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COMMITTEE ON FUTURES 

& DERIVATIVES REGULATION 

NEW YORK 

CITY BAR 

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MICIIAEL S. SACKIIEIM 

CHAIR 

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787 SEVENTH AVENUE 

FLOOR25 

NEW YORK, NY 10019 

Phone: (212) 839-5503 

Fax: (212) 839-5599 

msackheim@sidlcy.com 

DAVID A. FORM 

SECRETARY 

787 SEVENTH A VENUE 

FLOOR20 

NEW YORK, NY 10019 

Phone: (212) 839-5394 

Fax: (212) 839-5599 

dform@sidlt:y.com 

David Stawick 

Secretary 

June 16, 2009 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, N. W. 

Washington, D. C. 20581 

Re: Comments on Swap Hedge Exemption Concept Release 

Dear Mr. Stawick: 

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The Committee on Futures and Derivatives Regulation (the "Committee") of the New 

York City Bar Association (the "Association") is writing to submit comments on the "Concept 

Release on Whether to Eliminate the Bona Fide Hedge Exemption for Certain Swap Dealers and 

Create a New Limited Risk Management Exemption from Speculative Position Limits" that was 

published in the Federal Register on March 24, 2009. 

The Association is an organization of over 23,000 members. Most of its members 

practice in the New York City area. However, the Association also has members in nearly every 

state and over 50 countries. The Committee consists of attorneys knowledgeable about the 

trading and regulation of futures contracts and of over-the-cOWlter derivative products such as 
credit default swaps and it has a practice of publishing comments on legal and regulatory 

developments that have a significant impact on futures and derivatives markets. 

Our Committee generally supports regulatory initiatives that will improve market 

transparency and reduce systemic risk. In this case, however, we feel that the regulatory changes 

described in the Concept Release do not strike an appropriate balance between the market 

benefits and regulatory efficiency to be achieved and the negative effects and burdens that will 

be imposed on market participants. The elimination of the bonafide hedge exemption for swap 

activity is a drastic step that should not be undertaken unless there is conclusive proof of a 

problem that would be solved by such action. 

As an initial matter, any action taken by the Commission should take appropriate account 

of the significant difference between the legal relationship of a swap dealer with its counterparty 

and that of a futures commission merchant ("FCM") to its clients. Unlike FCMs, which 

traditionally have acted as agents for their clients, swap dealers act as principals in an arms 

length relationship with counterparties who in many instances carefully limit the information 

they provide to the dealer. The very nature of this different legal relationship makes it both 

impractical and inappropriate to put the swaps dealer in the position of policing or even 

obtaining its countcrparty's market positions, and could result dealers being required to 

categorize the activities of its swap counterparties on the basis of motivations and circumstance 

that may not be readily apparent. 

In addition, most swaps dealers are banks, broker dealers, or their affiliates, who are 

currently subject to prudential supervision. Recent market events have driven home the need for 

such institutions to maintain strong and effective risk management practices. Elimination of the 

bonafide hedge exemption will make it more difficult for these institutions to use the ready 

liquidity and comparative high degree of transparency ofthe futures markets as part oftheir risk 

management, and may lead to less effective or more expensive risk management at time when 

the regulatory system should be encouraging exactly the opposite. 

We have also set forth below some comments to the numbered questions in the Concept 

Release: 

1. Should swap dealers no longer be allowed to qualify for exemption under the existing 

bonafide hedge definition? 

No. Derivatives are a legitimate business activity of financial institutions and 

should give rise to a substantive exemption for relevant hedging activity. If there is a 

need for greater regulation of positions in the relevant commodity markets, it should be 

imposed across the board on all parties making usc of bona fide hedge exemptions, not 

just parties engaged in swap transactions. In addition, in view of the Treasury legislative 

proposal for the regulation of over~the-counter derivatives, any changes of this magnitude 

should be incorporated into any legislative proposal implementing the Treasury program. 

2. If so, should the Commission create a limited risk-management exemption for swap 

dealers based upon the nature oftheir clients (e.g., being allowed an exemption to the 

extent a client is a traditional commercial hedger)? 

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If the Commission were to eliminate the ability of swap dealers to qualify for the 

bona fide hedging exemption, then a broad and flexible risk management exemption 

should be adopted. In that case, if the swap dealer's client represents in writing to the 

swap dealer that it is a commercial hedger in respect of the underlying commodity, or a 

representation that it is an eligible commercial entity in respect of the underlying 

commodity, the swap dealer should be able to rely on the representation and thereby 

qualify for a risk management exemption. Given that the relationship between a swap 

dealer and its client is an arms-length principal relationship, no additional due diligence 

should be required of the swap dealer to verify the client's representation. 

3. Ifthe bonafide hedge exemption were eliminated for swap dealers, and replaced with a 

new, limited risk management exemption, how should the new rules be applied to 

existing futures positions that no longer qualify for the new risk-management exemption? 

For example, should existing futures positions in excess of current Federal speculative 

position limits be grandfathered until the futures and option contract in which they are 

placed expire? Should swap dealers holding such position be given a time limit within 

which to bring their futures position into compliance with Federal speculative limits? 

Should swap dealers holding such positions be required to bring their futures positions 

into compliance with the Federal limits as of the effective date of the new rules? 

To avoid confusion in the market place and needless market volatility resulting 

from swap dealers simultaneously adjusting their positions en masse, we think that it 

would be prudent to grandfather existing futures positions in excess of Federal position 

limits until the futures and option contracts in which they are placed expire. We do not 

believe that imposing an arbitrary time horizon is necessary. 

4. The existing bona fide hedge exemptions granted by the Commission extend only to 

those agricultural commodities subject to Federal speculative position limits. Should the 

reinterpretation of bona fide hedging and any new limited risk management exemption 

extend to other physical commodities, such as energy and metals, which are subject to 

exchange position limits or position accountability rules. 

We do not believe that the reinterpretation of bonafide hedging and any new 

limited risk management exemption extend to other physical commodities. To the 

contrary, we think that it would be in the public interest for the existing bonafide hedge 

exemptions to be extended to all commodities and not be limited to those agricultural 

commodities that are subject to Federal speculative position limits. This will render 

regulatory certainty to the application of the bona fide hedge exemptions across all 

markets and commercial traders. 

5. If a new limited risk management exemption were to be pennitted to the extent a swap 

dealer is taking on risk on behalf of commercial clients, how should the rules define what 

constitutes a commercial client? 

If a decision is made to create a new limited risk management exemption, the 

definition of a "commercial client" should include an individual or entity that either 

(i) produces, processes, merchandises, manufactures or consumes (on a commercial 

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basis) the commodity, (ii) incurs risks, in addition to the price risk, relating to the 

commodity in conjunction with its line ofbusiness, or (iii) regularly enters into 

commercial transactions to purchase or sell the commodity in conjunction with a line of 

its business. 

6. How should the Commission (and, if applicable, the responsible industry self-regulatory 

organization (SRO)) and the swap dealer itself verify that a dealer's clients are 

commercial? Is certification by the dealer sufficient or would something more be required 

from either the dealer or the client? If so, what should be reported and how oftenweekly, monthly, etc.? 

Given the arms-length relationship between swap dealers and their counterparties, 

it would be an undue burden to require a swaps dealer to verify the commercial nature of 

its client. Similar to a swap dealer being able to rely on other written representations 

contained in its contractual agreement with its client, a swap dealer should be permitted 

to rely on a written representation by its client that it is a commercial hedger in respect of 

the underlying commodity. Further, the Commission, through its market oversight and 

surveillance functions is better suited than swap dealers to verify (and where necessary, 

investigate) the status of entities holding themselves out as bona fide hedgers. 

We do not believe that the public interest necessitates requiring individuals or 

entities who hold themselves out as hedgers to register with the Commission or be subject 

to reporting requirements. This would be extremely burdensome on the commercial 

hedgers as well as the Commission's resources. 

7. For a swap dealer's noncommercial clients, should the rules distinguish between different 

classes ofnoncommercials-for example: (1) Clients who are speculators (e.g., a hedge 

fund); (2) clients who are index funds trading passively on behalf of many participants; 

and (3) clients who are intermediaries (e.g., another swap dealer trading on behalf of 

undisclosed clients, some of whom may be commercials)? 

The rules do not need to distinguish between different classes of noncommercials. 

However, we believe that index funds that trade passively on behalf of many participants 

should be included as a subcategory of a commercial hedger. Similarly, a swap dealer 

trading on behalf of undisclosed commercial clients should also be included as a 

subcategory of a commercial hedger. 

8. If a swap dealer were allowed an exemption for risk taken on against index-fund clients, 

how would the dealer satisfy the Commission that the fund is made up of many 

participants and is passively managed? Is certification by the dealer or fund sufficient or 

should the dealer or fund be required to identify the fund's largest clients? 

In the past few years index funds traded on regulated securities exchanges have 

become an important investment vehicle for the public. These are highly regulated and 

transparent investment vehicles that add to the market's liquidity, thereby facilitating the 

orderly functioning of the markets as well as the hedging activity of commercial entities. 

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Index funds that trade on behalf of passive public investors, are listed on regulated 

exchanges and that are operated by registered commodity pool operators, should be 

characterized as either bonafide hedgers or "index fund risk management traders" and 

thereby qualify for the limited risk management exemption. (This position is not 

dissimilar to the Commission's 1987 interpretation that clarified the hedging definition to 

include "long" strategies of institutional investors to hedge against interest rate exposure. 

52 Federal Register 27195 (CFTC, July 20, 1987).) 

As pointed out in prior responses, a dealer should be allowed to rely on a status 

representation from its counterparty and should not be required to satisfy the CFTC 

concerning the make-up and investment intent of the counterparty. 

9. If a swap dealer were allowed an exemption for risk taken on against another 

intermediary, how would the dealer satisfy the Commission that its intermediary client 

does not in turn have noncommercial clients that are in excess of position limits? Is 

certification by the dealer or second intermediary sufficient or should the dealer or 

intermediary be required to separately identify the intermediary's largest clients? 

The dealer or second intermediary should not be routinely required to identify its 

clients. Their identities should be disclosable to the Commission upon request, in which 

case the CFTC could then aggregate client positions across markets and dealers as 

required. 

10. What futures equivalent position level should trigger the new limited risk management 

exemption reporting requirement? For example, under the rules of the on-going special 

call to swap dealers and index funds described earlier, a swap dealer must report any 

client in any individual month that exceeds 25% of the spot month limit, or the net long 

or short position of a client that in all months combined exceeds 25% of the all-monthscombined limit. 

No response. 

11. If none of a swap dealer's clients exceed required reporting levels in a given commodity, 

or none of such clients exceed reporting levels in any commodity, what type of report 

should be filed with the Commission-e.g., a certification by the swap dealer to the 

Commission to that effect? 

Simple certification should be sufficient. 

12. Should there be an overall limit on a swap dealer's futures and option positions in any 

one market regardless of the commercial or noncommercial nature of their clients? For 

exarriple, "A swap dealer may not hold an individual month or all-months-combined 

position in an agricultural commodity named in§ 150.2 in excess of 10% ofthe average 

combined futures and delta-adjusted option month-end open interest for the most recent 

calendar year." 

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Placing a hard cap on a swap dealer's position limits would only result in clients 

shifting their hedging transactions to other swap dealers, needlessly penalizing the 

original dealer without limiting the activity in the aggregate. 

13. If a new limited risk-management exemption for swap dealers is created, what additional 

elements, other than those listed here, should be considered by the Commission in 

developing such an exemption? 

The Commission could require swap dealers to make their books and records 

available to the Commission for inspection upon request. 

14. How should the two index traders who have received no-action relief from Federal 

speculative position limits (see footnote 15) be treated under any new regulatory scheme 

as discussed herein? 

The index traders who have been granted no-action relief from Federal 

speculative position limits have relied in good faith on such relief. To our knowledge, 

their trading has not caused any disruption in the markets. Rescinding or revising the 

relief that the Commission previously granted is not in the public interest and may have 

an unnecessary disruptive effect on the beneficiaries of these letters and their public 

investors, 

15. What information should be required in a swap dealer's application for a limited risk 

management exemption? 

The swap dealer's application for a limited risk management exemption should 

contain compliance and internal audit procedures, and confirmation that it will obtain 

written representations from each of its clients in respect of their commercial hedging 

status. 

Any questions you may have about these comments should be directed to the 

undersigned. 

Very truly yours, 

~~w~~ 

MichaelS. Sackheim 

Chair, Committee on Futures and Derivatives Regulation 

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New York City Bar Association 

Committee on Futures & Derivatives Regulation 

Michael Sackheim, Chair 

Sam Abernethy 

Paul M. Architzel* 

Conrad G. Bahlke 

Brent A. Beck 

Lawrence S. Block 

Christopher Bowen 

Jan Paul Bruynes 

Ann F. Chamberlain 

Ian Cuillerier 

Daniel Cunningham 

Guy C. Dempsey* 

Karen Jeanne Du Brul 

David Form 

Martin Goldenberg 

Geoffrey Goldman 

Marvin J. Goldstein 

Joyce Hansen~ 

Jason Jurgens 

Gary Edward Kalbaugh 

Robert F. Klein* 

David Kozak 

Cindy Ma 

Robert M. McLaughlin 

Adjunct Members 

Stephen J. Obie, 

Lore C. Steinhausel1f 

Barbara B. Wierzynski~ 

Law School Student Interns 

Larry Bartenev 

Laurian Cristea 

David Form, Secretary 

Richard Miller 

Charles R. Mills 

Rita Molesworth 

Ernest T. Patrikis 

Robin Powers 

Allan Rooney 

Michael Sackheim* 

James Sanders 

Edmund Schroeder 

Timothy P. Selby 

Rakesh K. Sharma 

Felix Shipkevich 

Dennis C. Sullivan 

Lauren Ann Teigland-Hunt 

Deborah A. Tuchman 

Sherry Venokur 

Andris Vizbaras 

Ronald T. Wolf* 

Alice Yurke 

,These members of the Committee did not participate in this comment letter. 

*These members comprise the Ad Hoc Concept Release Working Group. 

NYI 7000924v.l