June 16, 2009 

David Stawick, Secretary 

Received CFTC 

Records Sectlon 

to/;to/~1 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, N.W. 

Washington, D.C. 20581 

Futures Industry Association 

2001 Pennsylvania Ave. NW 

Suite 600 

Wnshinr;ton, DC 20006-1823 

Re: Concept Release on Bona Fide Hedge Exemption, 

74 Fed. Reg. 12282 (March 24, 2009) 

Dear Mr. Stawick: 

202.466.5460 

202.2963184 fax 

www.future~i11du;try.org 

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COMMENT 

The Futures Industry Association welcomes this opportunity to submit these 

public comments on the Commission's above-referenced concept release published in the 

Federal Register on March 24, 2009. The Commission's concept release highlights significant 

regulatory issues relating to the Commission's essential statutory mission: to promote and 

preserve the integrity of the price discovery function performed by the futures markets. At its 

core, the Commission's concept release raises fbndamental issues concerning the relationship of 

certain over-the-counter derivatives transactions to the futures market price discovery process. 

FIA Position Summary. 

FIA bas always strongly supported eJiorts to provide the Commission with all 

necessary market surveillance tools as well as appropriately administered speculative position 

limits to prevent price manipulation or pdce distmiion in the futures markets.' Preserving the 

integrity of futures prices is essential to enabling the futures markets to continue to serve the 

congressionally-identified national public interests in hedging, price discovery and price 

dissemination (7 U.S. C. § 5(a)). 

FIA is a principal spokesman for the commodity futures and options industry. FfA's regular membership is 

comprised of approximately 30 of the largest futures commission merchants ("FCMs") in the United States. 

Among its associate members are representatives fi"om virtually all other segments of the futures industry, both 

national and international. Reflecting the scope and diversity of its membership, FIA estimates that its members 

effect more than eighty percent of all customer transactions executed on United States contract markets. 
David Stawick, Secretary 

June 16, 2009 

Page2 

FIA does not believe that revoking the so-called swap dealer hedge exemption or 

adopting the limited risk management exemption as proposed in the staffs September 2008 

Report would be sound public policy. Neither action would serve to promote or secure the 

integrity of the price discovery process. Dealer futures positions arc routinely and transparently 

reported to the Commission under its Large Trader Reporting System. The concept release cites 

no evidence that these dealer fhtures market positions have ever harmed the integrity of futures 

market prices by creating artificial prices or price distmtions of any kind. Yet revoking the 

dealers' hedge exemption raises the dangerous prospect of shrinking the common understanding 

of what is hedging in futures markets which could cause a broad swath of businesses to eschew 

hedging price risks in regulated futures markets. Those businesses would then be forced either to 

assume the price risks they could not hedge (in effect speculate on those price risks) or increase 

the use of OTC instruments directly to manage their price risks. In addition, the recommended 

limited risk management exemption would be unworkable and could actually distort the 

transparency of the Commission's market surveillance process. 

Instead of undertaking a proposed rulemaking on the measures outlined in the 

concept release, FIA recommends that the Commission consider a new rulernalcing that would 

focus on the extent to which, if any, certain OTC derivatives perform a significant price 

discovery function for regulated fut1rres markets and what form of additional Commission 

regulation, if any, would be appropriate for market surveillance purposes. ln that connection, the 

Commission may want to consider regularizing the monthly reporting process now conducted 

under the Commission's special call authority. This approach would be consistent with the 

regulatory reform legislation that is expected from President Obama's Administration according 

to statements from Treasury Secretary Timothy Geithner and Commission Chairman Gary 

Gensler as well as proposals already pending in Congress. Given the Commission's experience 

with the data of OTC derivatives it has captured through its special call process, a Commission 

rulemaking could be easily based on actual market experience and analysis of market positions 

rather than rhetoric and supposition. This rulemaking also could be combined with the 

Commission's announced plan to conduct a new rulemaking on how best to address uncleared 

significant price discovery contracts. See 74 Fed. Reg. 12178, 12181 (March 23, 2009). 

The Importance of Speculation. 

FIA agrees with the Commission that futures market prices must be protected 

fi·om price manipulation and other distortions. The integrity of the price discovery process is the 

primary force that allows businesses worldwide to re.ly on futures market prices as a reference 

point for commercial transactions and to hedge their price risk efficiently. Speculators play an 

essential role in the price discovery process to ensure properly functioning futures markets. 

Without speculators to assume the price risks that hedgers seek to avoid, fut11res market prices 

would be so volatile ~md unpredictable that the markets would be unable to serve the public 

interest in providing eflicient price risk management and reliable benchmark prices. Protecting 
David Stawick, Secretary 

June 16, 2009 

Page 3 

this dual goal of risk management and price discovery is at the core of the Commission's mission 

under the CEA. 

Congress itself has explicitly recognized the important role speculation plays by 

assuming price risks in liquid trading markets. In Section 3(a) of the CEA, Congress found that 

"The transactions subject to this chapter arc entered into regularly 

in interstate and international commerce and are affected with a 

national public interest by providing a means for nianaging and 

assuming price risks, discovering prices, or disseminating pricing 

information through trading in liquid, fair and financially secure 

trading facilities." 

(7 U.S.C. § 5(a) emphasis added). Thus, Congress has found that by assuming the price risk 

hedgers seek to avoid and by providing liquidity, speculative trading in the futures markets 

actually serves the public interest. 

Statutory and Regulatory Background of Position Limits. 

While Congress has recognized the vital role of speculation, Section 4a(a) of the 

CEA also authorizes the Commission to impose daily trading limits and speculative position 

limits for the purpose of "diminishing, eliminating or preventing" what the statute defines to be 

the burdens of excessive speculation: "causing sudden or umeasonable fluctuations or 

unwarranted changes" in the price of a regulated futures contract. 7 U.S. C. § 6a(a). The statute 

further makes it unlawful for any person, directly or indirectly, to exceed any daily trading limit 

or any speculative position limit imposed by the Commission. 7 U.S.C. § 6a(b). However, by 

law, none of these Commission limits applies to bona fide hedging transactions or positions as 

defined by the Commission. 7 U.S.C. § 6a(c). 

Under this statutory authority, the Commission has set speculative position limits 

for certain agricultural commodities (17 C.F.R. § 150.2) and exempted frorn those requirements 

bona fide hedge transactions as defined in 17 C.F.R. § 1.3(z). The Commission has delegated 

the authority to set position limits in other commodities to designated contract markets, which 

must meet Core Principle #5 by adopting, as necessary and appropriate, posi6on limits or 

accountability levels for speculators. 7 U.S.C. § 7(d)(5). Designated contract markets have 

adopted hedge exemptions from these requirements as appropriate. Both the Commission and 

the DCMs enforce these requirements. 
David Stawick, Secretary 

June 16, 2009 

Page 4 

Swap Dealers and the Hedge Exemption. 

The September 2008 Commission Staff Report summarized certain aspects of the 

activities of swap dealers and how these activities are regulated, including the hedge exemptions 

the dealers have received. 

"The swap dealer, which is often affiliated with a bank or other 

large financial institution, has emerged to serve as a bridge 

between the OTC swap market and the fl..Jtures markets. Swap 

dealers act as swap counterparties both to commercial firms 

seeking to hedge price risks and to speculators seeking to gain 

price exposure. In essence, swap dealers function as aggregators 

or market makers, offering contracts with tailored terms to their 

clients before utilizing the more standardized futures markets to 

manage the resulting risk." 

Staff Report on Commodity Swap Dealers and Index Traders with Commission 

Recommendations (Sept. 2008) ("CFTC Staff Report"), p. l. 

Beginning in 1991, the Commission granted hedge exemptions to swap dealers to 

the extent that they use futures markets "to manage the p1ice risk on their books that results from 

serving as a market maker to OTC clients." ld. The available evidence supports the rationale for 

the dealers' hedge exemption. Based on an analysis of special call data received from swap 

dealers, the CFTC staff concluded: "[F]utures market trades by swap dealers are essentially an 

amalgam of hedging and speculation by their clients. Thus, any particular trade that a swap 

dealer brings to the futures market may reflect information and decisions that originated with a 

hedger, a speculator, or some combination of both." CFTC Staff Report at 1-2. 

Some have claimed that the Commission's hedge exemption for swap dealers has 

been misused to allow market participants to violate position limits indirectly. Under this theory, 

market participants cause higher commodity prices by entering into OTC swap transactions with 

dealers who then establish corresponding positions in the futures markets. In effect, it is alleged 

that swap dealers are acting as conduits to mask excessive long speculative positions in futures 

markets. · 

This allegation is contradicted by the CFTC staff findings quoted above and, in 

PIA's view, misapprehends the Commission's current dealer exemptions. Any dealer whose 

principal or exclusive purpose is to collude with its swaps counterparty to evade position limits 

would not, and should not, be entitled to a hedge exemption. But there is no evidence that swap 

dealers generally engage in that misconduct as the Commission's extensive special call data over 

the last year has revealed and as the CFTC Staff Report's findings show. Instead, dealers enter 

into OTC swap transactions with counterparties and then offset the p1ice exposure they assume 
David Stawick, Secretary 

June 16, 2009 

Page 5 

from those transactions internally through swaps with other counterparties and other dealers. 

Dealers then hedge only their net price exposure on the futures market and therefore only that net 

price exposure has contributed to the futures price discovery process. 

The Commission's Stated Rationale for Revoking the Hedge Exemption. 

The Commission has never expressed any concern that the swap dealers' futures 

trading is harming price discovery in the futures markets. Instead, the Commission's stated basis 

for considering whether to revoke the dealer hedge exemption rests on just two points. First, the 

allegation that some of the swap dealers' counter-parties may be "purposefully evading the 

oversight and limits of the CFTC and exchanges." 74 Fed. Reg. 12285-86 (March 24, 2009) 

Second, the Commission wants to ensure that "manipulation is not occurring outside of 

regulatory view." Id. Neither concern is rationally related to the dealers futures trading itself-: let 

alone related to revoking the dealers' hedge exemption. 

Swap dealer futures trading does not evade CFTC and exchange oversight. On 

the contrary, like all other futures hedge positions, it is fully transparent and reported daily to the 

CFTC and exchanges, as required by law. Dealer futures trading therefore could not be part of a 

manipulation that is occurring outside the Commission's regulatory view. Instead dealer futures 

trading occurs in plain view of the Commission every day. 

Ironically, revoking the hedge exemption might discourage swap dealers from 

offsetting their net risk through regulated futures trading activities and might actually make the 

Commission's two stated concerns more likely to occur. In that sense, maintaining the dealer 

hedge exemption promotes regulated trading and enhances transparency to facilitate the 

Commission's market surveillance, the very objectives the Commission cites as the basis for 

considering whether to revoke the exemptions. 

Any case to revoke the dealer hedge exemption must be grounded in a concern 

with some reasonable factual basis that the dealers' futures market hedges are contributing to 

either price manipulation or what the statute defines as "excessive speculation" -- "sudden or 

unreasonable fluctuations or w1warranted changes" in futures market prices. Neither the 

Commission's Staff Report nor the concept release even attempts to make the case that the 

dealers' futures trading raises either concern. Given the transparent record of the swap dealers' 

trading activities over many years since the exemption was first granted, the absence of any 

claim or evidence supporting this position is most telling. 

Revoking the Hedge Exemption Would Increase Speculation and Risk. 

FIA expects other commentators to represent the views of the swap dealers and to 

describe the impact repeal of the hedge exemption may have on the dealers. FIA's opposition to 

repeal of the dealer hedge exemption is grounded in broader considerations. Based on the 
David Stawick, Secretary 

June 16, 2009 

Page 6 

available evidence, swap dealers use futures markets in an economically appropriate manner to 

reduce the price risks the dealers inevitably face in rmming their operations. The CFTC Staff 

Report contains no evidence that a swap dealer used the hedge exemption to manipulate a market 

price or caused even an "unwarranted chang~" in a futures market price. The report instead 

shows that dealers assume price risks their counterparties are trying to avoid. Dealers then offset 

their net price risk on the futures market. 

To obtain an exemption, a swap dealer must prove to the Commission and DCMs, 

as applicable, that the dealer's trading in futures would offset its actual net price risk in an 

economically appropriate manner. Like other hedge exemptions, the dealer hedge exemption 

itself is not open-ended. In granting hedge exemptions, the Commission and the DCMs limit the 

amount of futures trading activity the dealer may engage in under the exemption. The 

Commission and DCMs also may impose additional regulatory conditions on those obtaining the 

exemption, as they would for other hedgers. 

Given these facts, it is hard to imagine how the dealer could be said to be 

speculating in futures markets when the dealer establishes and resets futures positions to offset 

the net price risks the dealer assumes on swap transactions with its countefjJarties. For that 

reason, repealing the dealer hedge exemption c.ould rob the Commission's bona fide hedge 

definition of its well-established meaning. Corporations, pension funds, mutual funds and hedge 

funds that regularly use futures to offset price risks from other fon11S of financial transactions 

could lose their hedge status and be forced to use futures to offset price risks only within the 

prescribed speculation limits. These are major participants in the futures markets. For decades, 

the Commission and other policy makers have sought to encourage their use of the open, 

transparent, liquid and financially-secure trading facilities offered by regulated futures 

exchanges. The CFTC Staff Report details these actions and the longstanding congressional 

interest in facilitating regulated risk management techniques. 

No convincing case has been made, or could be made, to reduce the important 

liquidity each of these major market participants, including dealers, now contributes to the 

futures markets or to remove the price risk protection each of these entities now enjoys through 

regulated markets in currencies, interest rates, equity indexes, energy and agricultural 

commodities. But these adverse consequences are likely if the dealer hedge exemption is 

repealed. Less hedging means more price risk exposure for businesses and more risk for our 

economy as a whole. Especially in these challenging economic times, more risk exposure should 

be discouraged, not encouraged, by regulatory policy. The simple truth is irrefutable: when 

dealers establish futures positions to offset price risks they assume in swap transactions, they are 

hedging and the Commission/DCM exemptions that recognize that economic fact should not be 

repealed. 
David Stawick, Secretary 

June 16, 2009 

Page 7 

Revoking the Hedge Exemption Could Distort Market Surveillance. 

Some have argued for treating all of a swap dealer's futures positions as 

speculation by revoking the hedge exemption. That policy would surely distort market 

surveillance in many circumstances. The CFTC staii report confirms this risk. Swap dealers 

futures positions are not mirror images -- on a gross basis -- of their counterparties swaps 

positions. Instead, "[F]utures market trades by swap dealers are essentially an amalgam of 

hedging and speculation by their clients. Thus, any particular trade that a swap dealer brings to 

the futures market may reflect information and decisions that originated with a hedger, a 

speculator, or some combination ofboth." CFTC Staff Report at 1-2. 

Revoking the dealers' hedge exemption and treating their futures positions as 

speculative would distort market behavior. It is possible that all of a dealer's swap 

counterparties are hedgers (some long and some short) and that the "amalgam" of internal swap 

activity on a dealer's book would reflect just hedging activity. But when the dealer trades in 

futures to offset its net price risk, with the hedge exemption unavailable, it would be considered 

to be a speculator. That distorts economic reality in two ways. First, the dealer is hedging its net 

price risk, not speculating. Second, even if that hedging is disqualified, the dealer's futures 

position is caused by pure hedging activity of the dealer's swap counterparties. Characterizing 

that futures trading as speculation is surely a distortion. 

Another problem illustrated by the CFTC Sta±I Report is traceability and 

practicality. As the Commission's staff report confirms, swap dealers enter into many different 

swap transactions to net their exposures with multiple counterparties, including those assuming 

risk, hedging risk and dealing in risk. If the character of the swap transactions drives the 

characterization of the dealer's offsetting futures position, it will be very difficult, if not 

impossible, for the dealer and its futures commission merchant to sort out the proper 

characterization of the dealer's futures position. Given that kind of characterization uncertainty, 

the Large Trader Reports to the Commission on the dealer futures positions are likely to vary 

widely in terms of bow to label the underlying trading activity, what the Stafi Report calls the 

"amalgam" of its speculating and hedging swap counterparties. That kind of variety will not lead 

to enhanced transparency. Commission market surveillance will surely suffer. The ability of 

market participants to draw accurate conclusions from weekly Conm1itments of Traders reports 

also will be further compromised. 

A Different Regulatory Approach. 

On June 4, 2009, Commission Chairman Gary Gensler testified on the need for a 

comprehensive framework to regulate the OTC derivatives market. Among other proposals, 
David Stawick, Secretary 

June 16, 2009 

Page 8 

Chairman Gensler recommended that OTC positiOns in contracts that "perform or affect a 

significant price discovery function with respect to regulated markets" should be aggregated for 

position limit purposes with the applicable position limits for corresponding regulated markets.2 

An implicit corollary of Chairman Gensler's proposal is that some form of reporting system 

would apply to those price discovery related OTC positions.1 

PIA understands the CFTC's market surveillance interest in any OTC derivatives 

transactions that contribute to the price discovery process on CFTC-regulated markets. The 

Commission's existing special calls to swap dealers and index fund managers were borne out of 

that interest. The Commission may surely utilize that data to consider whether additional direct 

regulation would be appropriate for significant price discovery OTC transactions. At the least, 

FIA believes the Commission should consider initiating a rulemaking on these issues based on its 

analysis of the data it has collected through its special call authority and focusing on what 

impact, if any, OTC transactions have had on price discovery in regulated futures markets. The 

Commission may propose, as part of the rulemaking, to adopt a monthly repm1ing requirement 

for swap dealers that mirrors its current, ongoing special calls for OTC derivatives information. 

Perhaps such a rulemaking also could be combined with the Commission's announced 

rulemaldng on how to treat non-cleared significant price discovery contracts on eligible 

commercial markets. See 74 Fed. Reg. 12181 (March 23, 2009). 

In any event, FIA believes it would be problematic for the Commission by rule to 

impose on swap dealers certification requirements. Indeed, using the swap dealers to classify 

and certify the character of their counter-parties' OTC transactions may result in inaccurate data 

and distmied market surveillance, as the dealers Jack the relevant infon:nation to double check 

any representation by its swaps counterparty as to whether its swap transactions are hedges or 

speculation. Nor should those counterparties be forced to divulge that commercially sensitive 

information to their opposite parties in the swap negotiations; otherwise buy-side swap market 

participants would be operating at a significant infom1ational disadvantage with their dealers. 

The Commission's special calls directly to 14 co1m11odity index fund managers may reflect its 

appreciation of that market reality. See CFTC StaffReport at 16. 

2 Statement of Gary Gensler, Chairnian, CFTC, Before the Senate Committee on Agriculture, Nutrition and 

Forestry, June 4, 2009, page 5. 

According to Chairman Gensler, even for "customized' OTC derivatives that would not be subject to exchangetrading or a clearing system, the Commission should have the authority to impose recordkeeping and reporting 

requirements as well as a full audit trail of these transactions. Statement of Gary Gensler, Chairman, CFTC, 

Before the Senate Committee on Agriculture, Nutrition and Forestry, June 4, 2009, page 7. 
David Stawick, Secretary 

June 16, 2009 

Page 9 

For these reasons, FIA believes the stated conditions in the recommended limited 

risk management exemption would be unwise and unworkable. That is why we have declined to 

address the specific questions raised in the concept release that focus on the· framework 

contemplated by the recommendation. 

Conclusion. 

The Commission's concept release addresses a very important regulatory issue --

how best to preserve and protect the integrity of the price discovery process. FIA believes these 

issues should be addressed now through a Commission rulemaking on how, if at all, different 

types of OTC derivatives affect price discovery in futures markets. Once these issues have been 

analyzed, based on data obtained from the Commission's special calls and any other sources, the 

Commission will be in a better position to determine what regulatory authorities should be 

applied to those OTC derivatives that serve a significant price discovery function. This approach 

is consistent with the am.endments to the CEA Congress adopted in 2008, as well as recent 

statements by the Obama Administration and Chairman Gensler. FIA understands that the 

Commission may well determine that it needs additional statutory authority to extend its market 

surveillance powers in this area. If so, FIA would welcome the opportunity to work with the 

Commission in developing its proposals. 

FIA would not support repealing the dealer hedge exemption or replacing it with a 

limited risk management exemption. In our view, repealing the hedge exemption would harm 

those who rely on U.S. futures markets by calling into question the sound economic analysis that 

has served as the foundation for the Commission's bona tide hedging definition for decades. In 

addition, the recommended risk management exemption would impose on dealers regulatory 

conditions they could not meet and that might actually compromise Commission market 

surveillance goals. 

FIA believes the policy goals of CFTC Staff Report recommendation #5 could 

best be achieved by a different, more direct regulatory approach as outlined by Chairman 

Gensler, rather than the indirect certification approach the recommendation contemplated. FIA 

strongly supports making sure the Commission has all the necessary market surveillance data it 

needs to ensure the integrity of the futures market price discovery process. We look forward to 

working with the Commission to accomplish that goal. 

Futures Industry Association