II-O0019

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Holtan, Alexander S. <AHoltan@hunton.com>

Friday, November 5, 2010 6:56 PM

secretary <secretary@CFTC.gov>; OTCDefinitions

<OTCDefinitions@CFTC.gov>; EndUser <EndUser@CFTC.gov>

Mclndoe, David <dmcindoe@hunton.com>; Menezes, Mark W.

<mmenezes@hunton.com>; Sweeney, R. Michael <rsweeney@hunton.com>

Working Group of Commercial Energy Firms Comments on the Definition of

"Commercial Risk"

CFTC Letter for the Definition of Commercial Risk-(filed version)_(32897667)_

(7).pdf

Dear Secretary Stawick:

On behalf of the Working Group of Commercial Energy Firms, Hunton & Williams LLP submits for your

consideration this letter concerning the definition of "commercial risk" under Title VII of the Dodd-Frank Wall

Street Reform and Consumer Protection Act of 2010. If you have any questions, please contact David Mclndoe at

(202) 955-1947, Michael Sweeney at (202) 955-1944, or Mark Menezes at (202) 419-2122. Thank you for your

consideration.

Respectfully,

Alexander Holtan

Alexander Holtan*

Associate *not admitted in DC

WILLIAMS

AHoltan@hunton .com

Hunton & Williams LLP

1900 K Street, N.W.

Washington, DC 20006

Phone: (202) 778-2230

Fax: (202) 828-3768

*Virginia Member Only

www.hunton.com

This communication is confidential and is intended to be privileged pursuant to applicable law. If the reader of this message is not the

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HUNTON ’.:

WILLIAMS

HUNTON & WILLIAMS LLP

1900 K STREET, N.W.

WASHINGTON, D.C. 20006-1109

TEL 202  ̄ 955  ̄ 1500

FAX 202  ̄ 778  ̄ 2201

FILE NO: 76142.2

November 5, 2010

David A. Stawick, Secretary

Commodity Futures Trading Commission

Three Lafayette Center

1155 21st Street, NW

Washington, DC 20581

VIA ELECTRONIC MAIL

The Definition of "Commercial Risk" 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 the following pre-rulemaking

comments concerning the definition of "commercial risk" under Section 721(b) of Title VII of

the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act").

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.

The comments herein specifically address the definition of "commercial risk" under

Section 721(b) of the Act and that term’s application in the definition of "Major Swap

Participant" under new Commodity Exchange Act (the "CEA") provision la(33) and its

application with regard to the end user exemption from mandatory clearing under new Section

2(h)(7)(A) of the CEA. The Working Group appreciates the opportunity to submit these

comments and looks forward to working with the Commodity Futures Trading Commission

(the "Commission") to define the term "commercial risk" as part of the formal rulemaking

process for implementing this and other key definitions contained in Title VII.

ATLANTA AUSTIN BANGKOK BEIJING BRUSSELS CHARLOTTE DALLAS HOUSTON LONDON LOS ANGELES

McLEAN MIAMI NEW YORK NORFOLK RALEIGH RICHMOND SAN FRANCISCO WASHINGTON

www.hunton.com
WILLIAMS

David A. Stawick, Secretary

Commodity Futures Trading Commission

November 5, 2010

Page 2

I. RECOMMENDATIONS OF THE WORKING GROUP.

A. GENERAL.

1. DEFINITION OF "COMMERCIAL RISK."

The term "commercial risk" is used in the Act in two contexts. First, when

determining whether a firm holds a "substantial position" under the first prong of the

definition of Major Swap Participant, Swap transactions that hedge "commercial risk" are

removed from the analysis.1 Second, in order for a Swap to qualify for the end user clearing

exemption in new CEA Section 2(h)(7), the Swap must be used to "hedge or mitigate

commercial risk."

While the Act does not require the Commission to define the term "commercial risk,"

the Commission should use its authority to define what constitutes "commercial risk" to give

entities legal certainty as to which transactions are included in the "substantial position"

determination and which transactions qualify for the exemption from the mandatory clearing

requirement.2

The Commission should adopt a meaning of "commercial risk" that is consistent with

Congress’ intent to regulate over-the-counter Swap transactions that might pose risk to the

financial system of the United States. Given such Congressional intent, the Working Group

recommends the following definition of "commercial risk":

Commercial Risk. This term means any risk that a person

incurs, or anticipates incurring, in connection with the

ownership, procurement, production, manufacture, processing,

merchandising, marketing, transportation, transmission, storage,

or distribution, of a commodity, any byproduct of a commodity,

or a product or service related to a commodity, including, but

not limited to: market risk; credit risk; interest rate risk;

currency risk; operational and operating risk; and liquidity risk.

In both provisions in which it is used, the term "commercial risk" is used in the

context of hedging risk associated with a company’s business operations. Thus, the definition

1

2

New CEA Section la(33)(A)(i)(I).

Section 721 (b) of the Act gives the Commission the authority to define "commercial risk."
WILLIAMS

David A. Stawick, Secretary

Commodity Futures Trading Commission

November 5, 2010

Page 3

of "commercial risk" adopted by the Commission should capture those risks commonly

understood to be risks inherent in the operation of a commercial enterprise. The Working

Group’s suggested definition of "commercial risk" encompasses all such risks, from the price

risk associated with extracting commodities or purchasing raw materials to the interest rate

risk associated with issuing long-term debt to finance the construction of a power plant. Such

a definition is consistent with both a functional definition of "substantial position" and a

"robust end user clearing exemption." 3

The Working Group does not advocate a definition of "commercial risk" that is broad

enough to allow nearly every Swap to be a potential hedge transaction. The definition above

establishes a direct link between a firm’s core commercial business and the risk it is hedging.

There are other risks that might affect a business, but which have little direct correlation to the

day-to-day operation of that business. For example, sovereign events, acts of war,

technological innovation, and macro-economic phenomena are all things outside the scope of

the definition of "commercial risk" proposed by the Working Group.

DEFINITION OF "COMMERCIAL RISK" IN THE CONTEXT OF MAJOR

SWAP PARTICIPANT.

When determining whether a firm holds a "substantial position" under the first prong

of the definition of Major Swap Participant, Swap transactions that hedge "commercial risk"

are removed from the analysis.4 This provision was included by Congress to ensure "that few,

if any, end users will be major swap participants, as we have excluded ’positions held for

hedging or mitigating commercial risk’ from being considered as a ’substantial position.’’’s

The suggested construction of the term "commercial risk" will allow the Commission to

accurately access whether an entity does in fact have a "substantial position" in Swaps that

rises to the level of systemic importance.

The suggested construction of the term "commercial risk" would not cause the

definition of "Major Swap Participant" to be under-inclusive. Certain systemically important

See 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).

New CEA Section la(33)(A)(i)(I).

5 See, Floor colloquy between Congressman Frank, Chairman, Committee on Financial Services and

Congressman Peterson, Chairman, Committee on Agriculture in response to the letter from Sen. Dodd and Sen.

Lincoln. 156 Cong. Rec. H 5248 (daily ed. June 30, 2010) (statement by Cong. Peterson).
WILLIAMS

David A. Stawick, Secretary

Commodity Futures Trading Commission

November 5, 2010

Page 4

entities that hedge a vast majority of their "commercial risk" may not be captured under the

first prong of the definition of Major Swap Participant if "commercial risk" were to be

defined as proposed. However, the remaining two prongs of the definition of Major Swap

Participant include Swaps entered into to hedge commercial risk in their analysis and are

structured to capture such an entity if their Swaps create substantial counterparty exposure or

if they are a highly leveraged financial entity.6

3. DEFINITION OF "COMMERCIAL RISK" IN THE CONTEXT OF

MANDATORY CENTRAL CLEARING.

As noted above, Congress intended to create a "robust end user clearing exemption for

those entities that are using the swaps market to hedge or mitigate commercial risk.’’7 They

did so because "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.)’’8 To implement what Congress intended, the

Commission must adopt a definition of "commercial risk" that would allow those entities that

qualify to use the end user clearing exemption to do so when hedging all of their legitimate

commercial business risks.

In addition, the suggested definition of commercial risk would not allow the clearing

exemption to be used in a way that would allow financial firms to avoid mandatory clearing

for their hedges on speculative positions. Congress recognized the risk of this possible abuse

and responded by explicitly prohibiting financial entities from using the clearing exemption.9

6 For a more detailed discussion of the definition of "Major Swap Participant" please see the Working

Group’s Comment Letter on the definition of "Major Swap Participant" submitted to the Commission on

September 20, 2010.

See Dodd Lincoln letter, supra, note 2.

9 The prohibition on use of the clearing exemption by financial entities was introduced in the Senate

Committee on Agriculture, Nutrition, and Forestry’s Wall Street Transparency and Accountability Act of 2010,

which passed on April 21, 2010. The legislation was never formally filed with the Senate, but was combined

with Title VII of S. 3217 as passed by the Senate Committee on Banking, Housing, and Urban Affairs on March

25, 2010, which did not limit the clearing exemption to only nonfinancial firms.
WILLIAMS

David A. Stawick, Secretary

Commodity Futures Trading Commission

November 5, 2010

Page 5

4. HEDGING.

In both contexts in which the term "commercial risk" is used, it is used in context of

hedging commercial risk. The term "hedge" should be construed in a manner to cover any

transaction entered into to mitigate commercial risk, including transactions entered into to

mitigate risk associated with the price of physical commodities and transactions entered into

to hedge financial risk associated with the operation of a commercial business.1° The term

bonafide hedge is defined in new CEA Section 4a(c) and its application is extended to cover

Swaps as well as futures.11 This definition is largely a codification of the definition of"bona

fide hedge" in CFTC Regulation 1.3(z).

When defining what it means to hedge commercial risk, the Commission, consistent

with both its current practice and Congressional intent, should include any transaction

entered into by a commercial end user of Swaps to mitigate physical or financial risk

10 The Commission should again note the direct link it established between hedging and commercial

transactions and speculative and non-commercial transactions when determining what qualifies as a hedge of

commercial risk. See note 5 supra.

11 New CEA Section 4a(c)(2) states: "the Commission shall define what constitutes a bona fide hedging

transaction ...--

"(A)(i) represents a substitute for transactions made or to be made ... in a physical marketing channel;

"(ii) is economically appropriate to the reduction of risks in the conduct and management of a

commercial enterprise; and

"(iii) arises from the potential change in the value of--

"(I) assets that a person owns, produces, manufactures, processes, or merchandises or

anticipates owning, producing, manufacturing, processing, or merchandising;

"(II) liabilities that a person owns or anticipates incurring; or

"(III) services that a person provides, purchases, or anticipates providing or

purchasing; or

"(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)."
WILLIAMS

David A. Stawick, Secretary

Commodity Futures Trading Commission

November 5, 2010

Page 6

associated with the operation of a commercial business. The Commission has applied the

definition of "bona fide hedge" to transactions in which a party was hedging risk associated

with a physical commodity. The Commission has also recognized that bona fide hedging

transactions are a valid activity of financial entities.12 Congress also recognized that hedging

transactions by commercial end users of Swaps should include transactions that mitigate

physical or financial risk. Senators Dodd and Lincoln, in their June 30, 2010 letter to

Congressmen Frank and Peterson, state: "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.’’13

Energy market participants enter into a wide variety of customized Swaps to hedge

the risks inherent in operating a commercial energy firm, and all of these Swaps should be

considered hedges of commercial risk. Such Swaps vary in purpose and complexity. For

example, a commercial energy firm will often engage in basic Swaps such as an interest rate

Swap to hedge the risk associated with issuing long-term bonds to finance the construction of

a power plant or pipeline or a Swap to fix the price of natural gas delivered to a specific

location. Commercial energy firms will also enter into more complex and customized Swaps

such as weather Swaps to hedge demand volatility associated with unanticipated volatility in

the temperature. Thus, given the wide range of risks associated with the operation of a

commercial energy firm, the Commission should adopt a view of hedging commercial risk

that encompasses the Swap transactions entered into to mitigate such risks.

B. 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 their

proposed rules will impact Swap markets.

12 See CFTC Interpretive Letter 94-21, January 24, 1994, CFTC Interpretive Letter 95-27, February 16,

1995, and CFTC Interpretive Letter 97-30, April 21, 1997.

13 See Dodd Lincoln letter, supra, note 2.
WILLIAMS

David A. Stawick, Secretary

Commodity Futures Trading Commission

November 5, 2010

Page 7

II. CONCLUSION.

The Working Group supports tailored regulation that brings transparency and stability

to the energy Swap markets in the United States. We appreciate the balance the Commission

must strike between effective regulation and not hindering the energy 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,

/s/David T. McIndoe

David T. Mclndoe

Mark W. Menezes

R. Michael Sweeney, Jr.

Counsel for the

Working Group of Commercial Energy Firms