamic hedging is the ability to modify the 

hedging structure related to the physical asset or positions when the relevant pricing relationships applicable to that asset change.20 Dynamic hedging may involve 

leaving an asset or position unhedged when necessary to mitigate lost opportunity 

83

21 New CEA Section 2(h)(2) provides the Commission with the ability to determine whether 

a specific swap or group, category, type, or class of swaps should be required to be cleared. 22See Working Group, Comment Letter on Joint Notice of Proposed Rulemaking on Further 

Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major 

Security-Based Swap Participant’’ and ‘‘Eligible Contract Participant,’’ Notice of Proposed Rulemaking (Feb. 22, 2011). 

cost risk, which may require hedges to be established, unwound, and re-established 

on an iterative basis over time. The hedging of commercial risk should therefore include all hedging activity that maximizes the value of the asset. 

Given the customary use of portfolio and dynamic hedging in energy markets, it 

would be impracticable, if not impossible, for the vast majority of energy market 

participants to link hedges with specified underlying physical positions for purposes 

of complying with the End-User Exception. Accordingly, the Working Group respectfully submits that, as long as these transactions meet the underlying requirements 

of new CEA Section 2(h)(7)(A) and proposed CFTC Rule 39.6(a), they should unconditionally qualify for the End-User Exception. In the alternative, the cost burdens 

would be drastic, and the potential effects on liquidity would be severe, without resulting benefits to participants or the markets. 

D. The Applicability of the End-User Exception to Certain Affiliate Transactions Needs To Be Clarified 

New CEA Section 2(h)(7)(D)(i) permits an affiliate of a non-financial entity to use 

the End-User Exception if that affiliate, ‘‘acting on behalf of the person and as an 

agent, uses the swap to hedge or mitigate the commercial risk of’’ the non-financial 

entity or other affiliate that also qualifies as a non-financial entity. Notwithstanding 

this language, new CEA Section 2(h)(7)(D)(ii) prohibits an affiliate from using the 

End-User Exception if it is, among other things, a Swap Dealer or Major Swap Participant. These provisions are, however, silent with respect to swap transactions between affiliates within the same corporate family that are used to manage and allocate risk. The Commission should use the authority granted to it under new CEA 

Section 2(h)(2) to explicitly exempt such inter-affiliate swap transactions from mandatory clearing and, as applicable, the End-User Exception notification requirements set forth in proposed CFTC Rule 39.6(b).21

The Working Group respectfully submits that there is no benefit to the public interest or the Commission to require mandatory clearing or (as applicable) reporting 

of information pursuant to proposed CFTC Rule 39.6(b) with respect to inter-affiliate swaps that are used to manage and allocate risk within a holding company system or other organizational structure. Inter-affiliate swaps do not in any way enhance systemic risk, nor do they affect liquidity in swap markets. Information relating to such swap transactions is neither responsive to one of the central policy goals 

of Title VII of the Act—to enhance transparency in swap markets—nor is it necessary to prevent abuse. 

Should the Commission decline to grant the requested explicit exception from 

mandatory clearing and End-User Exception notification requirements for inter-affiliate swaps, the Working Group requests that, at a minimum, it clarify that otherwise qualified non-financial entities are not prohibited from utilizing the End-User 

Exception when engaged in swap transactions with Swap Dealer or Major Swap 

Participant affiliates. 

E. Presumption of Status as a Non-Financial Entity 

As noted in other comments filed with the Commission by the Working Group, 

the framework adopted in Title VII for the regulation of over-the-counter swap markets is based upon the existence of distinct classes of market participants.22 New 

CEA Section 2(h)(7) and provisions of the Proposed Rule implementing the End-User 

Exception recognize two distinct classes of market participants: (i) financial entities 

that are ineligible for this exception, and (ii) non-financial entities that are eligible 

for this exception upon compliance with certain conditions. In order to provide legal 

and regulatory certainty, and to be faithful to the intent of the Act, the Commission 

should not adopt any presumption that a ‘‘financial entity’’ as defined in new CEA 

Sections 2(h)(7)(C) and (D)(ii) for one kind of swap is also a financial entity for other 

kinds of swaps. Instead, market participants should be permitted to seek the exemption for each swap for which they are not registered as a swap dealer. Alternatively, 

the Commission should adopt a presumption that a market participant is a non-financial entity until proven otherwise. 

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23 7 U.S.C. § 19. 24Proposed Rule at 80754–55. 

F. The Proposed Rule Fails to Adequately Consider Anticipated Compliance 

Costs 

Section 15(a) of the CEA requires the CFTC, before promulgating a rule, to ‘‘consider the costs and benefits of the action of the Commission.’’ 23 The Proposed Rule

does not, as a general matter, provide any empirical data regarding the specific 

costs and benefit analysis specific to the implementation of proposed CFTC Rule 

39.6 by market participants.24 The Working Group requests that the Commission 

(i) consider the costs and benefits associated with the Proposed Rule in the manner 

prescribed by CEA Section 15(a), (ii) issue a supplemental new rule in this proceeding setting forth empirical data supporting its conclusions regarding the costs 

and benefits of the Proposed Rule, and (iii) notice the supplemental rule in the Federal Register for public comment. 

IV. Responses to Specific Requests for Comment 

A. Specific Requests for Comment Addressing Notification to the Commission 

Question: Are there clarifications or instructions the Commission could adopt that 

are useful for parties seeking to elect to use the end-user clearing exception? If so, 

what are they and what would be the benefits of adopting them? 

Response: As stated under Part III.A, above, the Working Group believes the nonfinancial entity electing to use the End-User Exception should be required to submit 

any relevant information in the same manner and form as the Commission’s current 

Form 40. 

Question: Would it be difficult or prohibitively expensive for persons to report the 

information required under the proposed § 39.6? If so, why? 

Response: As discussed under Part III.A, the Working Group believes that notification on a transaction-by-transaction basis will be prohibitively burdensome and 

expensive. Too many entities other than the traders would have to be involved in 

each deal if this cannot be handled on an aggregate basis. As such, the ability to 

hedge with an adequate price will be slowed due to data collection and additional 

employees needed to collect and report information. 

Question: Is the information the Commission proposes to collect in connection with 

the Financial Obligation Notice sufficient? Is other information needed to achieve 

the purposes of the Dodd-Frank Act? 

Response: The Working Group believes that no additional information is necessary 

to achieve the transparency objectives of new CEA Section 2(h)(7). 

Question: Is it necessary or appropriate for the Commission to collect additional 

general information on the credit support agreement and the collateral practices 

under the agreement, such as the level of margin collateral outstanding (e.g., less 

than or equal to a specified dollar amount, or greater than a series of progressively 

higher dollar amounts); the types of collateral provided (e.g., cash, government securities, other securities, other collateral), or the frequency of portfolio reconciliation? 

Response: The Working Group does not believe this additional information should 

be required, as such is not required by the CEA or the Act. 

Question: Is it necessary or appropriate for the Commission to collect additional 

general information on specific terms of the credit support agreement, such as 

whether the collateral requirements are unilateral or bilateral provisions and 

whether there are contractual terms triggered by changes in the credit rating or 

other financial circumstances of one or both of the counterparties? 

Response: The Working Group does not believe such additional information is necessary as such information provides no benefit to the Commission. 

Question: Is it necessary or appropriate for the Commission to collect additional 

general information about the guarantor, such as whether or not the guarantor is 

a parent or affiliate of the person electing to use the end-user clearing exception? 

Response: The Working Group does not believe such additional information. 

Question: Is it necessary or appropriate for the Commission to collect additional 

general information regarding the assets pledged, such as the type of security interest or the type of property being used as collateral? 

Response: The Working Group does not believe such additional information is necessary. 

Question: Is it necessary or appropriate for the Commission to collect additional 

general information regarding the segregation arrangements, such as the identity 

of the collateral agent or other third party involved in the arrangement, and inforVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00088 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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mation regarding whether the arrangement involves a custodian, triparty or different type of relationship? 

Response: The Working Group does not believe such additional information is necessary. 

Question: Is it necessary or appropriate for the Commission to collect additional 

general information regarding the adequacy of other means being used, or the adequacy of the financial resources available, to meet the financial obligations associated with the non-cleared swap? 

Response: The Working Group does not believe such additional information is necessary as such information provides no benefit to the Commission. 

Question: Should the Commission consider requiring parties electing to use the 

end-user clearing exception to report additional types of information, either in order 

to limit abuse of the exception or for other reasons? If so, what other information 

should be reported and what would be the benefit of requiring such information to 

be reported? What categories of information, if any, should not be required to be 

reported and why? 

Response: The Working Group does not believe additional information is necessary. As discussed under Part III.A.2, above, the Commission has adequate authority to limit abuses. 

B. Specific Request for Comment Regarding Treatment of Affiliates 

Question: Should the Commission provide additional clarity to the terms used in 

CEA Sections 2(h)(7)(C)(iii) and 2(h)(7)(D) in proposed § 39.6 for affiliates electing 

to use the end-user clearing exception? 

Response: The Working Group submits its response to this question under Part 

III.D, above. 

C. Specific Requests for Comment Addressing Board Approval Requirement 

Question: Should the Commission provide additional clarity to the requirements 

of CEA Section 2(j) [board approval] to facilitate compliance with proposed § 39.6 by 

parties electing to use the end-user clearing exception? 

Response: The Working Group submits its response to this question under Part 

III.B, above. 

Question: Should the Commission adopt more specific requirements to implement 

the provisions of CEA Section 2(j)? If so, what specific rules should the Commission 

consider and what would be the benefits of adopting them? 

Response: The Working Group submits its response to this question under Part 

III.B, above. 

D. Specific Requests for Comment Addressing Notification of the Commission 

Question: Does collecting Financial Obligation Notice information through SDRs 

provide sufficient assurance that the end-user clearing exception will be available 

to non-financial entities wishing to use the exception? Are SDRs reliable enough to 

be used for these purposes? 

Response: The Working Group submits its response to this question under Part 

III.A, above. 

Question: Is there a more feasible and cost effective way for the Commission to 

receive notification regarding the use of the end-user clearing exception? If so, what 

is the better alternative and in what ways is it better? 

Response: The Working Group submits its response to this question under Part 

III.A, above 

Question: Would the person reporting information to the SDR be in a position to 

have or be able to obtain, in all cases, the information the Commission is requiring 

to be reported under proposed Rule 39.6. If not, why not? Are there special considerations in this regard when a swap is between two non-financial entities that are 

each seeking to elect to use this exception? 

Response: The Working Group submits its response to this question under Part 

III.A.2, above. 

Question: Should the Commission require persons electing to use the end-user 

clearing exception to follow additional compliance practices in some circumstances? 

For example, should the Commission require electing persons to create a record of 

the means being used to mitigate the credit risk of the swap? Would such a requirement be redundant or duplicative of other proposed record-keeping requirements? 

Response: The Working Group submits that no additional compliance practices are 

required. The transactions at issue are governed by the terms of industry standard 

bilateral master agreements, which incorporate negotiated credit terms. 

86

E. Specific Requests for Comment Address the Hedging of Commercial Risk 

Question: Should swaps qualifying as hedging or risk mitigating be limited to 

swaps where the underlying hedged item is a non-financial commodity? 

Response: The Working Group supports the Commission’s proposed definition of 

‘‘commercial risk’’ in proposed CFTC Rule 39.6(c)(1). Non-financial commodities such 

as interest rate and foreign currency present risk that is central to the effective and 

efficient operations of a commercial enterprise. As such, swaps entered into to mitigate or hedge interest rate risk or currency risk should fall within the proposed definition of ‘‘commercial risk’’ and should be eligible for the End-User Exception (assuming the other qualifying requirements are satisfied). 

Question: Commenters may also address whether swaps qualifying as hedging or 

risk mitigating should hedge or mitigate commercial risk on a single risk or an aggregate risk basis, and on a single entity or a consolidated basis. 

Response: The Working Group submits its response to this question under Part 

III.C, above. 

Question: Whether swaps facilitating asset optimization or dynamic hedging 

should be included; and whether hedge effectiveness should be addressed. 

Response: The Working Group submits its response to this question under Part 

III.C, above. 

V. Open Comment Period 

Given the complexity and interconnectedness of all of the rulemakings under Title 

VII of the Act, and given that the Act and the rules promulgated thereunder entirely restructure over-the-counter derivatives markets, the Working Group respectfully requests that the Commission hold open the comment period on all rules promulgated under Title VII of the Act until such time as each and every rule required 

to be promulgated has been proposed. Market participants will be able to consider 

the entire new market structure and the interconnection between all proposed rules 

when drafting comments on proposed rules. The resulting comprehensive comments 

will allow the Commission to better understand how its proposed rules will impact 

swap markets. 

VI. Conclusion 

The Working Group supports appropriate regulation that brings transparency and 

stability to the energy swap markets in the United States. The Working Group appreciates this opportunity to comment and respectfully requests that the Commission consider the comments set forth herein as it develops a final rule in this proceeding. 

The Working Group expressly reserves the right to supplement these comments 

as deemed necessary and appropriate. 

If you have any questions, please contact the undersigned. 

Respectfully submitted,

R. MICHAEL SWEENEY, JR.; 

MARK W. MENEZES; 

DAVID T. MCINDOE; 

Counsel for the Working Group of Commercial Energy Firms. 

February 22, 2011

DAVID A. STAWICK,

Secretary,

Commodity Futures Trading Commission, 

Washington, D.C.

Re: Further Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major 

Swap Participant,’’ ‘‘Major Security-Based Swap Dealer’’ and ‘‘Eligible Contract Participant’’

Dear Secretary Stawick:

On behalf of the Working Group of Commercial Energy Firms (the ‘‘Working 

Group’’), Hunton & Williams LLP respectfully submits this letter in response to the 

Commodity Futures Trading Commission (the ‘‘CFTC’’) and Securities Exchange 

Commission (the ‘‘SEC,’’ and together with the CFTC, the ‘‘Commissions’’) request 

for comment concerning the Commissions’ Notice of Proposed Rulemaking on Further Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Dealer’’ and ‘‘Eligible Contract Participant’’

87

1 75 Fed. Reg. 80174 (Dec. 22, 2010). 2 CEA Section 1a(33)(A)(i). 

3 As discussed below, when determining whether a position is a ‘‘substantial position’’ if a position creates ‘‘substantial counterparty exposure,’’ the following swaps should be excluded: (a) 

swaps that are centrally cleared, (b) swaps to the extent their market value is collateralized and 

(c) swaps entered into between affiliates. These swaps do not have any significance to the stability of the financial system of the United States or any such risk can be better addressed elsewhere, such as the regulation of derivatives clearing organizations and clearing agencies. 

(the ‘‘Proposed Rules’’).1 This comment letter provides the Working Group’s comments regarding the proposed definition of ‘‘major swap participant.’’

The Working Group is a diverse group of commercial firms in the energy industry 

whose primary business activity is the physical delivery of one or more energy commodities to others, including industrial, commercial and residential consumers. 

Members of the Working Group are energy producers, marketers and utilities. The 

Working Group considers and responds to requests for public comment regarding 

legislative and regulatory developments with respect to the trading of energy commodities, including derivatives and other contracts that reference energy commodities. 

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the 

‘‘Act’’) vests the Commissions with new and expanded authority to regulate a wide 

array of participants in swap markets. Swap dealers, security-based swap dealers, 

major swap participants and major security-based swap participants in particular, 

will be required to develop and implement comprehensive measures to assure compliance with both substantive and procedural requirements under the Commissions’ 

new regulations set forth under the Act. Such regulations have been the subject of 

several key proposed rulemakings for which the Working Group has previously submitted comments. The Working Group anticipates submitting comments on the subjects of additional key proposed rulemakings. 

The Working Group appreciates the opportunity to provide these comments in response to the Proposed Rules and respectfully requests that the Commissions consider the comments set forth herein. The Working Group looks forward to working 

with the Commissions to further define the term ‘‘major swap participant’’ prior to 

the effective date of Title VII of the Act. Because the Commissions have not finalized the regulatory definition of the terms that are the subject of the Proposed 

Rules, members of the Working Group have commented on proposed rulemakings 

applicable to swap dealers and major swap participants. They are concerned about 

the potential that one or more aspects of the proposed definitions, which are unclear 

in material respects, could be interpreted such that they are deemed to be swap 

dealers or major swap participants. The Working Group would also note that the 

comments supplied herein are incomplete. Without a definition of ‘‘swap,’’ the Working Group is unable to provide complete comments on the proposed definition of 

‘‘major swap participant.’’

I. Comments of the Working Group 

The Working Group is generally supportive of the objective approach taken by the 

Commissions in further defining ‘‘major swap participant.’’ The use of objective criteria and tests will provide swap market participants with needed clarity and regulatory certainty with regard to their status as a potential major swap participant. 

However, multiple aspects of the proposed definition of ‘‘major swap participant’’ are 

vague in material respects and must be clarified so market participants can properly and consistently apply these aspects of the proposed definition to their own 

swap positions and related business activities. 

A. Proposed Definitions Must Reflect Congressional Intent To Capture Only 

Entities Presenting Significant Risk to the U.S. Financial System 

Congress clearly intended the definitions of ‘‘major swap participant’’ and ‘‘major 

security-based swap participant’’ to cover entities with swap portfolios that result 

in such entities presenting risk to the United States financial system. The first 

prong of the definition of ‘‘major swap participant,’’ as set forth in Commodity Exchange Act (‘‘CEA’’) Section 1a(33)(A)(i), deems any entity that ‘‘maintains a substantial position in swaps,’’ excluding, among other things, positions ‘‘held for hedging or mitigating commercial risk’’ of a major swap participant.2 In CEA Section 

1a(33)(B), Congress directed the Commissions to define the term ‘‘substantial position’’ at ‘‘the threshold that the Commission[s] determine to be prudent for the effective monitoring, management, and oversight of entities that are systemically important or can significantly impact the financial system of the United States.’’ 3 In general, this prong identifies as ‘‘major swap participants’’ those entities that have 

amassed speculative positions in swaps that are sufficiently large such that losses 

88

4 E.g., a major swap participant that becomes insolvent upon suffering massive losses on its 

portfolio of residential mortgage investments. 5See proposed CFTC Rule 1.3(sss). The Commissions recommend a threshold of $3 billion of 

current unsecured outward exposure or $6 billion in current outward and potential future unsecured exposure for an entity to have a substantial position in rate swaps and $1 billion in current outward unsecured exposure or $2 billion in current and future potential future unsecured 

exposure for an entity to have a substantial position in each of the other swap categories. For 

an entity’s swap positions to constitute a substantial counterparty exposure, the Commissions 

proposed a threshold of $5 billion of current uncollateralized exposure and $8 billion of current 

and potential future uncollateralized exposure. 

on these positions could have a materially adverse effect on the financial system of 

the United States. 

The second prong of the definition of ‘‘major swap participant’’ set forth in CEA 

Section 1a(33)(A)(ii) defines a ‘‘major swap participant’’ as a party whose ‘‘outstanding swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets.’’ Congress clearly intended this standard to be a substantial threshold. 

This prong addresses the risk that an entity could inject huge losses into the financial network by defaulting on its swap portfolio, whether or not the default is particular to swaps.4 In contrast to the first prong of the definition, the second prong 

contemplates potential losses beyond those inherent with an entity’s actual swap positions. 

Implicit in both of these prongs of the definition of ‘‘major swap participant’’ is 

Congress’ intent for the definition to capture those entities that are not swap dealers, but that pose a systemic risk as a consequence of their swap activities. An entity is systemically risky if its default would significantly impact the financial system. 

The degree of systemic risk an entity poses, therefore, is a function of (a) the potential size of its default, (b) the degree to which its default would be distributed 

through out the financial system, and (c) the probability of its default. Accordingly, 

any definition intended to capture systemically risky entities should take into account all of those factors. 

The tests proposed by the Commissions in the definitions of ‘‘major swap participant’’ and ‘‘major security-based swap participant’’ only consider the size of an entity’s swap portfolio and, to some extent, the degree to which its swaps are margined. 

To capture only those entities whose swap activities can significantly impact the financial system, the Commissions should also factor in (a) the assets an entity has 

available to cure any potential default on its swap portfolio and (b) the degree to 

which an entity’s potential swap exposures are concentrated among systemically important market participants. Consideration of those factors might result in the application of any potential definitions of ‘‘major swap participant’’ and ‘‘major security-based swap participant’’ being more difficult for the Commissions and market 

participants. However, that additional burden is justified. If such definitions account 

for these additional factors, they will be less likely to unduly burden less risky entities than the proposed definitions.5 Inclusion in the final rule of the additional factors would capture only entities that truly pose a systemic risk as a result of their 

swap activities. 

1. Different Thresholds Across Categories Does Not Reflect Systemic Risk 

The degree of systemic risk posed by an entity’s swap activities generally is not 

a function of the markets or products in which it transacts. So, the threshold level 

of swap activities to determine whether an entity is a major swap participant should 

not be different for different markets or classes of swaps. An entity, for example, 

is not more systemically risky because it has $1 billion in current outward exposure 

in ‘‘other commodities’’ swaps rather than $1 billion in current outward exposure in 

‘‘rate’’ swaps. However, under the Proposed Rule, in the first circumstance, the entity is treated as systemically important and in the second instance, it is not. 

The Commissions might have made market-by-market distinctions in the Proposed Rules because Section 1a(33)(C) of the CEA and Section 3(a)(67)(C) of the Securities Exchange Act of 1934 contemplate that a person may be designated as a 

major swap participant or major security-based swap participant for one or more 

categories of swaps or security-based swaps without being classified as such for all 

classes of swaps or security-based swaps. Congress likely understood that an entity 

might be a systemically significant participant because of its activity in one category 

of swaps, but might enter into other types of swaps from time to time. Prudential 

regulation would be unnecessary with respect to the entity’s truly ancillary swap 

activities. However, the need for regulation is triggered by the exposure inherent 

in an entity’s portfolio, not which markets a portfolio might cover. 

89

6Proposed Rules note 105. 7 CEA Section 1a(33). 

8See, e.g., Darryl Hendricks, John Kambhu, and Patricia Mosser, Systemic Risk and the Financial System, Background Paper presented at Federal Reserve Bank of New York and the National Academy of Sciences Conference on New Directions in Understanding Systemic Risk, 

May, 2006 and James Bullard, Christopher J. Neely, and David C. Wheelock, Systemic Risk and 

the Financial Crisis: A Primer, 91 FEDERAL RESERVE BANK OF ST. LOUIS REVIEW, Sep./Oct. 

2009, Sec. 5, Part 1 at 403–17. 9Diana B. Henriques, Enron’s Collapse: The Derivatives Market That Deals in Risks Faces a 

Novel One, N.Y. TIMES, Nov. 29, 2001. Available at : http://www.nytimes.com/2001/11/29/

business/enron-s-collapse-thederivatives-market-that-deals-in-risks-faces-a-novel-one.html, and 

Bank of International Settlements Press Release: The global OTC derivatives market at end—

June 2001 Second part of the triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, December 20, 2001. 

Accordingly, the Working Group believes that the exposure thresholds for the determination of substantial positions should be the same for each swap category. Alternatively, if the thresholds differ across swap categories, the Commissions must 

provide sufficient rationale to support such differences and such reasons should be 

solely based on concerns about the risk to the U.S. financial system. 

2. Proposed Thresholds Do Not Reflect Systemic Risk 

The objective standards outlined in the current definitions, as set out in the Proposed Rules, likely will capture entities that do not present systemic risk. While the 

Working Group supports the use of objective standards, it respectfully submits that 

the objective standards associated with proposed definitional tests have been set too 

low and should not be set as a static number. 

Though the Commissions conclude otherwise, the proposed thresholds used to determine whether an entity holds a substantial position or if its positions create substantial counterparty exposure do not fully reflect Congress’ desire for major swap 

participants to be limited to only those entities that are ‘‘systemically important or 

can significantly impact the financial system of the United States.’’ The Commissions state:

The proposed thresholds are intended to be low enough to provide for the appropriately early regulation of an entity whose swap or security-based swap positions have a reasonable potential of posing significant counterparty risks and 

risks to the market that stress the financial system, while being high enough 

that it would not unduly burden entities that are materially less likely to pose 

these types of risks.6

The instruction of Congress to the Commissions in the Act was to set definitions 

for ‘‘major swap participant’’ and ‘‘major security-based swap participant’’ that capture entities that are systemically important. The definition was intended to capture 

those entities that (a) for the purposes of the substantial position test ‘‘are systemically important or can significantly impact the financial system of the United 

States’’ and (b) for the purposes of the substantial counterparty exposure test whose 

swaps and resulting exposures ‘‘could have serious adverse effects on the financial 

stability of the United States banking system or financial markets.’’7 The Act does 

not establish visibility thresholds at which entities might potentially be systemically 

important. The Commissions should correct their interpretation of the Act to correctly reflect the statutory text and Congress’ true intent. Otherwise, the Commissions might regulate entities as major swap participants or major security-based 

swap participants that do not have swap portfolios that present risks to the U.S. 

financial system. There is no evidence to show this was Congress’s interest. 

The Commissions offer no evidence to support why the above thresholds were selected. The proposed thresholds do not appear to have any direct relationship to systemic risk. There are numerous examples of entities sustaining losses well in excess 

of the proposed limits. These entities not only did not cause a financial crisis, but 

also, in some cases, survived such losses. For example, the collapse of Enron is cited 

as an example of a high profile default that did not have a substantial systemic impact.8 Prior to its collapse, Enron had approximately $18.7 billion in derivatives exposure, which constituted approximately 3% of the notional outstanding in the global market for derivatives on ‘‘other commodities.’’ 9 Enron’s share of the market for 

derivatives on ‘‘other commodities’’ was more than ten times larger than the Commission’s proposed threshold. Despite this scale, the collapse of Enron did not trigger any systemic failure in the U.S. financial system. 

Another example of an entity sustaining massive losses in the energy derivatives 

markets, yet not causing the energy markets or U.S. financial system to collapse 

is Amaranth Advisors, LLC. On one trading day, September 14, 2006, Amaranth exVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00093 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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10Ludwig B. Chincarini, The Amaranth Debacle: A Failure of Risk Measures or a Failure of 

Risk Management?, THE JOURNAL OF ALTERNATIVE INVESTMENTS, Winter 2007, at 93. 11See Nicholas Vause, Counterparty risk and contract volumes in the credit swap market, BIS 

QUARTERLY REVIEW, December 2010. 12The Working Group respectfully suggests that the Commissions base these determinations 

on the BIS’ market size data until the Commissions determine the size of the swap markets 

they will regulate. 13Proposed Rules at 80215. 14Such categorization is also used in determining whether or not the end-user exception from 

the mandatory clearing requirement is available to certain market participants. 15The Working Group suggests that the CFTC adopt one provision in its regulations that defines when swaps are hedges or mitigate commercial risk. We note that the CFTC proposes a 

similar definition in proposed CFTC regulation 39.6. 16 Id. at 80214–15. 17 In the alternative, the Commissions should redraft it to read, ‘‘Not held for a purpose that 

is in the nature of speculation.’’

perienced losses of approximately $560 million in natural gas futures positions. Amaranth is believed to have experienced total losses in connection with such position 

in excess of $4.35 billion.10

The Commissions should adopt substantial position and substantial counterparty 

exposure tests that account for current conditions in swap markets. Setting thresholds that utilize static numbers will require the Commissions to revisit such thresholds over time in order to ensure they continue to reflect Congressional intent. For 

example, prices in energy markets are correlated to macroeconomic conditions. So, 

if the U.S. economy were to return to strong growth, the notional size of energy 

swap markets would grow as the prices of the underlying commodities rise. Though 

commercial energy firms’ absolute positions will rise, their relative positions will remain constant. On the other hand, other factors, such as the use of portfolio compression, might shrink the notional size of a market while the actual market value 

increases. The recent trend in the credit default swap market is an example.11 In 

short, rising energy prices could push many commercial energy firms over the proposed major swap participant determination thresholds or shrinking notional 

amounts in other markets could allow entities to avoid designation as a major swap 

participant. In both cases, those entity’s relative positions in their markets will remain unchanged and the risk they pose to the financial system will generally remain constant as well. 

The Working Group respectfully suggests that the Commissions set the following 

limits with respect to a substantial position in other commodities:

• a daily average aggregate uncollateralized outward exposure in excess of 1% of 

the gross market value of other commodity swaps; or

• a daily average aggregate uncollateralized outward exposure plus daily average 

aggregate potential outward exposure in excess of 2% of the gross market value 

of other commodity swaps.12

Such limits would better reflect Congress’ desire for the ‘‘major swap participant’’ 

definition to capture entities whose swap activities pose a systemic risk and that 

those limits will not require frequent modification as they are a relative measure 

of an entity’s systemic risk. 

3. Speculation, Investing and Trading Are Different Concepts 

Proposed CFTC Rule 1.3(ttt)(2)(i) 13 provides that any swap ‘‘held for a purpose 

that is in the nature of speculation, investing or trading’’ will not be considered a 

hedging transaction for purposes of the definitional tests.14 The Working Group recommends that this provision be deleted in the final rule.15

Proposed subparagraph (ttt)(1),16 the operative provision, describes certain hedging and credit mitigation activities. If a firm uses swaps for these activities, then 

such swaps are deemed to be held for ‘‘hedging or mitigating commercial risk’’ and 

excluded when determining whether a firm’s swap portfolio constitutes a substantial 

position. As hedges, they are not speculative. 

Proposed subparagraph (ttt)(2)(i) also should be deleted because it regulates 

swaps in connection with ‘‘investing or trading.’’ 17 While Congress was clearly concerned with speculation, it showed no similar concern for investing or trading. In 

fact, no where in Title VII do the terms ‘‘speculation, investing, or trading’’ appear 

together. Also, the phrasing ‘‘investing or trading’’ does not appear in Title VII. The 

Commissions have not defined ‘‘investing’’ or ‘‘trading’’ in the Proposed Rules. Thus, 

there are open questions about what activity constitutes investing or trading. For 

example, even if such terms were to be defined, does Title VII require the same 

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18Proposed Rules at 80195. See, also, Proposed Rules footnote 131 at same. 

treatment for swaps done for investing and trading purposes as it does for swaps 

entered into for speculative purposes? 

Trading and investing, as vernacular concepts, include both speculation and hedging. Use of such terms might suggest that hedging swaps, which constitute trading 

or investing activity, would not be afforded treatment as hedges under the definitional tests. This treatment of hedging swaps would effectively nullify the statutory 

provisions that exclude swaps for hedging purposes when determining whether a 

swap portfolio might constitute a ‘‘substantial position.’’

The Working Group also is concerned that the word ‘‘trading,’’ in particular, might 

impermissibly include the buying and selling of commodities by parties that are primarily in the business of producing, delivering, storing, marketing and managing 

physical commodities. This is traditional ‘‘commercial activity.’’ Yet, it might also 

come within the meaning of ‘‘trading.’’ Swaps executed in connection with this trading likely would constitute bona fide hedging transactions. It would make no sense 

for language in the Commissions’ regulations to disqualify such swaps from being 

hedges for purposes of the definitional tests. 

4. The Commissions Should Not Reclassify Swaps That Hedge Non-Swap Speculative Positions 

The Commissions, in the release to the Proposed Rules, introduced uncertainty as 

to the treatment of swaps entered into by a firm to hedge physical market positions. 

This may simply be a drafting issue, but the Working Group would respectfully request the Commissions to provide clarification. 

In footnote 128 to the Proposed Rules,18 the Commissions state that, ‘‘[s]wap positions that hedge other positions that themselves are held for the purposes of speculation or trading are also speculative or trading positions.’’ (emphasis added). 

There is no clarity as to what the Commissions meant by ‘‘other positions.’’ Perhaps 

it was an error, and the Commissions meant ‘‘other swap positions.’’

If the Commission intended to suggest that the hedge of a physical market position that is a ‘‘trading’’ position (i.e., held as a merchant or merchandiser in the 

commodity) would not qualify for treatment as ‘‘hedging or mitigating commercial 

risk’’ under the MSP definition, this would have serious consequences to physical 

market participants. All physical market participants, from car manufacturers, to 

toy stores, to merchant energy companies, are in the business of trying to sell a 

commodity for more than the cost of producing or procuring the commodity. An energy company procuring supply in advance of the summer driving season or a toy 

store stocking its shelves in advance of a holiday are each arguably taking a position in a physical market to trade based on speculation that there will be increased 

demand. If the phrase ‘‘other positions’’ is interpreted as applying to physical market positions, it could have the perverse result of treating certain bona fide hedges 

of positions as outright speculative swap positions. Thus, firms would be unable to 

exclude these swaps from the exposure calculations. 

On the other hand, if the footnote was intended to use the phrase ‘‘other swap 

positions,’’ the sentence in question would be consistent with what the Working 

Group believes the Commission’s intent to be. 

Such an interpretation of footnote 128 also is consistent with proposed CFTC Rule 

1.3(ttt)(2)(ii). This subparagraph, in describing swaps that are not hedging or mitigating commercial risk, reads:

(ii) Not held to hedge or mitigate the risk of another swap or securities-based 

swap position, unless that other position itself is held for the purpose of hedging 

or mitigating commercial risk as defined by this rule of § 350.4s67–4 of this 

title.

In this subparagraph, ‘‘other position’’ clearly references another swap or securitybased swap. Unlike footnote 128, subparagraph (ttt)(2)(ii) does not refer to swaps 

held to hedge ‘‘other position,’’ just those to hedge swaps or securities-bases swaps. 

Accordingly, the Working Group requests that the Commission clarify or correct 

(as appropriate) the phrase ‘‘other positions’’ in footnote 128 to mean ‘‘other swap 

positions.’’

Separately, the Working Group supports the inclusion of subparagraph (ttt)(2)(ii) 

in the Proposed Rules as it facilitates as firm’s effective management of it hedge 

portfolio when that portfolio includes swaps entered into in connection with commercial activity (e.g., the physical delivery of energy products). We note, however, 

that it prevents a swap intended to offset a speculative swap from being considered 

a hedge for purposes of the definitional tests. Yet, entering into an offsetting swap 

is a very common and efficient way in which market participants exit or limit a deVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00095 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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19The Working Group has given notice to Congress and the CFTC on several occasions of the 

potential impact to energy markets and the U.S. economy from reform of the energy swap markets. See for example, Comments of the Working Group on the CFTC’s proposed rule on Designation of a Chief Compliance Officer; Required Compliance Policies; and Annual Report of a Futures Commission Merchant, Swap Dealer, or Major Swap Participant, filed with the CFTC on 

January 18, 2011, Comments of the Working Group on the CFTC’s proposed rule on Regulations 

Establishing and Governing the Duties of Swap Dealers and Major Swap Participants, filed with 

the CFTC on December 15, 2010, and January 24, 2011. 

rivatives position. When considered in the context of systemic risk mitigation, the 

Working Group believes that all hedges should be treated as hedges. 

5. The Commissions Should Provide More Support for Their Conclusions With Respect to Administrative Law Matters 

The Commissions, in the release to the Proposed Rules, largely conclude that the 

requirements under several administrative statutes are satisfied because the Proposed Rules only concern definitional matters. As the definitions covered by the Proposed Rules are the keystone for Title VII, this conclusory approach to applicable 

administrative statutes is wanting. 

For example, the Commissions do not provide supporting discussion about the 

various thresholds contained in the Proposed Rule. There is no analysis as to why 

any particular threshold represents the best selection. There is no discussion of the 

impact to the U.S. economy from the selection of one threshold over another. These 

definitions simply cannot be made in a vacuum. Quantitative, economic analysis is 

required to understand how and why the Commissions fashioned the definitions as 

they appear in the Proposed Rule. 

Title VII and the rules to be promulgated by the Commissions thereunder will 

fundamentally effect the U.S. financial system and the U.S. economy. In the energy 

markets, they will effect the cost of electricity, natural gas and heating oil received 

by nearly every U.S. tax payer. The definitions are central to derivatives reform. 

Without them, the other statutory and regulatory provisions largely are inoperative. 

To hold that the definitional rules have little or no associated costs or economic impact (perhaps on the theory that it is the other statutory provisions or rules that 

actually impose the obligations and constraints) is to truly subvert substance to 

legal finery. 

Thus, among other things, the Working Group does not support the Commissions’ 

conclusion under the Small Business Regulatory Enforcement Fairness Act of 1996 

that the definitions do not constitute a ‘‘major’’ rule. The Commissions offer no support behind their conclusions that the Proposed Rules do not result in or are likely 

to result in the following:

• an annual effect on the economy of $100 million or more (either in the form of 

an increase or a decrease);

• a major increase in costs or prices for consumers or individual industries; or

• significant adverse effect on competition, investment or innovation.

The Working Group believes that the Proposed Rules will cause each of the foregoing to occur.19

The Commissions should provide economic analysis as to the import of the definitions they have selected. This information, however, should not appear solely in the 

final rule. The Working Group therefore requests that the Commissions (i) consider 

the costs and benefits associated with the Proposed Rules in the manner prescribed 

by CEA Section 15(a), (ii) issue a supplemental rule in this proceeding setting forth 

empirical data supporting its conclusions regarding the costs and benefits of the 

Proposed Rules, and (iii) notice the supplemental rule in the Federal Register for 

public comment. 

B. Suggested Improvements to Exposure Tests 

The definitional tests in the Proposed Rules are highly technical. They also are 

more challenging to use than may appear at first glance. Given the potential complexity of and likely interpretive issues with any tests set forth under the final definitions of ‘‘major swap participant’’ and ‘‘major security-based swap participant,’’ the 

Working Group requests that the Commissions solicit additional feedback from market participants prior to the issuance of a final rule. The Commissions also might 

request volunteers to walk-through the determination of whether they are a major 

swap participant or major security-based swap participant to ensure that the proposed tests actually function in practice. 

Attached as Exhibit A is an exercise through which members of the Working 

Group attempted to perform the definitional tests for major swap participant. The 

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20Proposed Rule at 80193. 21Proposed CFTC Rule 1.3(sss)(3)(iii). 

Proposed Rule, as described below, leaves certain matters open to interpretation or, 

in other cases, require entities to ‘‘fill in the blanks.’’ Accordingly, Exhibit A reflects 

some subjective interpretation. Thus, it is possible that the exercise is not how the 

Commissions intended the definitional tests to apply. Accuracy, however, was not 

the primary point of the exercise. Instead, the Working Group wants to demonstrate 

by example the need for the Commissions to (a) build and run such models to assure 

the definitional tests work in practice, (b) establish a step-by-step procedure for applying the definitional tests and (c) publish a ‘‘worksheet,’’ perhaps like Exhibit A,

to facilitate the definitional analysis by market participants. 

1. Clarifications Are Necessary for the Exposure Determinations 

Certain aspects of the proposed definitional tests must be further clarified or revised to ensure proper and consistent application of these tests by market participants. As stated above, the definitions should be styled to provide a clear step-bystep method for evaluating any given swap portfolio and must include clear definitions of critical terms and related calculations. 

There are several instances where descriptions of calculations related to the definitional tests are not clear. For example, proposed CFTC Rule 1.3(sss)(3)(ii)(A)(1), 

as currently styled, could be interpreted to require notional amounts be summed 

and then multiplied by the appropriate multiplier. However, when the entire regulation is read together, it appears that the notional amount of each swap is multiplied 

by the appropriate multiplier, a cap is applied with respect to credit default swaps, 

and then the products are summed. As another example, the adjustment for netting 

agreements in proposed CFTC Rule 1.3(sss)(3)(ii)(B) is not entirely clear. Is ‘‘NGR’’ 

(a) the net outward exposure (after netting) divided by gross outward exposure (before netting) or (b) the net exposure regardless of its direction divided by the gross 

exposures without regard to direction? (The detailed and technical nature of these 

examples underscores the need for active participation of industry representatives 

beyond submission of prose commentary.) 

To further illustrate, in determining the aggregate potential outward exposure of 

a swap portfolio under the Proposed Rules, the aggregate notional amount of a class 

of swaps in the portfolio is multiplied by a factor depending on duration.20 What 

is not clear from the text of the Proposed Rules is whether individual swaps spanning multiple time horizons should be bifurcated for reporting purposes so that the 

notional amount of the swap is split appropriately between applicable time horizons 

(as the Working Group believes would be appropriate), or if the entire notional 

amount of the swap should be reported only in the time horizon corresponding to 

the final maturity of the swap. 

There are additional instances in which the Commissions must further define 

some of the more basic elements included in prescribed calculations. For example, 

the Proposed Rules do not define the terms ‘‘notional principal amount’’ or ‘‘notional 

amount,’’ which appear to be used interchangeably and are integral to the calculation of potential outward exposure. Notional amounts for swaps, as understood by 

members of the Working Group, are not always established in dollars, but can also 

be established by reference to units of commodities. Thus, when determining an ‘‘aggregate notional amount’’ of a ‘‘notional principal amount’’ of swaps in a market participant’s portfolio, some conversion is necessary to transform notional amounts 

measured in units of commodities to dollar amounts. In addition, the Commissions 

should clarify whether or not outward exposure includes unpaid amounts under a 

swap. The final rule further defining ‘‘major swap participant’’ should provide sufficient technical guidance to answer seemingly basic questions such as these and provide clarity on the specific mechanics and the order in which the calculations in the 

Proposed Rule 1.3(sss) are to be performed. 

Exhibit B provides some specific recommendations of the Working Group with respect to language as it appears in the CFTC proposed Rule 1.3(sss). 

2. The Commissions Should Afford Favorable Treatment of Cleared Swaps and 

Swaps Subject to Daily Margining 

The Proposed Rules consider both cleared and daily margined swaps in the determination of potential outward exposure. The notional value of these swaps is effectively discounted by 80% when they are included in the potential outward exposure 

calculation to account for the risk mitigation benefits of central clearing and daily 

margining.21 The Working Group applauds the Commissions for accounting for the 

risk mitigation benefits of central clearing and daily margining, although the proVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00097 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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22The Working Group notes that it is unable to fully evaluate the proper risk discount for 

swaps subject to daily margining without knowing the parameters of margin requirements imposed on major swap participants. 23This proposed discount is appropriate to address systemic risk concerns, particularly in respect of the energy swap markets. As discussed elsewhere, the Working Group does not know 

of an example of a default in energy swaps triggering a systemic event to the U.S. financial 

system. 24Proposed Rule at 80188. 25 Inclusion of dormant trading relationship in the major swap participant definition would 

also serve as an incentive to terminate dormant master agreements. Master agreements are left 

in place even if there are no active trades between the counterparties, because, as the terms 

of the trading relationship are already in place, they allow the counterparties to enter into new 

trades quickly and efficiently. 

posed 80% discount potentially overstates the risk posed by daily swings in the 

value of such swaps. 

Cleared swaps, in particular, should not be considered in the determination of 

whether an entity is a major swap participant. Daily settlement of gains and losses 

on cleared swaps shortens the time horizon for exposure to changing market prices 

to a single day, and initial margin required by rules of derivatives clearing organizations (‘‘DCOs’’) ensures that sufficient funds will be available for settlement of daily 

losses in almost any conceivable circumstance. If the Commissions are concerned 

about the potential risk posed by daily price swings of cleared swaps, then the proper place to address this concern is in the regulations pertaining to initial margin 

requirements for DCOs and clearing agencies. 

Swaps that are subject to daily margining should also be discounted heavily in 

calculations of potential outward exposure. While the Proposed Rules state that ‘‘a 

swap shall be considered to be subject to daily mark-to-market margining if, and 

for so long as, the counterparties follow the daily practice of exchanging collateral 

to reflect changes in the current exposure arising from the swap,’’ the Working 

Group believes that the existence of contractual margining provisions should be sufficient justification for the discount contemplated in the proposed rule in the absence of evidence that the applicable party has consistently chosen not to enforce 

margin provisions contained in its agreements. Absent such evidence, the Working 

Group believes that a discount of 98% is appropriate to account for the risk that 

a counterparty cannot meet its daily margin call.22 23

3. Unused Unsecured Thresholds Should Not Be Included in Definitional Tests 

The method for determining aggregate potential outward exposure, as set forth 

in proposed CFTC Rule 1.3(sss)(3), appears to account for a portion of the potential 

exposure twice.24 The calculations require any uncollateralized threshold to be 

added to the aggregate uncollateralized outward exposure, which is then added to 

potential outward exposure to reach a representation of potential future exposure. 

It is entirely unclear why any unused unsecured threshold is equated to exposure, 

as it more accurately represents the absence of exposure. This proposed treatment 

is onerous and inconsistent with other standard financial measurements of exposure. For example, when calculating an entity’s debt-to-equity ratio, the indebtedness component of the calculation does not incorporate undrawn portions of revolving credit facilities or other forms of available but undrawn debt. At best, any unused unsecured threshold is a reserve for potential outward exposure. 

The unworkable nature of the proposed inclusion of unused unsecured thresholds 

is even more apparent when considered in the context of master agreements under 

which there are no trades in place in the calculation of potential outward exposure. 

Dormant master agreements represent an agreement as to the parameters that will 

govern any future trades between two parties. Such agreements do not represent 

an active credit relationship between the parties. Accordingly, unsecured thresholds 

contained in dormant master agreements should not be included in any measure of 

current or potential future exposure.25 The Proposed Rules should be clarified to exclude any unsecured thresholds under dormant master agreements from the calculation of current or potential future exposure. Additionally, the Proposed Rules should 

not require the inclusion of any unsecured threshold amount in excess of calculated 

outward exposure. 

The consideration of unsecured thresholds creates further complications in two 

other significant ways. First, for the purposes of determining whether an entity has 

a substantial position, positions entered into to hedge commercial risk are removed 

from the calculations. By including unused unsecured thresholds in the determination of substantial position, the CFTC is potentially reading the exclusion of hedge 

positions out of the Proposed Rules. If an entity has entered into both speculative 

and hedge positions under the same master agreement, how would an entity deterVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00098 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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26Proposed Rules at 80183. 27Proposed CFTC Rule 23.600. 28Proposed CFTC Rule 1.3(sss). 

mine what portion of any unused unsecured threshold should be allocated to hedge 

positions? 

Second, commercial energy firms often enter into master agreements that cover 

both physical and financial positions. Including both in one agreement is done for 

efficiency purposes. Only one agreement must be negotiated, and more importantly, 

counterparties are able to net physical and financial exposures. If unused unsecured 

exposure is required to be included in the determination of whether an entity is a 

major swap participant, then it is uncertain how that unused unsecured threshold 

should be allocated between potential physical positions and potential swap positions. A more fundamental legal question is how physical positions that are outside 

the CFTC’s jurisdiction should be considered. 

The Commissions might have added unused unsecured thresholds to the definitional formulas to discourage the use of unsecured trading. The Working Group believes that the loss of unsecured trading will result in a diminution of liquidity in 

the overall market. Many commercial energy firms rely on some amount of unsecured trading, both for administrative considerations and for allocation of cash resources. If unsecured trading is removed or receives punitive treatment under the 

Commissions’ regulations, then such firms might limit their trading or even exit the 

market all together. This would reduce liquidity for the entire market. Accordingly, 

the Working Group suggests that the Commissions not include unused unsecured 

thresholds in the definitional tests. 

4. Initial Margin Should Be Deducted From Aggregate Potential Outward Exposure 

In the release to the Proposed Rules, the Commissions specifically ask ‘‘if an entity currently has posted excess collateral in connection with a position, should the 

amount of that current over-collateralization be deducted from its measure of potential future exposure?’’ 26 The Working Group believes that such excess collateral 

should be deducted from potential outward exposure. In particular, any initial margin posted on a swap should be factored into the determination of aggregate potential outward exposure. If initial margin, as the CFTC’s own definition of the term 

states, is ‘‘money, securities, or property posted by a party to a swap as performance 

bond to cover potential future exposures arising from changes in the market value 

of the position,’’ 27 then the risk mitigation effects of any initial margin should logically be considered in the calculation of aggregate potential outward exposure under 

the proposed definition of ‘‘major swap participant.’’

5. Adjustments for Netting Agreements in the Calculation of Aggregate Potential Outward Exposure Should Be Revised 

The Proposed Rules provide an adjustment for netting in the calculation of aggregate potential outward exposure that relies on a specified formula referencing the 

ratio of net current exposure to gross current exposure derived from the calculation 

of aggregate uncollateralized outward exposure. The Working Group believes that 

this formula-based adjustment for netting is unnecessary because off-setting positions could be easily reflected directly in calculations of net total notional principal 

amount prior to application of conversion factors specified in the Table to § 1.3(sss)—

Conversion Factor Matrix for Swaps.28 This approach has been incorporated into example calculations provided in Exhibit A.

C. Collateral Considerations 

The Working Group supports the broadest definition of collateral for determining 

whether an ‘‘out-of-the-money’’ swap is secured for purposes of the definition of 

‘‘major swap participant.’’ The Commissions should recognize in the Proposed Rules 

that collateral for a swap might be in forms such as liens on assets and parent guarantees. 

Swaps that are secured by sufficient liens on property should be afforded the 

same discount as swaps subject to daily margining. Often, the value of collateral 

supporting the lien is several times greater than the exposure. Given the adequacy 

of this collateral, the Commissions should afford the same treatment to swaps 

collateralized in such a manner. Even if such swaps were subject to daily margining, 

the counterparty effectively would not be subject to delivery obligations because it 

had already delivered collateral far exceeding the exposure. 

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29Proposed Rules at 80202. 30The Working Group acknowledges that under certain unusual circumstances such aggregation would be appropriate. For example, it would be appropriate to aggregate positions of affiliated entities if an entity were attempting to evade registration as a major swap participant by 

trading swaps out of multiple subsidiaries under common control. 31 76 Fed. Reg. 4752 (January 26, 2011). 32The Working Group has submitted comments to the CFTC with respect to the 

extraterritorial application of its rules and regulation under Title VII of the Act. Working Group 

of Commercial Energy Firms comments to the CFTC’s Proposed Rule on Registration of Swap 

Dealers and Major Swap Participants, filed with the CFTC on January 24, 2011. 

D. Treatment of Affiliates 

1. Aggregation Across Enterprises 

The Commissions state that it would be appropriate to attribute a majority-owned 

subsidiary’s swap positions to a parent for the determination as to whether the parent is a major swap participant.29 In many circumstances aggregation would not be 

consistent with ‘‘the concepts of ‘substantial positions’ and ‘substantial counterparty 

exposure.’ ’’ 30 Positions of affiliates should not be aggregated to the extent that such 

affiliates are independently controlled and capitalized. Under these circumstances, 

the affiliate’s trading is not being coordinated with swap activities of other entities 

and only the assets of that entity are at risk in the event of a default. If an entity 

is independently controlled it is unlikely that such entity was created in an attempt 

for a parent to evade classification as a major swap participant, and if an affiliate 

is independently capitalized then there is no recourse to the parent entity or another affiliate. 

The market treats an independently controlled and capitalized entity as distinct 

from its parent and affiliates, so only its positions should be considered when attempting to determine if it is a major swap participant and should not be considered 

when determining if its parent company or affiliates are major swap participants. 

This approach is consistent with the treatment of affiliated companies under bankruptcy law where such companies are considered individually so as to not prejudice 

the rights of creditors to one entity by allowing recourse to the assets of such entity 

to creditors of an affiliate. This distinction allows subsidiaries to obtain favorable 

financing independent of any concerns of a corporate parent. The Commissions 

should give deference to the separateness of affiliates so long as they are managed 

as distinct entities. 

If the Commissions choose to aggregate the swap portfolios of affiliated entities 

for the purposes of the major swap participant determination, the Working Group 

respectfully requests that the Commissions not aggregate the positions of an entity 

that on its own is a swap dealer or major swap participant with those of its affiliates. To do so would eliminate an enterprise’s ability to segregate all of its regulated 

swap activities in one entity, and would thereby potentially subject that entire enterprise to prudential regulation. To the extent that an ultimate parent would be 

considered a major swap participant as a result of aggregation of positions of its 

subsidiaries, the designation should only apply to the parent itself and not to individual subsidiaries. Such designation should only apply to individual subsidiaries if 

the positions of such individual subsidiaries warrant such designation on a standalone basis. 

If the Commissions elect to aggregate swap portfolios of affiliated entities, the 

Commissions should provide a clear process by which entities might petition one or 

both of the Commissions to permit the petitioning entities to not aggregate positions. The petitioner should be permitted to provide evidence to the applicable Commission that the swap portfolios of its affiliates do not reflect a scheme to avoid registration as a major swap participant. This approach is consistent with the CFTC’s 

Notice of Proposed Rulemaking on Position Limits for Derivatives.31 In that notice, 

the CFTC provided a mechanism by which certain non-financial entities can 

disaggregate certain positions if the parent company can demonstrate that the 

owned non-financial entity is independently controlled and managed. The Working 

Group will comment separately on specific aspects of the proposed rule on Position 

Limits. 

Aggregation of swap portfolios also introduces issues with the extraterritorial application of the Commissions’ jurisdiction.32 Many of the Working Group members 

have affiliates that are not incorporated in and do not operate in the United States. 

These affiliates often trade in swaps outside of the United States. The Working 

Group recommends that the swap portfolios of such off-shore affiliates not be aggregated with swap portfolios of companies in the same enterprise that operate within 

the U.S. 

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33For discussion of the treatment of legacy portfolios and how they should be considered with 

regards to registration as a major swap participant please see the Working Group’s comments 

on the CFTC’s proposed rule on Registration Requirements for Swap Dealers and Major Swap 

Participants, filed with the CFTC on January 24, 2011. 34Proposed Rules at 80189.

2. Treatment of Inter-Affiliate Swaps 

Inter-affiliate swaps should not be considered when determining if an entity is a 

major swap participant. Transactions between two affiliated entities result in the 

same corporate family taking both sides of the swap. The corporate family’s net 

credit exposure from the trade is zero. Given that the net credit exposure is zero, 

consideration of inter-affiliate swaps when determining if an entity is a major swap 

participant would be counting swaps with no counterparty risk to the market in 

tests meant to arrive at some indication of the level of risk an entity poses to the 

U.S. financial system. 

E. Legacy Portfolios 

For many market participants, a large number of swaps in their portfolios were 

entered into prior to the enactment of the Act. These positions were entered into 

in the ordinary course of business before parties to these swaps could reasonably 

anticipate the possibility of being subject to prudential regulation because of these 

swap positions. The Working Group respectfully requests that the Commissions 

allow market participants whose current portfolios would make them a major swap 

participants to maintain their current positions and allow such positions to expire 

on their own terms without regulating the entities as major swap participants.33

Any entity that might be deemed a major swap participant should be permitted 

to not register as such if each of its relevant existing transactions expire according 

with their terms and such entity does not enter into any new swaps that would 

cause it to be deemed a major swap participant. This ‘‘grandfathering’’ of legacy 

portfolios would allow a smooth regulatory transition and would avoid any market 

disruption caused by entities closing-out a significant number of legacy positions in 

a short period of time to avoid being a major swap participant. We anticipate that 

any entity electing to grandfather a legacy portfolio would submit a brief petition 

to the applicable Commission. 

F. Netting of Physical Positions 

The Working Group strongly supports the Commissions’ decision to consider the 

risk mitigation effects of netting agreements when determining whether an entity 

is a major swap participant. The Commissions recognized that because (a) swaps are 

not necessarily hedged with other swaps and (b) swaps are also used to hedge nonswaps exposure, certain other positions should be considered for netting purposes. 

The Commissions state:

When calculating the net exposure the entity may take into account offsetting 

positions with that particular counterparty involving swaps, security-based 

swaps and securities financing transactions (consisting of securities lending and 

borrowing, securities margin lending and repurchase and reverse repurchase 

agreements) to the extent that is consistent with the offsets provided by the 

master netting agreement.34

The Working Group respectfully requests that the Commissions consider the netting of physical positions in commodities and offsetting swaps when calculating net 

exposure for the purposes of the major swap participant definition. Specifically, master netting agreements that cover entire trading relationships, not just uncleared 

energy-based swaps and the other listed products, should be considered. It is common practice for commercial energy firms to enter into a transaction for a physical 

energy commodity and then enter into a related uncleared energy-based-swap transaction with the same counterparty as a risk mitigation tool. Any multi-transactionnetting agreement between the two counterparties will typically net obligations 

under both the physical energy transaction and the uncleared energy-based swap. 

Moreover, trades in physical energy commodities and uncleared energy-based swaps 

are often inextricably linked, and counterparties should be able to consider their entire trading relationship when determining net exposure for the purposes of the definition of major swap participant. If the Commissions were to exclude physical positions from the netting calculations under the proposed major swap participant definition, then the unsecured exposure of many commercial energy firms would be substantially overstated, potentially causing such commercial energy firms to incorrectly be deemed major swap participants. 

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35Proposed CFTC Rule 1.3(qqq)(4). 36Working Group of Commercial Energy Firms comments to the CFTC’s Proposed Rule on 

Registration of Swap Dealers and Major Swap Participants, filed with the CFTC on January 

24, 2011. 37The Working Group notes that this suggested time frame differs from the more extended 

time frame recommended in its comments to the CFTC’s Proposed Rule on Registration of Swap 

Dealers and Major Swap Participants. The time frame suggested herein assumes that an entity 

becomes a major swap participant once the entire new regulatory regime imposed by Title VII 

of the Act is in place. Under these circumstances, an entity that is not a major swap participant 

from the outset can undertake some, but not all of the requirements imposed on major swap 

participants prior to exceeding the proposed thresholds. 

G. Limited Purpose Designations 

Section 1a(33)(C) of the CEA clearly states and Congress intended that entities 

can be designated as a major swap participant for only one category of swaps. Proposed CFTC Rule 1.3(qqq)(2) requires entities to make an affirmative application to 

the CFTC to be treated as a major swap participant for less than all of the major 

categories of swaps. However, the statute expressly presumes that an entity may 

be deemed a major swap participant for one category of swaps without being considered a major swap participant for other categories, thus creating a presumption in 

favor of the market participant, meaning an entity deemed to be a major swap participant for a category of swaps should be presumed to be a major swap participant 

only for that particular category. The Commissions have effectively flipped the statute on its head, establishing a presumption in direct contrast to the express statutory language. As such, the Working Group respectfully requests the Commissions 

to abandon proposed CFTC Rule 1.3(qqq)(2). 

If the Commissions choose to retain proposed CFTC Rule 1.3(qqq)(2), the Working 

Group believes that it will impose an unnecessary and potentially substantial burden on both (a) major swap participants that are clearly a major swap participant 

for one category of swap and (b) the Commissions which must process petitions to 

limit the scope of description. In the event that proposed CFTC Rule 1.3(qqq)(2) is 

retained, the Working Group respectfully suggests that the Commissions adopt a 

presumption that if 50% or more of a major swap participant’s swaps fall within 

one category of swaps and that entity’s swaps in other categories would not separately exceed any of the proposed thresholds, then that entity is a major swap participant for only that one category of swap. For example, the swap portfolios of 

many commercial energy firms that might be major swap participants are likely to 

be predominantly comprised of energy swaps, and the remainder of the portfolio are 

likely to be positions such as foreign exchange or interest rate swaps entered into 

to hedge commercial risk. Accordingly, such an entity should not have to file an application to have the scope of the application of the major swap participant definition limited. 

By adopting the recommended presumption, the Commissions will avoid placing 

a costly and unnecessary burden on entities that are clearly only a major swap participant for one class of swaps. In addition, the presumption would eliminate the 

need for the Commissions to process applications that are likely a mere formality. 

H. Timing Concerns 

The Working appreciates that the Commissions recognize exogenous market conditions could temporarily force a potential major swap participant over a threshold 

during one quarter. Allowing an entity that exceeds a threshold by twenty percent 

or less in one quarter an additional quarter as a reevaluation period will avoid market disruptions that could result from deeming as major swap participants entities 

that, through factors beyond their control, temporarily exceed a given threshold.35

An entity that potentially meets the definition of a major swap participant should 

be given two quarters to register as such. As discussed more completely in the 

Working Group’s comments to the CFTC’s Proposed Rule on Registration of Swap 

Dealers and Major Swap Participants,36 the determination of whether an entity is 

in fact a major swap participant will be a complex one. Further, coming into compliance with the regulatory obligations imposed on major swap participants will likely 

require a substantial expenditure of compliance and risk management resources and 

might require corporate restructuring as well as the restructuring of existing trading relationships. This compliance burden will be greatest for commercial entities 

that have never been subject to prudential regulation by a financial regulator. Accordingly, the Working Group believes that two quarters is the minimum amount 

of time an entity would need to register as a major swap participant.37

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I. Open Comment Period 

As the Commissions have proposed the definitions contained herein towards the 

end of releasing proposed rules under Title VII of the Act, and have yet to propose 

a definition of ‘‘swap,’’ market participants have not been able to offer fully informed 

comments on the CFTC’s and SEC’s proposed rules, especially comments regarding 

the cost implications of such rules. In addition, given the complexity and interconnectedness of all of the rulemakings under Title VII of the Act, and given that 

the Act and the rules promulgated thereunder entirely restructure over-the-counter 

derivatives markets, the Working Group respectfully requests that the Commissions 

hold open the comment period on all rules promulgated under Title VII of the Act 

until such time as each and every rule required to be promulgated has been proposed. Market participants will be able to consider the entire new market structure 

and the interconnection between all proposed rules when drafting comments on all 

of the proposed rules. The resulting comprehensive comments will allow the Commissions to better understand how their proposed rules will impact swap markets. 

II. Conclusion 

The Working Group supports appropriate regulation that brings transparency and 

stability to the swap markets in the United States. We appreciate the balance the 

Commissions must strike between effective regulation and not hindering the 

uncleared energy-based swap markets. The Working Group offers its advice and experience to assist the Commissions in implementing the Act. Please let us know if 

you have any questions or would like additional information. 

Respectfully submitted,

DAVID T. MCINDOE;

MARK W. MENEZES; 

R. MICHAEL SWEENEY, JR.; 

Counsel for the Working Group of Commercial Energy Firms.

100

EXHIBIT A

Calculation of Aggregate Uncollateralized Outward Exposure 

a. b. c. d. e. f. g. f. 

Counterparty 

Current Mark-to-Market 

Master Netting Net Exposure Posted Collateral Uncollateralized Exposure Positive Value Negative Value Net Swap Value 

Example Portfolio: 

Counterparty 1 $15,000,000 ($20,000,000) ($5,000,000) $0 ($5,000,000) $0 ($5,000,000) Counterparty 2 $5,000,000 ($35,000,000) ($30,000,000) $5,000,000 ($25,000,000) $5,000,000 ($20,000,000) Counterparty 3 $35,000,000 ($5,000,000) $30,000,000 $0 $30,000,000 $0 $0Counterparty 4 $1,000,000 ($16,000,000) ($15,000,000) $0 ($15,000,000) $0 ($15,000,000) Counterparty 5 $5,000,000 ($165,000,000) ($160,000,000) $10,000,000 ($150,000,000) $100,000,000 ($50,000,000)

Aggregate Uncollateralized Outward Exposure ($90,000,000)a. Legal entity that is contractual counterparty to swaps.b. Sum of mark-to-market value for all individual swaps with a respective counterparty that have a positive mark-to-market value (in-the-money-swaps). Amount will be > = $0.

c. Sum of mark-to-market value for all individual swaps with a respective counterparty that have a negative mark-to-market value (out-of-the-money swaps). Amount will be < = $0.

d. Sum of mark-to-market value for all individual swaps with a respective counterparty.e. Amount under valid master netting agreement with a respective counterparty available to offset negative net swap value reported in column d. Amount will be > = $0.

f. Net Exposure for a respective counterparty should be calculated as the lesser of $0 and the sum of columns d. and e.g. Amount of collateral posted to a respective counterparty and available to offset negative net exposure reported in column f. Amount will be > = $0.h. Uncollateralized Exposure for a respective counterparty should be calculated as the lesser of $0 and the sum of columns f. and g.

Aggregate Uncollateralized Outward Exposure equals the sum of column h. for entire portfolio of swap counterparties.

Calculation of Potential Outward Exposure

Notional Principal Amount = notional underlying quantity in units (i.e., MWh, MMBtu, gallons, etc.) multiplied by current market price per unit.

a. Indicator (Y/N) of daily margining.b. Applicable collateral threshold with respect to each counterparty. Amount will be < = $0c. Collateral threshold less uncollateralized exposure.d. Sum of Notional Principal Amount for all long swaps with a respective counterparty, categorized by applicable time period. For swaps that span multiple applicable time periods, report Notional Principal Amount that would be applicable for each time period. Amount reported will be > = $0.e. Sum of Notional Principal Amount for all short swaps with a respective counterparty, categorized by applicable time period. For swaps that span multiple applicable time periods, report Notional Principal Amount that 

would be applicable for each time period. Amount reported will be < = $0.f. Sum of amounts reported in d. and e.

g. Product of amounts for each respective time period in column e. and factors in matrix presented in the proposed rule.h. Absolute value of amount calculated for each counterparty in column g.

i. Net Swap Value from Aggregate Uncollateralized Outward Exposure calculation.j. Column hi. plus column h.k. Column i. minus column h.

l. Lesser of $0 and minimum value from columns j. and k.

m. Amount under valid master netting agreement with a respective counterparty available to offset negative net swap value reported in column l. Amount will be > = $0.

n. Amount of collateral posted to a respective counterparty and available to offset potential negative net exposure reported in column l. Plus additional collateral representing initial margin, independent amounts, and the 

like. Amount will be > = $0.o. Margining Adjustment (see below).p. Sum of columns l., m., n., and o. Amount will be < = $0.

101

Margining Adjustment: If Daily Margining = ‘‘Y’’ and Adjusted NSV (column l.) < 0

Multiply the amount by which PFE Factor (column h.) exceeds Available Threshold (column 

c.) by 0.8

Net effect is that only the PFE factor that exceeds available unsecured credit gets discounted. 

Calculation of Potential Outward Exposure 

See calculation detail for Aggregate Uncollateralized Outward Exposure a. b. c. 

Counterparty 

Current Mark-to-Market 

Master Netting Net Exposure Posted Collateral Uncollateralized Exposure Daily Margining Collateral Threshold Available Threshold Positive Value Negative Value Net Swap Value 

Example Portfolio: 

Counterparty 1 $15,000,000 ($20,000,000) ($5,000,000) $0 ($5,000,000) $0 ($5,000,000) N $0 $0Counterparty 2 $5,000,000 ($35,000,000) ($30,000,000) $5,000,000 ($25,000,000) $5,000,000 ($20,000,000) Y ($20,000,000) $0Counterparty 3 $35,000,000 ($5,000,000) $30,000,000 $0 $30,000,000 $0 $0 Y ($20,000,000) ($20,000,000) Counterparty 4 $1,000,000 ($16,000,000) ($15,000,000) $0 ($15,000,000) $0 ($15,000,000) Y ($20,000,000) ($5,000,000) Counterparty 5 $5,000,000 ($165,000,000) ($160,000,000) $10,000,000 ($150,000,000) $100,000,000 ($50,000,000) Y ($50,000,000) $0

Aggregate Uncollateralized Outward Exposure ($90,000,000) 

Calculation of Potential Outward Exposure—Continued 

d. e. f. 

Notional Principal Amount—Long Swaps Notional Principal Amount—Short Swaps Net Aggregate Notional Principal Amount 

< = One Year 1–5 Years > 5 Years < = One Year 1–5 Years > 5 Years < = One Year 1–5 Years > 5 Years 

$35,000,000 $20,000,000 $15,000,000 ($25,000,000) ($15,000,000) ($5,000,000) $10,000,000 $5,000,000 $10,000,000$45,000,000 $25,000,000 $20,000,000 ($15,000,000) ($5,000,000) ($1,000,000) $30,000,000 $20,000,000 $19,000,000$15,000,000 $5,000,000 $1,000,000 ($45,000,000) ($25,000,000) ($20,000,000) ($30,000,000) ($20,000,000) ($19,000,000) 

$250,000,000 $100,000,000 $50,000,000 ($25,000,000) ($10,000,000) ($5,000,000) $225,000,000 $90,000,000 $45,000,000$950,000,000 $550,000,000 $450,000,000 $0 $0 $0 $70,000,000 $34,000,000 $15,000,000 

Calculation of Potential Outward Exposure—Continued 

g.

0.1 0.12 0.15

h. i. j. k. l. m. n. o. p.

Converted Amount per Table to § 1.3(SSS) 

PFE Factor Net Swap Value (NSV) NSV Plus PFE Factor NSV Minus PFE Factor Adjusted NSV Master Netting Posted Collat- eral Margining Ad- justment Pot. Outward Exposure < = One Year 1–5 Years > 5 Years Total 

$1,000,000 $600,000 $1,500,000 $3,100,000 $3,100,000 ($5,000,000) ($1,900,000) ($8,100,000) ($8,100,000) $0 $0 $0 ($8,100,000) $3,000,000 $2,400,000 $2,850,000 $8,250,000 $8,250,000 ($30,000,000) ($21,750,000) ($38,250,000) ($38,250,000) $5,000,000 $5,000,000 $6,600,000 ($21,650,000) 

($3,000,000) ($2,400,000) ($2,850,000) ($8,250,000) $8,250,000 $30,000,000 $38,250,000 $21,750,000 $0 $0 $0 $0 $0

$22,500,000 $10,800,000 $6,750,000 $40,050,000 $40,050,000 ($15,000,000) $25,050,000 ($55,050,000) ($55,050,000) $0 $0 $28,040,000 ($27,010,000) 

$7,000,000 $4,080,000 $2,250,000 $13,330,000 $13,330,000 ($160,000,000) ($146,670,000) ($173,330,000) ($173,330,000) $10,000,000 $100,000,000 $10,664,000 ($52,666,000)

Aggregate Uncollateralized Outward Exposure—Continued ($109,426,000) 

102

EXHIBIT B

Proposed Language Changes 

Proposed CFTC Rule 1.3(sss)(2) 

(2) Aggregate uncollateralized outward exposure. 

(i) In general. Aggregate uncollateralized outward exposure in general means the 

sum of the current exposure, obtained by marking-to-market using industry standard practices, of each of the person’s swap positions with negative value in a major 

swap category, less the value of the collateral the person has posted in connection 

with those positions. 

(ii) Calculation of aggregate uncollateralized outward exposure. In calculating this 

amount the person shall, with respect to each of its swap counterparties in a given 

major swap category:

(A) Determine the dollar value of the aggregate current exposure arising from 

each of its swap positions with negative value (subject to the netting provisions 

described below) in that major category by marking-to-market using industry 

standard practices; and 

(B) Deduct from that dollar amount the aggregate value of the collateral the 

person has posted with respect to the swap positions. 

The aggregate uncollateralized outward exposure shall be the sum of those 

uncollateralized amounts across all of the person’s swap counterparties in the 

applicable major category.

(iii) Relevance of netting agreements.

(A) If the person has entered into multiple swaps under a single master agreement 

with a particular counterparty, or has a master netting agreement in effect with a 

particular counterparty to provide for netting of positions entered into under multiple 

master agreements, the person may measure the current exposure arising from its 

swaps in any major category on a net basis, as applicable, applying the terms of 

the each respective agreement. Calculation of net exposure may take into account 

offsetting positions entered into with that particular counterparty involving 

swaps (in any swap category) as well as security-based swaps, and securities financing transactions (consisting of securities lending and borrowing, securities 

margin lending and repurchase and reverse repurchase agreements), forward 

contracts, and any other qualified contracts to the extent these are consistent with 

the offsets permitted by the respective master agreement or master netting agreement , as applicable. 

(B) Such adjustments may not take into account any offset associated with 

positions that the person has with separate counterparties.

Comments:

Calculations of aggregate outward exposure should reflect two types of netting:

First, current exposure should be calculated on a net basis for all swap 

positions entered into under the same master agreement with a particular 

counterparty. 

Second, to the extent that the person has a master netting agreement in 

effect with a particular counterparty [as described in (iii)(A) above], current 

exposure for that counterparty should be calculated net of any potential offsetting positions under other agreements pursuant to the master netting 

agreement. The Commission should not limit the types of offsetting positions that may be taken into account to those specifically described in 

(iii)(A). 

Proposed CFTC Rule 1.3(sss)(3) 

(3) Aggregate potential outward exposure. 

(i) In general. Aggregate potential outward exposure in any major swap category 

means the sum of:

(A) The aggregate potential outward exposure for each of the person’s swap 

positions in a major swap category that are not subject to daily mark-to-market 

margining and are not cleared by a registered clearing agency or derivatives 

103

clearing organization, as calculated in accordance with paragraph (sss)(3)(ii); 

and 

(B) The aggregate potential outward exposure for each of the person’s swap 

positions in such major swap category that are subject to daily mark-to-market 

margining or are cleared by a registered clearing agency or derivatives clearing 

organization, as calculated in accordance with paragraph (sss)(3)(iii) of this section.

(ii) Calculation of potential outward exposure for swaps that are not subject to 

daily mark-to-market margining and are not cleared by a registered clearing agency 

or derivatives clearing organization.

(A) In general.

(1) For positions in swaps that are not subject to daily mark-to-market 

margining and are not cleared by a registered clearing agency or a derivatives clearing organization, potential outward exposure equals the total notional principal amount of those positions, calculated on a net basis for swaps 

entered into under a single master agreement with a particular counterparty, adjusted 

by the following multipliers on a position-by-position basis reflecting the 

type of swap. For any swap that does not appropriately fall within any of 

the specified categories, the ‘‘other commodities’’ conversion factors are to 

be used. If a swap is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the market 

value of the swap is zero, the remaining maturity equals the time until the 

next reset date. In the same respect, if a swap is structured with periodic settlement 

periods that occur over the life of the swap, where the parties calculate a settlement 

amount applicable only to that specific settlement period, the total notional amount 

of such swap should be bifurcated in calculations such that each settlement period 

constitutes a residual maturity for the notional amount applicable to that settlement 

period.

Table To § 1.3(sss)—Conversion Factor Matrix for Swaps 

Residual maturity Interest rate 

Foreign

exchange rate 

and gold 

Precious 

metals

(except gold) 

Other

commodities 

One year or less .................................... 0.00 0.01 0.07 0.10

Over one to five years ........................... 0.005 0.05 0.07 0.12

Over five years ...................................... 0.015 0.075 0.08 0.15

Residual maturity Credit Equity 

One year or less ..................................................................................................... 0.10 0.06

Over one to five years ........................................................................................... 0.10 0.08

Over five years ....................................................................................................... 0.10 0.10

(2) Use of effective notional amounts. If the stated notional amount on 

a position is leveraged or enhanced by the structure of the position, the calculation in paragraph (sss)(3)(ii)(A)(1) of this section shall be based on the 

effective notional amount of the position rather than on the stated notional 

amount.

Comments:

The Commission should clarify that ‘‘notional amount’’ simply means the 

product of the notional underlying quantity in units (i.e., MWh, MMBtu, gallons, etc.) of the applicable commodity with respect to each swap multiplied 

by current market price per unit of the applicable commodity. The term ‘‘notional amount’’ should be used consistently throughout the description of calculations. Notional amount should be calculated on net basis among all 

swaps entered into with a particular counterparty under a single master 

agreement. Additionally, the Commission should clarify that, for a swap that 

spans multiple time horizons specified in the Table to § 1.3(sss)—Conversion 

Factor Matrix for Swaps, the total notional amount for that swap should be 

bifurcated among applicable time periods when calculating potential outward 

exposure and not simply reported in the last applicable time period. 

104

(3) Exclusion of certain positions. The calculation in paragraph 

(sss)(3)(ii)(A)(1) of this section shall exclude:

(i) Positions that constitute the purchase of an option, such that the 

person has no additional payment obligations under the position; and 

(ii) Other positions for which the person has prepaid or otherwise satisfied all of its payment obligations.

(4) Adjustment for certain positions. Notwithstanding paragraph 

(sss)(3)(ii)(A)(1) of this section, the potential outward exposure associated 

with a position by which a person buys credit protection using a credit default swap or index credit default swap is capped at the net present value 

of the unpaid premiums. 

(B) Adjustment for master (B) Adjustment for master netting agreements. Notwithstanding paragraph (sss)(3)(ii)(A) of this section, for positions subject to 

master netting agreements the potential outward exposure associated with the 

person’s swaps with each counterparty may be reduced by amounts applicable to offsets permitted by the respective master netting agreement. If such offsets represent physically settled forward contracts pertaining to a non-financial commodity or security for deferred shipment or delivery or similar such contract that is not a swap, total notional 

amount of those positions calculated on a net basis for such forward contracts entered into 

under a single master agreement with a particular counterparty, adjusted by the multipliers 

specified in the Conversion Factor Matrix for Swaps specified above, on a position-byposition basis reflecting the type of swap that would me most applicable to such forward 

contract. For any forward contract that does not appropriately compare to any of the specified categories for swaps, the ‘‘other commodities’’ conversion factors are to be used. The 

total notional amount of each forward contract should be bifurcated in calculations such 

that each delivery period constitutes a residual maturity for the notional amount applicable 

to that delivery period. For other permitted offsets, potential outward exposure may only 

be reduced by amounts in excess of amounts included in calculations of aggregate 

uncollateralized outward exposure. equals a weighted average of the potential outward ex- posure for the person’s swaps with that counterparty as calculated under paragraph 

(sss)(3)(ii)(A), and that amount reduced by the ratio of net current exposure to gross cur- rent exposure, consistent with the following equation as calculated on a counterparty-bycounterparty basis:

PNet = 0.4 * PGross + 0.6 * NGR * PGross

Note to paragraph (sss)(3)(ii)(B): PNet is the potential outward exposure, adjusted 

for bilateral netting, of the person’s swaps with a particular counterparty; PGross is 

that potential outward exposure without adjustment for bilateral netting; and NGR

is the ratio of net current exposure to gross current exposure.

Comments:

The proposed methodology for calculating offsets attributable to master 

netting agreements is overly simplistic and would not likely produce reasonable results. Because the most likely type of offset to swaps exposure applicable to a valid and enforceable master netting agreement will be exposure related to forward contracts, the proposed methodology would produce a more 

reasonable result. 

(iii) Calculation of potential outward exposure for swaps that are subject to daily 

mark-to-market margining or are cleared by a registered clearing agency or derivatives clearing organization. For positions in swaps that are subject to daily markto-market margining or cleared by a registered clearing agency or derivatives clearing organization:

(A) Potential outward exposure equals the potential exposure that would be 

attributed to such positions using the procedures in paragraph (sss)(3)(ii) of this 

section multiplied by 0.2. 

(B) For purposes of this calculation, a swap shall be considered to be subject 

to daily mark-to-market margining if, and for so long as, the counterparties follow the daily practice of exchanging collateral to reflect changes in the current 

exposure arising from the swap (after taking into account any other financial positions addressed by aoffsets related to a master netting agreement between the 

counterparties and the existence of any thresholds for which a party is not required to 

post collateral). If the person is permitted by agreement to maintain a threshold 

for which it is not required to post collateral, only the total amount of that person’s potential outward exposure that, when added to the person’s aggregate outward expoVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00108 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
105

1Further Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Participant’’ and ‘‘Eligible Contract Participant,’’ 75 FED. 

REG. 80174 (Dec. 21, 2010). 

sure (prior to deducting aggregate value of the collateral the person has posted) would ex- ceedof that threshold, (regardless of the actual exposure at any time) shall be added to 

the person’s aggregate uncollateralized outward exposure for purposes of paragraph 

(sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B) of this section, as applicablemultiplied by 0.2. In 

addition, iIf the minimum transfer amount under the agreement is in excess of $1 million, the entirety of the minimum transfer amount shall be added to the 

person’s aggregate uncollateralized outward exposure for purposes of paragraph 

(sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B), as applicable. 

(C) For purposes of this calculation, the dollar amount the aggregate value of collateral 

the person has posted with respect to the swap positions in excess of aggregate outward 

exposure, including amounts that represent initial margin, independent amounts, and the 

like, may be deducted when calculating potential outward exposure.

Comments:

The proposed methodology for addressing master netting agreements 

should be revised to clarify that the lesser of (i) measured exposure related to 

swaps, and (ii) specified threshold amounts, will be included in calculations 

at 100%. Only measured exposure in excess of specified amounts will be afforded the 80% discount (0.2 multiplier). This would also clarify that threshold amounts with respect to dormant master agreements would not be included in calculations. The proposed methodology should also be revised to 

include a deduction for initial margin, independent amounts, and the like 

since these amounts would be available to offset potential future exposure on 

applicable swaps. 

February 22, 2011

DAVID A. STAWICK, Secretary,

Commodity Futures Trading Commission, 

Washington, D.C.

Re: Joint Notice of Proposed Rulemaking on Further Definition of ‘‘Swap Dealer,’’ 

‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based 

Swap Participant’’ and ‘‘Eligible Contract Participant,’’ RIN 3038–AD06

Dear Secretary Stawick: 

I. Introduction 

On behalf of the Working Group of Commercial Energy Firms (the ‘‘Working 

Group’’), Hunton & Williams LLP submits the following in response to the request 

for public comment set forth in the Joint Notice of Proposed Rulemaking, Further 

Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Participant’’ and ‘‘Eligible Contract Participant’’ 

(‘‘Proposed Rule’’) issued by the Commodity Futures Trading Commission (‘‘CFTC’’) 

and the Securities and Exchange Commission (‘‘SEC’’) (collectively, the ‘‘Commissions’’) and published in the Federal Register on December 21, 2010,1 proposing to 

further define the term ‘‘Swap Dealer.’’

The Working Group is a diverse group of commercial firms in the energy industry 

whose primary business activity is the physical delivery of one or more energy commodities to others, including industrial, commercial and residential consumers. 

Members of the Working Group are energy producers, marketers and utilities. The 

Working Group considers and responds to requests for public comment regarding 

regulatory and legislative developments with respect to the trading of energy commodities, including derivatives and other contracts that reference energy commodities. 

The Working Group appreciates the opportunity to provide these comments in response to the Proposed Rule and respectfully requests that the Commission consider 

the comments set forth herein. The Working Group looks forward to working with 

the Commissions to further define the term Swap Dealer prior to the effective date 

of Title VII. The comments herein specifically address the proposed further definition of Swap Dealer set forth in proposed CFTC Rule 1.3(ppp), pursuant to Section 

106

1a(49) of the Commodity Exchange Act (‘‘CEA’’), as established by Title VII, Subtitle 

A, Section 721 of the Dodd-Frank Wall Street Reform and Consumer Protection Act 

(the ‘‘Act’’). 

II. Executive Summary 

The Proposed Rule fails to consider the differences between the energy commodity 

markets and the financial swap markets. Energy commodity markets, in which parties enter into swaps with each other to ensure physical delivery and manage price 

risk, are different from the swap markets. The energy commodity markets comprise 

a minuscule portion of the total national notional amount of swap transactions. The 

Commissions’ proposed ‘‘one-size-fits-all’’ rule fails to recognize the unique nature of 

these markets. Unlike major financial institutions, non-dealer commercial energy 

firms function primarily as principals by transacting futures and energy-related 

swaps on a daily basis to mitigate price risk associated with providing necessary 

electricity, heating oil, natural gas, propane, gasoline and other energy commodities 

at affordable prices. 

The Proposed Rule incorrectly assumes that swap markets, including energy commodity swap markets, do not operate without the involvement of swap dealers. It 

is well recognized that non-dealer commercial energy firms routinely enter into 

swap transactions with other non-dealer commercial energy firms in over-thecounter (‘‘OTC’’) markets. Further, the Proposed Rule directly contradicts other proposed rules recently issued by the CFTC that clearly contemplate swap transactions 

occurring between two non-Swap Dealer counterparties. 

The proposed definition of Swap Dealer is over-broad and inconsistent with the 

statutory terms and Congressional intent. Congress intended to enhance substantially the regulation of those in the business of being Swap Dealers, not expand the 

definition to include almost any and all market participants in the swap markets. 

Congress expressly provided that the term Swap Dealer shall have a parallel meaning to the term ‘‘dealer’’ under the securities laws and as is otherwise set forth in 

the Act. 

Congress specifically listed four statutory criteria for Swap Dealers, provided for 

a General Exception, and created a de minimis test for those small or inconsequential Swap Dealers. The Commissions’ authority to further define Swap Dealer is limited to providing certainty as to those listed criteria, not creating new criteria or 

interpreting the definition contrary to the express terms or intent of Congress. 

Thus, the definition of Swap Dealer must be construed narrowly, based on commonly understood terms of dealing activity, and must account for the existence of 

other market participants. Yet the Commissions’ proposed ‘‘core’’ criteria of accommodating demand, being available to enter into swaps, entering into swaps with 

their own standard terms, or arranging swaps at the request of others provides for 

a broad definition of Swap Dealer that is not based on commonly understood terms 

of dealing activity. 

The Commissions’ interpretation of ‘‘market making’’ is broad and inconsistent 

with the CFTC’s own definition and interpretation of the term. Historically, ‘‘market 

making’’ is incident to dealing activity by those holding themselves out as and 

known in the market to be Swap Dealers. Swap Dealers are in the business of taking either side of a swap to effectuate the trade, regardless of price or commodity. 

They are not the producers or owners of commodities nor do they have obligations 

to buy or deliver commodities as their primary business, unlike non-dealer commercial firms. The Proposed Rule should be revised to expressly exclude activity legitimately incidental to the businesses of non-dealer commercial firms. 

Rather than providing clarity on the General Exception to swap dealing set forth 

by Congress, the Commissions proposed interpretation actually uses the General 

Exception to redefine the statutory Swap Dealer definition. The Proposed Rule ties 

the General Exception to language in the Swap Dealer definition, referring to swap 

dealing activity ‘‘as an ordinary course of’’ a ‘‘regular business.’’ However, the Commissions’ interpret this provision to say that any market participant in the swap 

markets is doing so as part of its regular business and thus is a dealer and unable 

to avail itself of the General Exception. Clearly, Congress did not intend any user 

of swap markets to be deemed a Swap Dealer. A better interpretation of the General 

Exception is to exclude swaps entered into by producers, processors, or commercial 

users of physical energy or agricultural commodities used as prudent price and risk 

management tools as part of the business of such producers, processors or commercial users of such commodities. 

The proposed de minimis exemption swallows the rule. Rather than determining 

which ‘‘mom and pop’’ or inconsequential Swap Dealers are eligible for the statutorily provided exemption from the enhanced regulatory regime for significant Swap 

Dealers, the Proposed Rule uses this exemption to determine who is a Swap Dealer. 

107

2Proposed Rule at 80183. 

The rule inexplicably provides that any entity who enters into more than twenty 

swaps, has more than fifteen counterparties, or holds more than $100 million in notional amount is a Swap Dealer regardless of its regular business. Such interpretation essentially makes every market participant in the swap markets a Swap Dealer 

and renders the express statutory definition superfluous. The Commissions should 

clarify that the de minimis exemption applies to those Swap Dealers that hold no 

more than one one-thousand of one percent (.001%) of the total notional amount of 

the U.S. swap markets. Such definition would capture Swap Dealers with an inconsequential position and activity in the markets. 

Alternatively, the Commissions should reconsider its rejection of a ‘‘relative test’’ 

for applying the de minimis exemption. Because the statutory definition of the de 

minimis exemption refers to ‘‘customers,’’ it is entirely appropriate that the Commissions consider a relative test measuring the ratio of a firm’s ‘‘customer’’ swaps notional amount to its total swaps notional amount. If an entity’s ratio is less than 

25%, it should be exempt from regulation as a Swap Dealer. 

The Proposed Rule should make clear that no affiliate transactions be considered 

dealing activity, including application of the de minimis criteria. Inter-affiliate 

transactions are used to manage and allocate risk within a company and do not 

present any risk to the markets or counterparties. 

Consistent with the Commissions’ practices, the Proposed Rule should provide a 

safe harbor and process for market participants to determine in good faith and with 

due diligence whether they need to register as a Swap Dealer. 

Finally, the cost and benefit analysis provided by the Commissions in the Proposed Rule does not appear to be based on any empirical data and does not appear 

to be consistent with the expected costs of compliance anticipated by market participants. The Commissions should therefore issue a supplemental rule in this proceeding setting forth empirical data supporting its conclusions regarding the costs 

and benefits of the Proposed Rule.

III. Comments of the Working Group of Commercial Energy Firms 

The Working Group generally supports the efforts of Congress and the Commissions to reform the derivatives markets to prevent abuses that led to the current 

fiscal crisis. However, for reasons discussed herein, the Working Group urges the 

Commissions to carefully construe the definition of Swap Dealer and proposed interpretational guidance so that it achieves the overarching policy goals of the Act without imposing unwarranted burdens on domestic energy markets and undue costs on 

the energy sector of the U.S. economy. 

As drafted, the Commissions’ proposed definition of Swap Dealer and associated 

interpretive guidance are fundamentally flawed. The proposed definition and guidance would implement a ‘‘one-size-fits-all’’ approach to commodities regulation, 

which fails to recognize the unique characteristics of the various OTC commodity 

markets in which swaps are traded, including energy markets. In this regard, the 

Commissions’ overly broad definition and guidance will sweep in a wide array of 

market participants that do not hold themselves out as ‘‘dealers’’ or engage in what 

has traditionally been viewed as ‘‘dealer’’ activity. 

Such a result runs counter to the statutory language and Congress’ intent to limit 

application of the Swap Dealer definition to those market participants engaged in 

what has historically been understood as ‘‘dealing’’ activity. Although Congress intended to enhance substantially the regulation of such activity, Congress also envisioned a regulatory framework conducive to the continued participation of active 

non-dealer market participants. Without significant revision, however, the Commissions’ proposed definition and guidance will thwart this effort and instead create unacceptable uncertainty, likely resulting in adverse impacts to energy markets and 

energy providers and their customers. 

A. Application of the Definition of Swap Dealer Should Avoid Adversely Impacting Domestic Energy Markets 

Final regulations and interpretive guidance further defining the term ‘‘Swap Dealer’’ should be appropriately construed to avoid adverse impacts to domestic energy 

markets. Indeed, in the Proposed Rule, the Commissions properly recognize that 

‘‘the swap markets are diverse and encompass a variety of situations in which parties enter into swaps with each other,’’ such as in energy commodities markets, including swap transactions involving oil and natural gas, and electricity generation 

and transmission.2 The Commissions highlight the complexities and unique characteristics of such energy markets and correctly invite comment as to ‘‘any different 

or additional factors that should be considered in applying the swap dealer definiVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00111 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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3 Id. at 80183–184. 4Such commodities are traded in markets typically regulated by other state and federal regulators and governed by well-understood market rules. 5 Non-dealer commercial energy firms primarily transact swaps to support hedging and trading activity associated with their underlying, primary physical business operations and/or that 

of their affiliates. From a trading perspective, this business involves transactions executed in 

physical energy markets, as well as hedges (which are often undertaken on a portfolio basis) 

and proprietary price discovery transactions executed in swap markets for energy commodities. 6See Dodd-Frank Act Conference Report Summary, available at http://banking.senate.gov/

public/index.cfm?FuseAction=Issues.View&Issuelid=84d77b9f-c7ab-6fe2-4640-9dd18189fb23. 

The summary explains that the goals of the Act, in part, are to ‘‘identify and address systemic 

risks posed by large, complex companies, products, and activities before they threaten the stability of the economy.’’ Id. 7See Comments of the Working Group submitted to the CFTC on December 15, 2010 in response to the CFTC’s request for comment concerning the cost-benefit analysis conducted pursuant to CEA Section 15. See Regulations Establishing and Governing the Duties of Swap Dealers 

and Major Swap Participants, 75 FED. REG. 71397 (Nov. 23, 2010). In those comments, the 

Working Group detailed the significant costs likely to be imposed on commercial energy firms 

should such firms be deemed Swaps Dealers. 

tion to participants in these markets.’’ 3 In accordance with this request, and to assist the Commissions in finalizing an appropriate definition of Swap Dealer that will 

not unduly burden domestic energy markets, the Working Group provides these 

comments regarding the unique characteristics of energy markets and the participants operating within these markets. 

Energy markets possess unique characteristics in terms of the instruments transacted, the market participants themselves, and the underlying products transacted, 

such as certain commodities that are not stored and are not capable of being 

stored.4 Distinct from institutions in the banking and financial system, which play 

an intermediary role in financial markets, nondealer commercial energy firms typically do not play intermediary roles in financial markets, and their swap trading 

activity is generally related to their respective physical portfolios of energy commodities.5

Unlike major financial institutions, non-dealer commercial energy firms function 

primarily as principals by transacting futures and energy-related swaps on a daily 

basis, among other things, to hedge (i.e., mitigate or off-set) the price risk associated 

with their core business of providing electricity, heating oil, natural gas, propane, 

gasoline and other energy commodities at competitive prices to satisfy current and 

future energy supply and demand. In this regard, the operation of assets and related trading activities of one non-dealer commercial energy firm are largely independent of other non-dealer commercial energy firms in the same product market. 

Should one party become unable to trade, its counterparties can easily enter the 

market to match the resulting open positions. 

Although significant external events can adversely impact multiple energy firms 

at the same time, the failure of one energy provider has never led to the systemic 

failure of the energy markets. Moreover, the failure of a non-dealer commercial energy firm has neither resulted in, nor raised concerns about, triggering a collapse 

of the U.S. banking and financial system. The absence of any large scale, long-term 

disruption of the operation of financial and physical energy markets following the 

Enron and Amaranth failures provides clear evidence that OTC derivatives in energy commodities do not create systemic risk to the financial system or within the 

energy industry of the type and nature that the Act is intended to prevent.6

Moreover, non-dealer commercial energy firms have a significant incentive to 

manage their exposure to all counterparties and, therefore, such firms are not materially at risk in the absence of government assistance. If the credit risk management 

practices and policies of non-dealer commercial energy firms are inadequate, the impacts of any resulting failure would fall on the shareholders of such entities, as was 

the case in the Enron and Amaranth failures. In the case of a failure of a non-dealer 

commercial energy firm, the burdens and obligations of the affected company will 

be borne by shareholders and investors, not by the federal government or, ultimately, taxpayers. 

In light of the above, applying the proposed definition of Swap Dealer and interpretive guidance to non-dealer commercial energy firms is inconsistent with Congressional intent and would result in the imposition of unnecessary and burdensome 

transactional, operating, and compliance costs.7 In order to cover such costs, nondealer commercial energy firms will be forced to divert resources away from investment in innovation, infrastructure, growth and jobs. Further, this will adversely affect liquidity, competition, efficiency and price discovery in energy markets as market participants either withdraw or no longer participate to the same extent. This, 

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8Proposed Rule at 80176 (proposing that ‘‘dealers tend to accommodate demand for swaps . . . 

from other parties.’’). See also Part III.C.2.d., infra, discussing the proposed ‘‘core’’ Swap Dealer 

criteria. 9Proposed Rule at 80177 n. 18. 10 Id. at 80177. 11 End-User Exception to Mandatory Clearing of Swap, 75 FED. REG. 80747 (Dec. 23, 2010) 

(‘‘End-User NOPR’’). 12 Id. (proposed CFTC Rule 39.6(a)). See also Real-Time Public Reporting of Swap Transaction 

Data, 75 FED. REG. 76141 (Dec. 7, 2010) (the proposed rule imposes reporting obligations on 

non-Swap Dealers for transactions executed off-facility ‘‘if neither party is a swap dealer nor a 

major swap participant.’’); Swap Data Recordkeeping and Reporting Requirements, 75 FED. REG. 

76574 (Dec. 8, 2010) (same). 

in turn, will result in higher energy prices for commercial, industrial, and retail consumers. 

B. The Application of the ‘‘Core’’ Swap Dealer Criteria to Energy Markets 

Is Not Consistent With the Statutory Language 

It is the extensive experience of the Working Group members that non-dealer 

commercial energy firms and other ‘‘traders’’ routinely enter into swap transactions 

where both parties are holding a position to hedge or to benefit from a forward view 

of the market rather than holding themselves out as ‘‘dealers.’’ However, under the 

broadly worded and subjective ‘‘core’’ Swap Dealer criteria proposed by the Commissions, such non-dealer commercial energy firms could be viewed as ‘‘accommodating 

demand’’ for these transactions—a key indicator of ‘‘dealing activity’’ in the Proposed 

Rule.8 As described in Part III.C.2, below, this result is not consistent with the statutory definition of Swap Dealer or the Congressional intent underlying Title VII. 

Further, the mere fact that the terms and conditions are customized should not 

change the role of that counterparty from that of a commercial market participant 

to that of a Swap Dealer. 

1. Energy Swap Markets Routinely Operate Without the Involvement of Swap Dealers 

The Working Group believes that the Commissions’ assertion that significant 

parts of the swap markets do not operate without the involvement of Swap Dealers 

is both unsupported and flawed when applied to energy markets. Specifically, instead of providing any analysis of the issue, the Commissions offer only the following unsupported opinion:

Some of the commenters appeared to suggest that significant parts of the swap 

markets operate without the involvement of swap dealers. We believe that this 

analysis is likely incorrect, and that the parties that fulfill the function of dealers should be identified and are likely to be swap dealers.9

Further, when discussing transaction activity in swap markets, the Commissions 

contend that:

in some markets, non-dealers tend to constitute a large portion of swap dealers’ 

counterparties. In contrast, non-dealers tend to enter into swaps with swap 

dealers more often than with other non-dealers.10

As detailed herein, the Working Group respectfully submits that these conclusions 

(i) are inaccurate with respect to energy markets, and (ii) are not supported by empirical data developed by, or provided at the request of, the Commissions. 

It is well recognized that non-dealer commercial energy firms routinely enter into 

swap transactions with non-dealer counterparties (e.g., other commercial firms) in 

OTC markets. Such transactions take place (i) in bilateral markets directly between 

the counterparties or where counterparties are matched by voice brokers, and (ii) 

on electronic trading facilities operating as exempt commercial markets, such as 

ICE. Indeed, a significant number of the transactions executed on ICE are between 

two end-user counterparties or between other non-dealer market participants. 

In other proposed rules issued pursuant to the Act, the CFTC expressly contradicts its assertion here that significant parts of the swap markets do not operate 

without the involvement of Swap Dealers. For instance, in the recently released notice of proposed rulemaking addressing the end-user exception from mandatory 

clearing requirements, the CFTC recognizes that in certain markets more than one 

counterparty to a swap may be qualified to elect to use the end-user exception from 

clearing.11 Because only ‘‘non-financial entities’’ can elect to use this exception, the 

language proposed in the End-User NOPR supports the proposition that portions of 

swap markets, notably energy markets, operate without dealer involvement.12

With respect to energy markets, as detailed in the below examples, non-dealer 

commercial energy firms will agree to enter into the ‘‘other side’’ of a bilateral swap 

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transaction proposed by another non-dealer counterparty where both parties are 

hedging or taking a forward view of the market. In this instance, neither party is 

engaged in swap dealing. They do not enter into such transactions (i) as a ‘‘service’’ 

to, or for the benefit of, their counterparty, (ii) to collect a fee, or (iii) as a ‘‘service’’ 

to, or for the benefit of the market generally, i.e., to enhance liquidity. Because they 

enter into such transactions to take a position for their own benefit, and not the 

benefit of their counterparty, this trading activity does not constitute swap dealing. 

Similarly, due to the unique characteristics of the underlying physical energy markets, non-dealer commercial energy firms often enter into swaps with customized 

terms and conditions. These terms are often highly negotiated and are intended to 

address the specific needs of the counterparties, i.e., hedging bespoke commercial 

risk or price discovery. 

2. Specific Examples of Transactions Occurring in Energy Markets Without Swap 

Dealer Involvement 

To assist the Commissions in better understanding the non-dealer to non-dealer 

transactions described above, the Working Group provides the following examples 

of transactions between non-dealer commercial energy firms that are ancillary or as 

an incident to their business as producers, processors, commercial users, or merchants of physical energy commodities. 

Example 1: Hedge Between Two Non-Dealer Commercial Energy Firms 

The following example illustrates how two non-dealer commercial energy firms 

seeking to hedge commercial risk can ‘‘respond to the interest of others’’ without 

‘‘dealing.’’

Company A is a natural gas producer that sells into the natural gas spot market. 

Company B is a retail seller of natural gas that sells natural gas to its customers at fixed prices but purchases the natural gas it sells in the spot market. 

Company A desires to hedge its spot sales exposure by entering into a swap 

where it is the floating price payer and receives a fixed payment. Company B 

desires to hedge its spot purchase exposure by entering into a swap where it 

is the fixed price payer and receives a floating payment. 

Company A and Company B have established bi-lateral trading documents 

and agreed on credit terms. They are aware of each others’ business needs and 

regularly communicate regarding the possibility of a mutually beneficial trade 

to hedge their respective commercial risks. 

Company A and Company B enter into a swap where Company A is the floating price payer and Company B is the fixed price payer. The swap is priced such 

that Company B makes a margin between the fixed price it receives from its 

retail customers and the fixed price it pays to Company A. The floating price 

is the spot natural gas price. 

Company A and Company B are not Swap Dealers. They are entering into 

a swap to hedge their commercial risk. Company A has fixed its output price. 

Company B has locked-in its margin and hedged its purchase price. While the 

companies could achieve the same result by using an intermediary such as a 

Swap Dealer, their transaction is more economic as they have ‘‘cut out the middleman.’’

Example 2: Structured Deals 

The following illustrates an example of how structured deals do not constitute 

‘‘dealing.’’

Company A enters into a deal to purchase all of the power off-take from a 

power plant for a period of 10 years. Company A also enters into a 10-year natural gas swap with the power plant, allowing it to fix its margins. The combination of those two transactions allows the owner of the plant to secure financing. 

Company A is not engaged in ‘‘dealing.’’

C. The Definition of Swap Dealer: Scope and Application 

1. The Definition of Swap Dealer and Interpretive Guidance Must Promote Legal and 

Regulatory Certainty 

The definition of Swap Dealer is a critical element of the new framework for the 

regulation of swaps in OTC markets embodied in Title VII of the Act. Together with 

the proposed definition of Major Swap Participant (‘‘MSP’’), the definition of Swap 

Dealer is one of the ‘‘gateways’’ through which the Commissions may exercise the 

new and expanded regulatory oversight authority granted to them under Title VII. 

The successful implementation of a new framework for the regulation of swaps is 

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13See Letter from Sen. Dodd, Chairman, Committee on Banking, Housing, and Urban Affairs 

and Sen. Lincoln, Chairman, Committee on Agriculture, Nutrition, and Forestry to Rep. Frank, 

Chairman, Committee on Financial Services, and Rep. Peterson, Chairman, Committee on Agriculture (June 30, 2010) (‘‘Lincoln-Dodd Letter’’) (explaining that ‘‘this is also why we narrowed 

the scope of the Swap Dealer and Major Swap Participant definitions. We should not inadvertently pull in entities that are appropriately managing their risk.’’). See also 156 CONG. REC. 

H5248 (daily ed. June 30, 2010) (statements of Rep. Frank and Rep. Peterson recognizing Lincoln-Dodd Letter and entering into Congressional Record). 14See Section 711 of the Act (stating that the term ‘‘Swap Dealer’’ shall have the ‘‘same 

meaning[] given the term[] in section 1a of the Commodity Exchange Act . . . .’’). The ‘‘same 

meaning’’ is the meaning provided by Congress in setting forth the definition of Swap Dealer 

in new CEA Section 1a(49), which parallels the meaning of ‘‘dealer’’ under existing securities 

laws and precedent. 15See, e.g., Wilson v. U.S. Parole Commission, 193 F.3d 195, 198 (3d Cir. 1999) (explaining 

that ‘‘[a]s a rule, a definition which declares what a term means is binding.’’) (citing National 

City Lines, Inc. v. LLC Corp., 687 F.2d 1122 (8th Cir. 1982); see also Colautti v. Franklin, 439 

U.S. 379, 392–93 (1979) (explaining that ‘‘[a] definition which declares what a term ‘means’ . . . 

excludes any meaning that is not stated.’’) (citing 2A C. Sands, Statutes and Statutory Construction § 47.07 (4th ed., Supp. 1978). 16See, e.g., United States v. Gertz, 249 F.2d 662, 666 (9th Cir. 1957) (explaining that ‘‘the word 

‘includes’ is usually a term of enlargement, and not of limitation.’’); Federal Election Commission

v. Massachusetts Citizens for Life, Inc., 769 F.2d 13 (1st Cir. 1985); Argosy Ltd. v. Hennigan,

404 F.2d 14 (5th Cir. 1968). 17The Commissions cite to Sections 712(d) and 721(b) of the Act as providing authority to redefine the term Swap Dealer. 

tied, in large part, directly to the Commissions’ ability to further define and apply 

Swap Dealer in a fashion that (i) promotes regulatory and legal certainty, (ii) is 

faithful to the statutory provisions and intent of Congress, and (iii) is consistent 

with the overarching objectives and structure of Title VII. 

If adopted as proposed, the Working Group is concerned that the definition of 

Swap Dealer and related guidance could be interpreted in a manner that effectively 

(i) limits the concept of an end-user to that of a one-directional (i.e., buy-side only) 

hedger, and (ii) leaves commercial market participants with active swap trading operations at risk of being designated as a Swap Dealer, including commercial energy 

firms that primarily transact swaps to hedge underlying physical commodity portfolios, assets, or positions. Such an interpretation is not faithful to the statute or 

Congressional intent, would create legal and regulatory uncertainty, and would be 

highly disruptive to the efficient operation of swap markets. 

The regulations implementing the definition of Swap Dealer must include a clear 

methodology that will allow market participants to determine whether they, or the 

counterparties with whom they transact, fall within this definition. This clarity and 

guidance is vital to ensuring the legal certainty and stability necessary to facilitate 

an orderly transition to new regulation under Title VII and avoid disruptions to energy swap markets. 

2. The Commissions Should Define and Interpret the Term Swap Dealer in a Manner 

That Gives Effect to the Statutory Language and Congressional Intent 

a. Congress Intended the Definition of Swap Dealer to Capture Entities Engaged in 

Traditional Dealing Activity 

The statutory language of new CEA Section 1a(49) establishes an unambiguous 

definition of Swap Dealer, including express exceptions and exemptions, to reflect 

Congress’ intent to (i) capture only those entities engaged in sufficient ‘‘dealing’’ activities to necessitate regulation under the Act, and (ii) to avoid inadvertently 

sweeping in those entities that are responsibly managing commercial risk.13 At the 

outset of Title VII of the Act, Congress expressly made clear that the term Swap 

Dealer shall have the same meaning as used in the Securities Exchange Act of 1934 

(‘‘1934 Exchange Act’’) and as amended by the Act.14 In this regard, Congress intended not to entirely redefine the well-known and understood meaning of what constitutes a ‘‘dealer,’’ but rather Congress provided specific meaning and context to the 

definition by drawing from the 1934 Exchange Act and principles of the Dealer/

Trader Distinction Rule. 

In setting forth the definition of a ‘‘Swap Dealer,’’ Congress expressly used the 

word ‘‘means’’ immediately following the term it intended to define, ‘‘Swap Dealer.’’15 Importantly, Congress did not use the word ‘‘includes’’ or ‘‘consists of,’’ nor did 

Congress list additional activities as illustrative, meaning Congress said what it 

meant.16 Any general authority Congress provided to the Commissions to further 

define Swap Dealer cannot exceed the bounds of the express definition or ignore the 

intent of Congress.17

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18 New CEA Section 1a(49)(A). 19 New CEA Section 1a(49)(C). 20Specifically, new CEA Section 1a(49)(D) provides that the ‘‘Commission shall exempt from 

designation as a swap dealer an entity that engages in a de minimis quantity of swap dealing 

in connection with transactions with or on behalf of its customers.’’ Id. 21See 15 U.S.C. § 78c(a)(5). 22See Definition of Terms in and Specific Exemptions for Banks, Savings Associations, and 

Savings Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934, 68 FED. 

REG. 8685, Final Rule, SEC Release No. 34–47364 (Mar. 2003) (‘‘Dealer/Trader Distinction 

Rule’’); Definition of Terms in Specific Exemptions for Banks, Savings Associations, and Savings 

Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934, Proposed Rule, 

SEC Release No. 34–46745 (Dec. 2002). 23The SEC explained, in part, in the Dealer/Trader Distinction Rule that ‘‘. . . the dealer definition has been interpreted to exclude ‘traders.’ The dealer/trader distinction recognizes that 

dealers normally have a regular clientele, hold themselves out as buying or selling securities 

at a regular place of business, have a regular turnover of inventory (or participate in the sale 

Specifically, Congress set forth the statutory elements for determining whether a 

person is a Swap Dealer, explicitly providing that ‘‘the term ‘swap dealer’ means any 

person who’’:

(i) holds itself out as a dealer in swaps;

(ii) makes a market in swaps;

(iii) regularly enters into swaps with counterparties as an ordinary course of 

business for its own account; or

(iv) engages in any activity causing the person to be commonly known in the 

trade as a dealer or market maker in swaps, provided however, in no event 

shall an insured depository institution be considered to be a swap dealer to the 

extent it offers to enter into a swap with a customer in connection with originating a loan with that customer.18

Accordingly, any person engaged in activities consistent with the express statutory 

criteria shall be deemed a Swap Dealer, and be subject to the applicable compliance 

obligations established in the Act. As detailed below, however, the Commissions 

went well beyond the express language of the statute, instead establishing additional ‘‘core’’ and ‘‘secondary’’ Swap Dealer criteria that are wholly inconsistent with 

the express statutory definition of Swap Dealer. 

As part of the definition of Swap Dealer, Congress also included a General Exception to the definition, providing that the term Swap Dealer ‘‘does not include a person that enters into swaps for such person’s own account, either individually or in 

a fiduciary capacity, but not as a part of a regular business.’’ 19 The inclusion of the 

General Exception again reflects Congress’ intent to capture entities engaged in traditional ‘‘dealing’’ activities, and thus the proper interpretation and application of 

the General Exception will avoid capturing entities not intended to be regulated as 

Swap Dealers, particularly those entities transacting in swap markets but not as 

a part of a regular business. To ensure the final rule and interpretive guidance 

properly reflect the statutory language and the intent of Congress, the Working 

Group provides, in Part III.D.1, below, specific comments and alternatives to the 

Commissions’ definition and interpretation of the General Exception and the term 

‘‘regular business.’’

Further, pursuant to the de minimis exemption established by Congress, entities 

that meet the swap dealing criteria set forth in new CEA Section 1a(49)(A) will nevertheless be exempt from the regulations of the Act applicable to Swap Dealers because their dealing activities would be so minimal as to not warrant regulation as 

a Swap Dealer.20 In contrast, the Commissions’ interpretation of this exemption 

suggests that if an entity fails to satisfy the de minimis criteria proposed by the 

Commissions, such entity would be deemed a Swap Dealer. Thus, rather than further limiting the scope of entities subject to the Act’s Swap Dealer regulations, as 

intended by Congress, such an interpretation establishes additional criteria by 

which to identify entities as Swap Dealers. 

b. The Statutory Definition of Swap Dealer is Based on the Definition and Interpretation of ‘‘Dealer’’ Under the Securities Laws and Rules 

All four elements contained in the definition of Swap Dealer set forth in new CEA 

Section 1a(49)(A) are based upon the definition of ‘‘dealer’’ set forth in Section 

3(a)(5) of the 1934 Exchange Act 21 and upon key elements of the SEC’s long-standing and well-known ‘‘Dealer/Trader Distinction Rule.’’ 22

The first two prongs of the statutory definition of Swap Dealer—holding oneself 

out as a dealer in swaps and making a market in swaps, respectively—were clearly 

relied upon by Congress in crafting the definition of Swap Dealer.23 Specifically, the 

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or distribution of new issues, such as by acting as an underwriter), and generally provide liquidity services in transactions with investors (or, in the case of dealers who are market makers, 

for other professionals).’’ See Dealer/Trader Distinction Rule at 8688 (citations omitted). 24See Dealer/Trader Distinction Rule at 8689 n. 26 (citing OTC Derivatives Dealers, Release 

No. 34–40594, Section II.A.1., n.61, 63 FED. REG. 59,362, 59,370 (Nov. 3, 1998)) (emphasis 

added). 25See note 14, supra. 26Proposed Rule at 80176. 27 Notably, the SEC applies the Dealer/Trader Distinction Rule to options, which, like swaps, 

are a derivative for which there is no limitation on the quantity of the underlying asset and 

there is no requirement to hold inventory in order to be a dealer. Thus, the basis for the Commissions’ distinction lacks a thorough understanding of the swaps and securities markets. 28 Compare new CEA Section 1a(49) and new 1934 Exchange Act Section 3(a)(71). 

Dealer/Trader Distinction Rule provides, in part, that a dealer is someone who is 

‘‘holding itself out as a dealer or market maker or as being otherwise willing to buy 

or sell one or more securities on a continuous basis.’’ 24

In relevant part, Section 3(a)(5) of the 1934 Exchange Act defines a ‘‘dealer’’ as 

‘‘any person that is engaged in the business of buying and selling securities for its 

own account through a broker or otherwise.’’ This definition has clear overlap with 

the third prong of the definition of Swap Dealer, particularly the key element of engaging in, or entering into, activities for one’s ‘‘own account.’’

Additionally, the ‘‘Exception’’ from the definition of dealer provided in the 1934 

Exchange Act provides that ‘‘[t]he term ‘dealer’ does not include a person that buys 

or sells securities for such person’s own account, either individually or in a fiduciary 

capacity, but not as a part of a regular business.’’ Importantly, this exception is virtually identical to the General Exception included in the definition of Swap Dealer 

in new CEA Section 1a(49)(C). 

The above comparison illustrates that Congress, in drafting the definition of Swap 

Dealer, adopted specific language and principles from the definition of ‘‘dealer’’ 

under the 1934 Exchange Act. Notably, Congress also chose not to adopt other SEC 

statutory language or principles based on SEC precedent. Accordingly, Congress intended that, in interpreting and implementing the term Swap Dealer, such interpretation should be modeled after the SEC’s Dealer/Trader Distinction Rule, taking 

into account applicable differences between swaps and securities markets. Consequently, in further defining the term Swap Dealer, the Commissions were required to fully consider the SEC’s interpretive guidance of the term ‘‘dealer.’’ 25 However, as discussed below, the Commissions did not thoroughly consider existing 

precedent, choosing instead to adopt unsupported ‘‘core’’ and ‘‘secondary’’ criteria, 

which resulted in a proposed definition and interpretation of Swap Dealer that fails 

to follow the statute or effectuate the intent of Congress. 

Furthermore, the Working Group believes that the Commissions’ decision in the 

Proposed Rule to adopt Dealer/Trader Distinction—like guidance for security-based 

swaps, but not for swaps traded in commodity markets, is unreasonable in light of 

the statutory language and Congressional intent. The Commissions attempt to justify their distinction, in part, by explaining that:

The definition of swap dealer should be informed by the differences between 

swaps, on the one hand, and securities and commodities, on the other. Transactions in cash market securities and commodities generally involve purchases 

and sales of tangible or intangible property. Swaps, in contrast, are notional 

contracts requiring the performance of agreed terms by each party.26

This is not, however, an informed basis to justify the SEC and CFTC adopting diametrically opposed positions for security-based swaps and swaps traded in commodity markets.27

To be sure, the definitions of ‘‘Swap Dealer’’ and ‘‘Security-based Swap Dealer’’ set 

forth in the Act are virtually identical and, as discussed above, modeled in large 

part on existing SEC precedent.28 Yet, with limited explanation, the Commissions 

reach opposite results. Thus, the distinction is contrary to the express statutory language and Congressional intent, which support definitions of Swap Dealer and Security-based Swap Dealer that are consistent with SEC precedent. 

c. The Definition of Swap Dealer Must Account for the Existence of Other Market 

Participants 

The Commissions should establish guidance interpreting the definition of Swap 

Dealer that appropriately recognizes the existence of other market participants 

transacting in different types of swap markets. The regulatory framework adopted 

in Title VII is based upon the existence of, at a minimum, four classes of market 

participants: (i) Swap Dealers; (ii) MSPs; (iii) non-financial end-users (i.e., those eliVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00117 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
114

29Proposed Rule at 80177–178. 30 Id. at 80,176, 80,178. The Commissions’ proposed Core S/D Criteria provide that:

• dealers tend to accommodate demand for swaps and security-based swaps from other

parties;

• dealers are generally available to enter into swaps or security-based swaps to facilitate

other parties’ interest in entering into those instruments;

• dealers tend not to request that other parties propose terms of swaps or security-based

swaps; rather, dealers tend to enter into those instruments on their own standard terms

or terms they arrange in response to other parties’ interest; and

• dealers tend to be able to arrange customized terms for swaps or security-based swaps

upon request, or create new types of swaps or security-based swaps at the dealer’s own

initiative. 

31 It is instructive to look at the definitions of ‘‘swap dealer’’ and ‘‘producer/merchant/processor/user’’ set forth in the explanatory notes of the CFTC’s Disaggregated Commitment of Traders Report:

Producer/Merchant/Processor/User: An entity that predominantly engages in the production, processing, packing or handling of a physical commodity and uses the futures markets

to manage or hedge risks associated with those activities.

Swap Dealer: An entity that deals primarily in swaps for a commodity and uses the futures

markets to manage or hedge the risk associated with those swaps transactions. The swap

dealer’s counterparties may be speculative traders, like hedge funds, or traditional commercial

clients that are managing risk arising from their dealings in the physical commodity.

See Disaggregated Commitments of Traders Report, Explanatory Notes, available at http://

www.cftc.gov/MarketReports/CommitmentsofTraders/DisaggregatedExplanatoryNotes/

index.htm. 

gible to use the clearing exception); and (iv) all other market participants that are 

not Swap Dealers, MSPs, or non-financial end-users. Pursuant to the framework 

contemplated by Congress, the Commissions are required to further define Swap 

Dealer in a manner that gives meaning and effect to each distinct class of market 

participant. 

The proposed definition of Swap Dealer and the interpretational guidance in the 

Proposed Rule are based upon a very broad reading of the four disjunctive prongs 

of new CEA Section 1a(49)(A)(i)–(iv). Rather than proposing interpretational guidance for each of the four disjunctive prongs of the statutory definition of Swap Dealer, the subjective identifying characteristics promoted by the Commissions appear 

to apply to all prongs. This approach to identifying Swap Dealers, as well as the 

qualified guidance interpreting the General Exception to the definition of Swap 

Dealer, creates uncertainty regarding the universe of market participants that must 

register as a Swap Dealer. 

To minimize such uncertainty, to the greatest extent possible, concrete and objective fact-based guidance should be included in the final rule that clearly illustrates 

swap trading activity that falls either within (i) the definition of Swap Dealer or 

(ii) the General Exception. Because the Proposed Rule unequivocally places the obligation on market participants to self-select whether they must register as a Swap 

Dealer, this guidance is particularly important to mitigate potential non-compliance 

risk. 

d. The Proposed ‘‘Core’’ Swap Dealer Criteria Do Not Distinguish Between the Roles 

of Different Swap Market Participants 

Citing the unique characteristics of swap markets, the Commissions decline to 

adopt interpretive guidance distinguishing the activities of dealers from traders in 

swap markets.29 In lieu of adopting such guidance, the Commissions propose certain 

‘‘core’’ criteria for identifying Swap Dealers (‘‘Core S/D Criteria’’), as well as other 

additional criteria (‘‘Secondary S/D Criteria’’).30 As noted above, in order to demonstrate consistency with the express statutory definition, the underlying Congressional intent, and the regulatory framework embodied in Title VII, the guidance interpreting the definition of Swap Dealer should distinguish the roles of different 

swap market participants in a meaningful manner. Moreover, such guidance should 

recognize that, in certain instances, dealers and traders engage in overlapping types 

of conduct; however, this fact alone should not result in a trader being subject to 

dealer regulation.31

The proposed Core and Secondary S/D Criteria do not accomplish these objectives. 

To be sure, Congress intended for the CFTC to regulate only those swap market 

participants who engage in dealing, a concept well-understood and recognized in securities markets. The proposed Core and Secondary S/D Criteria instead provide 

only vague concepts that will potentially sweep in numerous other market particiVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00118 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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32See Part III.C.2.b., supra, discussing Congress’ intent to base the definition of Swap Dealer 

on the 1934 Exchange Act definition of ‘‘dealer’’ and the Dealer/Trader Distinction Rule. 33The CFTC’s online glossary, titled ‘‘A Guide to the Language of the Futures Industry,’’ sets 

forth the Commission’s own definition of the term ‘‘Market Maker.’’ As highlighted below, the 

CFTC views a market maker as an entity that has an obligation to buy or sell when there is 

an excess of sell or buy orders (as the case may be):

[P]rofessional securities dealer or person with trading privileges on an exchange who has

an obligation to buy when there is an excess of sell orders and to sell when there is an excess

of buy orders. By maintaining an offering price sufficiently higher than their buying price,

these firms are compensated for the risk involved in allowing their inventory of securities to

act as a buffer against temporary order imbalances. In the futures industry, this term is sometimes loosely used to refer to a floor trader or local who, in speculating for his own account,

provides a market for commercial users of the market. Occasionally a futures exchange will

compensate a person with exchange trading privileges to take on the obligations of a marketmaker to enhance liquidity in a newly listed or lightly traded futures contract. (Emphasis

added).

See https://www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/index.htm. 34See note 33, supra. See also SEC online guidance interpreting a ‘‘Market Maker’’ as:

a firm that stands ready to buy and sell a particular stock on a regular and continuous

basis at a publicly quoted price. You’ll most often hear about market makers in the context

of the NASDAQ or other ‘‘over the counter’’ (OTC) markets. Market makers that stand ready

to buy and sell stocks listed on an exchange, such as the New York Stock Exchange, are called

‘‘third market makers.’’ Many OTC stocks have more than one market-maker. Market-makers

generally must be ready to buy and sell at least 100 shares of a stock they make a market

in. As a result, a large order from an investor may have to be filled by a number of marketmakers at potentially different prices.

See http://www.sec.gov/answers/mktmaker.htm. 

pants within the definition of Swap Dealer—a result clearly not contemplated by 

Congress given the distinct classes of market participants established by Title VII. 

Indeed, to avoid such an unintended result, Congress purposely based the definition 

of Swap Dealer on applicable SEC precedent in order to limit the term’s application 

to only those market participants engaged in what has historically been understood 

as dealing activity.32

3. The Commissions Should Interpret ‘‘Market Making’’ Consistent With Existing 

CFTC Interpretation 

The Working Group is concerned that the Commissions’ interpretation of the 

‘‘market making’’ language in new CEA Sections 1a(49)(A)(ii) and 1a(49)(A)(iv) is 

overly broad and inconsistent with CFTC precedent. The Commissions should therefore reconsider their interpretation and issue interpretative guidance in the final 

rule clarifying the meaning and scope of this language. Such guidance should clearly 

recognize that the activity of ‘‘market making’’ is an incident of dealing activity in 

swap markets. 

Consistent with the CFTC’s glossary definition of ‘‘Market Maker,’’ ‘‘dealing activity’’ generally occurs when a party acts as an intermediary for others to access a 

market.33 A hallmark of dealing activity is that a party’s business is to continually 

stand ready, willing, and able to take either side of a transaction and trade with 

its customers in accordance with a ‘‘bid/ask’’ spread on its own account. In fact, the 

CFTC’s definition of ‘‘Market Maker’’ connotes this ‘‘obligation’’ to buy or sell.34 In 

general, a dealer seeks to remain neutral to price movements with respect to the 

swap at issue, as well as the underlying commodity. Dealers, in large part, profit 

from intermediation fees and ancillary services to their dealing activity (e.g., providing investment advice), not from realizing changes in the value of the swaps 

transacted or the underlying commodities. 

In contrast, a non-dealer commercial energy firm, on occasion, may take either 

side of any particular swap transaction, depending on its needs. This behavior is 

distinct from dealing activity as it is driven by the commercial energy firm’s underlying commercial business operations, including specific customer-related obligations 

in physical markets. Given this direct nexus to the commercial energy firm’s primary business operations in physical markets, such activity does not constitute 

‘‘market making’’ and is not incident to dealing activity in swap markets. 

The Commissions should interpret ‘‘market making’’ in a manner that is generally 

consistent with the CFTC’s own glossary definition of ‘‘Market Maker.’’ This may 

be accomplished by the development of enumerated criteria that identifies different 

activities that constitute ‘‘market making’’ in swap markets, i.e., a person who has 

an obligation to buy when there is an excess of sell orders and to sell when there 

is an excess of buy orders. 

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35 Note, proposed new language is underlined. This alternative definition revises only new 

CEA Section 1a(49)(A). The Working Group offers revised language to the General Exception 

and the de minimis exemption in Sections III.D.1 and 2, herein. See also Attachment A, attached 

hereto. 36See Part III.C.3, infra, discussing the need for a consistent interpretation of ‘‘market making.’’ See also note 34, infra, regarding SEC online guidance interpreting a ‘‘market maker,’’ in 

part, as: ‘‘a firm that stands ready to buy and sell a particular stock on a regular and continuous 

basis at a publicly quoted price’’ (emphasis added). 

The Commissions should not, however, treat ‘‘market making’’ activity as the sole 

measure of whether an entity engaged in such activity is a Swap Dealer. An occasional two-way trade made by a market participant, when offered for customary 

commercial purposes, such as to briefly test a market for price discovery purposes 

or as an adjunct to an underlying physical business, does not constitute the type 

of ‘‘continuous, ready, willing and able’’ trading activity that is a key indicium of 

a ‘‘professional’’ market maker. 

4. The Working Group Offers a Proposed Alternative Definition of Swap Dealer 

In light of the numerous statutory and policy concerns outlined above with respect 

to the Commissions’ proposed definition of Swap Dealer and interpretive guidance, 

the Working Group offers the following alternative definition of Swap Dealer that 

will mitigate many of the identified concerns and bring the definition and its interpretation back within the limited scope originally intended by Congress: 

17 CFR 1.3(ppp) Swap Dealer.35

(1) IN GENERAL. The term ‘‘swap dealer’’ means any person who:

(i) Holds itself out as a dealer in swaps; 

(ii) Makes a market in swaps;

‘‘Makes a market’’ means regularly providing two-sided pricing:

(a) for a particular swap for execution for a person’s own account; or 

(b) pursuant to a contractual obligation.

(iii) Regularly enters into swaps with counterparties as an ordinary 

course of business for its own account; or 

(iv) Engages in any activity causing it to be commonly known in the trade 

as a dealer or market maker in swaps.

provided, however, that an entity shall not be considered to be a swap dealer to the extent 

that it offers to enter into, or enters into, a swap:

(a) to hedge or mitigate commercial risk; 

(b) for the purpose of benefiting from future changes in the commodity 

reference price (i.e., the price to which the floating leg of a swap is indexed); 

(c) on a designated contract market or swap execution facility, unless 

suchentity is making a market in that swap; or 

(d) that is a physical option that includes the obligation to deliver or receive a commodity if the option is exercised. 

(d) to provide two-sided pricing in a market of limited or episodic liquidity for the purpose of:

(I) discovering a price for the swap or the underlying commodity, 

or 

(II) eliciting bids and offers for the swap from other 

marketparticipants.

Given that the Commissions’ have interpreted the principle ‘‘market making’’ in 

a broad fashion, the first proposed change is to provide specificity to the second 

prong of the Swap Dealer definition by expressly defining the term ‘‘makes a market’’ as regularly providing two-sided pricing: (i) for a particular swap for execution 

for a person’s own account, or (ii) pursuant to a contractual obligation. As previously 

described, making a market often means a party continually stands ready, willing, 

and able to take either side of a transaction and trade with its customers in accordance with a ‘‘bid/ask’’ spread on its own account.36 The proposed additional language 

will ensure the market making prong is applied narrowly so as to limit the scope 

of entities subject to regulation as Swap Dealers to those entities engaged in the 

sort of dealing activity intended to be regulated by Congress under the Act. 

The additional language offered by the Working Group—proposed subsections (a)–

(d)—would expressly exclude from the definition those activities historically underVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00120 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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37The phrase ‘‘hedge or mitigate commercial risk’’ could ultimately be tied to proposed CFTC 

Rule 1.3(ttt), but only if the Commissions adopt the framework recommended by the Working 

Group with respect to proposed CFTC Rule 1.3(ttt) in comments submitted contemporaneously 

with this comment letter on the Commissions’ proposed definitions of ‘‘Major Swap Participant’’ 

and ‘‘End-User.’’ 38For example, a natural gas company holds natural gas inventory when the natural gas markets are thin at a value it believes to be $4.00/MMbtu. It posts a bid price of $3.80 and an offer 

of $4.20 for a portion of its inventory. If the bid price hits and the offer lifted, it now knows 

the $4.00/MMbtu estimation was low and it is in a better position to sell its full physical inventory at the higher price. If the company wanted to hold its inventory but try to execute its hedge 

position, it would engage in similar behavior to discover a true market price. 

stood as not constituting dealing. Namely, the proposed language would exclude the 

following activities:

• Swaps for Hedging Commercial Risk: The Commissions should expressly exclude from the Swap Dealer definition swaps offered or entered into for purposes of hedging or mitigating commercial risk. The Working Group recognizes 

that this principle is generally accepted by the Commissions; however, providing 

express language to this effect in the final rule would provide greater certainty 

to market participants and would effectuate Congressional intent.37

• Swaps for Making a Profit: The Commissions should expressly exclude from the 

definition of Swap Dealer swaps offered or entered into for purposes of benefiting from a forward view of the market, such as profits sought from future 

changes in the price of the underlying commodity. Doing so will ensure that the 

definition of Swap Dealer captures only those market participants involved in 

‘‘dealing’’ activities.

• Swaps Traded On-Facility: The Commissions should expressly exclude from the 

definition of Swap Dealer swaps offered or entered into on designated contract 

markets and swap execution facilities, unless the entity entering into or offering 

the on-facility swap is making a market in that swap. Such an exclusion will 

provide certainty that market participants who are anonymously matched on a 

swap execution facility are not accommodating demand. This scenario clearly 

should not be considered as accommodating demand and yet because the Commissions’ Core S/D Criteria are broad, the Working Group believes an express 

exclusion would better serve the market.

• Physical Options: The Commissions should expressly exclude from the definition 

of Swap Dealer swaps offered or entered into that are physical options that include an obligation to deliver or receive a commodity if the option is exercised. 

Such an exclusion is consistent with the definition of ‘‘swap’’ in new CEA Section 1a(47), which, if interpreted properly, excludes these physical options. 

Thus, without evidence to the contrary, the Commissions have no authority to 

regulate physical market participants as Swap Dealers simply for transacting 

in physical commodity options.

• Providing Two-Sided Pricing in Markets of Limited or Episodic Liquidity: The 

Commissions should exclude from the definition of Swap Dealer swaps offered 

or entered to provide two-sided pricing in a market of limited or episodic liquidity either for the purpose of (i) discovering a price for the swap or the underlying commodity, or (ii) eliciting bids and offers for the swap from other market 

participants. Such activity is distinct from dealing activity because the fundamental purpose is price discovery. Nor is this ‘‘market making’’ given that the 

market participant is not functioning specifically for the purpose of being a liquidity provider, but rather the activity is intended to be in furtherance of its 

commercial business.38

D. The Commissions Must Provide Greater Clarity and Guidance Regarding 

the Proposed General Exception and the De Minimis Exemption 

1. The General Exception 

a. The Interpretive Guidance Explaining ‘‘Regular Business’’ Is Circular and Creates 

Uncertainty 

The Working Group believes that the decision of the Commissions to tie prong 

three of the definition of Swap Dealer to the General Exception, i.e., to entities that 

regularly enter into swaps for their own account, is inconsistent with the clear Congressional intent of the General Exception and will result in significant legal and 

regulatory uncertainty for market participants. Specifically, the Proposed Rule

states that:

118

39Proposed Rule at 80177. 40 Id. (emphasis added). 41 Id. (emphasis added).

. . . clause [1a(49)](A)(iii) of the definition should be read in combination with 

the express exception in subparagraph (C) of the swap dealer definition, which 

excludes ‘‘a person that enters into swaps for such person’s own account, either 

individually or in a fiduciary capacity, but not as a part of a regular business.’’ 

Thus, the difference between the inclusion in clause (A)(iii) and the exclusion 

in subparagraph (C) is whether or not the person enters into swaps as a part 

of, or as an ordinary course of, a ‘‘regular business.’’ 39

The Commissions continue, explaining that:

We believe that persons who enter into swaps as a part of a ‘‘regular business’’ 

are those persons whose function is to accommodate demand for swaps from 

other parties and enter into swaps in response to interest expressed by other 

parties. Conversely, persons who do not fulfill this function should not be 

deemed to enter into swaps as a ‘‘regular business’’ and are not likely to be swap 

dealers.40

As evidenced by the above excerpts, rather than developing an independent basis 

by which to interpret ‘‘regular business,’’ the Commissions define the General Exception by simply citing to the definition of Swap Dealer, resulting in circular reasoning that does not assist market participants in determining whether their activities meet the exception. Said differently, the Commissions rely upon the Swap Dealer definition to define what ‘‘regular business’’ is not, which, given the broad interpretation of Swap Dealer proposed by the Commissions, will undoubtedly create significant legal and regulatory uncertainty. The Commissions should avoid this circular logic and instead develop clear guidance as to what constitutes ‘‘regular business.’’

Additionally, the Commissions attempt to provide further guidance as to how the 

CFTC will determine whether an entity is a Swap Dealer, explaining that:

In sum, to determine if a person is a swap dealer, we would consider that person’s activities in relation to other parties with which it interacts in the swap 

markets. If a person is available to accommodate demand for swaps from other 

parties, tends to propose terms, or tends to engage in the other activities discussed above, then the person is likely to be a swap dealer. Persons that rarely

engage in such activities are less likely to be deemed swap dealers.41

The Working Group believes that this interpretation, and the use of a number of 

qualifiers, such as the terms ‘‘not likely,’’ ‘‘available,’’ ‘‘tends to,’’ ‘‘likely,’’ ‘‘less likely,’’ and ‘‘rarely,’’ creates significant uncertainty regarding the scope and applicability of the General Exception. Congress provided an exception for those entities 

that engage in swap dealing activities that are incidental to their non-swap dealing 

businesses. Congress recognized that many businesses use swap markets to manage 

their financial and physical delivery obligations and commercial risk. This use is incidental to their primary businesses and their use of the swap markets in this manner does not make them Swap Dealers. Thus, the Commissions should clarify this 

language in order to (i) help more clearly define the universe of market participants 

that fall within the definition of Swap Dealer, and (ii) provide the legal and regulatory certainty required for market participants to rely in good faith on the General 

Exception. 

b. In the Alternative, the Commissions Should Provide a Commodity-Based Exception 

Given the shortcomings of the Commissions’ proposed interpretation of ‘‘as a part 

of a regular business,’’ the Working Group recommends that the Commissions revise 

the proposed General Exception. In doing so, the Commissions should make it clear 

that swap transactions entered into for customary economic purposes relating to a 

market participant’s primary underlying business as a producer, processor, commercial user, or merchant of a physical energy or agricultural commodity should not be 

considered part of an entity’s ‘‘regular business’’ for purposes of the General Exception. 

To this end, the Working Group proposes the following revised definition of ‘‘Exception’’ for the Commissions’ consideration: 

119

42 Note, proposed new language is underlined. See also Attachment A, attached hereto. 43See Public Hearing to Review Implementation of Title VII of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act: Hearing Before the House Committee on Agriculture, 112th 

Cong. (Feb. 10, 2011) (testimony of CFTC Chairman Gary Gensler explaining that the size of 

the U.S. swaps market is approximately $300 trillion and that ‘‘the largest 25 bank holding companies currently have $277 trillion notional amount of swaps.’’). Based on Chairman Gensler’s 

figures, the largest 25 bank holding companies control approximately 92 percent of the U.S. 

swaps market. See also ‘‘Goldman Sachs, Morgan Stanley Would Be Least Affected by Swaps 

Proposal,’’ Bloomberg News (June 23, 2010), available at http://www.bloomberg.com/news/

2010-06-23/goldmansachs-morgan-stanley-would-be-least-affected-by-swaps-proposal.html (concluding that the five major U.S. commercial banks and their subsidiaries held 97 percent of the 

notional amount of outstanding derivatives in the fourth quarter of 2009). 44 Note, proposed new language is underlined. See also Attachment A, attached hereto. 

17 CFR 1.3(ppp)(2).42

EXCEPTION. The term ‘‘swap dealer’’ does not include a person that enters into 

swaps for such person’s own account, either individually or in a fiduciary capacity, but not as a part of a regular business.

(i) The following swap transactions shall not be considered in determining a person’s Regular Business:

(a) Swaps entered into by a producer, processor, or commercial user of, or a merchant handling a physical energy or agricultural commodity that are ancillary or as an incident to the person’s business as a producer, processor, or commercial user of, or a merchant handling a physical energy or agricultural commodity.

(ii) ‘‘Regular Business’’ means a usual and significant business activity of a person as measured by, among other things, revenues, profits, volume, value-at-risk, exposure 

and resources devoted to the business. 

2. De Minimis Exemption 

a. Proposed Alternative Approach to the De Minimis Exemption 

The Commissions’ interpretation of the de minimis exemption suggests that if an 

entity fails to satisfy the de minimis criteria proposed by the Commissions, such entity would be deemed a Swap Dealer. In this manner, the Commissions’ proposed 

definition effectively establishes additional criteria by which to identify entities as 

Swap Dealers. Such an application of the exemption was not the intent of Congress. 

The Working Group believes Congress intended the de minimis exemption to apply 

to those Swap Dealers who engage in limited amounts of swap dealing or whose notional amount of exposure is small. 

Further, the Working Group recognizes the widely accepted reports that at least 

92% of the total value of the notional amounts of the outstanding OTC swaps is held 

by the 25 largest bank holding companies.43 Such entities are Swap Dealers and 

should be covered by the Proposed Rule. The de minimis exemption should therefore 

be crafted to distinguish the remaining notional exposure in the entire U.S. swap 

market. The Commissions’ proposed de minimis definition does not accomplish this 

objective. 

In this context, the Working Group offers the following alternative approach to 

the de minimis exemption: 

17 CFR 1.3(ppp)(4).44

DE MINIMIS EXCEPTION.

(i) A person shall not be deemed to be a swap dealer for any major category of 

swaps as a result of swap dealing in connection with transactions with or on behalf 

of its customers if the notional amount of the swap positions connected with those 

activities did not exceed one one-thousandth of one percent (.001%) of the total no- tional amount of swaps in the United States. The total notional amount of swaps in 

the United States shall be determined by the Commission on an annual calendar basis. 

(ii) For purposes of this section, the measure of the percent of the total notional 

amount of swaps in the United States during a calendar quarter shall equal the arithmetic mean at the close of each business day, beginning the first business day of each 

calendar quarter and continuing through the last business day of that quarter. 

(iii) A person that is not registered as a swap dealer, and which does not qualify 

for the exception in Section 1.3(ppp)(2) above, but which exceeds the criterion in this 

section as a result of its swaps dealing will not be deemed to be a swap dealer until 

the earlier of the date on which it submits a complete application for registration as a swap dealer or two months after the end of the calendar quarter in which it first 

exceeds this criterion. Notwithstanding the previous sentence, if a person that is not 

registered as a swap dealer meets the criteria in this section to be a swap dealer but 

120

45Please note that in comments on the definition of ‘‘Major Swap Participant’’ submitted contemporaneously with this comment letter, the Working Group recommends different registration 

timing for MSPs than the timing presented here for Swap Dealers (i.e., two consecutive quarters 

vs. two months after the end of the calendar quarter). In this comment letter, the Working 

Group maintains the CFTC’s proposed Swap Dealer registration timing requirements in order 

to demonstrate the framework analysis. 46Proposed Rule at 80180. 47 Id. (emphasis added). 48 A definitional distinction that is critical for this alternative metric is that between ‘‘customer’’ and ‘‘counterparty.’’ This distinction is created by the statutory language—new CEA Section 1a(49)(A)(iii) of the Swap Dealer definition refers to ‘‘counterparties,’’ while the de minimis

provision in Section 1a(49)(D) refers to ‘‘customers.’’ However, the statute itself provides no definitional guidance for this distinction. The concept of ‘‘customer’’ seems to imply some manner 

of relationship that extends beyond the bare terms of the particular transaction, as distinct from 

does not exceed the threshold in (ii) by more than twenty percent in that quarter that 

person will not be subject to the timing requirements unless and until at the end of 

the next fiscal quarter that person exceeds the criterion.45

(iv) A person that is deemed to be a swap dealer in this section shall continue to 

be deemed a swap dealer until such time that its swap positions in (i) do not exceed 

the criterion for four consecutive quarters.

The Working Group suggests the alternative language as it provides an appropriate threshold to identify swap dealing which is above a de minimis level. The 

Working Group respectfully submits that one one-thousandth of one percent of the 

total notional amount of swaps in the U.S. is by definition a de minimis amount. 

Further, the calculation, as set forth above, mirrors the Commissions’ proposal for 

determination of a MSP. 

b. Rejection of a Relative Test for Applying the De Minimis Exemption Is Not Based 

on Reasoned Decision-Making 

The Working Group has concerns with the Commissions’ rejection of proposals to 

apply the de minimis exemption using a test that measures the size of an entity’s 

customer-facing, dealing activities relative to the size its overall swap trading operations.46 As support for this decision, the Commissions take the view that the use 

of a ‘‘relative test’’ for applying the de minimis exemption would favor larger, more 

active traders over smaller, less active traders. Specifically, the Proposed Rule states 

that: 

Aside from the fact that the statute does not explicitly call for a relative test, 

such an approach would lead to the result that larger and more active companies, which presumably would be more able to influence the swap markets, 

would be more likely to qualify for the exemption than smaller and less active 

companies. Also, a relative test would require a means of measuring the person’s dealing activities, but also would require a means of measuring the larger 

scope of activities to which its swap dealing or security-based swap dealing activities are to be compared, thus introducing unnecessary complexity to the exemption’s application.47

Notwithstanding the Commissions’ position that the adoption of a relative test 

would favor companies with larger, more active swap trading operations, the Working Group contends that the rejection of such a test actually could competitively disadvantage such companies. Moreover, the basis for qualifying for the de minimis ex- emption appears to be fundamentally different from the basis for determining 

whether an entity is a trader and thus the Working Group requests that the Commissions reconsider a relative test. 

The statement in the Proposed Rule that use of a ‘‘relative test’’ would harm 

smaller companies with less active trading operations is flawed. Regardless of an 

entity’s size, if a dominant portion of its overall trading activities involve customerfacing transactions and the entity otherwise meets the definition of ‘‘Swap Dealer,’’ 

then that entity’s functional role in swap markets should be viewed as that of a 

‘‘dealer.’’ If the Commissions do not wish to impose the onerous prudential, business 

conduct, record-keeping and reporting requirements applicable to Swap Dealers on 

smaller companies with less active trading operations, then the Commissions should 

establish an exemption from such regulatory requirements, rather than exempting 

them from Swap Dealer status. 

In this context, the Working Group recommends the Commissions consider replacing the proposed mechanism to define the de minimis threshold with an approach 

that examines the ratio of a firm’s ‘‘customer’’ swaps notional amount (on a deltaequivalent basis) to total swaps notional amount (delta-equivalent), and excludes 

from the Swap Dealer definition any entity for which this ratio is less than 25%.48

121

the relationship of mere trading counterparties, where two entities have met in the market 

place and transacted, each for its own reasons. One element suggestive of a ‘‘customer’’ relationship might be a concept of ‘‘solicitation,’’ in the sense that a counterparty would be an entity’s 

customer if such entity solicits the counterparty to do a transaction on the grounds that it will 

be beneficial to the counterparty. This ‘‘solicitation’’ concept must be distinguished from a ‘‘Request for Proposal’’ or ‘‘Request for Quote’’ process, in which an entity solicits transactions, but 

for the purpose of benefiting the entity itself, rather than for the benefit of the solicited 

counterparty or counterparties. In addition, a counterparty would seem to be an entity’s customer if such entity provided advice on the transaction that was material to the counterparty’s 

decision to transact, or with whom. 49Proposed Rule at 80180. The Proposed Rule provides that ‘‘[w]e understand that in general 

the notional size of a small swap or security-based swap is $5 million or less . . . .’’ Id. 50 Id. 51See new CEA Section 2(e). 

For banks subject to the Volcker rule, the value for the proposed metric should 

never be less than 0.5. This is the value of the metric in a world in which (1) the 

bank’s customer deals do not provide any diversification of risk, (2) the bank hedges 

all of the risk from the customer deals with non-customer deals, and (3) the bank 

does no other non-customer deals because they would be prohibited by the Volcker 

rule. To the extent customer deals hedge each other and the bank hedges only the 

residual with non-customer deals, the metric will approach one (1.0). As a result, 

the proposed critical value of 0.25 provides ample room to assure that entities properly viewed as swap dealers cannot resort to the de minimis exception. 

c. The Proposed Aggregate Gross Notional Amount Is Unsupported and Unduly Restrictive 

Should the Commissions forego adopting the Working Group’s proposed alternative de minimis definition or a relative test and instead maintain their proposed 

framework, the Working Group submits that the proposed hard cap on aggregate 

notional amount of $100 million is unsupported and unduly restrictive. Indeed, 

under the Commissions’ proposal, a non-dealer commercial firm or end-user that 

has, for example, four customer-facing swaps with an aggregate notional amount of 

over $100 million would be required to register as a Swap Dealer. Such a result is 

at odds with Congressional intent to regulate as Swap Dealers only those entities 

commonly understood to engage in dealing activity. 

The Commissions attempt to justify this cap with an unsupported assumption 

that the average amount of a small swap transaction is $5 million.49 The Commissions, however, fail to set forth in the Proposed Rule the underlying data to support 

this claim, and thus the Commissions’ decision to set the cap at $100 million lacks 

a proper evidentiary foundation. 

In a further attempt to justify the $100 million notional amount threshold, the 

Commissions explain that:

given the customer protection issues raised by swaps and security-based 

swaps—including the risks that counterparties may not fully appreciate when 

entering into swaps or securities-based swaps—we believe that this notional 

amount reflects a reasonable limit for identifying those entities that engage in 

a de minimis level of dealing activity.50

This rationale, however, does not hold up to closer scrutiny. The Act expressly prohibits unsophisticated parties from entering into inappropriate derivatives transactions by limiting the types of counterparties that can participate in those markets.51 As such, only eligible contract participants (‘‘ECP’’) are eligible to participate 

in off-facility swap transactions. Given that ECPs are sophisticated parties that 

fully appreciate the attendant risks involved when engaging in swaps in physical 

markets, the Commissions’ assertion that such parties require ‘‘customer protection’’ 

is contrary to the market participant framework contemplated by Congress and established by the Act. 

Due to the current economic recession in the U.S., energy prices remain depressed 

compared to periods of strong and sustained economic growth. Consequently, commercial energy firms that presently meet the requirements of the de minimis exemption may no longer meet this exemption if the aggregate notional amount of 

their existing deals exceed the $100 million threshold simply due to rising energy 

prices. As such, the Commissions should increase the hard cap for aggregate notional amount of customer-facing transactions beyond the proposed $100 million 

threshold, or otherwise provide some form of flexibility to market participants. At 

a minimum, the Commissions should include in the final rule any data related to 

its determination that the average value of a small swap transaction is $5 million. 

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52Proposed Rule at 80182. 53Proposed CFTC Rule 1.3(ppp)(3). 54 New CEA Section 1a(49)(B).

d. The Commissions Should Revisit the Scope and Application of the Twenty Transaction Threshold 

Based on guidance in the Proposed Rule interpreting proposed CFTC Rule 

1.3(ppp)(3) as covering different ‘‘types, classes, and categories of swaps,’’ 52 the 

Working Group believes that the twenty transaction threshold of the de minimis exemption is grossly insufficient and should be significantly higher. To be sure, market participants exceeding the twenty transaction threshold, including non-dealer 

commercial firms and end-users, will be deemed Swap Dealers simply for 

transacting in swap markets for their customary business purposes. Certainly Congress did not intend for such a far-reaching result. In the absence of any supporting 

data from the Commissions, the Working Group is unable to contemplate any justification for this number and requests the Commissions to identify their reasoning. 

To the extent the Commissions do not have a reasonable basis, the Working Group 

requests the Commissions to develop a more appropriate transaction threshold 

based on empirical swap market data. 

Should the Commissions fail to significantly increase the proposed threshold in 

the final rule, the Working Group seeks clarification regarding the scope and application of the proposed threshold embedded in the de minimis exemption. In the energy context, it is not clear whether the twenty transaction threshold would apply 

to all energy commodities combined (i.e., energy swaps or metals swaps), or on a 

commodity-by-commodity basis (i.e., power swaps, natural gas swaps, silver swaps, 

etc.). If the Commissions apply the threshold to all energy commodities combined, 

a commercial energy firm that engaged in the following customer-facing swaps 

would be required to register as a Swap Dealer: (i) three customer-facing crude 

swaps, (ii) three fuel swaps, (iii) three heating oil swaps, (iv) three gasoline swaps, 

(v) three natural gas swaps, (vi) three natural gas liquids swaps, and (vii) two power 

swaps. Such a result is clearly not intended by Congress, as numerous commercial 

energy firms will surpass the twenty transaction threshold simply by engaging in 

swaps for customary business activities, unrelated to any dealing activity whatsoever. At a minimum, therefore, the Commissions should apply the threshold on a 

commodity-by-commodity basis. 

E. The Proposed Limited Designation Requirement Creates a Presumption 

Contrary to the Statute 

The Commissions’ proposed limited designation requirement creates a presumption that a person who is a Swap Dealer ‘‘shall be deemed to be a swap dealer with 

respect to each swap it enters into regardless of the category of the swap or the person’s activities in connection with the swap.’’ 53 Accordingly, the CFTC intends to 

view an entity deemed a Swap Dealer for one category of swaps to be deemed a 

Swap Dealer for all other activities, unless and until such entity seeks and obtains 

CFTC approval that its Swap Dealer designation should be limited to certain activities. 

This presumption, however, is contrary to the express statutory language of the 

Act, which provides that:

A person may be designated as a swap dealer for a single type or single class 

or category of swap activities and considered not to be a swap dealer for other 

types, classes, or categories of swaps or activities.54

The statute expressly presumes that an entity may be deemed a Swap Dealer for 

some activities without being considered a Swap Dealer for other activities, thus 

creating a presumption in favor of the market participant, meaning an entity 

deemed to be a Swap Dealer for a swap or category of swaps should be presumed 

to be a Swap Dealer only for that particular activity. The Commissions have effectively flipped the statute on its head, establishing a presumption in direct contrast 

to the express statutory language. As such, the Working Group respectfully requests 

the Commissions to abandon proposed CFTC Rule 1.3(ppp)(3) or, alternatively, to 

revise the rule to reflect the fact that entities designated as a Swap Dealer for one 

category of swaps shall not be deemed a Swap Dealer or any other financial entity 

(as defined under CEA 2(h)(7)(C)) for other swaps. 

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55Proposed Rule at 80183. 56 7 U.S.C. § 19(a). 57Proposed Rule at 80204. 

F. Additional Issues Requiring Clarification With Respect to the Proposed 

Definition of Swap Dealer 

1. Issues Related to Affiliate Transactions 

The Commissions invite comment with respect to how the Swap Dealer definition 

should be applied to swaps executed between members of an affiliated group. The 

Working Group generally supports the approach taken by the Commissions with respect to affiliate transactions, particularly the Commissions’ recognition that transactions between affiliates are used for risk management purposes and that swaps 

between affiliates ‘‘may not involve the interaction with unaffiliated persons that we 

believe is a hallmark of the elements of the definitions that refer to holding oneself 

out as a dealer or being commonly known as a dealer.’’ 55

However, given that transactions between affiliates are used for the ‘‘allocation of 

risk within a corporate group,’’ the Working Group requests the Commissions to 

clarify that in no case shall any transactions between corporate affiliates be considered dealing activity for purposes of determining whether an entity is a Swap Dealer, including application of the de minimis criteria. As noted by the Commissions, 

inter-affiliate transactions do not carry any of the elements of dealing activity given 

that the transactions are used to manage and allocate risk within a holding company system or other organizational structure. 

2. Safe Harbor for Good Faith Efforts To Comply With the Proposed Rule

The Proposed Rule’s requirement that market participants self-select whether registration as a Swap Dealer is required raises significant compliance risks. Consequently, the Commissions should seek to facilitate compliance with the Proposed 

Rule and work with industry members as the definition of Swap Dealer becomes effective. Market participants that exercise due diligence and make good faith efforts 

to determine whether registration is required, but do not register, should not be 

subject to enforcement action. Thus, the CFTC should enhance relevant guidance, 

including the No Action Letter process, for providing comfort to market participants 

that enforcement would not be recommended under specific fact-based scenarios. 

G. The Commission’s Cost-Benefit Analysis Is Insufficient and Inconsistent 

With Anticipated Compliance Costs 

Section 15(a) of the CEA requires the CFTC, before promulgating a rule, to ‘‘consider the costs and benefits of the action of the Commission.’’ 56 As a general matter, 

the cost and benefit analysis specific to regulations regarding Swap Dealers does not 

appear to be based on any empirical data and does not appear to be consistent with 

the expected costs of compliance anticipated by market participants.57 In particular, 

the Swap Dealer cost-benefit analysis does not evaluate the costs to be imposed on 

the numerous additional market participants likely to be swept into the Swap Dealer category as a result of the overly broad definition of Swap Dealer proposed by 

the Commissions. 

If these market participants choose to exit the swap markets rather than absorb 

the costs of potential regulation as a Swap Dealer, such departures will adversely 

impact liquidity as remaining swap transactions become concentrated in a smaller 

number of market participants, notably financial institutions. Accordingly, the Commissions should perform a liquidity cost analysis that assesses the probability and 

impacts of such a result. Such an analysis also should consider the number of nondealer market participants expected to be designated as Swap Dealers simply for 

exceeding the low thresholds set forth in the Commissions’ proposed de minimis

framework. 

The Working Group therefore requests that the Commissions (i) consider the costs 

and benefits associated with the Proposed Rule in the manner prescribed by CEA 

Section 15(a), (ii) issue a supplemental rule in this proceeding setting forth empirical data supporting its conclusions regarding the costs and benefits of the Proposed 

Rule, and (iii) notice the supplemental rule in the Federal Register for public comment. 

IV. Conclusion 

The Working Group supports appropriate regulation that brings transparency and 

stability to the energy swap markets in the United States. The Working Group appreciates this opportunity to comment and respectfully requests that the CommisVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00127 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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1Please note that the underscored text reflects the Working Group’s proposed revisions. 

2The phrase ‘‘hedge or mitigate commercial risk’’ could ultimately be tied to proposed CFTC 

Rule 1.3(ttt), but only if the Commissions adopt the framework recommended by the Working 

Group with respect to proposed CFTC Rule 1.3(ttt) in comments submitted contemporaneously 

with this comment letter on the Commissions’ proposed definitions of ‘‘Major Swap Participant’’ 

and ‘‘End-User.’’

sion consider the comments set forth herein as it develops a final rule in this proceeding. If you have any questions, please contact the undersigned. 

Respectfully submitted,

MARK W. MENEZES; 

R. MICHAEL SWEENEY, JR.; 

DAVID T. MCINDOE; 

Counsel for the Working Group of Commercial Energy Firms. 

ATTACHMENT A

Proposed Revised Definition of Swap Dealer 

17 CFR 1.3(ppp) Swap Dealer.1

(1) IN GENERAL. The term ‘‘swap dealer’’ means any person who:

(i) Holds itself out as a dealer in swaps; 

(ii) Makes a market in swaps; 

‘‘Makes a market’’ means regularly providing two-sided pricing:

(a) for a particular swap for execution for a person’s own account; or 

(b) pursuant to a contractual obligation.

(iii) Regularly enters into swaps with counterparties as an ordinary course of 

business for its own account; or 

(iv) Engages in any activity causing it to be commonly known in the trade 

as a dealer or market maker in swaps.

provided, however, that an entity shall not be considered to be a swap dealer to the extent that 

it offers to enter into, or enters into, a swap:

(a) to hedge or mitigate commercial risk; 2

(b) for the purpose of benefiting from future changes in the commodity reference 

price (i.e., the price to which the floating leg of a swap is indexed); 

(c) on a designated contract market or swap execution facility, unless such entity 

is making a market in that swap; 

(d) that is a physical option that includes the obligation to deliver or receive a commodity if the option is exercised; or 

(e) to provide two-sided pricing in a market of limited or episodic liquidity for the 

purpose of:

(I) discovering a price for the swap or the underlying commodity, or 

(II) eliciting bids and offers for the swap from other market participants.

(2) EXCEPTION. The term ‘‘swap dealer’’ does not include a person that enters into 

swaps for such person’s own account, either individually or in a fiduciary capacity, 

but not as a part of a regular business.

(i) The following swap transactions shall not be considered in determining a person’s 

Regular Business:

Swaps entered into by a producer, processor, or commercial user of, or a merchant 

handling a physical energy or agricultural commodity that are ancillary or as an incident to the person’s business as a producer, processor, or commercial user of, or a 

merchant handling a physical energy or agricultural commodity.

(ii) ‘‘Regular Business’’ means a usual and significant business activity of a person as 

measured by, among other things, revenues, profits, volume, value-at-risk, exposure and 

resources devoted to the business.

(3) SCOPE. [No proposed changes.] 

(4) DE MINIMIS EXCEPTION.

(i) A person shall not be deemed to be a swap dealer for any major category of swaps 

as a result of swap dealing activity in connection with transactions with or on behalf of 

its customers if the notional amount of the swap positions connected with those activities 

did not exceed one one-thousandth of one percent (.001%) of the total notional amount 

125

3 In comments on the definition of ‘‘Major Swap Participant’’ submitted contemporaneously 

with this comment letter, the Working Group recommends different registration timing for 

MSPs than the timing presented here for Swap Dealers (i.e., two consecutive quarters vs. two 

months after the end of the calendar quarter). In this comment letter, the Working Group maintains the CFTC’s proposed Swap Dealer registration timing requirements in order to demonstrate the framework analysis. 1This letter sets out general observations about the Commission’s rulemaking process to date. 

The Working Group intends to submit a separate letter on the topic of sequencing the final rules 

and their implementation. 

of swaps in the United States. The total notional amount of swaps in the United States 

shall be determined by the Commission on an annual calendar basis. 

(ii) For purposes of this section, the measure of the percent of the total notional amount 

of swaps in the United States during a calendar quarter shall equal the arithmetic mean at the close of each business day, beginning the first business day of each calendar quarter 

and continuing through the last business day of that quarter. 

(iii) A person that is not registered as a swap dealer, and which does not qualify for 

the exception in Section 1.3(ppp)(2) above, but which exceeds the criterion in this section as a result of its swap dealing activity will not be deemed to be a swap dealer until the 

earlier of the date on which it submits a complete application for registration as a swap 

dealer or two months after the end of the calendar quarter in which it first exceeds this 

criterion. Notwithstanding the previous sentence, if a person that is not registered as a swap 

dealer meets the criteria in this section to be a swap dealer but does not exceed the threshold in (ii) by more than twenty percent in that quarter that person will not be subject to 

the timing requirements unless and until at the end of the next fiscal quarter that person 

exceeds the criterion.3

(iv) A person that is deemed to be a swap dealer in this section shall continue to be 

deemed a swap dealer until such time that its swap positions in (i) do not exceed the criterion for four consecutive quarters. 

March 22, 2011

DAVID A. STAWICK, Secretary,

Commodity Futures Trading Commission, 

Washington, D.C.

Re: Rulemaking under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Dear Secretary Stawick:

On behalf of the Working Group of Commercial Energy Firms (the ‘‘Working 

Group’’), Hunton & Williams LLP respectfully submits this letter to the Commodity 

Futures Trading Commission (the ‘‘Commission’’) to offer certain observations regarding the approach by which the Commission might implement regulations under 

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the 

‘‘Dodd-Frank Act’’).1

The Working Group is a diverse group of commercial firms in the energy industry 

whose primary business activity is the physical delivery of one or more energy commodities to others, including industrial, commercial and residential consumers. 

Members of the Working Group are energy producers, marketers and utilities. The 

Working Group considers and responds to requests for public comment regarding 

regulatory and legislative developments with respect to the trading of energy commodities, including derivatives and other contracts that reference energy commodities. 

Because the Commission has not finalized the regulatory definition of the terms 

such as ‘‘swap dealer,’’ ‘‘major swap participant’’ and ‘‘swap,’’ members of the Working Group have commented on proposed rulemakings applicable to swap dealers and 

major swap participants and offer their thoughts contained herein on requirements 

imposed on ‘‘swap dealers’’ and ‘‘major swap participants.’’ While members of the 

Working Group have never considered themselves, or been viewed by others as swap 

dealers or major swap participants, they are concerned with the breadth and vagueness of the proposed rules and, thus, have commented on proposed rules imposing 

obligations on swap dealers and major swap participants. 

I. Comments of the Working Group 

Title VII of the Dodd-Frank Act places a substantial burden on the Commission. 

The Commission is tasked with constructing a new regulatory regime for swap markets based on the contours set forth in the Dodd-Frank Act. It is charged with comVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00129 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
126

2Satisfying these three goals would not only fulfill the Commission’s obligation under Section 

15(a) of the Commodity Exchange Act (‘‘CEA’’) to consider and evaluate the costs and benefits 

of a proposed rule, but it would also adhere to the intent of President Obama’s Executive Order 

on Improving Regulation and Regulatory Review. Exec. Order No. 13563, 76 Fed. Reg. 3821 

(January 18, 2011) (the ‘‘Executive Order’’). The Working Group acknowledges, that as an independent agency, the Commission is not subject to the Executive Order. However, the Working 

Group encourages the Commission to adhere to President Obama’s intent. 3See, Public Hearing to Review Implementation of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 112th Cong. (Feb. 10, 2011) (statement of Hon. Gary 

Gensler, Chairman, CFTC). Chairman Gensler stated that, based on OCC estimates, the largest 

25 bank holding companies held $277 trillion in notional amount of swaps and that the domestic 

swap market was approximately seven times larger than the $40 trillion futures market. Based 

on those figures, the 25 largest bank holding companies would hold 99% of the domestic swap 

market. See also, Chairman Gensler’s Budget Transmission Letter (Feb. 14, 2011). Chairman 

Gensler stated that, based on OCC estimates, the largest 25 bank holding companies held $277 

trillion in notional amount of swaps and that some estimates placed the size of the U.S. swap 

market at ‘‘as big as $300 trillion.’’ Based on those figures, the 25 largest bank holding companies would hold 91% of the domestic swap market. 4See, Gary Gensler, Chairman, CFTC, Remarks Before ISDA Regional Conference (Sept. 16, 

2010). Chairman Gensler stated ‘‘initial estimates are that there could be in excess of 200 entities that will seek to register as swap dealers.’’

pleting this monumental task in less than a year with limited resources. The Commission must balance the timing requirements set forth by Congress with the need 

to construct rules that (1) accomplish the goals of the Dodd-Frank Act, (2) are enforceable by the Commission and (3) cause the least disruption in, and impose the 

lowest possible costs on swap markets.2 The Working Group respectfully submits 

this letter to assist the Commission in satisfying these three goals. 

A. Market Analysis 

As a threshold matter, when proposing a rule, the Commission should conduct a 

careful analysis of the markets and market participants to which the rule will 

apply. Without a comprehensive understanding of the relevant market and its participants, the Commission will be unable to ensure that such proposed rule will 

meet the three goals set forth above. Further, analysis of the relevant market and 

its participants is necessary to satisfy the Commission’s cost benefit obligations 

under Section 15(a) of the CEA. Such analysis is warranted particularly for swap 

markets that traditionally have not been regulated pervasively by the Commission, 

such as the energy swap markets. 

The current approach taken by the Commission to the regulation of swap markets 

does not appear to have the benefit of such careful market analysis. For example, 

as Chairman Gensler has stated repeatedly, over $277 trillion in notional amount 

of domestic swaps are held by 25 bank holding companies.3 Said another way, those 

25 bank holding companies are party to 91–99% of domestic swaps. Despite these 

compelling statistics, the proposed definition of ‘‘swap dealer’’ appears to be based 

on the premise that the universe of swap dealers extends far beyond this group of 

financial institutions.4 Drafting the definition of ‘‘swap dealer’’ in a manner that 

captures entities far beyond these 25 bank holding companies will have serious implications for swap markets. As noted above, in crafting rules, the Commission must 

take into account the costs of regulation. In this instance, the Commission must 

weigh (a) the costs of extending the comprehensive regulation imposed on swap 

dealers to entities beyond the 25 bank holding companies against (b) the potential 

benefits of this additional regulation. If the Commission extends the definition of 

‘‘swap dealer’’ beyond such bank holding companies, it will impose substantial additional costs on consumers and the overall swap markets, while providing little or 

no benefit to the economy. Further, extending the designation of swap dealers beyond these core bank holding companies will not further the underlying intent of 

the Dodd-Frank Act. 

B. The Commission Should Continue Its Principles-Based Approach 

1. The Dodd-Frank Act Generally Allows the Commission To Adopt Principles-Based 

Regulations 

The Commission has an established history of effective oversight through a principles-based approach to regulation. The Working Group believes that the Commission should remain squarely within this tradition. This tradition results in clear 

statements of the goals and requirements of regulation and is based upon the market participants’ deep experience and knowledge of the swap markets to create efficient compliance solutions. It also reduces the burden on the Commission to craft 

and monitor compliance with granular criteria. 

127

5See, for example, the requirement in Section 731 of the Dodd-Frank Act for swap dealers and 

major swap participants to provide daily marks to counterparties on uncleared swaps. 6See Notice of Proposed Rulemaking on Business Conduct Standards for Swap Dealer and 

Major Swap Participants with Counterparties 75 Fed Reg. 81519 (Dec. 28, 2010), notes 47, 50, 

52. The ‘‘best practices’’ upon which the Commission relies on in certain circumstances are the 

work of the Counterparty Risk Management Policy Group, which was comprised almost entirely 

of representatives from the largest banks. 

While the Dodd-Frank Act is prescriptive in many of the requirements that it imposes,5 many of the rules proposed by the Commission have been prescriptive when 

the Dodd-Frank Act allows the Commission ample latitude to craft rules consistent 

with a principles-based approach. For example, Section 731 of the Dodd-Frank Act 

requires the Commission to set basic duties of, and business conduct standards for, 

swap dealers and major swap participants, including disclosure of material risks associated with swaps and having processes in place to ensure compliance with position limits. However, the rules proposed by the Commission to implement such duties and business conduct standards go well beyond setting a general compliance, 

risk management, and disclosure framework for swap dealers and major swap participants. The Proposed Rule on Duties of Swap Dealers and Major Swap Participants would codify a set of detailed aspirational ‘‘best practices,’’ arguably appropriate only as guidance for financial entities, as legal requirements for all swap 

dealers and major swap participants. The Proposed Rule on Business Conduct 

Standards for Swap Dealer and Major Swap Participants with Counterparties would 

impose a suitability standard on swap dealers and major swap participants and also 

seeks to codify a set of detailed aspirational ‘‘best practices’’ intended as guidance 

for financial entities as legal requirements for all swap dealers and major swap participants.6

In these two rulemakings, among others, the Commission has taken an unnecessary prescriptive approach. This approach will not result in market participants taking the proper approach to compliance, i.e., developing an organic ‘‘culture of compliance’’ within the company to constantly improve compliance as markets evolve and 

react to conditions. A prescriptive approach limits the judgment of entities and their 

personnel to essentially binary decisions, and, thus, leads to robotic compliance 

practices that seek only to assure compliance with the letter of the Commission’s 

regulations and not the intent. Under such prescriptive approach, market participants might know what they can and cannot do but will not fully understand the 

policy behind the rules. 

2. Overly Prescriptive Rules Will Limit Participation in Swap Markets 

Adopting prescriptive rules for all market participants based on aspirational ‘‘best 

practices’’ for financial entities will limit competition in swap markets. Markets 

function best when there is a large and diverse group of participants. This is particularly true in the energy swap markets, where many large commercial energy 

firms are active traders. This activity brings liquidity to the markets, and it also 

helps disperse counterparty credit risk. As drafted, many of the proposed rules 

might not be workable for non-financial swap market participants and, even if they 

prove workable, they would likely impose substantial costs on such market participants. 

A prescriptive approach to rulemaking might lead to a perverse result of promoting the further concentration of market activity and risk in certain swap markets to institutions that are ‘‘too big to fail.’’ The consequence of being a swap dealer 

or a major swap participant for a non-financial entity, such as a commercial energy 

firm, is that it will be regulated as a financial entity. Accordingly, depending on the 

scope and compliance burden imposed under the final regulations, it is possible that 

non-financial entities will decrease or discontinue their participation in swap markets. 

Only entities that can structure their businesses to meet the prescriptive requirements included in many of the Commission’s proposed rules will have the ability 

to be central players in markets. The burdens of regulatory compliance as a swap 

dealer or major swap participant effectively will become a substantial barrier to 

entry to those non-financial entities looking to become active, sophisticated traders 

in swap markets. Non-financial entities that are currently active market participants will have to reevaluate their activity in the swap markets. Some may continue 

as major market participants. Others may not. In such cases, the relative role of 

financial firms in the operation of the swaps market will increase and, as other entities leave the market, liquidity will likely decrease and volatility will increase. 

This concern is especially relevant in swap markets that currently rely on nondealer market participants for a substantial amount of transaction volume. In energy swap markets, many parties trade directly without the involvement of a swap 

128

7 Elective Rulemakings include, but are not limited to, proposed rules on portfolio compression, portfolio reconciliation, the suitability standard for non-swap dealer and non-major swap 

participant counterparties and the provision of scenario analysis. 8The Working Group is not suggesting that the definition of ‘‘swap dealer’’ be constructed to 

capture these 25 bank holding companies because they are large bank holding companies. The 

definition should focus on the role played in the market by potential ‘‘swap dealers’’ and should 

be calibrated to capture these 25 bank holding companies because they are party to a vast majority of domestic swaps. The Commission, of course, has the authority to expand the definition 

if it is necessary with regards to the post-Dodd-Frank Act market structure. 

dealer or other intermediary. An overly broad definition of ‘‘swap dealer’’ or rules 

that force all energy swaps to be done through swap dealers or other intermediaries 

likely will harm an otherwise mature and efficient market. Swaps between commercial energy firms where neither party plays the role of a dealer bring cost savings 

to the market and energy consumers, valuable liquidity to the market and help disperse credit risk among a wide number of market participants that are generally 

outside the core of the U.S. financial system. Without certainty that they will not 

be regulated like financial entities, commercial energy firms will be reluctant to 

enter into swaps with each other. The end result will be a market dominated by 

financial firms that are ‘‘too big to fail,’’ a loss of liquidity, a possible increase in 

consumer energy prices and a loss of market expertise. 

C. Elective Rule Makings 

As noted above, by requiring the Commission to issue numerous rulemakings in 

a short period of time, the Dodd-Frank Act tasks the Commission with a substantial 

undertaking. Given these mandatory obligations, the Working Group advises the 

Commission to postpone the consideration of any proposed rules not explicitly required by the Dodd-Frank Act (‘‘Elective Rulemakings’’) until all of the required 

rulemakings have been completed, and more importantly, until the effects of the required rulemakings on swap markets are known.7

Delaying the consideration of the Elective Rulemakings would have multiple advantages. First, delaying these rulemakings will allow the Commission and market 

participants to dedicate their limited resources to only those undertakings required 

by Congress. Second, by waiting until the regulatory paradigm set forth by Title VII 

of the Dodd-Frank Act is in place, the Commission can determine if the Elective 

Rulemakings are in fact necessary. Third, if the Commission finds that the Elective 

Rulemakings are necessary, the delay will enable the Commission to focus on the 

Elective Rulemakings. Delay and subsequent consideration will ensure that the 

Elective Rulemakings further the intent of the Dodd-Frank Act, will work in swap 

markets, and will accomplish the desired result without imposing undue burdens on 

the Commission and swap market participants. In this light, the Working Group respectfully requests that the Commission postpone all Elective Rulemakings until the 

entire mandatory Dodd-Frank Act regulatory paradigm is in place. 

D. Working Group Recommendations 

In light of the difficulties that the Commission faces in creating rules that (1) accomplish the goals of the Dodd-Frank Act, (2) are workable for the Commission and 

market participants and (3) accomplish these two goals while limiting the negative 

impacts on swap markets, the Working Group has the following three suggestions. 

First, the Working Group suggests that the Commission limit the scope of the definition of ‘‘swap dealer’’ in a manner that captures only those 25 bank holding companies that hold over 90% of the notional value of domestic swaps.8 Doing so will 

accomplish the intent of the Dodd-Frank Act in that it will capture the overwhelming majority of the U.S. swap market and will do so in a manner that limits 

the costs to market participants. Adopting such a definition will allow the Commission to focus its limited resources on a small number of market participants and 

will allow traders who are not thought of by the market as swap dealers to remain 

active market participants. Setting a definition of swap dealer that captures the remaining minimal percentage of the market will impose substantial marginal costs 

on the Commission and on the many market participants that will be captured. 

Therefore, to do so, the Commission should determine that there is a compelling 

benefit to the market that outweighs the additional costs. 

Second, where possible, the Commission should retain its traditional principlesbased approach to regulation. The Dodd-Frank Act is prescriptive in some specific 

areas, but it generally does not limit the Commission’s ability to write rules that 

provide discretion to market participants to design and implement compliance measures. Such adaptability is necessary to allow a diverse community of active traders 

to remain in swap markets so that such markets remain liquid and well functioning. 

Permissive rules will allow market participants to put in place compliance and risk 

129

9There is a good amount of academic writing supporting the Working Group’s suggestion for 

an integrated, principles-based regulatory paradigm. See, John S. Moot: Compliance Programs, 

Penalty Mitigation and the FERC, 29 ENERGY LAW JOURNAL 547 (2008); Donald C. Langevoort, 

Monitoring: The Behavioral Economics of Corporate Compliance with Law, 2002 COLUM. BUS. 

L. REV. 71 (2002); Kimberly D. Krawiec, Corporate Decisionmaking: Organizational Misconduct: 

Beyond the Principal-Agent Model, 32 FLA. ST. L. REV. 571 (2005); and Jennifer Arlen and 

Reinier Kraakman, Controlling Corporate Misconduct: An Analysis of Corporate Liability Regimes, 72 N.Y.U.L. REV. 687 (1997). 10 If the Commission elects to use the 2(h) extension in Section 723 to help phase in Title VII 

of the Dodd-Frank Act’s compliance requirements, it is possible that the implementation dates 

for certain rules will be extended beyond the maximum one year 2(h) extension period. In such 

an event, the Working Group suggests that the Commission use its existing statutory authority 

to address any gaps in the regulatory treatment of swaps and swap market participants. 

management infrastructure that is most efficient for their individual circumstances. 

Issuing permissive rules will also allow the Commission to easily adapt such rules 

to changing market conditions. Said differently, prescriptive rules will likely be too 

rigid to adapt to changing market conditions, and it is probable that the Commission will have to reissue such rules to account for such changes. Finally, if the Commission issues permissive rules, it will allow market participants to approach compliance from a holistic perspective. Market participants will be able to construct 

compliance and risk management programs that encourage self-governing and selfreporting and create a culture of compliance rather than the ‘‘check-the-box’’ approach that is the logical outgrowth of prescriptive rules. 

If the Commission elects to retain its traditional principles-based approach, the 

Working Group respectfully submits that the Commission develop a formal policy 

statement with respect to compliance under the rules it proposes under the DoddFrank Act. The statement should identify the policy objectives for the overall regulatory effort, the proper design of regulations to support those policy objectives and 

the factors by which the Commission will determine if its proposed regulations adhere to Congress’ intent. This statement would be the ‘‘blueprint’’ for effective regulation of swap dealers and major swap participants. Adopting a policy statement 

will send a clear message to market participants of the Commission’s policy goals 

and expectations, which will facilitate regulatory certainty as well as uniform and 

orderly enforcement of the existing and new rules and regulations adopted by the 

Commission.9

Third, the Working Group respectfully suggests that the Commission prioritize 

drafting sound and functional regulations over promulgating rules within a certain 

time period. Rulemaking should be a deliberate, methodical and iterative process. 

If the Commission, in its attempt to satisfy Congressionally mandated deadlines, 

issues rules that leave significant legal uncertainty, are unworkable or impose substantial unnecessary costs on swap markets, then it is likely that the Commission 

will have to revisit a number of rulemakings. If this is the case, not only would the 

Commission have to expend additional resources to do so, but swap markets will be 

confronted with an extended period of legal uncertainty. 

Thankfully, Congress provided the Commission with two tools with which it can 

take the time necessary to draft regulations that (1) accomplish the goals of the 

Dodd-Frank Act, (2) are enforceable by the Commission and (3) satisfy these latter 

two goals while causing the least disruption in and imposing the lowest possible 

costs on swap markets, without departing significantly from the timing requirements set forth in Title VII of the Dodd-Frank Act. 

Section 754 of the Dodd-Frank Act provides ‘‘the provisions of this subtitle shall 

take effect on the later of 360 days after the date of the enactment of this subtitle 

or, to the extent a provision of this subtitle requires a rulemaking, not less than 

60 days after the publication of the final rule or regulation implementing such provisions of this subtitle.’’ Section 754 would allow the Commission to delay the effective date of any final rule promulgated under Title VII of the Dodd-Frank Act until 

the Commission determines the market is ready to comply. In addition, Section 723 

of the Dodd-Frank Act grants the Commission the authority to allow market participants to remain subject to current Section 2(h) of the CEA for up to a year after 

the Dodd-Frank Act becomes effective.10 The Working Group respectfully submits 

that by using the authority granted to it under Sections 754 or 723 of the DoddFrank Act, the Commission can take the time necessary to construct sound rules 

without violating Congress’ required time frame. 

II. Conclusion 

The Working Group supports tailored regulation that brings transparency and 

stability to the swap markets in the United States. We appreciate the balance the 

Commission must strike between effective regulation and not hindering the 

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1The use of different effective dates (the date on which a rule becomes effective) and implementation dates (the date on which market participants must comply with the relevant rule) 

will allow the Commission to gradually phase-in the regulatory requirements imposed by Title 

VII of the Dodd-Frank Act while providing the market with regulatory certainty as to regulatory 

obligations. 2 A similar request was made by Senator Stabenow, Chairman of the Senate Committee on 

Agriculture, Nutrition and Forestry. Senator Stabenow stated ‘‘We must consider how new rules 

will fit together in a way that makes sense for the markets; whether that is phasing-in implementation or carefully sequencing the rules, . . . We must make sure the market infrastructure 

is in place, the technology is ready, and that market participants are able to meet the requirements of this law. The new accountability and transparency we have created is clearly in the 

public interest and the most important thing is to get it right, not do it quickly.’’ Implementation 

uncleared energy-based swap markets. The Working Group offers its advice and experience to assist the Commission in implementing the Act. Please let us know if 

you have any questions or would like additional information. 

Respectfully submitted,

DAVID T. MCINDOE; 

R. MICHAEL SWEENEY, JR.; 

MARK W. MENEZES; 

ALEXANDER S. HOLTAN; 

Counsel for the Working Group of Commercial Energy Firms. 

March 23, 2011

DAVID A. STAWICK, Secretary,

Commodity Futures Trading Commission, 

Washington, D.C.

Re: Sequencing of Release of Final Rules under the Dodd-Frank Act

Dear Secretary Stawick:

On behalf of the Working Group of Commercial Energy Firms (the ‘‘Working 

Group’’), Hunton & Williams LLP respectfully submits this letter regarding the 

order in which the Commodity Futures Trading Commission (the ‘‘Commission’’) 

might issue final rules under the Dodd-Frank Wall Street Reform and Consumer 

Protection Act (the ‘‘Dodd-Frank Act’’). The Working Group appreciates the opportunity to share its views with the Commission. 

The Working Group is a diverse group of commercial firms in the energy industry 

whose primary business activity is the physical delivery of one or more energy commodities to others, including industrial, commercial and residential consumers. 

Members of the Working Group are energy producers, marketers and utilities. The 

Working Group considers and responds to requests for public comment regarding 

regulatory and legislative developments with respect to the trading of energy commodities, including derivatives and other contracts that reference energy commodities. 

In developing the suggestions contained herein, the Working Group has focused 

on what it believes are the best interests of the swap markets, the Commission, 

other regulators, market participants, and the U.S. economy. The suggestions are 

based on the Working Group’s experience in the energy markets, but can be applied 

to all swap markets. The ideas expressed herein are not intended to promote the 

interests of any one group. We firmly believe that the well-being of any market participant benefits the swap markets as a whole. 

I. General Comments 

The Working Group fully supports the Commission’s focus on the sequencing of 

its rules under Title VII of the Dodd-Frank Act and the solicitation of input from 

market participants. A considered approach to the release of the final rules will 

greatly assist the transition of many market participants to the new regulatory paradigm, particularly for participants in swap markets such as the energy swaps market that the Commission largely has not regulated previously. If the Commission 

releases final rules, sets effective dates and sets implementation dates in a logical 

manner, market participants will have a meaningful opportunity to review such 

rules, evaluate their compliance obligations under such rules, and design and implement measures to meet such obligations in a reasonably efficient manner.1

The Working Group urges the Commission to not sacrifice sound reasoning for expediency and to take the time necessary to implement Title VII of the Dodd-Frank 

Act properly.2 The Working Group recommends the Commission not release rules 

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of Title VII of the Wall Street Reform and Consumer Protection Act, Senate Committee on Agriculture, Nutrition and Forestry, 112th Cong. (Mar. 3, 2011) (statement of Senator Stabenow). 3The Working Group also is concerned that the proposed rules released to date mandate requirements that do not work well together. For example, in the proposed rule on Swap Trading 

Relationship Documentation Requirements for Swap Dealers and Major Swap Participants (76 

FED. REG. 6715 (Feb. 8, 2011)), all documentation must be completed before or contemporaneous 

with trade execution, including the confirmation. (Proposed CFTC Rule § 23.504). However, in 

the proposed rule on Confirmation, Portfolio Reconciliation and Portfolio Compression Requirements for Swap Dealers and Major Swap Participants (75 FED. REG. 81519 (Dec. 28, 2010)), confirmations are done after trade execution. (Proposed CFTC Rule § 23.501). 4For example, the term ‘‘processed electronically’’ as used in proposed CFTC Rule 23.501 

(swap confirmation) and the term ‘‘notional amount’’ as used in the proposed definition of ‘‘major 

swap participant’’ in proposed CFTC Rule 1.3(qqq) also must be further defined. 5We note that the Commission has informally continued to accept comments even though 

stated deadlines have passed. The Working Group proposes an official ‘‘open comment period.’’

under title VII of the Dodd-Frank Act before such rules, taken in related subject 

matter groups, are fully developed. The market place is far better served if the Commission considers all of the final rules in a comprehensive and organized fashion. 

Doing so promotes consistency in terms and the overall design across the rules. 

Thus far, the rulemaking process has occurred piecemeal and not in a logical order, 

creating significant uncertainty in swap markets. A significant challenge in commenting on the rules proposed thus far is the impossibility for any market participant to understand how all of the rules fit together.3 It will be substantially burdensome and costly if market participants must design and implement regulatory compliance and risk management programs without knowing all of the requirements of 

the Commission’s regulations issued under the Dodd-Frank Act. The burden and 

cost are amplified as market participants face compliance deadlines that are too 

close in time. 

A comprehensive review of the Commission’s proposed rules shows that additional 

rulemakings are likely needed to further define key requirements and terms and 

how they will impact market participants.4 In certain cases it might be appropriate 

for the Commission to reissue substantially revised versions of a proposed rule as 

comments received might demonstrate the need for significant changes from the initial proposed rule. Also, under established principles of administrative law, final 

rules are susceptible to challenge if (a) they did not provide parties with sufficient 

notice that the proposed rule might apply to them, thereby providing that person 

with a meaningful opportunity to comment or otherwise participate in the rulemaking process, or (b) do not constitute a logical outgrowth of the proposed rule. 

The Working Group encourages the Commission to facilitate continued public comment as it develops regulations. 

At the close of the comment period of the last rule to be proposed under Title VII 

of the Dodd-Frank Act, the Commission should allow market participants a period 

of time to consider all of the rules proposed under Title VII of the Dodd-Frank Act 

in the aggregate.5 Following the review period, the Commission should provide a period in which market participants can comment on all of the rules. These comments 

would not only address the merits and impacts of the rules on a holistic basis, but 

also the ultimate cost of implementation and the time it will take to comply with 

all requirements. The comments will no doubt be substantiality more informed and 

complete as market participants will have the benefit of placing each rule within 

the overall context of the Commission’s new regulatory regime. 

II. Market Participants Need Ample Time To Comply With Proposed Rules 

Market participants have not had sufficient time to prepare to comply with rules 

to be issued by the Commission under Title VII of the Dodd-Frank Act. Title VII 

is a fundamental redesign of the derivative markets, particularly for the energy 

swap market. Title VII by itself did not provide an adequate basis for market participants to foresee all the implications of the market redesign. Uncertainty continues as to certain key definitions, such as the definition of ‘‘swap’’ and the definition of ‘‘swap dealer.’’ Under the many proposed rules, entities face a myriad of potential requirements, many of which are interrelated and potentially redundant. 

While it might be reasonable to expect an entity to be in a position to quickly comply with one rule, it is not reasonable to expect an entity to be in immediate or almost immediate compliance with a substantial number of new rules at the same 

time or in rapid succession. 

III. Two Important Observations About the Rules and the Marketplace 

When considering the order in which the Commission might issue rules and the 

dates by which such rules become effective, the Commission should consider two 

concepts. 

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6For example, if the Commission adopts capital and margin requirements modeled after those 

imposed on banks, a vast majority of such institutions are banks and will likely have systems 

in place to comply with such capital and margin requirements with minimal modifications. 7Public Hearing to Review Implementation of Title VII of the Dodd-Frank Wall Street Reform 

and Consumer Protection Act, House Committee on Agriculture, 112th Cong. (Feb. 10, 2011) 

(statement of Hon. Gary Gensler, Chairman, CFTC). 

First, the Commission’s regulations can be structured as building blocks, one set 

of rules providing the necessary foundation for subsequent rules. Said a bit differently, the Commission should issue final rules in a manner that allows an entity 

to allocate resources, hire personnel and design and test systems to meet the requirements of one rule that then prepares such entity to address the requirements 

of a subsequent rule. For example, entities should be able to first hire a chief compliance officer who should have a reasonable period of time in which to write, test 

and implement policies and procedures that, in turn, allow that entity to provide 

compliant disclosure to its counterparties. In addition, many of the requirements imposed by the Dodd-Frank Act depend on the existence of other new regulatory entities. For example, the reporting requirements largely depend on swap data repositories being fully operational. 

Second, not all entities that come within the definitions of ‘‘swap dealer’’ and 

‘‘major swap participants’’ are the same or even similar. Some will have large swap 

portfolios and a substantial market share, presenting unique risks to the U.S. financial system. As these entities likely have been subject to prudential regulation by 

a financial regulator, their compliance and risk management infrastructure might 

be easily modified to meet the new requirements imposed by the Commission. Thus, 

compliance with the Commission’s rules may be a minor incremental cost.6 In contrast, many entities that might come within the definitions of ‘‘swap dealer’’ and 

‘‘major swap participant,’’ particularly those never subject to prudential regulation 

by a financial regulator, will likely have to make substantial or wholesale changes 

to their corporate structure and their compliance and risk management infrastructure. For these entities, the requirements of the Dodd-Frank Act and the Commission’s rules represent a fundamental redesign of their operations and, in some cases, 

their business. In particular, many commercial energy firms still do not know if they 

are, and do not anticipate being, swap dealers. However, if they are deemed as such, 

this will be the first time many of them will be subject to prudential regulation and 

coming into compliance will be a costly, time consuming process. 

Recognizing that all entities potentially designated as swap dealers are not similar: the Commission should concentrate its attention and resources to overseeing 

compliance by market participants previously subject to prudential regulation by a 

financial regulator, and that are commonly known today as swap dealers. The Commission should allow other entities that come within the definitions of ‘‘swap dealer’’ 

and ‘‘major swap participant’’ a longer period to meet their compliance obligations. 

There is no standard test for determining which market participants are traditionally recognized as swap dealers. However, the Commission might focus on those 

bank holding companies that hold a vast majority of the market share in the swap 

markets. In his testimony before the House Committee on Agriculture, Chairman 

Gensler noted that 25 bank holding companies in the United States are a party to 

$277 trillion notional in swaps, which constitutes over 90% of domestic swaps.7 In 

addition, these bank holding companies are already subject to some degree of prudential regulation by a financial regulator. If the Commission concentrates on those 

25 bank holding companies first, the Commission will capture a vast majority of 

U.S.-based swap activity as an initial matter and will likely be imposing regulation 

on those entities most prepared to comply in short order. 

While the Dodd-Frank Act and the Commission’s regulations place most compliance obligations on swap dealers and major swap participants, many requirements 

will fall on entities that are not swap dealers or major swap participants. The Working Group recommends the Commission, to the greatest extent possible, impose compliance obligations on these market participants last, and only if necessary. Said differently, a swap dealer should come into compliance ahead of the end-users with 

which it trades swaps. 

Even after the definitions of ‘‘swap dealer’’ and ‘‘major swap participant’’ are finalized, some entities still might not have a clear understanding if they are covered 

by the definitions and will need to seek guidance from the Commission as to their 

status or attributes of about their businesses. Such a consultation process should 

be developed in light of the vague and overly broad definitions that have been proposed. 

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8The Working Group of Commercial of Energy Firms, in its comments to the Commission’s 

Proposed Rules on Real-Time Public Reporting of Swap Transaction Data, Swap Data Recordkeeping and Reporting Requirements, and Reporting, Recordkeeping, and Daily Trading Records 

Requirements for Swap Dealers and Major Swap Participants, all filed with the Commission on 

February 7, 2011, suggested a phase-in approach for the multiple reporting and record keeping 

requirements that might serve as a model for an overall phase-in approach. 

IV. Recommended Implementation Process 

As alluded to above, each of the Commission’s rules have at least three dates that 

the Commission should coordinate in the sequencing of the final rules it issues 

under the Dodd-Frank Act: (a) the date the rule is issued; (b) the date the rule is 

effective and (c) the implementation date(s) on which the compliance obligations 

must be satisfied. The distinction between these dates is important. The Commission should issue final rules with sufficient notice and, by careful structuring of effective dates and compliance deadlines, provide ample time for entities to come into 

compliance. As an alternative, the Commission could make the implementation date 

of one or more rules contingent on the implementation date of other rules that 

should logically come first in the series of rulemakings. 

The Working Group recommends that the Commission issue final rules and set 

their effective and related compliance dates as set forth in Exhibit A. Exhibit A is 

comprehensive, but not exhaustive, list of all of the rules the Commission has proposed under the Dodd-Frank Act. In constructing Exhibit A, the Working Group 

first determined the major goals of the Dodd-Frank Act, such as putting in place 

a mandatory clearing requirement and reporting regime. The Working Group then 

determined which rules must be in place to reach that goal and put such rules in 

groups for sequencing purposes. The Working Group next determined the order in 

which such rule groups should be implemented in order to allow the market to 

adapt and continue to function. Finally, the Working Group combined the implementation plans for each individual goal into a macro-implementation plan, or critical path for implementation, which is reflected in Exhibit A.

The Working Group developed its recommendations based on the observation 

above that the rules work together in an iterative, building block manner. Accordingly, the Commission should first release the definitional rules, including the definition of swap, (with ample periods to facilitate entities engaging with the Commission to resolve uncertainties and otherwise reorganize or restructure their businesses). The definitional rules will allow parties to make critical determinations 

about their regulatory status and the derivatives transactions into which they enter. 

In addition, the Commission should issue final rules for the institutions, such as 

swap data repositories and derivatives clearing organizations, that will lay the 

ground work for the new regulatory regime as soon as practicable. Three months 

after issuing the final definitions, the Commission should issue the registration 

rules. This will allow the Commission to identify those entities that warrant immediate and longer term regulatory oversight. About the same time or shortly thereafter, the Commission should release rules for governance and internal business 

conduct standards. Swap dealers and major swap participants should have a period 

of time to organize and develop their systems and personnel to comply with regulations that do not entail counterparty interface. Only after swap dealers and major 

swap participants have their corporate structure, systems, policies and procedures 

in place should the Commission’s rules governing transactions with counterparties 

become effective. Finally, rules that may place compliance obligations on entities 

that are not swap dealers or major swap participants should become effective. 

It is our expectation that, once all of the regulatory requirements are known, entities will immediately begin working to implement measures in an attempt to comply 

with all rules applicable to them. However, it would be unreasonable to expect entities to implement all of these measures at the same time. Time is needed to allow 

thoughtful design and preparation. In addition, a phased-in approach will allow entities to incur costs over time.8

Finally, where a proposed rule requires substantial changes to existing information technology infrastructure or the creation of new information technology infrastructure, the Working Group requests that the Commission adopt a ‘‘beta testing’’ 

period coupled with a good faith safe harbor. During the beta testing period, market 

participants should be required to attempt to comply with the rule in question. 

However, if a market participant attempts to comply with such rule and fails because the relevant technology fails, the market participant should not face any sanction. 

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9 CFTC Chairman Gary Gensler, Implementing the Dodd-Frank Act, Remarks before the Futures Industry Association’s Annual International Futures Industry Conference, Boca Raton, 

Florida (Mar. 16, 2011). 10For example, if there are no SDRs in place, market participants could be required to put 

in place technology to report swaps directly to the Commission. Once SDRs come online, market 

participants will be required to put in place technology to report to SDRs. 11 If the Commission elects to use the 2(h) extension in Section 723 to help phase in Title VII 

of the Dodd-Frank Act’s compliance requirements, it is possible that the implementation dates 

for certain rules will be extended beyond the maximum one year 2(h) extension period. In such 

an event, the Working Group suggests that the Commission use its existing statutory authority 

to address any gaps in the regulatory treatment of swaps and swap market participants. 

V. Chairman Gensler’s Suggested Approach to Implementation 

In his speech before the Futures Industry Association, Chairman Gensler set forth 

a three group approach to the implementation of the final rules implementing Title 

VII of the Dodd-Frank Act.9 The Working Group sees value in the Chairman’s suggested approach. However, there are three issues about which the Working Group 

disagrees with the Chairman’s plan. 

First, the definition of ‘‘swap’’ should be issued at the beginning of the implementation process along with all other definitions. For many market participants, the 

scope of the definition of ‘‘swap’’ will be a substantial factor in the determination 

of whether they are a swap dealer or major swap participant. For example, without 

knowing which derivatives will be included in the definition of ‘‘swap,’’ market participants will be unable to perform the tests necessary to determine whether they 

are a major swap participant. Waiting to the end of the implementation process to 

issue the final definition of ‘‘swap’’ will introduce significant uncertainty into the 

swap markets. 

Second, the rules that address the institutions that will serve as the foundation 

of the post Dodd-Frank Act market infrastructure should be introduced as soon as 

practicable. Without those rules in place, market participants might be required to 

put in place expensive, though temporary, changes to systems in order to comply 

with the Dodd-Frank Act requirements.10 The Chairman’s proposed implementation 

plan would place many of these rules in the middle group. The Working Group suggests that these rules be addressed as a threshold matter. 

Third, the Chairman’s proposal anticipates being able to issue all final rules within the next six months. The Working Group believes that Commission staff will need 

a substantial period of time to consider market participants comments on many 

rules and will need additional time to make necessary changes to such rules. The 

Chairman’s suggested timing would severely limit Commission staff’s ability to draft 

well reasoned and sound final rules. 

VI. Statutory Support for Extended Compliance Periods 

Congress gave the Commission discretion in designing and implementing rules 

under the Dodd-Frank Act. In particular, Section 723 of the Act provided that the 

Commission, upon petition by market participants, could continue the availability 

of the exclusion of Section 2(h) of the CEA with respect to certain commodity transactions for up to one year after the general effectiveness of Title VII of the DoddFrank Act. Several entities applied to the Commission for the continued application 

of Section 2(h). The Commission might provide such continuation of Section 2(h) to 

facilitate an orderly transition to a new regulatory regime under the Dodd-Frank 

Act.11 In addition, Section 754 of the Act allows the Commission to set effective 

dates for rules required under Title VII to be set at no earlier than sixty days after 

the publication of such rules. The authority granted to the Commission under Sections 723 and 754 of the Act should allow the Commission to provide the time necessary for market participants to come into compliance with the requirements of the 

new regulatory regime. 

VII. Conclusion 

The Working Group supports regulation that brings transparency and stability to 

the swap markets in the United States. The Working Group appreciates the balance 

the Commission must strike between effective regulation and not hindering the 

swap markets. Please let me know if you have any questions or would like additional information, including a working version of Exhibit A. In addition, members 

of the Working Group can be made available to meet with Commissioners or Commission staff to further discuss how the recommendations contained herein were 

reached. 

Respectfully submitted,

DAVID T. MCINDOE; 

135

MARK W. MENEZES; 

R. MICHAEL SWEENEY, JR.; 

ALEXANDER S. HOLTAN; 

Counsel for the Working Group of Commercial Energy Firms.

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EXHIBIT A

Sequencing of Issuance of Final Rules Under the Dodd-Frank Act 

This chart shows the order in which the Working Group suggests the Commission issue final rules.The suggested schedule for the issuance of final rules does not include a hard start date. The Working Group recommends that the Commission start releasing the final rules in the sequence set forth below when each group of rules 

is ready to be considered.

Month 0 1 2 3 4 5 6 7

Definitions Propose Definition of 

Swap and Reopen Comment Period on Other Definitions 

Comment Period 

Closes for All Definitions 

Issue Final Rules 

Duties Reopen Comment Period Comment Period Closes Issue Final Rules Capital and Margin Propose Rules Comment Period 

Closes 

Issue Final Rules 

Institutions Issue Final Rules Before the End of This 

Period 

Mandatory Clearing Issue Final Rules Before the End of This 

Period 

Position Limits Reissue Proposed Rule Comment Period 

Closes 

Issue Final Rules 

Reporting First TAC Meeting * Second TAC Meeting * Third TAC Meeting * Reopen Comment Period Comment Period Closes Issue Final Rules Market Practices Issue Final Rules Definitions—Given that the definition of ‘‘swap’’ has yet to be proposed and the comment period is closed on all other definitions, the Working Group requests that the Commission reopen the comment period for the other definitions upon proposing a definition of ‘‘swap,’’ with such comment period for all such proposed rules closing in 60 days.

Duties—After all the final definitions are issued, market participants will have a clearer picture as to which entities the definitions cover. Market participants, armed with knowledge of the scope of the definitions, should be 

given an opportunity to comment on the proposed rules that might impose duties on them. Therefore, the Commission should reopen the comment period on those rules that impose duties on swap dealers and major swap participants after the final definitions have been published.

Capital and Margin—Capital and margin requirements should be made final (though not effective) on about the same day the definitions are finalized.

Institutions—The Working Group urges the Commission to issue final rules for market institutions as soon as practicable. The existence of entities such as SDRs and SEFs is integral to the new regulatory framework for swap 

markets. These institutions must be in place before market participants can begin to comply with requirements such as mandatory clearing and reporting.

Mandatory Clearing—As with market institutions, mandatory clearing rules should be finalized as soon as possible. The Commission should determine which swaps will be subject to the mandatory clearing requirements soon 

as possible. To make this process efficient, the Working Group recommends the Commission, as an initial matter, address only those swaps currently being cleared.

Position Limits—The Working Group, as discussed in its forthcoming comments on the proposed rule on position limits, anticipates that certain parts of the proposed position limits rules will have to be amended to such a degree that the proposed rule will have to be reissued. Once reissued, market participants should have at least an additional 30 days during which to comment on that proposed rule.

Reporting—Reporting will be a complex logistical undertaking. As a threshold matter, to even begin this process, an SDR must be registered for the relevant class of swaps. The Working Group recommends the Commission hold 

multiple Technology Advisory Committee meetings to walk through implementation issues with regard to the proposed reporting rules. After those meetings, market participants should be given the chance to file additional 

comments on such proposed rules.

Market Practices—Market practice rules should be issued by July 21, 2011, as required by Section 753 of the Act.

* Assuming there is an SDR.

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Sequencing of Implementation Dates for Rules Under the Dodd-Frank Act 

Box Opening = Final Rule Released (or operation begun).Box Closing = Implementation DateThe Implementation Date represents the time at which market participants must be in compliance with the relevant rule. For example, on the Implementation Date for the proposed rules on Registration and Core Principles for 

SDRs, any potential SDRs would have to be operational. The suggested implementation process does not include a hard start date. The Working Group recommends that the Commission start the suggested process when the final rules are ready to be issued in the sequenced manner suggested by the Working Group.

138


11207001
139

Sequencing of Implementation Dates for Rules Under the Dodd-Frank Act—Continued 

1 In its comments to the Commission’s proposed rule on the registration of swap dealers and major swap participants, the Working Group recommended that the Commission allow market participants a one year period in which 

they could determine if they would have to register as a swap dealer or major swap participant. Following the registration period, the Working Group suggests a phased in approach to the certification of compliance for rules applicable to swap dealers and major swap participants.

2The Working Group recommends that the Commission require market participants first hire a CCO, then allow the CCO to put in place internal business conduct standards and then put in place business conduct standards for 

interaction with counterparties.

3The Working Group recommends that the Commission delay issuing any rules regarding portfolio compression and reconciliation until after the compliance deadline for all rules required under Title VII of the Dodd-Frank Act 

have been issued. If the Commission chooses to issue such rules, the Working Group estimates that the compliance deadline for such rules would be up to 12 months after what is currently depicted given the likely intensive IT modifications that will be required to comply.

4 Capital Requirements may be one of the most costly regulatory requirements under Title VII. Market participants should be afforded the opportunity to review these rules prior to making elections as to whether to continue trading 

that results in such entity being designated a swap dealer or major swap participant. Such entities should also be afforded ample time to take corporate actions necessary to meet the capital requirements.

5The implementation of margin requirements will require documentation standards to be in place.6The Working Group suggests that DCOs be operational within ten months of the effective date of the Dodd-Frank Act. Such a time frame will allow the Commission to complete action to effect the mandatory clearing requirement 

as soon as practicable.

7The Working Group realizes that this proposed rule might require existing DCOs to alter their current ownership structure, so the implementation time period is set at 26 months. However, rules that are not affected by the ownership structure of the DCO should be implemented earlier.8The Working Group realizes that the Commission has not issued a proposed rule on this topic. To allow market participants to understand the implications of central clearing of swaps, segregation requirements for DCOs must be 

in place prior to the mandatory clearing requirement.

9SDRs would have to be operational on this date to allow market participants to begin to comply with reporting requirements in a timely fashion.10This short implementation period assumes that (a) the Commission only initially reviews swaps that are currently cleared to determine if they should be subject to the mandatory clearing requirement and (b) the DCOs clearing 

these swaps will quickly be able to comply with the requirements imposed on DCOs by the Dodd-Frank Act. Those swaps should be deemed submitted to the Commission on the effective date of Dodd-Frank and the Commission should review them within the statutorily required 90 day period. The proposed timeline would allow the Commission to start the implementation process as late as June of 2012 and still meet the G20 goal of clearing all standardized derivatives by the end of 2012.

11The Working Group is still reviewing the Commission’s Proposed Rule on Position Limits and will provide comment on the implementation timing in comments on that proposed rule.12 All traditional swap dealer reporting parties previously subject to prudential regulation by a financial regulator (‘‘Traditional Swap Dealers’’).13 All other reporting parties.14 All swaps executed on facility or cleared through a DCO.15 All standardized swap executed off-facility and not centrally cleared entered into by Traditional Swap Dealers.16 All other standardized swap executed off-facility and not centrally cleared and all non-standardized swaps executed off-facility and not centrally cleared entered into by Traditional Swap Dealers.17 All other non-standardized swaps executed off-facility and not centrally cleared. 

140

Rule Categories 

Definitions Duties Capital and Mar- gin Institutions Mandatory Clear- ing Position Limits Reporting Market Practices Other 

Definition of Swap NOPR on Swap Trading Relationship 

Documentation for SDs and MSPs 

Capital Requirements NOPR on Core Principles and Other Requirements for SEFs NOPR on Process for Review of Swaps for Mandatory Clearing Position Limits IFR on Reporting of Pre-Enactment Swaps ANOPR on Disruptive Trading Practices JNOPR on Reporting by Investment Advi- sors to Private 

Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF 

NOPR on Further Definitions of SD, MSP 

and ECPs 

JNOPR on Orderly 

Liquidation Termination Provisions in Swap Trading Relationship Documentation for SDs and MSPs 

Margin Requirement NOPR on Governance 

and Additional COI Requirements for DCOs, DCMs, and SEFs 

NOPR on Requirements for Processing, Clearing, and 

Transfer of Customer Positions 

IFR on Reporting of 

Post-Enactment Swaps 

NOPR on Prohibition 

of Market Manipulation 

NOPR on Commodity 

Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations 

NOPR on End-User Exception to Mandatory 

Clearing 

NOPR on Designation 

and Duties of Chief Compliance Officer 

NOPR on Core Principles and Risk Management Requirements for DCOs NOPR on Real-Time Public Reporting of Swap Transaction and Pricing Data NOPR on Conforming Amendments to Reg- ulations Applicable to Commodity Pool 

Operators and Commodity Trading Advisors 

NOPR on Commodity 

Options and Agricultural Swaps 

NOPR on Conflict of 

Interest Policies for SDs & MSPs 

NOPR on Reporting 

and Recordkeeping Requirements for DCOs 

NOPR on Swap Data 

Reporting and Recordkeeping Requirements 

NOPR on Removing 

References to Credit Ratings from Commission Regulations 

NOPR on Definition of 

Agricultural Commodity 

NOPR on Internal 

Business Conduct Standards for SDs and MSPs 

NOPR on Registration 

of Intermediaries 

NOPR on Reporting, 

Recordkeeping and Daily Trading Records for SDs & MSPs 

NOPR on Business Affiliate Marketing 

and Disposal of Consumer Information Rules 

NOPR on Registration 

of Swap Dealers and Major Swap Participants 

NOPR on Requirements for DCOs, 

DCMs, and SEFs Regarding the Mitigation of Conflicts of Interest 

NOPR on Position Reports for Physical 

Commodity Swaps 

NOPR on Privacy of 

Consumer Financial Information 

NOPR on Protection of 

Collateral of Counterparties to Uncleared Swaps 

NOPR Regarding Investment of Customer Funds and 

Credit Ratings 

NOPR on Conflict of 

Interest Policies for FCMs 

NOPR on Whistleblower Provisions NOPR on Financial Resources Requirements for DCOs 

141

NOPR on Business 

Conduct Standards with Counterparties 

NOPR on Provisions 

Common to Registered Entities (Certification and Approval Procedures for New Products, Rules and Rule Amendments Submitted to the CFTC by Registered Entities) 

NOPR on Confirmation, Portfolio Reconciliation, and Portfolio Compression 

Requirements for Swap Dealers and Major Swap Participants 

ANOPR on Protection 

of Cleared Swaps Customers Before and After Commodity Broker Bankruptcies 

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1Position Limits for Derivatives, Notice of Proposed Rulemaking, 76 FED. REG. 4752 (Jan. 26, 

2011). 2Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111–203, 124 Stat. 

1376 (2010). 

March 28, 2011

DAVID A. STAWICK, Secretary,

Commodity Futures Trading Commission, 

Washington, D.C.

Re: Position Limits for Derivatives, RIN 3038–AD15 and 3038–AD16

Dear Secretary Stawick: 

I. Introduction 

On behalf of the Working Group of Commercial Energy Firms (the ‘‘Working 

Group’’), Hunton & Williams LLP hereby submits these comments in response to the 

request for public comment set forth in the Commodity Futures Trading Commission’s (the ‘‘CFTC’’ or ‘‘Commission’’) Notice of Proposed Rulemaking, Position Limits 

for Derivatives (the ‘‘Proposed Rule’’), published in the Federal Register on January 

26, 2011,1 which establishes position limits for certain physical commodity derivatives pursuant to newly amended Section 4a(a) of the Commodity Exchange Act 

(‘‘CEA’’), as established by Section 737 the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank’’ or the ‘‘Act’’).2

The Working Group is a diverse group of commercial firms in the energy industry 

whose primary business activity is the physical delivery of one or more energy commodities to others, including industrial, commercial, and residential consumers. 

Members of the Working Group are energy producers, marketers, and utilities. The 

Working Group considers and responds to requests for public comment regarding 

regulatory and legislative developments with respect to the trading of energy commodities, including derivatives and other contracts that reference energy commodities. 

II. Executive Summary 

The Working Group strongly supports the goals of the Act to enhance transparency and reduce systemic risk in the swap markets. The Working Group appreciates the opportunity to provide the comments set forth herein and requests the 

Commission’s consideration of such comments in order to adopt, if at all, position 

limits that are effective and workable for market participants. 

As an initial matter, and as discussed in Part III.A, below, the Working Group 

submits that, prior to establishing and imposing speculative position limits in any 

specific market, the CEA requires the Commission to analyze the relevant markets 

and find that such position limits are indeed necessary. If implemented without sufficient study, speculative position limits will disrupt today’s highly efficient energy 

commodity markets by (i) reducing liquidity, (ii) impairing price discovery, and (iii) 

preventing market participants from effectively and efficiently hedging their commercial risk exposure. 

Additionally, as set forth in Part III.A, below, the Commission’s proposal for 

Phase II single-month and all-months-combined (‘‘AMC’’) position limits are entirely 

unnecessary, and accordingly, should be rejected. The Working Group submits that 

such limits could have significant adverse impacts on derivatives markets. As such, 

the Working Group strongly urges the Commission to use the discretion afforded to 

it pursuant to new CEA Section 4a(a) and decline the adoption of single-month and 

AMC position limits in any final rule issued in this proceeding at this time. 

As discussed in Part III.B, below, the Working Group believes that there are several flaws in the proposed definition of a bona fide hedging transaction that could 

disrupt the efficient operation of energy commodity markets. In failing to provide 

a vehicle for market participants to apply for, and receive, an exemption from speculative position limits for ‘‘non-enumerated hedges,’’ the Commission, contrary to the 

intent of Congress, has eliminated several important classes of transactions from 

the definition of a bona fide hedging transaction that are routinely undertaken in 

energy markets to hedge or mitigate commercial risk. The Working Group provides 

in Parts III.B.1, below, several examples of such excluded transactions. As illustrated by these examples, this proposed definition simply does not reflect the hedging practices generally used in commodity markets, especially energy markets. Specifically, as discussed in Part III.D, below, to qualify for a bona fide hedging exemption, the proposed definition appears to require market participants to match on a 

one-to-one basis a swap transaction to a specific physical transaction. Participants 

143

in energy commodity markets, however, frequently enter into swaps and futures to 

hedge underlying physical assets on a portfolio or aggregate basis. The Working 

Group submits that any final rule adopted by the Commission in this proceeding 

must preserve the ability of commercial energy firms to effectively and efficiently 

hedge their commercial risk exposure. 

The Working Group further requests in Part III.C, below, that the Commission 

provide certainty to market participants as to how the process will work for applying for exemptions from speculative position limits should the Commission adopt 

one in any final rule. As written, the Proposed Rule provides an insufficient application process for exemptions and instead requires market participants to file daily 

reports on their cash market commodity activities upon exceeding any position limit. 

The Working Group submits that this creates not only an unnecessary compliance 

burden on market participants but also a significant burden on the Commission who 

will have to review and evaluate daily such position reports. Should the Commission 

adopt an application process in any final rule, the Working Group strongly suggests 

that it provide market participants an opportunity to comment on such process. 

As discussed more thoroughly in Part III.F, below, the Working Group believes 

the Phase I spot-month position limits must (i) be reconsidered in many respects 

and (ii) more appropriately accommodate the hedging needs of market participants. 

As recommended in Part III.F.1, below, the process for determining deliverable supply must be fully transparent and provide market participants the opportunity to 

comment on the DCM estimates of deliverable supply and any Commission proposal 

for spot-month position limits. Further, as set forth in Part III.F.2, below, with respect to the proposed spot-month position limits for cash-settled contracts, the 

Working Group submits that (i) the Commission’s proposal to set the limit for cashsettled contracts equal to the level for physically-settled contracts is not grounded 

in a sound regulatory foundation, (ii) the proposal unduly restricts the position of 

cash-settled referenced contracts that may be held by market participants, and (iii) 

the proposed conditional exemption for cash-settled contracts inappropriately requires market participants to hold no physically settling futures contracts in order 

to qualify for such exemption. In Part III.F.3, below, the Working Group recommends that the Commission initially identify the universe of referenced paired 

contracts based only on those contracts that are cleared, and after such initial identification, identify which swaps constitute a referenced paired contract during its 

process for determining whether a swap must be mandatorily cleared pursuant to 

the Act. 

Regarding the proposed visibility levels and related reporting requirements, the 

Working Group submits in Part III.G, below, that such are unnecessary in light of 

the transparency created by the Act and the Commission’s existing special call authority. The Working Group believes that such requirements will result in a substantial and disproportionate burden on bona fide hedgers without providing any 

benefit to the markets. 

Moreover, as discussed in Part III.I, below, the Working Group generally supports 

the proposed aggregation rules and disaggregation exemption as applied to ‘‘owned’’ 

non-financial entities. Yet it respectfully requests that the Commission (i) provide 

guidance on the required showing a market participant must make in demonstrating independent control, (ii) permit market participants discretion in using 

internal or external personnel to make any assessments relating to the independence of its owned non-financial entities, and (iii) confirm that the positions of owned 

non-financial subsidiaries or affiliates demonstrating independent control will not be 

aggregated with a parent financial entity. 

Finally, and not of least importance, as discussed in Part III.J, below, the Working Group strongly recommends that the Commission conduct a thorough cost-benefit analysis of this Proposed Rule, which should include the costs presented in the 

Paper Reduction Act section of the Proposed Rule.

III. Comments of the Working Group of Commercial Energy Firms 

A. The Commission Has Not Established the Foundation for the Imposition 

of Federal Speculative Position Limits for Exempt and All Agricultural 

Commodities 

As a threshold matter, the Working Group respectfully submits that Congress did 

not mandate the establishment of speculative position limits for exempt and all agricultural commodities or authorize the Commission to so impose them without an 

analysis and finding of the need for, or appropriateness of, speculative position limVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00147 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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3See CEA Sections 4a(a)(2)–(5) (requiring that the Commission establish position limits ‘‘as 

appropriate’’). 4See Federal Speculative Limits for Referenced Energy Contracts and Associated Regulations,

Notice of Proposed Rulemaking, 75 FED. REG. 4144 (Jan. 26, 2010); The Futures Industry Association, Inc., Comment Letter (Mar. 8, 2010); International Swaps and Derivatives Association, 

Inc. (‘‘ISDA’’), Comment Letter (April 16, 2010); Working Group of Commercial Energy Firms,

Comment Letter (April 26, 2010). 5See CME Group, Pre-Rulemaking Position Limit Comments (Oct. 25, 2010); The Futures Industry Association, Inc., Pre-Rulemaking Position Limit Comments and Recommendations (‘‘FIA 

Pre-Rulemaking Comments’’) (Oct. 1, 2010). 6The analogs in existing Commission regulations are Sections 1.3(z)(3) and 1.47. Under the 

Proposed Rule, Section 1.3(z) would not apply to speculative position limits for exempt and agricultural commodities and Section 1.47 would be deleted altogether. 7Proposed CFTC Rule 151.5(a)(1).

its in any specific market.3 This issue has been addressed in comment letters filed 

in response to the Commission’s January 26, 2010 Notice of Proposed Rulemaking, 

Federal Speculative Limits for Referenced Energy Contracts and Associated Regulations,4 and in pre-rulemaking comments filed in connection with the potential implementation of speculative position limits under Dodd-Frank.5 Moreover, the Working 

Group is informed that other interested parties will address this issue in their comments submitted in this rulemaking proceeding. The Working Group supports the 

principle that the CEA requires additional analysis before the Commission can finalize a speculative position limit rule for exempt and all agricultural commodities. 

In Section III.F, below, the Working Group presents its concerns regarding the 

proposed spot-month limits for referenced contracts should the Commission move 

forward and implement such limits using the phased approach outlined in the Proposed Rule. In addition to its concerns regarding the proposed Phase I spot-month 

limits, the Working Group submits that imposing position limits for non-spot 

months and AMC could result in significant, unintended adverse impacts on derivatives markets, particularly markets for energy commodities. 

The Proposed Rule fails to provide any verified, empirical data, or cost-benefit 

analysis justifying the imposition of Phase II non-spot-month and AMC limits that 

can be reviewed and commented upon by interested parties—even on a prophylactic 

basis. Notwithstanding this lack of analysis, non-spot month and AMC position limits are unnecessary if the Commission develops appropriate spot-month limits. As 

such, the Working Group strongly recommends the Commission use the discretion 

afforded under new CEA Section 4a(a) and forego the implementation of Phase II 

non-spot month and AMC position limits in any final rule issued in this proceeding. 

The comments that follow are submitted by the Working Group to address concerns with respect to specific provisions in the Proposed Rule so that a final rule, 

if one is ultimately adopted, will contain the clearest and most workable provisions. 

B. The Proposed Definition of a Bona Fide Hedging Transaction Is Seriously Flawed 

The Working Group submits that there are several, very specific and somewhat 

technical, flaws in the proposed definition of a bona fide hedging transaction that 

threaten its utility for commercial energy firms. As such, the Working Group provides the following comments addressing its concerns with specific provisions of the 

Proposed Rule and respectfully requests that the Commission address each of them 

prior to the adoption of any final rule. Doing so will ensure that any final rule 

adopted by the Commission in this proceeding will be clearer and more workable 

(i.e., commercially practicable). 

1. There is No Basis for the Elimination of ‘‘Non-Enumerated’’ Hedges 

Without much explanation, the Commission excluded from proposed CFTC Rule 

151.5 provisions that would define ‘‘non-enumerated hedges’’ or provide a vehicle for 

a commercial energy firm to apply for, and receive, an exemption from speculative 

position limits for ‘‘non-enumerated hedges.’’ 6 In contrast, the Proposed Rule provides that the only transactions or positions that would be recognized as bona fide

hedges would be those described under proposed CFTC Rule 151.5(a)(2) as ‘‘enumerated hedges.’’ Specifically, the proposed rule states, in relevant part: 

‘‘[N]o transactions or positions shall be classified as bona fide hedging for purposes of § 151.4 unless . . . the provisions of paragraph (a)(2) of this section 

have been satisfied.’’ 7

In taking this position (hereinafter referred to as the ‘‘Enumerated Hedges Only’’ 

provision), the Commission has eviscerated the general definition of bona fide hedging transactions or positions as set forth in proposed CFTC Rule 151.5(a)(1), which 

came directly from CEA Section 4a(c)(2), as amended by Dodd-Frank. Significantly, 

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8 In addition, the Commission’s proposal simultaneously establishes and eliminates the availability of the so-called ‘‘pass-through’’ exemption identified in proposed CFTC Rule 

151.5(a)(1)(iv)(A) and CEA Section 4a(c)(2)(B). To be certain, proposed CFTC Rule 

151.5(a)(1)(iv)(A) is nearly identical to the discretionary pass-through provision in new CEA Section 4a(c)(2)(B). As such, the Commission clearly sought to establish a pass-through exemption. 

And yet the Commission’s proposed CFTC Rule 151.5(a)(2) would eliminate the use of any such 

exemption. The Working Group believes that the Commission likely did not intend such a result. 9This does not mean that the Commission is compelled to grant exemptions—it will retain 

its discretion on a case-by-case basis based on the market’s ability to support it, among other 

things. What it does mean, however, is that if the Commission believes an exemption may be 

warranted to add liquidity to a particular market at a particular time it would not be forced 

to promulgate an amendment to Part 151.5 in order to do so. 10See analogous new CEA Section 4a(c)(2). 

the Commission has effectively eliminated from the bona fide hedging definition numerous classes of transactions that Congress intended to include.8 The Working 

Group identifies and describes several of these transactions in subparts III.B.1.i–

III.B.4, below. 

The Working Group respectfully submits that it is neither in the public interest 

nor is it in the Commission’s interest as a market regulator to structure a rule that 

eliminates its flexibility to allow hedge exemptions based on ‘‘non-enumerated hedging transactions.’’ Markets are dynamic. Many of the proposed rules being implemented by the Commission pursuant to Dodd-Frank, particularly this Proposed 

Rule, may have the result of diminishing liquidity in certain markets. Thus, the 

Working Group submits that the Commission should preserve its ability to allow exemptions based upon non-enumerated transactions.9

Accordingly, in order to ensure consistency with the statutory language of new 

CEA Section 4a(c) and avoid harmful impacts to markets for Referenced Contracts, 

the Working Group suggests that the Commission (i) strike the last clause in proposed CFTC Rule 151.5(a)(1)(iv)(B)—‘‘and the provisions of paragraph (a)(2) of this 

section have been satisfied;’’ and (ii) revise the lead-in language of proposed CFTC 

Rule 151.5(a)(2) to add following the word ‘‘includes’’ the phrase ‘‘, but is not limited 

to,’’. Specifically, the Working Group proposes the following revisions: 

§ 151.5 Exemptions for referenced contracts. 

(a) BONA FIDE HEDGING TRANSACTIONS OR POSITIONS.

(1) Any trader that complies with the requirements of this section may 

exceed the position limits set forth in § 151.4 to the extent that a transaction or position in a referenced contract: 

* * * * *

(iv) Reduces risks attendant to a position resulting from a swap 

that—

* * * * *

(B) Meets the requirements of paragraphs (a)(1)(i) through 

(a)(1)(iii) of this section. Notwithstanding the foregoing, no transactions or positions shall be classified as bona fide hedging for purposes of § 151.4 unless such transactions or positions are established and liquidated in an orderly manner in accordance with 

sound commercial practices and the provisions of paragraph (a)(2) of 

this section have been satisfied.

(2) ENUMERATED HEDGING TRANSACTIONS. The definition of bona fide

hedging transactions and positions in paragraph (a)(1) of this section includes, but is not limited to, the following specific transactions and positions: . . .

Subparts III.B.1.i–III.B.4, below, address the identified flaws with the Commission’s current proposal for the definition of a bona fide hedge, and support the 

Working Group’s recommendation to revise the proposed language of the bona fide

hedging transaction definition. 

i. Hedges Relating to Assets That a Person Anticipates Owning or Merchandising 

Would Not Constitute Bona Fide Hedges Under the Proposed Rule 

Proposed CFTC Rule 151.5(a)(1) includes as a bona fide hedge the anticipated 

ownership, production, manufacture, processing, or merchandising of an exempt or 

agricultural commodity.10 Yet proposed CFTC Rule 151.5(a)(2), which sets forth 

‘‘Enumerated Hedging Transactions,’’ does not contain a parallel provision. Indeed, 

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11Proposed CFTC Rule 151.5(a)(2)(i)(B). 12Proposed CFTC Rule 151.5(a)(2)(ii)(C). 13To the extent that language in the enumerated hedging section of the proposal parallels language in the enumerated hedging section of current Rule 1.3(z), the Working Group submits 

that the impact is different as a result of the elimination of the availability of an exemption 

for non-enumerated hedges. 14Often times, commercial energy firms competing to serve load under similar RFP arrangements have been required to leave in place fixed price quotes longer than the four (4) day window set forth in the example above. 15 End-User Exception to Mandatory Clearing of Swaps, Notice of Proposed Rulemaking, 75 

FED. REG. 80747 (Dec. 23, 2010) (‘‘Proposed End-User Exception Rule’’); Working Group of Commercial Energy Firms, Comment Letter (Feb. 22, 2011); Further Definition of ‘‘Swap Dealer,’’ 

‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Participant’’ and ‘‘Eligible Contract Participant,’’ 75 FED. REG. 80174 (Dec. 21, 2010); Working Group 

of Commercial Energy Firms, Comment Letter (Feb. 22, 2011). 

only ‘‘unsold anticipated production’’ 11 and ‘‘unfilled anticipated requirements,’’ including requirements for ‘‘processing, manufacturing, and feeding’’ 12 qualify as enumerated hedges. Thus, as a result of the Enumerated Hedges Only provision, certain transactions entered into to hedge anticipated ownership or merchandising of 

an exempt or agricultural commodity would not qualify as bona fide hedging transactions under the Proposed Rule.13 The Working Group provides two such examples. 

Example 1. 

At 8:00 a.m. commercial energy firm X becomes aware of the availability of a spot 

cargo of heating oil moving from Europe to the United States. Firm X believes that 

it can acquire the cargo over the next few hours or days, manage the discharge of 

the product at the end of the voyage, and re-sell the heating oil to a distributor in 

the northeast at the end of the month. While Firm X begins negotiations to purchase 

and re-sell the cargo, it is not concerned about upward price risk during the period 

of its purchase negotiations but is seriously concerned about downward price risk between now and the time it establishes its sale price. It sells New York Mercantile Exchange (‘‘NYMEX’’) heating oil futures contracts for its expected delivery month. 

Under the Commission’s proposal, this transaction would not qualify as a bona fide

hedge.

Example 2. 

Utility X periodically issues requests for proposals (‘‘RFP’’) looking to obtain fixed 

price electricity supply for groups of its customers. For example, it may be looking 

for a fixed price for electricity for a term of three (3) years for its commercial customer class. In its RFP, Utility X requires that Bidders provide firm electricity at 

a fixed price and at designated locations on its electrical system. As it is for Full 

Requirement, Bidders must ensure that enough electric supply is delivered to Utility 

X so that it can meet the load requirements of its commercial customers. Actual deliveries of electricity are equal to actual usage of electricity by Utility X’s commercial 

customers and results in physical delivery of electricity. Finally, the RFP requires 

that the fixed price offer be provided on or before the close of business, March 31, 

and be left open; that is, the price quoted must remain firm while Utility X evaluates 

and then selects the winning bidder on April 3.14

Power Marketer Y is preparing to respond to Utility X’s RFP. It believes it can arrange for a physical supply of electricity supply on competitive terms. However, 

Power Marketer Y is concerned that prices in the electricity market will increase 

while it is holding open its fixed price for Utility X and then completing the transaction for the physical supply. Power Marketer Y enters into an electricity swap to 

protect against increases in prices while it leaves open the bid during the three day 

evaluation period and thereafter completes negotiations for the physical electricity 

purchase if Utility X accepts its price quote. Under the Commission’s proposal, the 

electricity swap transaction would not qualify as a bona fide hedge. If Power Marketer Y faces position limit restrictions in this situation, it would have to raise its 

fixed price quote to Utility X to account for the risk of the price moving and this 

could result in higher costs to Utility X’s customers.

The Working Group notes that the variance in the treatment of marketing or merchandising activities and the treatment of producers or processors in the Proposed 

Rule is remarkably similar to the differential treatment of cash market ‘‘trading’’ 

positions provided in footnotes 23 and 128 of the proposed rules implementing the 

End-user Exception and further defining the term Major Swap Participant, respectively, and upon which the Working Group commented in the relevant proceedings.15 The Working Group’s concern was that in those proposed rules, the Commission appeared to take the position that a marketer or merchandiser that acquired a commodity for resale (i.e., a cash market ‘‘trading’’ position) would not be 

147

16See 17 CFR § 32.4(a) (2010) (‘‘a producer, processor, or commercial user of, or a merchant 

handling, the commodity’’ may be an offeree of an option under the trade option exemption) (emphasis added). 17 Exemption for Certain Contracts Involving Energy Products, 58 FED. REG. 21286 (Apr. 20, 

1993) (granting exemptive relief in response to an application filed by a group of entities which 

represented that each was a producer, processor and/or merchandiser of crude oil, natural gas 

and/or crude oil and natural gas products, or was otherwise engaged in a commercial business 

in these commodities). 18See Section 4a(c) of the CEA (‘‘producers, purchasers, sellers, middlemen, and users of a 

commodity or product derived therefrom’’ should be eligible for hedge exemptions) (emphasis 

added). 19See analogous new CEA Section 4a(c)(2). 20Without impacting their illustrative value, these examples have been simplified, and certain 

factors, such as the time value of money, have been eliminated. 21 Note that this ‘‘value’’ exists whether commercial energy firm Z ever owns or intends to own 

the physical commodity. In some circumstances, the firm might choose to release the capacity 

to a third-party and realize the value of the transportation service from the capacity release 

transaction. 

entitled to treat a hedge of that position as ‘‘mitigating or reducing commercial risk’’ 

in order to avail itself of the end-user exception or certain calculations in connection 

with the definition of Major Swap Participant. 

As in the instant proceeding, such differential treatment in those proposed rules 

wouldeffectively eliminate ‘‘merchant,’’ 16 ‘‘merchandiser,’’ 17 or ‘‘middlemen’’ 18 from 

the litany of commercial parties historically recognized as part of the chain from the 

production to the consumption of commodities. These parties own physical commodities and bear significant price risk as a result. The Working Group respectfully submits that this result is contrary to the CEA and that the use of derivatives by these 

firms to hedge that risk should qualify as bona fide hedges and as ‘‘hedging and 

mitigating commercial risk’’ under the Commission’s rules. 

ii. Hedges of Services Would Not Constitute Bona Fide Hedges Under the Proposed 

Rule 

Proposed CFTC Rule 151.5(a)(1) would include as a bona fide hedging transaction 

‘‘services that a person provides or purchases, or anticipates providing or purchasing.’’ 19 However, proposed CFTC Rule 151.5(a)(2), which sets forth Enumerated 

Hedging Transactions, does not contain a parallel provision. Thus, under the Enumerated Hedges Only provision, hedges of the potential change in value of services 

would not constitute as bona fide hedging under the Commission’s proposal. The 

Working Group provides the following two examples to illustrate such hedges.20

Example 1. 

Commercial energy firm Z is a wholesale marketer of natural gas. It has an opportunity to acquire one year of firm transportation on Natural Gas Pipeline (‘‘NGPL’’) 

from the Texok receipt point to the Henry Hub delivery point for an all-in cost of 

$.30/mmbtu. The ‘‘value’’ of that service at that time is $.33/mmbtu, measured as 

the difference between the price at which one can sell the natural gas at the delivery 

point minus the price at which one can purchase the gas at the receipt point. At that 

time, commercial energy firm Z can enter into a swap locking in the calendar 2012 

strip at Texok at a price of $4.00/mmbtu and sell a calendar strip of NYMEX Henry 

Hub natural gas futures contracts locking in a sale price at a weighted average of 

$4.33/mmbtu. Entering into those two separate transactions without having actually 

purchased or sold natural gas to transport has allowed commercial energy firm Z 

to hedge the value of the firm transportation service that it holds or can acquire.21

However, under the Commission’s proposal, the transaction would not qualify as a 

bona fide hedge transaction.

Example 2. 

Natural Gas Producer X has new production coming on line over the next few years 

in the Gulf of Mexico. The production is located near Point A on Pipeline Y’s interstate natural gas pipeline system. Producer X has the desire to sell gas to customers 

in Region B as the price for natural gas in Region B is significantly higher than at 

Point A, where natural gas would currently be delivered into Pipeline Y’s system. 

Producer X contacts Pipeline Y and negotiates a Precedent Agreement with the pipeline under which Pipeline Y will build new transportation capacity from Point A to 

Region B. Under the Precedent Agreement, Producer A is obligated to pay demand 

charges to the pipeline for a term of 5 years from the date the pipeline goes into commercial operation, if Pipeline Y is able to complete a successful open season and obtains the necessary permits to construct and operate the new section or expansion of 

its pipeline system from Point A to Region B. The open season is designed to attract 

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22See NYMEX Rule 559.C and ICE OTC Regulatory Rulebook for Significant Price Discovery 

Contracts, Rule 1.17 (‘‘ICE OTC Rule 1.17’’). 

commitments from other potential shippers to help support the cost of building and 

operating the pipeline expansion. The schedule calls for a completion of construction 

and commercial operation of the pipeline expansion on March 31, 2013. Producer X is concerned that the natural gas price differential between Point A 

and Region B could collapse and is fairly confident the expansion project will be 

completed. In order to manage the risk associated with the 5-year financial commitment to Pipeline Y, i.e., pipeline demand charges, Producer X enters into swaps at 

Point B for a term of April 1, 2013 to March 31, 2018, to lock-in the price spread 

between Point A and Region B. Under the Commission’s Proposed Rule, the swap 

transactions would not qualify as bona fide hedges. In this case, the expansion of 

the pipeline system that would afford customers in Region B more access to lower 

priced gas might not occur without the ability to count the swaps associated with 

this transaction as a bona fide hedge. 

Example 3. 

Commercial energy firm A is an electric utility that owns coal-fired generation facilities. Firm A enters into contracts with major railroads to transport coal from producing regions to its various generating facilities. One or more of these contracts are 

subject to a fuel surcharge, whereby rates paid by firm A to transport coal are indexed to the price of diesel fuel. As prices for the diesel fuel rise, the rate paid by 

firm A to transport coal also rises. To mitigate this risk, firm A could enter into a 

long position in futures contracts or swaps for the diesel fuel, whereby gains realized 

on these instruments should prices rise would off-set any increase in the rate paid 

by firm A to transport coal. Under the Proposed Rule, however, these transactions 

would not qualify as bona fide hedge transactions since they would be entered into 

as a hedge of services—in this case, coal transportation services.

2. Spreads and Arbitrage Positions Would Not Qualify as Bona Fide Hedges Under 

the Proposed Rule

Section 4a(a) of the CEA both before and after the passage of Dodd-Frank authorizes the Commission to ‘‘exempt[] transactions normally known to the trade as 

‘spreads’ or ‘straddles’ or ‘arbitrage’ or from fixing limits applying to such transactions or positions different from limits fixed for other transactions or positions.’’ 

Under the regimes for speculative position limits currently administered by both 

NYMEX and the IntercontinentalExchange (‘‘ICE’’), exemptions from speculative position limits are available for arbitrage, intra-commodity spread, inter-commodity 

spread, and eligible option/option or option/futures spread positions.22 Under the 

Proposed Rule, these classes of transactions would not qualify for an exemption. 

Arbitrage and spread positions create a limited risk of causing sudden or unreasonable fluctuations or unwarranted changes in the price of a commodity. In fact, 

they are universally recognized as transactions that limit unwarranted changes in 

price by tying the price of one instrument to another, creating a market efficiency 

that reduces the risk of aberrational pricing. The Working Group submits that there 

has never been an issue of sudden or unreasonable fluctuations or unwarranted 

changes in price attributable to arbitrage or spread positions that would justify the 

elimination of exemptions for such transactions at this time. 

The Working Group respectfully suggests that the fact that these positions currently exist in the market and may be the basis for an exemption from limits on 

both NYMEX and ICE requires that the Commission consider the potential negative 

impact on liquidity if such positions were no longer to be permitted such treatment. 

Therefore, as provided for under CEA Section 4a(a), the Commission should permit 

exemptions from position limits for transactions such as spreads or arbitrage. 

3. Cross-Commodity Hedges Would Not Be Permitted To Be Carried Into the Spot 

Month 

Proposed CFTC Rule 151.5(a)(2)(v) would permit cross-commodity hedges ‘‘provided that the positions shall not be maintained during the five last trading days 

of any referenced contract.’’ This would result in transactions, such as the one set 

forth in the following example, being excluded from treatment as a bona fide hedging transaction. 

Example. 

Commercial energy firm J supplies jet fuel to airlines at a variety of airports in 

the United States, including Houston Intercontinental Airport. It has a fixed-price 

contract to purchase jet fuel from a refinery on the gulf coast during early June. Because there is no liquid jet fuel futures contract, commercial energy firm J uses the 

149

23 17 CFR § 1.3(z). 24See proposed CFTC Rule 151.5(c) (with respect to hedging anticipated unsold production or 

anticipated unfilled requirements, a trader must submit to the Commission a 404A filing at 

least ten days in advance of the date that such transactions or positions would exceed the applicable position limits). See also proposed CFTC Rule 151.5(c)(1)(ii), (iv), and (v) (each subsection 

contains the phrase ‘‘which may not exceed one year’’). This restriction, however, should only 

be applied to referenced agricultural commodities. The Working Group is also concerned that 

this proposed rule could be read to effectively restrict the ability of participants in exempt commodity markets to hedge exposure to price volatility for transactions that are more than one 

year in duration. The Commission should clarify and, as necessary, rectify, the language of proposed CFTC Rule 151.5(c)(1)(ii), (iv), and (v) to avoid such a result. 25The Commission would be fully justified under the CEA to make such a determination to 

leave the upper limit of an exemption undefined. See CEA Sections 4a(a)(2)(A) and 4a(a)(5)(A). 

If that was the Commission’s intention behind this proposed exemption process, the Working 

Group would fully support it. 

June NYMEX physically-delivered WTI crude oil futures contract to hedge its price 

risk. Under the Proposed Rule, commercial energy firm J would be required to liquidate its hedge during the last five trading days of the June contract and either 

remain unhedged or replace its June hedge with a contract that represents a completely different delivery period and, therefore, a different supply/demand and pricing profile.

4. The Working Group Questions the Phraseology Used in the Proposed Rule that 

Would Treat as Bona Fide Hedges ‘‘Purchases of Referenced Contracts’’ on the 

One Hand, and ‘‘Sales of Any Commodity Underlying Referenced Contracts’’ on 

the Other 

The purpose and effect of the distinction presented in proposed CFTC Rule 

151.5(a)(2) are unclear to the Working Group. Specifically, the lead-in language to 

proposed subpart 151.5(a)(2)(ii) states that ‘‘purchases of referenced contracts’’ may 

qualify as bona fide hedges provided certain conditions are met. In contrast, the 

lead-in language to proposed subpart 151.5(a)(2)(i) states that ‘‘sales of any commodity underlying referenced contracts’’ may qualify as bona fide hedges provided 

the right conditions are met. Nowhere in the Proposed Rule does the Commission 

explain the purpose behind this distinction. Under the analogous provisions of Section 1.3(z) of the Commission’s current regulations,23 purchases and sales are treated equally—that is, purchases or sales of futures contracts (and not the underlying 

commodity) may qualify as bona fide hedging transactions. Thus, it appears that the 

phrase ‘‘any commodity underlying’’ ought not to be included in proposed CFTC Rule 

151.5(a)(2). The Working Group respectfully requests that in any final rule issued 

in this proceeding the Commission either (i) harmonize the two provisions in the 

Proposed Rule, or (ii) clarify the intent and purpose behind the distinction should 

the Commission adopt such language. 

C. The Process for Applying for, and Receiving, Exemptions From Speculative Position Limits Is Also Flawed 

1. The Proposed Rule Unnecessarily Abandons the Current Energy Market Process 

of Applying in Advance for Exemptions From Speculative Position Limits 

Current practice on both NYMEX and ICE permits a commercial energy firm to 

apply, in advance, for an exemption from speculative position limits. With the exception of exemptions for ‘‘anticipated unsold production’’ and ‘‘anticipated unfilled requirements,’’ 24 the Proposed Rule abandons that construct. The Working Group respectfully submits that such an approach is flawed for the reasons set forth below. 

i. The Proposed Rule Creates Uncertainty for Market Participants 

Under current practice, a market participant would apply for an exemption from 

speculative position limits that would allow it to hold positions subject to the exemption up to a stated quantity. Such practice provides commercial energy firms with 

certainty and precise knowledge as to what the exchange (i.e., NYMEX) or exempt 

commercial market (‘‘ECM’’) with significant price discovery contracts (i.e., ICE), as 

applicable, will permit. Unlike current practice, the Proposed Rule leaves the upper 

limit of an exemption undefined.25 Unless the Commission is proposing that there 

is no upper limit for bona fide hedge transactions, which is highly doubtful, then 

the proposed process leaves a market participant without any knowledge as to when 

its positions will be deemed by the Commission to be ‘‘too much.’’

By way of example, assume the speculative position limit for an energy commodity 

is 1,000 contracts, and a commercial energy firm with significant inventory could 

justify an exemption to allow it to hold 6,000 contracts. In NYMEX’s view, however, 

the market could support an exemption only to a level of 3,000 contracts. Under curVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00153 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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26The Working Group notes that in a prior rulemaking to establish federal speculative position limits, the Commission sought to establish an application process for bona fide hedge exemptions. See Federal Speculative Position Limits for Referenced Energy Contracts and Associated Regulations, Notice of Proposed Rulemaking, 75 FED. REG. 4144 (Jan. 26, 2010). 27 In addition to providing market participants with the ability to provide comments on the 

application process in the context of the instant rulemaking, the Working Group suggests that 

the Commission also host a technical conference or other forum to permit market participants 

to interface with the Commission and make recommendations. Upon issuance of a proposed application process, the Commission should then provide an appropriate opportunity for comment. 28See NYMEX Rule 559; ICE OTC Rule 1.16. 29See 17 CFR § 18.05; 21 (2010). 

rent practice, the commercial energy firm would know, in advance, that the potential acquisition of additional cash market risk would not result in additional room 

to hedge on NYMEX and could make a considered decision to make, or not make, 

the acquisition, knowing it might have to hold it unhedged. 

In contrast, the Proposed Rule does not provide a market participant the opportunity to know in advance what the Commission would determine to be the upper 

limit that the market could support. Pursuant to the Proposed Rule, a market participant must make the required filings with the Commission upon reaching the position limit of 1,000 contracts. In accordance with its internal policies and business 

practice, a market participant would continue to increase its position and make the 

corresponding required filings without ever knowing when and at what level the 

Commission would say ‘‘enough.’’

The Working Group believes that, at some point, the Commission would say 

‘‘enough’’ on the same basis that NYMEX currently limits exemption levels even 

when they would be fully justified based upon a participant’s cash market exposure. 

Yet the Proposed Rule makes no provision for when or how the Commission would 

establish an upper bound, and fails to state whether a market participant would be 

required to liquidate or offset positions established in good faith before an upper 

bound was communicated. Commercial energy firms cannot afford to operate under 

this process, or lack thereof, as it creates a high level of uncertainty. 

ii. The Commission Should Provide Clear Guidance on the Application Process for 

Hedge Exemptions Should It Adopt One in Any Final Rule Issued in the Proceeding 

Should the Commission adopt an application process for bona fide hedge exemptions in any final rule issued in this proceeding, the Working Group suggests that 

the Commission provide clear guidance on such process and permit market participants an opportunity to comment.26 Any application process adopted by the Commission should require market participants to apply for exemptions only once. Currently, market participants seek exemptions from the exchanges. Yet, under any 

final rule adopted by the Commission, market participants should not be required 

to apply for exemptions from both the CFTC and the exchanges. Such a requirement 

would impose significant burdens on market participants.27

iii. Daily Reporting of Cash Market and Other Positions Is Burdensome and Unnecessary 

Under current practice on both NYMEX and ICE, a party with a hedge exemption 

is not required to make regular filings with the exchange or ECM. Nevertheless, a 

market participant remains subject to inquiry by NYMEX or ICE 28 and the requirement to justify the use of the exemption. Additionally, the market participant remains subject to the special call authority of the CFTC 29 and an enforcement action 

if such market participant used an exemption to hold speculative positions in excess 

of the position limit. 

Under the Proposed Rule, a party will be required to submit daily reports 

itemizing the following information with respect to such position: (1) the cash market commodity hedged, the units in which it is measured, and the corresponding referenced contract that is used for hedging the cash market commodity; (2) the number of referenced contracts used for hedging; (3) the entire quantity of stocks owned 

of the cash market commodity that is being hedged by a position in a referenced 

contract; (4) the entire quantity of open fixed price purchase commitments in the 

hedged commodity outside of the spot month of the corresponding referenced contract; (5) the entire quantity of open fixed price purchase commitments in the 

hedged commodity in the spot month of the corresponding referenced contract; (6) 

the entire quantity of open fixed price sale commitments in the hedged commodity 

outside of the spot month of the corresponding referenced contract; and (7) the entire quantity of open fixed price sale commitments in the hedged commodity in the 

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30See proposed CFTC Rule 151.5(b). 31The Working Group notes that, in the CFTC’s proposed rule on the end-user exception from 

mandatory clearing, the Commission recognizes that whether a position is used to hedge or mitigate commercial risk should be determined by the facts and circumstances at the time the swap 

is entered into, and should take into account the person’s overall hedging and risk mitigation 

strategies. See Proposed End-User Exception Rule, at 80753. In relevant part, the Proposed EndUser Exception Rule states:

As a general matter, the Commission preliminarily believes that whether a position is used

to hedge or mitigate commercial risk should be determined by the facts and circumstances

at the time the swap is entered into, and should take into account the person’s overall hedging

and risk mitigation strategies. The Commission expects that a person’s overall hedging and

risk management strategies will help inform whether or not a particular position is properly

considered to hedge or mitigate commercial risk for purposes of the clearing exception.

The Working Group respectfully submits that the Commission should take this same approach 

herein and recognize that the determination of what is a bona fide hedge transaction is informed 

by a market participant’s overall hedging and risk management strategy. 32For example, a commercial energy firm may enter into several swap transactions to hedge 

a single physical position. This approach is used to spread out risk among different 

Continued

spot month of the corresponding referenced contract.30 Building the system to perform such reporting will be a significant and unnecessary expense, and the management and execution of the system to satisfy the daily reporting obligation an unnecessary burden. 

iv. Daily Review of Positions Is a Burden that the Commission Does Not Need To 

Impose Upon Itself 

In order to manage the speculative limit regime that the Commission is proposing 

to establish, CFTC staff will be required to review and evaluate daily the positions 

of all market participants that exceed the speculative position limits. First, as described in Part III.C.1.i, above, CFTC staff will need to do so to determine when 

to say ‘‘enough’’ to a bona fide hedger with legitimate hedging needs that may be 

greater than the market for a particular instrument can bear. Second, staff will also 

need to do so to verify the veracity of a market participant’s claim of eligibility for 

a hedge exemption, something that is currently only done on a periodic basis. The 

Working Group respectfully submits that the monitoring and verification obligations 

placed on CFTC staff will require the expenditure of considerable Commission resources and are unnecessary, especially at a time of significant budgetary constraint. 

D. The Proposed Framework for Bona Fide Hedge Exemptions Should Reflect the Hedging Practices of Commodity Markets 

In addition to the Working Group’s specific concerns regarding the technical flaws 

with the proposed definition of the bona fide hedging exemption and the process of 

applying for an exemption, the Working Group respectfully requests the Commission 

to recognize that, although market participants in physical energy commodity markets use swaps and futures to hedge underlying physical positions, they frequently 

do not execute such transactions specifically for the purpose of hedging a specified 

underlying physical position (i.e., on a one-for-one basis). Prudent risk management 

practices generally involve hedging underlying physical assets and related positions 

on a portfolio or aggregate basis.31 A commercial firm will normally hedge these exposures utilizing physical transactions, futures, and swaps, the exact combinations 

of which will be determined by various characteristics that may be unique to such 

firm. 

Further, in order to effectively and efficiently mitigate commercial risk associated 

with underlying physical assets and related positions, commercial energy firms will 

also dynamically hedge their aggregate exposures on a regular and on-going basis 

to optimize the value of underlying physical assets or portfolios. A key aspect of dynamic hedging is the ability to modify the hedging structure related to the physical 

asset or positions when the relevant pricing relationships applicable to that asset 

change. Dynamic hedging may involve leaving an asset or position unhedged when 

necessary to mitigate the risk of lost opportunity costs, which may require hedges 

to be established, unwound, and re-established on an iterative basis over time. 

In this context, the concept of bona fide hedging should include all hedging activity that maximizes the value of the asset. The adoption of a prescriptive one-to-one 

matching requirement of each swap to a specific physical transaction or an asset 

position is inconsistent with the hedging practices of many participants in commodity markets, particularly energy markets, and is thus unnecessary and overly 

burdensome.32 As such, the Working Group requests that the Commission modify 

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counterparties and to obtain the best overall pricing possible for the hedge. Given the dynamic 

and volatile nature of energy markets, it is very difficult for a commercial energy firm or any 

other market participant to assert on an intra-day, real-time basis or at a later point in time 

whether a particular swap or futures transaction is functioning as a hedge. Under this example, 

it would be difficult, if even possible, for a swap dealer to step into the shoes of its commercial 

counterparty on a transaction-by-transaction-basis for purposes of applying the pass-through 

provisions of CEA Section 4a(c)(2)(B). 33See FIA Pre-Rulemaking Comments at 8; Morgan Stanley, Position Limits Pre-Rule Proposal Comments and Recommendations, at 10 (Oct. 25, 2010). 34Section 4a(a) of the CEA states: ‘‘[N]othing in this section shall be construed to prohibit the 

Commission from . . . exempting transactions normally known to the trade as ‘spreads’ or 

‘straddles’ or ‘arbitrage.’ ’’

its hedge exemptions and their related reporting requirements to reflect more appropriately the actual hedging practices of participants in energy markets in any final 

rule it adopts in this proceeding. 

E. The Pass-Through Provision Is Not Required, and Therefore, the Commission Should Adopt an Alternative Approach: Permit Risk Management Exemptions From Position Limits 

As amended by Title VII of the Act, new CEA Section 4a(c)(2)(B) permits the passthrough of a bona fide hedge exemption from speculative position limits to swap 

dealers taking the other side of a hedge transaction from an end-user. In relevant 

part, new CEA Section 4a(c)(2)(B) states:

(2) For the purposes of implementation of subsection (a)(2) for contracts of 

sale for future delivery or options on the contracts or commodities, the Commission shall define what constitutes a bona fide hedging transaction or position 

as a transaction or position that—

* * * * *

(B) reduces risks attendant to a position resulting from a swap that—

(i) was executed opposite a counterparty for which the transaction 

would qualify as a bona fide hedging transaction pursuant to subparagraph (A); or 

(ii) meets the requirements of subparagraph (A).

This discretionary provision effectively allows a swap dealer to ‘‘step into the 

shoes’’ of a commercial firm or end-user counterparty for purposes of being exempted from applicable speculative position limits. 

1. The Pass-Through Is No Longer Required; the Concerns Over Risk Management 

Exemptions Have Been Ameliorated 

The Working Group submits that the transparency created in exempt commodity 

markets by Title VII of the Act, together with the Commission’s exemptive authority 

under new CEA Section 4a(a)(7), render this pass-through provision unnecessary. 

The Working Group supports pre-rulemaking comments submitted by other interested parties 33 recommending that the Commission continue its practice of granting 

arbitrage and risk management exemptions from position limits for positions that 

serve the same or similar function as a bona fide hedge position, but do not fall 

squarely within the definition of a bona fide hedge.34 Risk management exemptions 

from position limits are essential to the risk management practices of commercial 

energy firms; however, such exemptions had come under scrutiny because they allowed a swap dealer to get a hedge exemption to hedge the risk of swaps opposite 

speculative traders whose swap positions were unknown to the Commission and 

were subject to neither position limit nor accountability rules. Under Dodd-Frank, 

those concerns are no longer present. That is, virtually all swap transactions will 

be reported to swap data repositories (‘‘SDRs’’), prices will be reported to the public, 

and the parties will be subject to large trader reporting rules. Accordingly, the Commission may grant risk management exemptions on the basis of a party’s need, ability to manage the positions, and the ability of the market to support the positions, 

all without concern that it has enabled a ‘‘dark market’’ with attendant risks of ‘‘excessive speculation.’’

Section 4a(a)(7) provides the Commission with broad authority to exempt any persons or transactions from speculative position limits that it sets under Section 4a. 

The Working Group respectfully submits that the Commission exercise its exemptive authority to grant exemptions in appropriate circumstances rather than establish a pass-through exemption, the need for which has been significantly diminished 

given the transparency created in exempt commodity markets by the Act. 

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35The Working Group submits that the Proposed Rule will impose costs for monitoring compliance associated with the Commission’s proposed pass-through provision. See infra Part III.J, discussing the Commission’s costs and benefit analysis. 36See, e.g., ICE OTC Rule 1.16. 37Proposed CFTC Rule 151.5(g)(1) states: ‘‘The party not hedging a cash market commodity 

risk, or both parties to the swap if both parties are hedging a cash market commodity

risk . . . .’’ The Working Group submits that if both counterparties are hedging, there is no need 

to pass through their respective hedge exemptions and thus fails to understand the provision 

as written. 38The Commission also recognizes the difficulty in discerning between speculation and hedging. See End-User Exception Rule, at 80753. 

2. If Adopted, the Pass-Through Provision Raises Significant Compliance Concerns 

To the extent the Commission declines the Working Group’s recommendation to 

eliminate the pass-through provision in favor of risk management exemptions, the 

Working Group submits that the implementation of such provision in energy markets would create several practical concerns. Importantly, for the reasons described 

below, the resulting burdens and cost impacts of a pass-through provision will be 

disproportionately borne by those commercial firms, including energy firms, that 

presently manage risk through hedging practices.35

i. The Proposed Rule Contemplates One-for-One Hedging 

For example, the Working Group is concerned that market participants will be required to engage in a transaction-by-transaction analysis for purposes of determining whether a particular trade is in fact a bona fide hedge. As discussed in Part 

III.D, above, such an approach is inconsistent with the routine hedging practices 

employed by many participants in commodity markets, particularly energy markets. 

Specifically, these market participants determine their aggregate underlying exposures in physical markets and match hedges to those physical positions rather than 

hedging on a one-to-one basis. 

With this in mind, the pass-through of bona fide hedge exemptions as contemplated in the Proposed Rule is unworkable as it would require hedgers claiming 

the use of a bona fide hedge exemption to match a swap that hedges or mitigates 

commercial risk with a specified underlying physical commodity transaction. To the 

extent the Commission uses its discretion to retain the pass-through of bona fide

hedge exemptions, the Working Group suggests that the Commission maintain the 

approach currently used by DCMs and ECMs with significant price discovery contracts—which is to focus on market participants’ overall physical exposures and 

match hedges to the physical position.36

ii. Written Trade-by-Trade Representations and Acknowledgements Are Not Practical in Dynamic, Fluctuating Markets 

Proposed CFTC Rule 151.5(g) requires that a party relying on the bona fide hedging exemption provide a written representation verifying that the particular swap 

qualifies as a bona fide hedging transaction under proposed Rule 151.5(a)(1)(iv).37

Given the discretionary nature of new CEA Section 4a(c)(2)(B), the Working Group 

believes that such written representation should be optional, not mandatory (understanding that absent a representation, there would be no pass-through). It is impracticable to require a trader to make a determination at the time of the trade on 

the nature of the transaction, particularly, whether the swap is a hedge or speculative in nature.38 Moreover, as stated above, it would be impracticable, if not impossible, for the vast majority of market participants to link hedges with specified underlying physical positions for purposes of complying with the pass-through requirements in proposed CFTC Rule 151.5(g). 

iii. The Requirement that Parties Verify the Ongoing Nature of a Hedge Is Not 

Workable 

The Working Group is also concerned with proposed CFTC Rule 151.5(j)(2), which 

permits a party to exceed a position limit only ‘‘to the extent and in such amounts 

that the qualifying swap directly offsets, and continues to offset, the cash market 

commodity risk of a bona fide hedger counterparty.’’ This provision is problematic 

as it implies that a hedger must monitor and track the status of a each transaction 

it represented to its counterparty as a bona fide hedge and continually inform and 

represent to the counterparty that such swap continues to be a bona fide hedge. 

Such requirement would result in significant and costly burdens on hedgers. 

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39The Working Group supports proposed CFTC Rule 151.4(c)(3) requiring estimates submitted 

by a DCM to be accompanied by a description of the methodology used by the DCM and any 

supporting data.

F. Problems With the Proposed Spot-Month Limits 

1. The Determination of Deliverable Supply Should Be Fully Transparent and Subject to Public Notice and Comment 

Pursuant to proposed CFTC Rule 151.4(c), DCMs that list referenced physical delivery contracts would be required to submit estimates of deliverable supply for 

those physical commodities to the Commission on an annual basis. The Proposed 

Rule notes that the Commission will rely on a DCM’s estimate of deliverable supply 

unless it ‘‘determines to rely on its own estimate.’’ Given the overwhelming importance of the determination of deliverable supply for a Referenced Contract in establishing workable spot-month position limits under the framework set forth in the 

Proposed Rule, this process should be fully transparent,39 and the Commission 

should provide public notice and permit comment by interested parties. In furtherance of this process, the Working Group suggests the following approach: 

• November 30—DCM Estimate Submissions. DCMs submit to the Commission 

deliverable supply estimates for each physical delivery referenced contract that 

is subject to a spot-month limit and listed or executed pursuant to the rules of 

such DCMs. This submission is immediately noticed by the Commission for public comment.

• Mid-December—Comment Deadline on DCM Estimates. Interested parties would 

have 15 days to submit comments to the Commission providing their views on 

the DCM’s deliverable supply estimates.

• Mid-January—CFTC Issues Proposed Position Limits. Approximately 30 days 

following the submission of comments on the DCM deliverable supply estimates, 

the Commission would publish (or post on its website) proposed position limits 

for each referenced contract.

• February 1—Comment Deadline on Proposed Position Limits. Interested parties 

would have 15 days to submit comments on the Commission’s proposed position 

limits for each referenced contract.

• March 1—CFTC Issues Final Position Limits. The CFTC would release (or post 

on its website) final position limits for each referenced contract.

• April 1—New Position Limits Become Effective. Affected market participants 

would receive approximately 30 days to come into compliance with the new position limits. The new position limits would remain in effect until March 31st of 

the following year.

Finally, the Working Group strongly recommends that the Commission grandfather any position put on in good faith prior to the effective date of any final position limit set by Commission rule, regulation, or order. 

2. The Proposed Spot-Month Position Limits for Cash-Settled Contracts Should be 

Reconsidered 

i. The Working Group Respectfully Submits that the Limit for Cash-Settled Contracts Does Not Need to Equal the Limit for Physically-Settled Contracts 

In the first transitional phase, proposed CFTC Rule 151.4 would apply spot-month 

position limits separately for physically-delivered contracts and all cash-settled contracts, including cash-settled futures and swaps. The Commission has proposed to 

set the limit for cash-settled contracts at the same level as the level for physicallysettled contracts, a level which is established as 25% of deliverable supply. While 

the Working Group notes that the establishment of identical spot-month limits for 

cash- and physically-settled contracts has been the practice in recent years, it respectfully submits that the practice is not grounded in a sound regulatory foundation. Cash-settled contracts have substantially different potential impacts on pricing. Although deliverable supply is an important component for establishing position 

limits, if any, for physically-delivered contracts, its importance is greatly diminished 

with respect to cash-settled contracts. The Working Group respectfully submits that 

the Commission reconsider this approach and establish a much higher, more appropriate spot-month limit, if any, on cash-settled contracts. 

ii. As Applied to Cash-Settled Referenced Contracts, the Proposed Rule Significantly 

Reduces a Trader’s Permitted Position 

The Working Group submits that such approach inappropriately cuts in half position limits on cash-settled referenced contracts. For example, a NYMEX Henry Hub 

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40Specifically, the conditional exemption for cash-settled contracts would apply if (i) such positions are exclusively in cash-settled contracts, and (ii) a trader holds physical commodity positions that are less than or equal to 25 percent of the estimated deliverable supply. With regard 

to the second condition, a trader may not hold or control (a) positions in cash-settled contracts 

in the spot month that exceed the level of any single month position limit, (b) any positions in 

the physical delivery referenced contract based on the same commodity that is in such contract’s 

spot month, and (c) cash or forward positions in the referenced contract’s spot month in an 

amount that is greater than one-quarter of the deliverable supply in the referenced contract’s 

underlying commodity. See proposed CFTC Rule 151.4(a)(2). 41The Commission should not be concerned about excluding uncleared contracts because as 

soon as they become large or material for limit purposes, the Commission can make them subject to mandatory clearing. 

Natural Gas (NG) physically-settled futures contract has a spot-month limit of 

1,000. As a result, NYMEX (NN) cash-settled futures and an ICE HH LD1 swap 

each have a spot-month limit of 1,000. By separating the spot-month limits into 

‘‘physically-delivered’’ and cash-settled,’’ and setting each spot-month limit at 1,000, 

a market participant is effectively forced to add its NN position to its HH LD1 position, and whereas it previously could have held 1,000 in each (2,000 in total), it can 

now only hold 1000 cash-settled contracts in total. Such a result will likely constrict 

liquidity in the NYMEX NN and ICE HH LD1 markets. This is contrary to two of 

the express policy goals of CEA Section 4a(a): (i) ensuring sufficient market liquidity, and (ii) ensuring that the price discovery function of the underlying market is 

not disrupted. 

Post Dodd-Frank position limits also will include swaps that previously were traded over-the-counter (‘‘OTC’’) and not subject to limits. As a result, the imposition 

of limits on cash-settled positions will be even more constraining, as positions previously excluded from a market participant’s position will now be required to be included, while the levels will be reduced in some circumstances. Thus, the Working 

Group respectfully requests that the Commission reconsider its spot-month position 

limits and modify them accordingly. 

iii. Conditional Exemption for Cash-Settled Contracts Should Permit Market Participants To Hold Physically-Settled Futures Contracts 

In order to promote liquidity and efficient price discovery, proposed CFTC Rule 

151.4(a)(2) provides for a conditional spot-month limit. A trader would be permitted 

to acquire positions that are five times the spot-month limit if such positions are 

exclusively in cash-settled contracts, and the trader holds physical commodity positions that are less than or equal to 25 percent of the estimated deliverable supply 

of a physical commodity.40 However, to qualify for the conditional exemption, market participants may not hold any physically-settled futures contracts. 

The Working Group believes the condition requiring market participants to hold 

no physically settling futures contract is contrary to the statutory goals of CEA Section 4a to promote transparency, protect price discovery, and ensure the efficiency 

of markets. To the extent a hedger wants to avail itself of the conditional spotmonth limit, it would be required to move out of physically settled futures, which 

would reduce liquidity and price discovery in the physically settled futures markets. 

The Working Group is concerned that the diminution in liquidity could negatively 

impact price convergence in the core physical delivery contract. 

Accordingly, to accommodate more appropriately the hedging needs of market participants, the Working Group suggests an approach wherein cash-settled position 

limits are set as a multiple of physically-settled position limits, and so long as a 

market participant is not in violation of any position limit, their physical positions 

should not be limited in any manner. 

3. The Commission Should Identify All Referenced Paired Contracts Subject to SpotMonth Position Limits 

Without clear guidance from the Commission, the broad and vague language defining referenced paired contracts could lead to subjective and inconsistent interpretations by market participants seeking to identify the universe of referenced paired 

contracts. As such, the Working Group requests that the Commission identify the 

universe of futures contracts, option contracts, swaps, or swaptions that constitute 

referenced paired contracts and provide market participants the opportunity to comment on any Commission determination. Because the Commission cannot identify 

uncleared contracts until they are executed, it should limit referenced paired contracts to only those that are cleared.41

Further, after the Commission’s initial identification, the Working Group suggests 

that, in its process for determining whether a swap must be cleared pursuant to the 

Act, the Commission should also determine whether such swap constitutes a refVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00159 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
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42The core referenced futures contracts in the energy sector that are subject to position visibility levels are: NYMEX Light Sweet Crude Oil (22,500 contract level); NYMEX NY Harbor 

Gasoline Blendstock (7,800 contract level); NYMEX Henry Hub Natural Gas (21,000 contract 

level); and NYMEX NY Harbor No. 2 Heating Oil (9,900 contract level). 43See proposed CFTC Rule 151.6. The Working Group notes that the visibility limits are 

below, and in some cases, significantly below, the all months combined and any month position 

limits. 44These statements must include: (i) the date the trader’s position initially reached or exceeded the visibility level; (ii) gross long and gross short positions on an all-months-combined basis; 

(iii) the contract month and the trader’s gross long and gross short positions in the relevant 

single month (if visibility levels are reached or exceeded in any single month); and (iv) if applicable, certification no positions subject to the additional reporting requirements set forth in the 

Proposed Rule are held. 45 17 CFR § 18.05. 46See infra Part III.J, discussing the Commission’s costs and benefit analysis. 

erenced paired contract. New CEA Section 4a(a)(7) provides the Commission with 

broad authority to exempt swaps from speculative position limits it establishes pursuant to Section 4a. If a swap is not required to be cleared pursuant to the mandatory clearing requirements of the Act, it should not be included for purposes of determining position limits. 

G. The Proposed Position Visibility Levels Will Impose a Disproportionate 

Burden on Hedgers 

Notwithstanding the absence of any mandate from the Act, the Commission proposes to establish position visibility levels for referenced contracts other than agricultural contracts,42 and establishes reporting requirements for all traders exceeding those levels in all months or in any single month, including the spot month.43

Traders with positions above visibility levels in these referenced contracts would be 

required to submit statements containing additional information about their cash 

market and derivatives activity, including data relating to substantially the same 

commodity (i.e., commodities that are different grades or formulations of the same 

basic commodity).44

These visibility and consequent reporting requirements are unnecessary given the 

transparency provisions that currently exist under the CEA and those being implemented under Title VII of the Act. For example, transparency is provided under: (i) 

the Large Trader Reporting System for futures markets; and (ii) reporting requirements adopted under Title VII applicable to large swap traders and registered entities, including derivative clearing organizations (‘‘DCO’’); and (iii) reporting requirements of uncleared OTC transactions to SDRs or the Commission itself. Further, to 

the extent that the Commission seeks specific information regarding the hedge exposures of a large market participant (or group of large market participants), it can 

exercise its special call authority set forth in Rule 18.05 of the Commission’s Regulations.45

Further, the Proposed Rule fails to address and analyze adequately the compliance costs of meeting such visibility requirements and articulate any material benefits accruing to swap or futures markets.46 The Working Group submits that, in contrast to speculators, compliance with the proposed visibility levels will result in a 

substantial and disproportionate burden on bona fide hedgers, as hedgers will be required to produce voluminous data. 

Therefore, in light of the transparency created by Title VII of the Act and the 

Commission’s ability to request data from market participants pursuant to its existing special call authority, the Working Group submits that the imposition of position 

visibility levels and periodic reporting requirements for hedge exposures is unwarranted. Such requirements will unnecessarily impose a substantial compliance burden for all markets participants and would not provide any benefit that justifies the 

costs. 

H. Transactions Between Affiliates Should Not Be Counted for Position 

Limit Compliance Purposes 

Inter-affiliate transactions that merely shift risk between one corporate affiliate 

and another (i.e., a book transfer) should not be counted for purposes of complying 

with position limits. Indeed, inter-affiliate swaps do not in any way enhance systemic risk, nor do they affect liquidity in swap markets. Specifically, inter-affiliate 

transactions do not add to concentration in the market and therefore cannot lead 

to an attempt by a market participant to corner the market through excessive speculation. Consequently, the Working Group submits that there is no benefit in including affiliate transactions in any position limit. 

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47Such safe harbor protection is required to permit certain market participants to communicate internally to determine how they must comply with the proposed aggregation requirements and ensure that they do not violate the Commission’s proposed rules or the rules and 

regulations of other federal regulators with jurisdiction over their operations. 

I. Aggregation of Positions 

The Working Group generally supports the proposed aggregation rules and 

disaggregation exemption as applied to ‘‘owned’’ non-financial entities. However, the 

Working Group respectfully requests clarification on the scope and application of the 

indicia of independent control. Specifically, the Commission should (i) clarify the 

type of showing a market participant must make to demonstrate independent control; (ii) provide reasonable flexibility for market participants to address specified 

indicia through alternative, yet functionally equivalent, measures; and (iii) confirm 

that the positions of a non-financial subsidiary or affiliate that meet the applicable 

independent management and trading requirements will not be aggregated with a 

parent financial entity. 

The Working Group submits that employees such as attorneys, accountants, and 

risk management personnel may be shared between two affiliate companies without 

violating the independence requirements under proposed CFTC Rule 151.7, so long 

as they do not actively and personally perform day-to-day trading activities and engage in day-to-day trading decisions. The Working Group further submits that risk 

management systems may also be shared between affiliated companies without violating the independence requirements under proposed CFTC Rule 151.7, so long as 

appropriate security mechanisms are in place to prevent each company from gaining 

access to information or data about its affiliated companies’ positions, trades, or 

trading strategies. 

Although the Working Group generally supports the proposed aggregation rules 

and disaggregation exception, it fails to understand certain aspects of proposed 

CFTC Rule 151.7(g). Specifically, subpart (g)(1)(ii) requires that, in any application 

for a hedging exemption, a market participant must provide an ‘‘independent assessment report’’ as described in proposed CFTC Rules ‘‘151.9(c)(1)(iii) and 151.9(f)(3).’’ 

The Working Group notes that these cross-references do not exist and believes this 

discrepancy is the result of a typographical error that should be corrected. Notwithstanding these errors, the Working Group requests that the Commission provide 

market participants flexibility in meeting the requirements of proposed CFTC Rule 

151.7(g). Specifically, the Working Group respectfully requests that the Commission 

permit market participants discretion in using internal or external personnel to 

make assessments relating to the independence of its owned non-financial entities. 

Finally, the Working Group recommends that the Commission treat the application for exemption from aggregation requirements for non-financial entities required 

by proposed CFTC Rule 151.7(g) as a self-certification requirement that is effective 

immediately upon filing. In addition, the Commission should provide a safe harbor 

for market participants that submit such applications in good faith to promptly correct inadvertent errors or make adjustments in an orderly manner to comply with 

newly implemented regulatory requirements under Title VII of the Act.47

J. Meaningful Comment on the Anticipated Costs and Benefits of the Proposed Rule Is Not Possible at This Time 

The Working Group respectfully submits that it cannot meaningfully respond to 

the costs unless a comprehensive and complete view of all Dodd-Frank rulemakings 

are known. In particular, the Commission has not yet issued a proposed or final rule 

further defining the term ‘‘swap,’’ as set forth in new CEA Section 1a(47)(A). As 

such, the Working Group and other market participants are unable to ascertain the 

universe of transactions that may be subject to Commission oversight as ‘‘swaps’’ 

and, thus, subject to the requirements of the Proposed Rule. This guidance is critical 

to the efforts of affected market participants to identify and understand the scope 

and impact of the Proposed Rule and effectively comply with it. 

The reporting requirements proposed by the Commission as discussed above are 

commercially impractical and if implemented would create substantial and perhaps 

irreparable costs to the market and market participants. Further, it is difficult, if 

not impractical, to meaningfully analyze the costs to traders applying for, and reporting pursuant to, the bona fide hedge exemption because it is unclear how the 

reporting obligations would fit at this time with the many other reporting requirements proposed by the Commission for market participants. Therefore, the Working 

Group respectfully reserves the right to comment at a later date on the costs from 

the Proposed Rule, when those costs can be better understood and quantified. However, the Working Group offers analysis on several issues regarding the Commission’s discussion of costs in the Proposed Rule.

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48The Commission does not provide a breakdown between annualized capital and start up 

costs and annual total operating and maintenance costs in the discussion of costs in the Paperwork Reduction Act analysis. Therefore it is not possible to ascertain the operating and maintenance costs noted in the Proposed Rule, and discussed herein, which the impacted market participants can expect to bear on an annual basis. 49For a complete discussion regarding the Working Group’s cost estimates of the CFTC’s proposed rules, see the Comments of the Working Group submitted in response to the CFTC’s proposed rule regarding the duties of swap dealers and MSPs, filed on January 24, 2011. Regulations Establishing and Governing the Duties of Swap Dealers and Major Swap Participants, 75 

FED. REG. 71,397 (Nov. 23, 2010). 

The Proposed Rule’s analysis of requirements under the Paperwork Reduction Act 

address three main areas of costs that commercial firms can anticipate: (i) bona fide

hedge related reporting requirements, (ii) record-keeping requirements for traders 

applying for bona fide hedge exemptions, and (iii) costs arising from the visibility 

level reporting obligations. The Proposed Rule states that the costs related to the 

reporting of bona fide hedges are anticipated to be $37.6 million in the aggregate. This equates to $188,000 per market participant. The record-keeping requirements 

for traders applying for bona fide hedge exemptions are anticipated to be an addi- tional $10.4 million in the aggregate for annualized start up and capital costs and 

annual operating costs, which equates to $65,000 per market participant.48 In addition, the Proposed Rule estimates that the costs to implement the position visibility levels is approximately $29.7 million in the aggregate, which equates to $212,000 

per market participant. The costs associated with those market participants that exceed the visibility levels and need to seek a bona fide hedge exemption are esti- mated to be approximately $465,000 per market participant. 

The costs set forth in the Paperwork Reduction Act analysis are not considered 

in the cost-benefit analysis set forth in the Proposed Rule. The costs outlined in the 

Paperwork Reduction Act section, along with the additional costs imposed by the 

Proposed Rule on bona fide hedgers, should be subject to a thorough cost-benefit 

analysis of any final rule issued in this proceeding. For example, should the Commission exercise its discretion and adopt the pass-through provision, additional costs 

not considered by the Proposed Rule are the costs associated with monitoring compliance with the pass-through provision set forth in proposed CFTC Rule 

151.5(a)(1)(iv) that will be imposed on entities relying on the bona fide hedge exemption. 

The Proposed Rule does not offer any empirical evidence as to the criteria for selecting, or process for identifying, the universe of market participants likely to be 

impacted by this rulemaking. For example, the Commission anticipates that on an 

annual basis, 140 market participants would be subject to the visibility level reporting obligations, and 200 would be subject to the reporting requirements applicable 

to bona fide hedging transactions. Given that visibility limits are to be set at a substantially lower level than the proposed position limits, the Working Group respectfully submits that it would be reasonable to assume that the number of entities impacted by the visibility limits would be greater than those which would need to seek 

a bona fide hedge exemption. However, the Proposed Rule espouses an opposite 

view. 

Further, the cost estimates for wage and salary have been estimated from the Securities Industry and Financial Markets Association (‘‘SIFMA’’) information. Internal data collected and analyzed by members of the Working Group suggest that the 

average cost per hour is approximately $120, much higher than SIFMA’s $78.61, as 

relied upon by the Commission.49 In addition, many commercial firms, including 

members of the Working Group, are not staffed with the expertise to build the systems that will be required to comply with the various reporting provisions of the 

Proposed Rule. The Working Group anticipates that its members will be utilizing 

the expertise of consultants to create and implement the information technology systems required by the Proposed Rule. Firms will be seeking these services at a time 

when consultants are in high demand and even before the implementation of DoddFrank requirements are at capacity. Thus, the cost estimates offered in the Proposed Rule regarding anticipated wage and salary impacts may be significantly 

below the costs of consultants. 

IV. Open Comment Period 

Given the complexity and interconnectedness of all of the rulemakings under Title 

VII of the Act, and given that the Act and the rules promulgated thereunder entirely restructure OTC derivatives markets, the Working Group respectfully requests that the Commission hold open the comment period on all rules promulgated 

under Title VII of the Act until such time as each and every rule required to be 

promulgated has been proposed. Market participants will be able to consider the enVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00162 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
159

tire new market structure and the interconnection between all proposed rules when 

drafting comments on proposed rules. The resulting comprehensive comments will 

allow the Commission to better understand how its proposed rules will impact swap 

markets. 

V. Conclusion 

The Working Group supports appropriate regulation that brings transparency and 

stability to the energy swap markets in the United States. The Working Group appreciates this opportunity to comment and respectfully requests that the Commission consider the comments set forth herein as it develops a final rule in this proceeding. 

The Working Group expressly reserves the right to supplement these comments 

as deemed necessary and appropriate. 

If you have any questions, please contact the undersigned. 

Respectfully submitted,

R. MICHAEL SWEENEY, JR.; 

MARK W. MENEZES; 

DAVID T. MCINDOE; 

Counsel for the Working Group of Commercial Energy Firms. 

SUBMITTED QUESTIONS

Response from Hon. Gary Gensler, Chairman, Commodity Futures Trading 

Commission 

Questions Submitted by Hon. Collin C. Peterson, a Representative in Congress from 

Minnesota 

Question 1. Your testimony suggests that regulations may be applied to some 

asset classes before others. Which asset classes do you think would see regulation 

first, and what qualities about these asset classes make them ripe for regulation as 

opposed to others? 

Answer. The Commission proposed a rule to establish a process for the review and 

designation of swaps for mandatory clearing. One of the primary goals of the DoddFrank Act was to lower risk by requiring standardized swaps to be centrally cleared. 

The process set out in the proposed rule is consistent with the Congressional requirement that derivatives clearing organizations (DCOs) be eligible to clear the 

swaps and that before a swap becomes subject to mandatory clearing, the public 

gets to provide input on the contract or class of contracts. The proposed rule would 

provide a process to implement the Dodd-Frank Act requirement that a DCO that 

plans to accept a swap (or group, category, type, or class of swaps) for clearing to 

submit the swap to the Commission for review. The proposed rule also includes a 

process to implement the Dodd-Frank requirement for Commission-initiated review 

of swaps, including by class. The Commission sought public comment on all aspects 

of the review process. In addition, DCO submissions and Commission-initiated reviews would be subject to public comment under the proposed rule’s processes.

Question 2. There have been a number of concerns raised about the Commission’s 

proposed definition of swap execution facility (SEF) and its requirement that participants must request price quotes from multiple participants. In contrasts the SEC 

and European regulators appear to be willing to allow one-to-one price quotations, 

similar to what occurs in over-the-counter markets today.

(a) Explain the reasoning behind the Commission proposal. How will the multiple bid requirement benefit market participants?

(b) Given that the legislative language for SEFs and security-based SEFs are 

virtually identical, is it possible for both the CFTC’s and the SEC’s very different proposals to be in compliance with the law? If so, what is a rationale for 

living with the differences?

(c) Assuming the Commission and the EU continue down their separate paths 

on this issue, what is to prevent business from moving overseas to what may 

be viewed as a more favorable trading venue?

Answer. The CFTC’s proposed SEF rule will provide all market participants with 

the ability to execute or trade with other market participants. It will afford market 

participants with the ability to make firm bids or offers to all other market participants. It also will allow them to make indications of interest—or what is often referred to as ‘‘indicative quotes’’—to other participants. Furthermore, it will allow 

participants to request quotes from other market participants. These methods will 

160

provide hedgers, investors and Main Street businesses both the flexibility to execute 

and trade by a number of methods, but also the benefits of transparency and more 

market competition. The proposed rule’s approach is designed to implement Congress’ mandates for transparency and competition where multiple market participants can communicate with one another and gain the benefit of a competitive and 

transparent price discovery process. 

The proposal also allows participants to issue requests for quotes, whereby they 

would reach out to a minimum number of other market participants for quotes. It 

also allows that, for block transactions, swap transactions involving non-financial 

end-users, swaps that are not ‘‘made available for trading’’ and bilateral transactions, market participants can get the benefits of the swap execution facilities’ 

greater transparency or, if they wish, would still be allowed to execute by voice or 

other means of trading. 

In the futures world, the law and historical precedent is that all transactions are 

conducted on exchanges, yet in the swaps world many contracts are transacted bilaterally. While the CFTC will continue to coordinate with the Securities and Exchange Commission (SEC) to harmonize approaches, the CFTC also will consider 

matters associated with regulatory arbitrage between futures and swaps. The Commission has received public comments on its SEF rule and will move forward to consider a final rule only after staff has had the opportunity to summarize them for 

consideration and after Commissioners are able to discuss them and provide feedback to staff. 

As the Commission works to implement the derivatives reforms in the DoddFrank Act—with regard to execution requirements as well as all other areas—we 

are actively coordinating with international regulators to promote robust and consistent standards and avoid conflicting requirements in swaps oversight. The Commission participates in numerous international working groups regarding swaps, including the International Organization of Securities Commissions Task Force on 

OTC Derivatives, which the CFTC co-chairs with the SEC. The CFTC, SEC, European Commission and European Securities Market Authority are coordinating 

through a technical working group.

Question 3. Most estimates place the world’s 25 largest banks as a party to more 

than 90% of the world’s swaps. When you testified here last, you suggested that 200 

entities would likely register as swap dealers and that most of them would be affiliates of the large banks, who are being required to spin off parts of their swap business under other provisions of Dodd-Frank. Assuming the CFTC’s proposed definition of swap dealer remains, of these 200 entities, how many do you believe will 

not be affiliates of these 25 large banks and who generally would make up these 

non-affiliated swap dealers? 

Answer. In the first week of December 2010, the CFTC and the SEC jointly issued 

a proposed rulemaking to further define the term ‘‘swap dealer.’’ To date, there are 

more than 200 comments responding to the proposal. Many of the commenters addressed why the definition of swap dealer should or should not encompass particular 

types of companies. The particular characteristics and activities that would require 

a company to register as a swap dealer will be addressed in the final rule, after taking the comments into account.

Question 4. In his testimony for the next panel, Mr. McMahon with Edison Electric Institute appears to not want regulators to impose capital or margin requirements on swaps entered into strictly between swap dealers and major swap participants because of potential costs. Given that you think the risks involved with swaps 

between end-users and financial players do not merit margin requirements, what 

are your thoughts about Mr. McMahon’s idea to do the same for dealer to dealer 

swaps? 

Answer. In passing the Dodd-Frank Act, Congress recognized the different levels 

of risk posed by transactions between financial entities and those that involve nonfinancial entities, as reflected in the non-financial end-user exception to clearing. 

The CFTC also has recognized this, for example, in its proposed rule regarding margin requirements for swap dealers and major swap participants. For any transaction 

involving a non-financial end-user engaged in hedging or mitigating commercial 

risk, neither party is required to post margin. 

In the joint rulemaking to further define the term ‘‘swap dealer,’’ the SEC and 

the CFTC proposed factors for the de minimis exemption based on the aggregate 

effective notional amount of an entity’s trades, its level of trading activity with special entities, the number of counterparties it transacts with and the number of 

swaps it trades. 

161

Before the Commission proceeds to final rules, Commission staff will read and 

summarize all submitted public comments, and Commissioners will have the opportunity to review comments and provide feedback.

Question 4a. In his testimony for the next panel, Mr. McMahon with Edison Electric Institute worries that his members’ ‘‘accommodating’’ the demand of third parties for swaps are being viewed by the CFTC as dealing activity and such activity 

could get his members listed as swap dealers.

(a) Have you heard about this ‘‘accommodating’’ swap activity that his members 

have engaged in and what do you see are the similarities and differences between it and a dealer’s swap activity?

(b) Although it would not qualify now under the proposed rules, isn’t such ‘‘accommodating’’ swap activity a likely reason why Congress included a de minimis exception to the definition of swap dealer?

(c) Assuming this activity does classify one of his members as a swap dealer:

(i) Would the full scope of regulation under the proposed rules apply to all 

his swap activity or just this ‘‘accommodating’’ activity?

(ii) If his counterparties to these ‘‘accommodating’’ swaps were end-users, 

wouldn’t such swaps still be eligible for the clearing exception and an exception from margin, as you envision it?

Answer. The CFTC and SEC jointly issued a proposed rule to further define the 

terms ‘‘swap dealer,’’ ‘‘securities-based swap dealer,’’ ‘‘major swap participant’’ and 

‘‘major securities-based swap participant.’’ The Commissions specifically sought public comment regarding the appropriate clarifications to the detailed definition included in the statute. While the de minimis exemption may apply in particular relevant circumstances, the Commissions sought specific comment with regard to additional factors to be considered where the de minimis exemption level may be exceeded. The Commission has received substantial public comment in response. Staff will 

analyze, summarize and consider public comments before the Commission proceeds 

further. 

Question Submitted by Hon. Randy Hultgren, a Representative in Congress from Illinois 

Question. As you know, the Committee has expressed concerns that the Commission is not conducting adequate cost-benefit analysis, and as a result does not know 

the impact the wave of proposed regulations will have on the economy and our markets. For example, you’ve received public comments that calculations of the costs of 

proposed rules by stakeholders have far surpassed those calculated by the Commission—by as much as 20 times, 63 times and even 4,000 times.

• As you hit the ‘‘natural pause’’ in rulemaking and review the ‘‘whole mosaic of 

rules and how they interrelate,’’ do you intend to review the costs and benefits 

of the rules when applied comprehensively?

• If no—Don’t you think that’s the critical component to understanding whether 

the rules will have a negative impact on the economy and jobs?

• If yes—Do you intend to improve the cost-benefit analysis that you’re conducting so that your estimates are not 4,000 times below those calculated by 

stakeholders?

Answer. The CFTC has endeavored to include well-developed considerations of 

costs and benefits in each of its proposed rulemakings. Relevant considerations are 

presented not only in the cost-benefit analysis section of the CFTC’s rulemaking releases, but additionally are discussed throughout the release in compliance with the 

Administrative Procedure Act, which requires the CFTC to set forth the legal, factual and policy bases for its rulemakings. 

In addition, Commissioners and staff have met extensively with market participants and other interested members of the public to hear, consider and address 

their concerns in each rulemaking. CFTC staff hosted a number of public 

roundtables so that rules could be proposed in line with industry practices and address compliance costs consistent with the CFTC’s obligations to promote market integrity, reduce risk and increase transparency as directed in Title VII of the DoddFrank Act. Information from each of these meetings—including full transcripts of 

the roundtables—is available on the CFTC’s website and has been factored into each 

applicable rulemaking. 

With each proposed rule, the Commission has sought public comment regarding 

costs and benefits. 

162

With the substantial completion of the proposal phase of rule-writing, the public 

in recent weeks has had the opportunity to review the whole mosaic of proposed 

rules. To facilitate this review, the CFTC reopened or extended comment periods for 

most of our proposed rules for an additional 30 days—allowing the public to submit 

any comments they may have after seeing the entire mosaic at once, including comments about potential compliance costs as well as phasing of implementation dates 

to help the agency as we go forward with finalizing rules. In addition, in May CFTC 

and SEC staff held a 2 day roundtable to hear from the public on implementation 

dates for final rules. The Commission also offered a 60 day public comment file to 

hear specifically on this issue. This comment period allowed for presentation of information regarding the costs and benefits of the rules on a comprehensive basis. 

Final rules will be developed only after staff can analyze, summarize and consider 

comments; after the Commissioners are able to discuss the comments and provide 

feedback to staff; and after we consult with fellow regulators on the rules. 

Question Submitted by Hon. Christopher P. Gibson, a Representative in Congress 

from New York 

Question. At a time when our economy is struggling to recover, I remain particularly concerned with our international competiveness. Technology and expertise 

have allowed the futures industry to spread throughout the globe. I understand the 

CFTC has been working closely with the European Commission, the European Central Bank, new European Securities and Markets Authority and other regulators 

overseas. I appreciate those efforts, and I hope the close consultations will continue. 

In a speech you delivered last month, you discussed the importance of ‘‘harmonizing 

oversight’’ of the swaps market. My question gets back to process and the speed at 

which the CFTC is moving, as well as the lack of clarity and definitions. Given the 

pace of the proposed rules, do you believe the CFTC is in danger of moving ahead 

of the EU and others? How is it possible to ‘‘harmonize oversight’’ if our rule making 

preempts theirs? 

Answer. Regulators across the globe continue to work together towards achieving 

common goals including the G20 agreement of September 2009 that: all standardized OTC derivative contracts should be traded on exchanges or electronic trading 

platforms, where appropriate, and cleared through central counterparties by the end 

of2012 at the latest. OTC derivative contracts should be reported to trade repositories. And non-centrally cleared contracts should be subject to higher capital requirements. 

Japan is now working to implement its reforms. In September of last year, the 

European Commission (E.C.) released its swaps proposal. The European Council and 

the European Parliament are now considering the proposal. Asian nations, as well 

as Canada, also are working on their reform packages. 

As we work to implement the derivatives reforms in the Dodd-Frank Act, we are 

actively coordinating with international regulators to promote robust and consistent 

standards and avoid conflicting requirements in swaps oversight. The Commission 

participates in numerous international working groups regarding swaps, including 

the International Organization of Securities Commissions Task Force on OTC Derivatives, which the CFTC co-chairs with the Securities and Exchange Commission 

(SEC). The CFTC, SEC, European Commission and European Securities Market Authority are intensifying discussions through a technical working group. 

As we do with domestic regulators, we are sharing many of our memos, term 

sheets and draft work product with international regulators. We have been consulting directly and sharing documentation with the European Commission, the European Central Bank, the UK Financial Services Authority, the new European Securities and Markets Authority, the Japanese Financial Services authority and regulators in Canada, France, Germany and Switzerland. 

The Dodd-Frank Act recognizes that the swaps market is global and interconnected. It gives the CFTC the flexibility to recognize foreign regulatory frameworks that are comprehensive and comparable to U.S. oversight of the swaps markets in certain areas. In addition, we have a long history of recognition regarding 

foreign participants that are comparably regulated by a home country regulator. 

The CFTC enters into arrangements with our international counterparts for access 

to information and cooperative oversight. We have signed Memoranda of Understanding with regulators in Europe, North America and Asia. 

Questions Submitted by Hon. William L. Owens, a Representative in Congress from 

New York 

Question 1. Will the Commission fully exempt end-users, including utilities, to 

hedge their commercial risks without having to clear those swaps and without the 

parties having to post margin? 

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Answer. In passing the Dodd-Frank Act, Congress recognized the different levels 

of risk posed by transactions between financial entities and those that involve nonfinancial entities, as reflected in the non-financial end-user exception to clearing. 

The CFTC has recognized this in its proposed rule regarding margin requirements 

for swap dealers and major swap participants. For any transaction involving a nonfinancial end-user engaged in hedging or mitigating commercial risk, neither party 

is required to post margin. 

Before the Commission proceeds to final rules, Commission staff will read and 

summarize all submitted public comments, and Commissioners will have the opportunity to review comments and provide feedback.

Question 2. The business conduct rules established for governmental entities could 

potentially affect the access to and cost of swaps for public power utilities. What 

is the Commission doing in its rulemaking to ensure that governmental entities, like 

public power systems, continue to have access to swaps without the imposition of 

new burdensome and costly requirements? 

Answer. The Commission’s proposed business conduct standards rules track the 

statutory directive under the provisions of the Dodd-Frank Act that create a higher 

standard of care for swap dealers dealing with Special Entities, which include governmental entities. The proposed rules were designed to enable swap dealers to 

comply with their new duties in an efficient and effective manner. The Commission 

is reviewing the comments it has received on the proposed rules to ensure that the 

final rules achieve the statutory purpose without imposing undue costs on market 

participants. The proposed rulemaking release specifically asked that the public provide comment regarding associated costs and benefits.

Question 3. As you note in your testimony, the CFTC has yet to issue any guidance on what constitutes a ‘‘swap’’, and has yet to issue final rules on who’s a ‘‘swap 

dealer’’, or a ‘‘major swap participant.’’ How has this process impacted the SEC–

CFTC Working Group’s ability to participate in the rulemaking process, and, perhaps more importantly, how has it impacted the ability of members of the Working 

Group to evaluate how the CFTC’s proposed regulatory regime will impact business 

operations? 

Answer. The joint CFTC–SEC proposed rule to further define the terms ‘‘swap,’’ 

‘‘security-based swap,’’ ‘‘mixed swap’’ and ‘‘security-based swap agreement’’ was published in the Federal Register on May 23, 2011.

Question 4. As you know, the CFTC is mandated under Dodd-Frank to have final 

rules issued by mid-July 2011. Can you provide a timeline on an appropriate strategy or timeline by which the CFTC should make effective its final rules in a manner 

that will provide entities, such as those in the SEC–CFTC’s Working Group, adequate time for compliance? If applicable, please describe any potential implementation phase-ins, delaying of effective dates, or order by which certain final rules 

should be issued or become effective. 

Answer. In enacting title VII of the Dodd-Frank Act, Congress gave the CFTC 

latitude with respect to the effective dates of particular requirements. In May, the 

Commission re-opened many of its comment periods that had closed and extended 

some existing comment periods so that the public could comment in the context of 

the entire mosaic of proposed rules. This opportunity was available with respect to 

all relevant proposed rules, giving the public and market participants the opportunity to comment on compliance costs and to make recommendations regarding the 

schedule of implementation. That extended comment period closed on June 3, 2011. 

In addition, on May 2 and 3, CFTC and SEC staff held roundtable sessions to obtain 

public input on implementation dates of the various rulemakings. Prior to the 

roundtable, on April 29, CFTC staff released a document that set forth concepts that 

the Commission may consider with regard to the effective dates of final rules for 

swaps under the Dodd-Frank Act. We also offered a 60 day public comment file to 

hear specifically on this issue. The roundtable and resulting public comment letters 

will help inform the Commission as to what requirements can be met sooner and 

which ones will take a bit more time.

Question 5. If subject to the regulatory requirements associated with being a swap 

dealer or major swap participant, you’ve testified that energy firms would face significant compliance costs. Could you briefly describe for this Committee how regulation as a swap dealer or major swap participant would impact additional compliance 

costs on energy companies? 

Answer. The Dodd-Frank Act requires that swap dealers comply with rules establishing capital requirements, margin requirements, and business conduct standards. 

For non-bank swap dealers, the CFTC is responsible for issuing regulations establishing those requirements. The Commission has endeavored to include well-developed considerations of costs and benefits in each of its proposed rulemakings. RelVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00167 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
164

evant considerations are presented not only in the cost-benefit analysis section of 

the CFTC’s rulemaking releases, but additionally are discussed throughout the release in compliance with the Administrative Procedure Act, which requires the 

CFTC to set forth the legal, factual and policy bases for its rulemakings. 

In addition, Commissioners and staff have met extensively with market participants and other interested members of the public to hear, consider and address 

their concerns in each rulemaking. CFTC staff hosted a number of public 

roundtables so that rules could be proposed in line with industry practices and address compliance costs consistent with CFTC obligations to promote market integrity, reduce risk and increase transparency as directed in Title VII of the DoddFrank Act. Information from each of these meetings—including full transcripts of 

the roundtables—is available on the CFTC’s website and has been factored into each 

applicable rulemaking. 

With each proposed rule, the Commission has sought public comment regarding 

costs and benefits.

Question 6. You mentioned in your testimony that the CFTC is reviewing the de 

minimis exception for swap dealers. What do you believe would be an appropriate 

de minimis exception? 

Answer. In the joint rulemaking to further define the term ‘‘swap dealer,’’ the SEC 

and the CFTC proposed factors for the de minimis exemption based on the aggregate effective notional amount of an entity’s trades, its level of trading activity with 

special entities, the number of counterparties it transacts with and the number of 

swaps it trades. Specifically, to qualify for the de minimis exemption under the proposed rule, the entity’s total notional swap activity must not exceed $100 million 

in a 12 month period, the notional amount of transactions with special entities must 

not exceed $25 million, it must not enter into swaps with more than 15 

counterparties, and must not enter into more than 20 swaps as a dealer in a 12 

month period. The Commissions specifically requested that the public provide comments regarding the proposal with respect to the de minimis exemption.

Question 7. Congress directed the CFTC to ‘‘consider whether to exempt small 

banks, savings institutions, farm credit system institutions, and credit unions.’’ Will 

the Commission clarify in its final rules that farm credit system institutions, credit 

unions and small banks with under $10 billion in assets will qualify for the enduser clearing exemption? 

Answer. The Dodd-Frank Act specifically provides for an exception from the clearing requirement for non-financial end-users hedging or mitigating commercial risk. 

It also requires the CFTC to consider whether to exempt farm credit system institutions, depository institutions and credit unions with total assets of $10 billion or less 

from the clearing mandate. The CFTC issued a proposed rulemaking with respect 

to the end-user exception from the clearing requirement that also requested comment regarding such small financial institutions. The Commission has received substantial public comment in response. Staff will analyze, summarize and consider 

public comments before the Commission proceeds further. 

Response from James M. Field, Senior Vice President and Chief Financial 

Officer, Deere & Company 

Question Submitted by Hon. Randy Hultgren, a Representative in Congress from Illinois 

Question. I’m concerned about the impact of Title VII on pension plans. Can you 

tell me if Deere’s pension plan engages in swaps? What would be the impact for 

Deere retirees if the plan were no longer able to engage in swaps or if they became 

prohibitively expensive? 

Answer. The John Deere Pension Trust maintains trading positions in derivative 

contracts to implement asset allocation, investment strategies, and for risk management. Interest rate swaps are used for asset/liability surplus risk management. Currency spots and forwards are used to mitigate foreign exchange risk for investments 

held in currencies other than the U.S. dollar. Commodity total return swaps are 

used as a liquid alternative for implementing commodity exposures. If the pension 

trust was no longer able to engage in swaps, or swaps became prohibitively expensive due to Title VII or other regulations, the plans would incur higher transactions 

costs and experience higher volatility and surplus risk. This is clearly not in the 

best interest of plan beneficiaries nor the corporate plan sponsor, and ultimately 

could impact the level of benefits provided to plan participants, including the possibility of freezing, closing or termination of the plans. 

165

1Pub. L. No. 111–203, 124 Stat. 1376 (2010). 

2See End-User Exception to Mandatory Clearing of Swaps, 75 Fed. Reg. 80747 (proposed Dec. 

23, 2010) (to be codified at 17 CFR pt. 39); Further Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based 

Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Participant’’ and ‘‘Eligible 

Contract Participant,’’ 75 Fed. Reg. 80174 (proposed Dec. 21, 2010) (to be codified at 17 CFR 

pts. 1 & 240). 3See Reopening and Extension of Comment Periods for Rulemakings Implementing the DoddFrank Wall Street Reform and Consumer Protection Act, 76 Fed. Reg. 25274 (May 4, 2011). 4 12 U.S.C. § 2001(a). 

Response from Ann E. Trakimas, Chief Operating Officer, CoBank, Greenwood Village, CO; on behalf of Farm Credit Council 

Question Submitted by Hon. Christopher P. Gibson, a Representative in Congress 

from New York 

Question. I remain extremely concerned about potential effects on my family 

farms and coops in my district. Falling under the definition of a swap dealer could 

significantly harm the ability of my farmers, who already face financial challenges, 

to hedge risk. On a related note, I am troubled over the testimony on Farm Credit 

Institutions. In your written testimony you address the potential for the CFTC to 

take a narrow approach to the $10 billion asset limit. What might an overly narrow 

interpretation of the asset limit mean for the Farm Credit System? Additionally, 

what could collateral and mandatory clearing mean to farm credit in my district? 

Answer. Attached is a copy of the comment letter we submitted June 3 to the 

CFTC regarding the costs associated with both mandatory clearing and swap dealer 

regulation. Also attached is an earlier comment letter (Feb 22, 2011) we submitted 

to the CFTC regarding the ‘‘swap dealer’’ definition and ‘‘end-user’’ exception. 

As you will note it is difficult to precisely estimate the costs of collateral and mandatory clearing, both in general as well as with respect to your Congressional District. We do note that the as a cooperative system, the costs of compliance become 

part of the operating rate that borrowers are ultimately responsible to bear. All 

farmers, ranchers and their cooperatives in your district would share proportionately in those costs. 

We hope this additional information is responsive to your inquiry. If we can provide further assistance, please let us know. 

ATTACHMENT 1

June 3, 2011

By Electronic Submission

Mr. David A. Stawick, 

Secretary, 

Commission Commodity Futures Trading Commission, 

Washington, D.C.

Re: Entity Definitions (RIN 3038–AD06, RIN 3235–AK65) End-User Clearing Exception (RIN 3038–AD10)

Dear Mr. Stawick:

The Farm Credit Council, on behalf of its members, submits further comments on 

rules issued by the Commodity Futures Trading Commission (the ‘‘Commission’’) to 

implement the Dodd-Frank Wall Street Reform and Consumer Protection Act 

(‘‘Dodd-Frank’’).1 As you know, on February 22, 2011, we submitted comments on 

the notices of proposed rulemaking concerning both the further definition of ‘‘swap 

dealer’’ and the end-user clearing exception.2 We appreciate the opportunity to supplement these comments in light of the comprehensive regulatory framework that 

the Commission has now proposed.3

The Farm Credit Council is the national trade association for the Farm Credit 

System, a government instrumentality created ‘‘to accomplish the objective of improving the income and well-being of American farmers and ranchers by furnishing 

sound, adequate, and constructive credit and closely related services to them, their 

cooperatives, and to selected farm-related businesses necessary for efficient farm operations.’’ 4 Today, the Farm Credit System comprises five banks and 87 associations, which together provide 40% of agricultural lending in the United States. To 

provide tailored financing products for farmers and farm-related businesses, Farm 

Credit System institutions rely on the safe use of derivatives to manage interest 

rate, liquidity, and balance sheet risk, primarily in the form of interest rate swaps. 

These non-speculative swaps are backed by collateral. Specifically, as of March 

31, 2011, the Farm Credit System’s total derivatives exposure, net of collatVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00169 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
166

eral ($204 million), represented approximately 11 to 12 basis points of the 

System’s total loan volume ($177.5 billion). Respectfully, we would advocate 

that such a limited FCS exposure does not rise to current concerns related 

to systemic risk and/or interconnectivity.

As we have previously explained, Congress intended Farm Credit System institutions to qualify for the end-user exception to mandatory clearing. In this regard, we 

urged the Commission to clarify that it will consider (1) the average assets of that 

bank’s affiliated lending organizations, and (2) risk-based factors to determine 

whether a financial institution’s derivatives activity should be subject to mandatory 

clearing. Further, we have explained that no Farm Credit System institution should 

be regulated as a swap dealer. In this regard, we have urged the Commission to 

clarify that, like the commercial banks with which they compete, Farm Credit System institutions will be exempt from swap dealer regulation for swaps entered into 

in connection with originating customer loans. 

Mandatory clearing or swap dealer regulation would raise the costs of risk management for Farm Credit System institutions and their borrowers. These new costs 

would reduce liquidity, discourage effective risk management, and frustrate the 

Farm Credit System’s congressionally endorsed mission of providing financing to 

rural America. Having had more time to evaluate the consequences of these proposed regulations, the Farm Credit Council can now provide a clearer estimate of 

the costs that would result from mandatory clearing or swap dealer regulation. Although proposed requirements for margin on uncleared swaps will impose still additional costs on Farm Credit System institutions, the Farm Credit Council will address those proposed rules in separate comment letters. 

I. Costs of Mandatory Clearing 

We estimate that, conservatively, mandatory clearing would impose new 

costs on Farm Credit System institutions ranging from $6 million to $27.2 

million, per year. This estimate depends on the direction and volatility of interest 

rates, which in some scenarios, may require Farm Credit System institutions to post 

additional margin and thereby incur costs exceeding even the high end of our estimate. For example, our estimate would have to be raised if exchanges were to increase initial margin requirements in response to changes in interest rates. 

Our estimate represents the incremental costs that would result from moving the 

Farm Credit System’s current bilateral interest rate swaps to major clearinghouses. 

First, we estimate that clearing would impose millions of dollars annually in transaction and operational costs. Specifically, Farm Credit System institutions would 

have to pay new fees to clearinghouses, futures commission merchants, and swap 

execution facilities. Additionally, Farm Credit System institutions would have to 

incur the cost of developing new systems to process cleared trades. 

More significantly, Farm Credit System institutions would incur financing costs 

associated with posting initial and variation margin at clearinghouses. These financing costs are more difficult to predict because they depend on both the value of the 

Farm Credit System’s swap positions, which may trigger variation margin requirements, and the level of interest rates, which will govern the cost of meeting margin 

calls. In fact, the negative carry associated with financing margin calls could easily 

exceed the assumptions we used to arrive at our estimates, pushing the annual cost 

of mandatory clearing above $27 million. 

Finally, in addition to the up to $27 million in new annual costs discussed above, 

mandatory clearing will require Farm Credit System institutions to post funds as 

margin that they could otherwise lend to farmers and farm-related businesses. The 

largest two Farm Credit System banks estimate that they will likely have to post 

$250 million and $50 million in initial margin annually. In an adverse scenario, 

Farm Credit System institutions will have to post even larger amounts in variation 

margin. To be sure, the Farm Credit System currently posts—and collects—collateral from its bilateral swap counterparties, and Farm Credit System institutions 

carefully manage counterparty credit risk. To the extent that more margin is required at a clearinghouse, however, those funds will no longer be available for loans 

to farmers, ranchers, and farm-related businesses. 

Accordingly, we continue to believe that, especially given the costs it would impose, mandatory clearing is not warranted for the Farm Credit System, which poses 

little risk to the United States financial system. 

II. Costs of Swap Dealer Regulation 

The costs of swap dealer regulation are more difficult to quantify. Currently, one 

Farm Credit System bank, CoBank, provides swaps to its customers, most commonly in the form of interest rate swaps tied to the financial terms of the loans it 

issues. If CoBank did not qualify for the exception granted to insured depository inVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00170 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
167

5 Consistent with the Farm Credit Act’s ‘‘objective . . . to encourage farmer- and rancherborrowers[’] participation in the management, control, and ownership of a permanent system of 

credit for agriculture,’’ 12 U.S.C. § 2001(b), Farm Credit System banks are cooperatives primarily owned by their affiliated associations, and Farm Credit System associations are cooperatives owned by their borrowers. 

stitutions providing swaps in conjunction with loans to a customer or the de minimis exception to the swap dealer definition, compliance risks and new regulation 

would force CoBank to cease activity causing it to be a swap dealer. This would impose costs on both CoBank and its member associations.5

As we explained in our February 22 letter, CoBank manages the risk of customer 

default by requiring certain customers to enter into swaps that hedge fluctuations 

in interest rates. This way, if interest rates rise—thereby raising the cost of loan 

payments—the customer will be hedged. CoBank usually has between $2 to $3 billion in these risk-reducing customer transactions. Eliminating the ability to help 

customers hedge changes in interest rates would increase credit risk to CoBank on 

this portion of its loans. 

If CoBank ceased its customer derivatives activity, CoBank’s affiliated associations would also face additional costs. These associations use swaps provided by 

CoBank to position their equity over a medium-term timeframe to earn a consistent 

return on equity. A consistent return on equity is important because, unlike commercial banks, cooperative Farm Credit System associations return their profits to 

their borrower-members in the form of patronage distributions. The consistent return therefore allows the associations to pay a consistent level of patronage distributions to the farmers and ranchers that borrow from them. We estimate that losing 

the ability to invest their equity over a longer time horizon would cost CoBank’s affiliated associations an estimated $5 to $15 million in funds that are currently returned to borrower-members in patronage distributions. 

Accordingly, we continue to believe that no Farm Credit System institution warrants regulation as a swap dealer. To the contrary, the risk-reducing products that 

CoBank offers actually make the bank safer and provide benefits to the Farm Credit 

System’s member-borrowers. 

III. Conclusion 

For the reasons set forth above, the Farm Credit Council continues to urge the 

Commission to clarify both that Farm Credit System institutions will: (1) be eligible 

for the end-user clearing exemption, such as looking through each Farm Credit 

Bank to the average size of its affiliated associations, and (2) that Farm Credit System institutions will not be regulated as swap dealers to the extent they enter into 

swaps in connection with originating customer loans. Mandatory clearing or swap 

dealer regulation would raise costs—and increase risk—to the Farm Credit System 

and the farmers and ranchers that rely on it as a source of financing. Because Farm 

Credit System institutions are already safe and sound, and because they responsibly 

manage their derivatives exposure, we do not believe they pose systemic risk warranting these costly new regulations. 

The Farm Credit Council appreciates the opportunity to comment. If you have any 

questions or we can provide other information, please do not hesitate to contact us. 

As always, we would welcome the opportunity to work with the Commission in developing the final rule. 

Sincerely,

ROBBIE BOONE,

Vice President, Government Affairs,

Farm Credit Council.

CC:

Honorable GARY GENSLER, Chairman;

Honorable MICHAEL DUNN, Commissioner;

Honorable JILL E. SOMMERS, Commissioner;

Honorable BART CHILTON, Commissioner;

Honorable SCOTT D. O’MALIA, Commissioner.

ATTACHMENT 2

February 22, 2011

By Electronic Submission


11207002.eps
168

1 End-User Exception to Mandatory Clearing of Swaps, 75 Fed. Reg. 80747 (proposed Dec. 23, 

2010) (to be codified at 17 CFR pt. 39). Section 723 of Dodd-Frank, Pub. L. No. 111–203, 124 

Stat. 1376, 1675–82 (2010), amends Section 2 of the Commodity Exchange Act (‘‘CEA’’), 7 U.S.C. 

§ 2. 

2 12 U.S.C. § 2001(a). 

Mr. David A. Stawick, 

Secretary, 

Commission Commodity Futures Trading Commission, 

Washington, D.C.

Re: End-User Exception to Mandatory Clearing of Swaps (RIN 3038–AD10)

Dear Mr. Stawick:

The Farm Credit Council, on behalf of its members, submits these comments on 

the Notice of Proposed Rulemaking (‘‘NOPR’’) issued by the Commodity Futures 

Trading Commission (‘‘Commission’’) concerning the end-user exception to mandatory clearing under Section 723 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank’’).1

The Farm Credit Council is the national trade association for the Farm Credit 

System, a government instrumentality created ‘‘to accomplish the objective of improving the income and well-being of American farmers and ranchers by furnishing 

sound, adequate, and constructive credit and closely related services to them, their 

cooperatives, and to selected farm-related businesses necessary for efficient farm operations.’’ 2 Fulfilling this mission, the Farm Credit System’s five banks and 87 associations currently account for 40% of agricultural lending in the United States. To 

provide tailored financing products for farmers and farm-related businesses, Farm 

Credit System institutions rely on the safe use of derivatives to manage interest 

rate, liquidity, and balance sheet risk, primarily in the form of interest rate swaps. 

Because we believe Congress intended the end-user exception to preserve our ability 

to provide dependable financing to farmers, farm-related businesses, and rural 

America, the Farm Credit Councilappreciates the opportunity to comment. 

I. Summary of Comments 

The Farm Credit Council supports Dodd-Frank’s goal of making the derivatives 

market safer, and appreciates that mandatory clearing of swaps entered into by 

risky Wall Street institutions will provide important protections for the market. But 

clearing would also make the derivatives that the Farm Credit System safely and 

effectively uses to manage risk more expensive. These new costs would reduce liquidity, discourage effective risk management, frustrate the Farm Credit System’s 

congressionally endorsed mission, and diminish rural America’s access to credit. 

Congress did not intend, and the Commission should not endorse, such a result. Accordingly, the Commission should permit all Farm Credit System institutions to use 

the end-user clearing exception. 

Specifically, our comments address the following issues:

• Dodd-Frank does not limit eligibility for the end-user exception to institutions 

with total assets of $10 billion or less, and any such limit would be particularly 

inappropriate for the Farm Credit System.

• In order to preserve competition for agricultural lending, the Commission must 

‘‘look through’’ Farm Credit System banks to the smaller associations that own 

them and that benefit from the banks’ derivatives activity. Otherwise, Farm 

Credit System associations would have to bear the cost of mandatory clearing, 

while competing commercial banks would not.

• Because the Farm Credit Administration effectively regulates Farm Credit System institutions; because Farm Credit System institutions only enter into safe, 

non-speculative swaps backed by collateral; and because the Farm Credit System is not interconnected with other financial entities, the Farm Credit System’s derivatives activity does not warrant mandatory clearing.

• Alternatively, the Commission should adopt a risk-based approach to mandatory clearing, similar to the proposed definition of major swap participant, that 

would exempt small financial institutions whose current uncollateralized exposure and potential future exposure fall below certain thresholds. 

II. Dodd-Frank Does Not Impose an Asset Limit on Which Farm Credit System Institutions May Qualify for the End-User Clearing Exception 

Dodd-Frank requires the Commission to ‘‘consider whether to exempt . . . farm 

credit system institutions, . . . including . . . farm credit system institutions with 

169

3Pub. L. No. 111–203, § 723, 124 Stat. at 1680 (CEA § 2(h)(7)(C)(ii)). 4 156 Cong. Rec. H5246 (daily ed. June 30, 2009) (emphasis added). 5 156 Cong. Rec. S5921 (daily ed. July 15, 2010) (emphasis added). 6See Letter from Sens. Dodd and Lincoln to Reps. Frank and Peterson, in 156 Cong. Rec.

S6192 (daily ed. July 22, 2010). 7 156 Cong. Rec. H5246 (daily ed. June 30, 2009) (statement of Rep. Holden).

total assets of $10,000,000,000 or less.’’ 3 The Farm Credit Council urges the Commission to clarify that this language does not set an asset limit on which institutions the Commission may exempt from mandatory clearing. 

In fact, Congress gave the Commission broad authority to permit Farm Credit System institutions, including those with total assets of more than $10 billion, to 

use the end-user exception. The following colloquy between Representatives Holden 

and Peterson of the House Agriculture Committee makes this clear:

Mr. HOLDEN. . . . Mr. Speaker, I now would like to enter into a colloquy with 

the chairman of the Agriculture Committee. 

Mr. Chairman, the conference report includes compromise language that requires the Commodity Futures Trading Commission to consider exempting 

small banks, Farm Credit System institutions and credit unions from provisions 

requiring that all swaps be cleared. We understand that community banks, 

Farm Credit institutions and credit unions did not cause the financial crisis 

that precipitated this legislation. While the legislation places a special emphasis 

on institutions with less than $10 billion in assets, my reading of the language 

is that they should not in any way be viewed by the Commodity Futures Trading 

Commission as a limit on the size of the institution that should be considered 

for an exemption.

Mr. Chairman, would you concur with this assessment? 

Mr. PETERSON. Yes, I fully agree. The language says that institutions to be considered for the exemption shall include those with $10 billion or less in assets. It is not a firm standard. Some firms with larger assets could qualify,

while some with smaller assets may not. The regulators will have maximum 

flexibility when looking at the risk portfolio of these institutions for consideration of an exemption.4

Senator Lincoln made a similar statement in the Senate. She observed that ‘‘small 

financial entities, such as banks, credit unions and farm credit institutions below 

$10 billion in assets—and possibly larger entities—will be permitted to utilize the 

end-user clearing exemption with approval from the regulators.’’ 5

In giving the Commission the authority to exempt institutions with assets exceed- ing $10 billion, Congress sought to avoid imposing new, clearing-related costs on the 

Farm Credit System. As Senators Dodd and Lincoln explained, ‘‘These entities did 

not get us into this crisis and should not be punished for Wall Street’s excesses. 

They help to finance jobs and provide lending for communities all across this nation. 

That is why Congress provided regulators the authority to exempt these institutions.’’ 6

Further, as Representative Holden described in detail, mandatory clearing would 

have no benefit as applied to Farm Credit System institutions because they already 

effectively manage risk:

Farm Credit System institutions are regulated and examined by a fully empowered independent regulatory agency, the Farm Credit Administration, which 

has the authority to shut down and liquidate a system institution that is not 

financially viable. In addition, the Farm Credit System is the only GSE that 

has a self-funded insurance program in place that was established to not only 

protect investors in farm credit debt securities against loss of their principal 

and interest, but also to protect taxpayers.

These are just a few of the reasons why the Agriculture Committee insisted that 

the institutions of the Farm Credit System not be subject to a number of the 

provisions of this legislation. They were not the cause of the problem, did not 

utilize TARP funds, and did not engage in abusive subprime lending. We have 

believed that this legislation should not do anything to disrupt this record of 

success.7

Although Farm Credit System associations have, on average, total assets that are 

well under $10 billion, all of the five Farm Credit System banks have total assets 

exceeding $10 billion. If, despite the Commission’s broad authority to exempt all 

Farm Credit System institutions, the end-user exception were confined to institutions with total assets of $10 billion or less, no Farm Credit System bank would 

qualify, and the bulk of the System’s derivatives activity would be subject to a costly 

170

8 12 U.S.C. § 2001(b). 9See id. § 2124(c) (providing that ‘‘[v]oting stock may be issued or transferred and held only 

by . . . cooperative associations eligible to borrow from the banks’’). 10 Id. § 2128(a). 11See id. § 2075. 12 156 Cong. Rec. H5246 (daily ed. June 30, 2009) (statement of Rep. Peterson). 

new clearing requirement. As the legislative history demonstrates, the Commission 

can and should avoid this result. Accordingly, the Farm Credit Council urges the 

Commission to permit all Farm Credit System institutions—regardless of their total 

assets—to use the end-user clearing exception. 

III. If the Commission Adopts an Asset Test, It Should Look Through Farm 

Credit System Banks to the Small Associations Whose Risk They Hedge 

With Derivatives 

If the Commission adopts an asset-based test for which financial institutions qualify for the end-user exception, it should clarify that it will look through Farm Credit 

System banks and consider the average assets of their affiliated associations. As explained below, any other approach would give commercial banks an unfair competitive advantage in the market for agricultural lending. 

Consistent with Congress’s ‘‘objective . . . to encourage farmer- and rancherborrowers[’] participation in the management, control, and ownership of a permanent system of credit,’’ 8 the Farm Credit System has a unique structure. Farm 

Credit System banks are cooperatives primarily owned by their affiliated associations.9 The Farm Credit Act authorizes the banks ‘‘to make loans and commitments 

to eligible cooperative associations.’’ 10 Farm Credit System associations are, in turn, 

authorized to make loans to bona fide farmers and ranchers, rural residents, and 

persons furnishing farm-related services.11 Put simply, Farm Credit banks lend to 

Farm Credit associations, which lend to farmers, and farmers own the Farm Credit 

associations, which own the Farm Credit banks. 

Accordingly, Farm Credit System banks are larger than their affiliated associations. For example, AgriBank, FCB, is the largest district bank, and its assets exceed $10 billion. But the 17 associations that own 99% of AgriBank have average 

assets of $3.6 billion, well below the $10 billion threshold suggested in Dodd-Frank. 

Unique among agricultural lenders, the Farm Credit System’s legal structure 

places the funding function for each district with the district bank. Centralized 

funding, in turn, enables the associations to benefit from lower administrative and 

operational costs. Swaps are executed by the district bank to gain hedge accounting, 

to minimize administrative costs, and to minimize counterparty credit risk and margin requirements via district-wide netting of offsetting exposures. This is more cost 

effective and strengthens the liquidity of the System. As a result, Farm Credit System associations have a lower risk profile than the small commercial banks with 

which they compete. 

If the Commission adopted a $10 billion asset limit, this structure would place 

Farm Credit System associations at a competitive disadvantage with respect to commercial banks. Absent a ‘‘look through’’ provision for Farm Credit System institutions, small commercial banks would be eligible for the end-user exception on a 

standalone basis, while Farm Credit System associations would have to bear the 

costs of mandatory clearing. Clearing costs would, in turn, be passed on to farmers 

and ranchers in the form of higher effective interest rates on loans. Community 

banks eligible for the end-user clearing exception would therefore be able to gain 

market share by offering lower interest rates. Even banks that do not qualify for 

the end-user exception would benefit from spreading the costs of clearing across 

their entire business, including segments outside agriculture. 

Although the majority of Farm Credit System associations have assets of less 

than $10 billion, the few associations with greater assets do not present risk requiring mandatory clearing. Even the failure of a large association would have no material impact on the Farm Credit System’s ability to meet its debt obligations because 

the five Farm Credit System banks are jointly and severally liable for the System’s 

notes and bonds. Thus, no association is so large that it would impact System debt 

holders if it were placed in receivership. By contrast, if a standalone commercial 

bank fails, its bondholders will likely face losses. 

As noted, Congress gave the Commission ‘‘maximum flexibility’’ to adopt an equitable solution for which small financial institutions will qualify for the end-user exception.12 The Farm Credit Council believes that the fair way to compare the hedging activities that benefit Farm Credit System associations with the hedging activities of their competing commercial banks is to consider the average assets of Farm 

Credit System associations in a particular district. If the Commission does not adopt 

171

13 NOPR, 75 Fed. Reg. at 80753. 14 Id. 15 12 U.S.C. § 2252(a)(10). 16See id. § 2261. 17See id. §§ 2264–2265. 18See id. § 2268. 19See id. § 2183. 20See 12 CFR §§ 615.5200–615.5215. 21See id. § 615.5205. 22The name CAMELS derives from the rating’s focus on six factors: capital, assets, management, earnings, liquidity, and sensitivity to market risk. 23Farm Credit Administration, 2009 Annual Report on the Farm Credit System 42, available 

at http://www.fca.gov/Download/AnnualReports/2009AnnualReport.pdf. 

such a ‘‘look through’’ approach, small Farm Credit System associations would be 

forced to raise interest rates for farmers and ranchers, and they would be placed 

at a competitive disadvantage in the market for agricultural lending. 

IV. Farm Credit System Institutions Should Qualify for the End-User Clearing Exception 

The Commission requested comment on, among other issues, whether an exception for Farm Credit System institutions would be appropriate.13 As we describe 

more fully below, an exception is appropriate because the non-speculative, 

collateralized derivatives activity of comprehensively regulated Farm Credit System 

institutions does not pose risk to the United States financial system warranting 

mandatory clearing. Further, imposing a costly new clearing requirement on Farm 

Credit System institutions would frustrate Congress’s equally important mission of 

providing a dependable source of financing for rural America. 

A. Farm Credit System Institutions Do Not Cause Systemic Risk Warranting Mandatory Clearing

1. Comprehensive Regulation by the Farm Credit Administration Adequately Mitigates the Risk of Farm Credit System Institutions

The Farm Credit Council agrees that the Commission should ‘‘take into account 

the supervisory regimes to which Small Financial Institutions are currently subject, 

and whether those regulatory regimes adequately mitigate any risks associated with 

an exception[.]’’ 14 Farm Credit System institutions are regulated by the Farm Credit Administration, an independent federal agency that adequately mitigates any 

risks associated with permitting Farm Credit System institutions not to clear derivatives. 

First, the Farm Credit Act authorizes the Farm Credit Administration to exercise 

broad powers ‘‘for the purpose of ensuring the safety and soundness of System institutions.’’ 15 Those powers include: 

• Bringing cease and desist proceedings against any institution or institution-affiliated party that has engaged, is engaging, or is about to engage in an unsafe 

or unsound practice; 16

• Suspending or removing directors or officers of Farm Credit System institutions 

who engage in unsafe or unsound practices; 17 and 

• Assessing civil monetary penalties against institutions or individuals thatviolate 

provisions of the Farm Credit Act or Farm Credit Administrationregulations.18

Further, if the Farm Credit Administration determines that a System institution is 

in an ‘‘unsafe or unsound condition to transact business,’’ the Farm Credit Administration may place that institution in conservatorship or receivership.19

Second, the Farm Credit Administration effectively oversees the capital adequacy 

of System institutions. By regulation, the Farm Credit Administration ensures that 

institutions meet minimum capital requirements and establish written capital adequacy plans reviewed by that agency.20 Specifically, each Farm Credit System institution must maintain permanent capital of at least 7% of its risk-adjusted asset 

base.21 The Farm Credit Administration also rates the safety and soundness of each 

System institution using the uniform Financial Institutions Rating System, or CAMELS.22 At the end of 2009, 82% of Farm Credit System banks and direct lending 

associations earned a score of one or two, out of five, on the CAMELS scale, with 

a score of one indicating that the institution is ‘‘sound in every respect.’’ 23 Indeed, 

more than 90% of System assets are currently housed in institutions rated one or 

two. 

Third, the Farm Credit Administration adequately oversees derivatives activity. 

By regulation, Farm Credit System institutions must adopt policies that mitigate 

172

24See 12 CFR § 615.5133. 25Memorandum from Roland E. Smith, Director, to Chairman, Board of Directors, Chief Executive Officer, All Farm Credit Institutions Regarding Counterparty Risk (Oct. 21, 2003), available at http://www.fca.gov/apps/infomemo.nsf (click on ‘‘Counterparty Risk’’). 26 Id. 27 NOPR, 75 Fed Reg. at 80753. 28See Further Definition of ‘‘Swap Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap Participant,’’ ‘‘Major Security-Based Swap Participant’’ and ‘‘Eligible Contract Participant,’’ 75 Fed. 

Reg. 80174, 80187–94 (proposed Dec. 21, 2010) (to be codified at 17 CFR pts. 1 & 240). 29See Federal Farm Credit Banks Funding Corporation, Third Quarter 2010—Quarterly Information Statement of the Farm Credit System 26 (Nov. 10, 2010) (hereinafter ‘‘Third Quarter 

2010 Information Statement’’), available at http://www.farmcredit-ffcb.com/farmcredit/financials/quarterly.jsp.

risk, including credit risk, by limiting their exposure to single or related 

counterparties, geographical areas, industries, or obligations with similar characteristics.24 The Farm Credit Administration has further directed each Farm Credit 

System institution ‘‘to establish a policy with appropriate limits to ensure that 

counterparty risks are consistent with the institution’s risk-bearing capacity.’’ 25 In 

reviewing institutions’ policies on exposure to counterparty credit risk, the Farm 

Credit Administration considers: 

• Criteria for appropriate due diligence including processes for measuring and 

managing counterparty risk;

• Criteria for selecting and maintaining relationships with counterparties, which 

may include credit ratings;

• Controls that limit the exposure of capital to single counterparties expressed as 

a percent of the institution’s capital base;

• Periodic reporting and monitoring of counterparty exposures to the board;

• Periodic reporting to the board on each counterparty’s financial condition, including an assessment of its ability to perform on agreements and contracts executed with the institution; and

• Actions to mitigate an institution’s exposure in the event the financial condition 

of a counterparty deteriorates and doubts arise about its ability to perform in 

accordance with the relevant agreements or contracts.26

Together, these comprehensive regulatory requirements effectuate the Farm Credit Administration’s mission of ensuring a safe, dependable source of credit for agriculture and rural America. The Commission should not add a costly, unnecessary 

clearing requirement when the Farm Credit Administration’s regulation and oversight already effectively mitigate risk to the financial system.

2. Farm Credit System Institutions Primarily Use Fixed-for-Floating 

Interest Rate Swaps and Effectively Manage Counterparty Credit 

Risk

The Farm Credit Council further agrees that the Commission should ‘‘consider 

treating different types of swaps differently when considering whether any exception 

should be available.’’ 27 Because the Farm Credit System uses safe, non-speculative 

interest rate swaps and already effectively addresses counterparty credit risk, clearing should not be required. 

Farm Credit System institutions primarily use plain vanilla, fixed-for-floating interest rate swaps, and materially all of our derivatives qualify for hedge accounting 

treatment. Farm Credit System institutions do not use swaps to speculate, and do 

not use the credit default swaps that caused the financial crisis. As the Commission 

determined in setting a higher substantial position threshold in the rate swaps category for purposes of identifying major swap participants, interest rate swaps are 

less risky than more complex or speculative instruments.28

Further, Farm Credit System institutions already effectively manage counterparty 

credit risk. To minimize the risk of credit losses from derivatives, Farm Credit System institutions deal with counterparties that have an investment grade or better 

long-term credit rating from a nationally recognized statistical rating organization, 

and further monitor the credit standing of and levels of exposure to individual 

counterparties. System institutions enter into master netting agreements that govern all derivative transactions with a counterparty. Substantially all derivative contracts are supported by credit support agreements requiring the bilateral posting of 

collateral in the event certain dollar thresholds of exposure are reached. These 

thresholds are small relative to the bank’s capital. Accordingly, as of September 30, 

2010, the net exposure of Farm Credit System institutions to swap dealers was only 

$252 million.29

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30Testimony of Chairman Gary Gensler before the House Committee on Agriculture (Feb. 10, 

2011), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opagensler-68.html. 31See Third Quarter 2010 Information Statement 32 (Nov. 10, 2010).

B. The Farm Credit System Is Not Interconnected with Other Financial 

Institutions

The Farm Credit Council recognizes that the determination of whether Farm 

Credit System institutions should be exempted from mandatory clearing depends 

not only on their safety and soundness, but also on the extent to which they are 

interconnected with other financial entities. As Chairman Gensler has recognized, 

‘‘[t]he risk of a crisis spreading throughout the financial system is greater the more 

interconnected financial companies are to each other.’’ 30 Farm Credit System institutions are not so interconnected with other financial entities to raise this concern. 

First, based on their unique funding structure, Farm Credit System institutions 

neither borrow from nor lend to commercial banks. As a result, Farm Credit System 

institutions’ primary credit relationships with other financial entities include (1) derivatives counterparty relationships and (2) federal funds investments. As described 

above, Farm Credit System institutions carefully manage derivatives counterparty 

relationships with bilateral collateral agreements, so that the System’s exposure to 

counterparties is at low levels relative to capital. Federal funds investments, which 

are primarily overnight, can be unwound on any day with no transaction costs 

should credit concerns arise. 

Second, because Farm Credit System institutions do not take deposits, Farm 

Credit System banks and associations cannot experience a ‘‘run on the bank.’’ To 

the extent the concern about interconnectedness involves the consequences of declining depositor confidence, it does not apply to the Farm Credit System because the 

System does not rely on depositors for funding. 

Finally, the Systemwide Debt Securities used to fund the Farm Credit System are 

insured by the Farm Credit System Insurance Corporation, a government-controlled, 

independent entity, that administers an insurance fund. As of September 30, 2010, 

the assets in the insurance fund totaled $3.193 billion, or roughly 2% of the Farm 

Credit System’s aggregate insured obligations.31 If a bank cannot pay principal or 

interest on an insured debt obligation, the Insurance Corporation must pay investors from the fund. In the event that the entire insurance fund is exhausted, investors have further recourse to the five Farm Credit System banks, which are jointly 

and severally liable for Systemwide Debt Securities. Accordingly, even though most 

investors in Systemwide Debt Securities are professional money managers, not 

banks, these layers of investor protection make sure that the Farm Credit System 

will not cause a run on the funding of other entities. 

C. Imposing a Costly, New Clearing Requirement Would Frustrate the 

Farm Credit System’s Mission of Providing Financing to Rural America

Although mandatory clearing would not make the Farm Credit System’s derivatives activity safer, it would substantially raise the costs of derivatives for our members. For example, our members would incur significant negative carry costs on investments or cash posted to meet new initial margin requirements. Furthermore, if 

the clearing alternatives do not offer end-users interest on initial and variation margin, the Farm Credit System’s costs could easily increase by tens of millions of dollars. 

Market volatility, the direction of interest rates, and the maturity term of outstanding swaps also affect the amount of margin required. If market volatility returned to the levels observed after the Lehman Brothers bankruptcy in September 

2008, the initial margin requirement for the Farm Credit System’s derivatives could 

be expected to at least triple, and the projected negative carry expense on this component would easily exceed $2 million annually. 

At September 30, 2010, the majority of the System’s derivative positions had positive market value, so on an aggregate basis, the System was not required to provide 

a material amount of collateral or variation margin to our derivative counterparties. 

If, however, interest rates increase, the derivative exposure would swing in favor of 

our counterparties, and System institutions would then be required to provide variation margin, in addition to required initial margin. In this scenario, negative carry 

on variation margin is expected to be a significant cost. To minimize negative carry, 

it is especially important that clearing rules provide a mechanism for end-users of 

over-the-counter swaps to earn interest on the variation margin provided to our 

counterparties. On top of these costs would be new account fees paid to clearing 

members, which we estimate could easily reach $1.5 to $2.5 million each year. 

174

32 12 U.S.C. § 2001(a). 33 156 Cong. Rec. H5246 (daily ed. June 30, 2009) (statement of Rep. Holden). 34 NOPR, 75 Fed. Reg. at 80754. 35See Further Definition, supra note 28, at 80188–94. 

These millions of dollars in new costs would make derivatives less attractive for 

risk management. To the extent new costs discourage Farm Credit System institutions from safely entering into derivatives to hedge or mitigate risk, mandatory 

clearing would actually make the Farm Credit System less safe. These new costs 

also represent millions of dollars that the Farm Credit System could otherwise lend 

to farmers and farm-related businesses, and new costs the Farm Credit System will 

have to offset with higher interest rates to farm-related businesses. In this way, 

mandatory clearing would frustrate the Farm Credit System’s mission of providing 

safe, dependable financing to rural America. 

In deciding which institutions should be eligible for the end-user exception, the 

Commission should consider that the Farm Credit System’s mission is also federal 

policy. Congress created the System ‘‘to accomplish the objective of improving the 

income and well-being of American farmers and ranchers by furnishing sound, adequate, and constructive credit and closely related services to them.’’ 32 Dodd-Frank 

does not alter this congressional goal. To the contrary, Congress ‘‘insisted that the 

institutions of the Farm Credit System not be subject to a number of the provisions 

of [Dodd-Frank].’’ 33

V. Alternatively, the Commission Should Adopt a Risk-Based Approach for 

Determining Which Small Financial Institutions Will Be Exempt From 

Mandatory Clearing 

The Commission requested comment on whether ‘‘measures other than total assets of $10 billion, such as financial risk or capital, . . . could be used for determining whether an entity qualifies for an exception.’’ 34 The Farm Credit Council believes that systemic risk created by derivatives is not a function of an institution’s 

asset size; it is a function of the type and amount of derivative activity after netting 

offsetting positions and collateral. Put simply, small financial institutions entering 

into many risky trades pose greater risk to the financial system than larger institutions that carefully manage their derivatives portfolio. Accordingly, the Commission 

should focus on risk instead of asset size. 

The Commission has already proposed such a risk-based framework for determining when an entity has a ‘‘substantial position’’ in a major swaps category warranting regulation as a major swap participant.35 The Farm Credit Council proposes 

that a similar test measuring uncollateralized current exposure or current exposure 

plus potential future exposure would be appropriate in determining which small financial institutions pose enough risk to warrant mandatory clearing. Specifically, 

we believe that current uncollateralized exposure of $2 billion in the rate swaps category and $1 billion in other categories—or current uncollateralized exposure and 

potential future exposure of $3 billion for rate swaps or $1 billion for other swaps—

would be appropriate. These proposed thresholds, which are lower than the thresholds the Commission has proposed for identifying major swap participants, would 

both address risk among financial entities and more accurately capture financial institutions whose swap exposure poses risk to the financial system. 

Alternatively, the Commission could adopt a test based on an institution’s exposure to swaps as a percentage of capital. The Farm Credit Council suggests that 

appropriate risk limits would be current uncollateralized exposure to swaps of 10% 

of capital, or current uncollateralized plus potential future exposure to swaps of 20% 

of capital. We believe these limits would appropriately identify which small financial 

institutions pose systemic risk warranting mandatory clearing. We believe that 

mandatory clearing would not be justified for institutions with less exposure to 

swaps as a percentage of capital. A test of current uncollateralized swap exposure 

as low as 5% of capital would, however, allow most of the Farm Credit System’s risk 

management activities to survive without a costly new clearing requirement. 

VI. Conclusion 

For the reasons described above, the Farm Credit Council urges the Commission 

to exercise its ample authority to permit all Farm Credit System institutions—including those with total assets exceeding $10 billion—to use the end-user clearing 

exception. Because Farm Credit System banks use derivatives on a district-wide 

basis to manage risk for much smaller associations, the Commission should look 

through the banks to the average asset size of their affiliated associations. Otherwise, mandatory clearing would put small Farm Credit System associations at a 

competitive disadvantage with respect to competing commercial banks. This apVerDate 0ct 09 2002 12:58 Jul 22, 2011 Jkt 041481 PO 00000 Frm 00178 Fmt 6621 Sfmt 6621 I:\DOCS\112-07\65892.TXT BRIAN
175

proach is appropriate because safe, sound Farm Credit System institutions do not 

need an additional, redundant layer of regulation. And new clearing regulation 

would impose costs that would both discourage Farm Credit System institutions 

from mitigating risk and diminish the availability of credit for farmers and rural 

America. 

The Farm Credit Council appreciates the opportunity to comment. If you have any 

questions or we can provide other information, please do not hesitate to contact us. 

As always, we would welcome the opportunity to work with the Commission in developing the final rule. 

Sincerely,

ROBBIE BOONE,

Vice President, Government Affairs,

Farm Credit Council.

CC:

Honorable GARY GENSLER, Chairman;

Honorable MICHAEL DUNN, Commissioner;

Honorable JILL E. SOMMERS, Commissioner;

Honorable BART CHILTON, Commissioner;

Honorable SCOTT D. O’MALIA, Commissioner.

Æ


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