Received CFTC 

International Swaps and Derivatives Association, Inc. Records Section 

360 Madison Avenue, 16th Floor (;lit New York, NY, 10017 {.,; 1 -- Z:1 

United States of America · "'· COMMENT 

Telephone: (212) 901-6000 

Facsimile: (212) 901-6001 

email: isda@isda.org 

website: www.isda.org 

June 16, 2009 

Mr. David Stawick 

Secretary 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, N.W. 

Washington, DC 20581 

Re: Concept Release regarding Bona Fide Hedge Exemptions: 

12282 (March 24, 2009) 

Dear Mr: Stawick: 

This letter is submitted on behalf of the International Swaps and Derivatives 

Association, Inc. ("ISDA'') in response to the concept release (the "Release") issued by the 

Commodity Futures Trading Commission (the "CFTC" or the "Commission") regarding whether 

the CFTC should eliminate bona fide hedge exemptions for over-the-counter ("OTC") derivative 

exposures that swap dealers have to their counterparties and replace such exemptions with 

limited risk management exemptions. In the short time following the publication of the Release, 

various policyrnakers-including the Secretary of the Treasury and the Commission's new 

Chairman-have discussed a range of proposals with respect to the regulation of derivatives and 

derivatives markets. Certain of these proposals, if adopted, would affect CFTC practices with 

respect to bona fide hedge exemptions. The questions raised in the Release with respect to OTC 

derivative hedges exemptions are therefore relevant in the context of the treatment of hedge 

exemptions as part of broader regulatory reform and any further action by the Commission 

should only be considered in that context. 1 

ISDA, which represents participants in the privately negotiated derivatives 

industry, is among the world's largest global financial trade associations as measured by number 

of member firms. ISDA was chartered in 1985, and today has over 820 member institutions from 

57 countries on six continents. These members include most of the world's major institutions 

The Release was published in the Federal Register on March 24, 2009 (74 Fed. Reg. No. 

240 at 12282 et seq.). 
IS D A International Swaps and Derivatives Association, Inc. 

that deal in privately negotiated derivatives, as well as many of the businesses, governmental 

entities and other end-users that rely on over-the-counter derivatives to manage efficiently the 

financial market risks inherent in their core economic activities. Information about ISDA and its 

activities is available on the Association's web site: www.isda.org. 

Background 

Swap Dealers' Use of Hedge Exemptions. ISDA represents the vast majority of 

swap dealers who execute swap transactions for a variety of end-users. To provide these 

services, ISDA members regularly obtain and rely on hedge exemptions to access the futures 

markets to hedge exposure arising from customized swap transactions. As such, ISDA believes 

that the experiences of its members in relation to hedge exemptions and the reliance that such 

institutions have placed on hedge exemptions are relevant for the Commission to consider in the 

context of the review that it has undertaken in connection with the Release. 

Derivative transactions, such as swaps and cash-settled options, allow market 

participants, including commodity producers, processers, and end-users, as well as corporations, 

banks and governmental entities, to manage financial risks caused by fluctuating interest rates, 

currencies, commodity prices and securities prices. In commodities markets, swap dealers play a 

critical role by enabling both commercial and noncommercial market participants to transfer 

risks through the use of specialized transactions to address specific commodity hedging and price 

exposure needs. Such transactions are often not available on futures markets. For example, 

derivative transactions allow airlines to hedge effectively their price exposure to jet fuel, even 

though there are no jet fuel contracts available on the futures markets for airlines to hedge 

directly their price exposure. By entering into such transactions as principals the swap dealers 

also assume the administrative burden of managing the risks arising from the differential 

between the commitments undertaken in connection with derivative transactions with the 

transactions that are available to hedge the risks arising from such transactions. 2 These types of 

arrangements, for example, provide the airlines with protection from their price exposure to jet 

fuel. Furthermore, customized derivative transactions allow airlines and other end-users to 

hedge their market risks without having to access the markets directly. Requiring end-users to 

access the markets directly prevents them from precisely hedging their financial risks, as 

required to utilize FAS 133 "hedge accounting" rules. This creates additional volatility on their 

balance sheets, which could lower balance sheet valuations for end-users and restrict their 

financial growth as they must maintain capital to protect against unhedged financial risks. ISDA 

believes that the financial system and the economy as a whole are materially stronger and more 

resilient because of such swap transactions. 

In order to manage the risks associated with the risk transfer transactions 

described above, swap dealers enter into various types of transactions as hedges. These may 

include OTC derivatives with other dealers or market participants and exchange traded futures 

and options on futures. The ability of swap dealers to access futures exchanges to hedge risks 

assumed in entering into OTC derivative depends in many instances on the availability of bona 

2 Staff Report on Commodity Swap Dealers and Index Traders with Commission 

Recommendations, at pp. 11-2. 

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lSD A International Swaps and Derivatives Association, Inc. 

fide hedge exemptions. Swap dealers are able to offer efficiency and competitive pricing to their 

clients by managing the risks associated with the various positions in their books across all 

markets and all participants, without regard a particular counterparty' s line of business or 

motivation for entering into a transaction. In this manner, swap dealers aggregate and offset the 

various OTC derivative exposures (long and short and across all counterparties) and access 

exchanges (incurring the associated costs) for only the net residual risk that remains after such 

aggregating and offsetting. 

Special Call and September 2008 Report. During the spring and summer of 2008, 

crude oil, gasoline and various agricultural and other commodities reached record high prices. 

The increased price and volatility of these commodities, especially for crude oil, prompted the 

CFTC to issue a Special Call to swap dealers engaged in the business of offering swaps on 

physical commodities to provide the CFTC with data on the activity of their end-users in both the 

futures and OTC markets (the "Special Call"). The Special Call required swap dealers engaged 

in commodity index businesses, other large swap dealers, and commodity index funds to provide 

data relating to the total activity of their end-users in the futures and over-the-counter markets, 

and to categorize the activities of their respective end-users, beginning December 31, 2007 

through June 30, 2008. 

In September 2008, the CFTC issued a Staff Report on Commodity Swap Dealers 

and Index Traders with Commission Recommendations (the "September 2008 Report"). The 

September 2008 Report analyzed the data gathered on the end-users from December 31,2007 

through June 30, 2008 under the Special Call and issued a series of recommendations to provide 

greater transparency in the "maruier and amount of trading that occurs through swap dealers. "3 

After the publication of the September 2008 Report, the CFTC continues to gather data on the 

end-users from swap dealers every month. 

Recommendation Five. Recommendation Five of the September 2008 Report 

calls on the CFTC to issue an advance notice of proposed rulemaking on whether to eliminate 

bona fide hedging exemptions for swap dealers and replace them with a limited risk management 

exemption together with a reporting requirement. The September 2008 Report suggested that the 

requirement be triggered when noncommercial swap clients reach a certain position level and 

that it also obligate swap dealers to certify that their noncommercial clients do not exceed 

position limits for exchange-traded futures on the underlying commodities. The Release seeks 

comments and information on whether to proceed with Recommendation Five to eliminate the 

bona fide hedge exemption for swap dealers and replace it with the conditional limited risk 

management exemption. The Release also asks what form the new limited risk management 

rules should take and how they should be implemented. 

ISDA appreciates the opportunity to express its views on the Release and the 

ability to work with the CFTC and other policymakers to provide additional transparency into 

3 Staff Report on Commodity Swap Dealers and Index Traders with Commission 

Recommendations, at p. 32. 

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IS D A International Swaps and Derivatives Association, Inc. 

derivative transactions, and to prevent market manipulation and price disruptions. However, 

ISDA is concerned that implementing the recommendations in the Release as proposed would 

greatly limit the ability of swap dealers to facilitate the risk management of commercial and 

noncommercial market participants, who rely on derivative transactions to transfer risks inherent 

in their business/investment portfolios to specialists that have the requisite experience and 

infrastructure to manage such risks. Implementing the recommendations in the Release as 

proposed would seriously undermine this function. ISDA strongly believes that ceasing to grant 

to swap dealers new hedge exemptions and/or eliminating existing hedge exemptions will 

deprive the market of a valuable tool used by commercial and noncommercial market 

participants that will result in decreased liquidity and impairment of price discovery in the 

commodity markets. Furthermore, we recommend that the CFTC clearly define which party and 

under what conditions an entity would be subject to the regulations in the Release. 

ISDA also believes that there are a number of more appropriate ways to promote 

transparency in the swap market and to prevent market manipulation and price disruption and we 

are pleased to share our ideas with the CFTC. In particular, ISDA agrees that carefully tailored 

and targeted reporting requirements can provide additional transparency into the commodity 

markets, allowing swap dealers to continue to serve their important risk management function for 

market participants. We believe, however, that even new reporting requirements need to be 

evaluated in light of information learned in the Special Call and in light of other regulatory and 

legislative initiatives. 

Introduction 

Analysis of Special Call Data. The Commission initiated the Special Call out of a 

concern that energy price volatility was exacerbated by noncommercial market participants. In 

point of fact, the data gathered pursuant to the Special Call supported the opposite conclusion. 

The Special Call data reflected more than 90% of the actual total long and short futures and 

options positions held by all the swap dealers as well as "essentially all of the index trading done 

through swap dealers" for NYMEX crude oil positions. 4 Of this universe, 20 market participants 

were identified to the CFTC as having aggregate positions (all on-exchange futures positions 

plus all OTC positions combined, on a futures equivalent basis) that exceed position 

accountability levels. And of those 20, 14 were commercial entities, while 6 were 

noncommercial entities. 5 The September 2008 Report also confirmed that none of these 

combined positions violated any existing laws or regulations and the amounts by which the 

traders exceeded the limit or level were "generally small."6 

4 

5 

6 

Staff Report on Commodity Swap Dealers and Index Traders with Commission 

Recommendations, at p. 23. 

Staff Report on Commodity Swap Dealers and Index Traders with Commission 

Recommendations, at p. 23-4. 

Staff Report on Commodity Swap Dealers and Index Traders with Commission 

Recommendations, atp. 5. 

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IS D A International Swaps and Derivatives Association, Inc. 

In addition, the September 2008 Report found that, during the run up of energy 

prices during the first six months of 2008, the aggregate long positions of commodity index 

traders in NYMEX crude oil declined roughly 11%, as index traders rebalanced their portfolios 

in response to the rise in crude oil prices. The September 2008 report stated that, "In other 

words, the sharp rise in the net notional value of commodity index business in crude oil futures 

appears to be due to an appreciation of the value of existing positions caused by the rise in crude 

oil prices and not the result of more money flowing into commodity index trading." 7 The 

findings of the September 2008 report are consistent with other reports showing that the 

volatility in commodity prices were the result of supply and demand, not a result of additional 

activity in the markets from noncommercial participants. 8 

·Additional Data. ISDA applauds the timely release of the September 2008 

Report. But as the Report itself noted, the collection of data and subsequent analysis by CFTC 

staff was undertaken during a relatively short timeframe. Given that the CFTC has continued to 

collect data from swap dealers under the Special Call, ISDA believes that it would be highly 

useful, and perhaps essential, for the CFTC to analyze and subsequently release additional data 

gathered from the Special Call before taking further action on the Release or any proposed rules. 

7 

8 

Staff Report on Commodity Swap Dealers and Index Traders with Commission 

Recommendations, at pp. 22-3. 

In March 2009, the Task Force on Commodity Futures Markets of the International Organization 

of Securities Commissions ("IOSCO"), co-chaired by the CFTC and the United Kingdom's 

Financial Services Authority, issued a report on the agricultural and energy commodities markets 

that found that economic fundamentals were the primary cause in the price volatility in the 

physical commodities markets during the summer 2008, not speculative activity. Task Force on 

Commodity Futures Markets Final Report, Technical Committee of the International 

Organization of Securities Commission (March 2009). The International Monetary Fund's World 

Economic Outlook, published in October 2008, found that "there is little discernable evidence 

that the buildup of related financial positions [in commodity markets] has systematically driven 

either prices for individual commodities or price formation more broadly." World Economic 

Outlook, International Monetary Fund (October 2008). A report by the European Commission 

concluded that the rise and fall of the price in oil in the recent past was due to supply and demand 

factors, with little or no evidence to suggest that speculators flooding the commodity markets 

caused price volatility. First Interim Report on Oil Price Developments and Measures to Mitigate 

the Impact oflncreased Oil Prices, European Commission (1 September 2008). In addition, the 

preliminary assessment of the CFTC Inter-Agency Task Force on Commodity Markets is that 

fundamental supply and demand is the underlying causes of oil price volatility, not speculators. 

Interagency Task Force on Commodity Markets, Interim Report on Crude Oil, Washington D.C. 

Finally, a Government Accountability Office report released in January 2009, at the request of 

U.S. House Agriculture Committee Chairman Collin Peterson, found limited evidence that 

speculation was affecting commodity prices, even using empirical studies designed to detect a 

very weak relationship between futures speculators and commodity prices. All of the empirical 

studies upon which the GAO based their report showed, " ... limited statistical evidence of a 

causal relationship between speculation in the futures markets and changes in commodity 

prices-regardless of whether the studies focused on index traders, specifically, or speculators, 

generally." Issues Involving the Use of the Futures Markets to Invest in Commodity Indexes, 

Government Accountability Office, at 5. GA0-09-285R Commodity Indexes (January 30, 2009). 

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IS D A International Swaps and Derivatives Association, Inc. 

The additional findings would establish a foundation for any proposed rules by resting the 

CFTC's subsequent conclusions on additional data points gathered after the rapid decline in 

commodity prices. This additional transparency would be beneficial to the commodity markets 

and helpful to policymakers as they examine the various available alternatives to the existing 

position limit and hedge exemption regime. We encourage the CFTC to release analysis and 

aggregate data gathered from June 30, 2008 to the present. We also urge the CFTC to make 

publicly available the additional data received from the Special Call on an aggregated basis, to 

provide the public with access to this valuable information. 

ISDA also remains concerned that the September 2008 Report was released 

before the CFTC's staff could thoroughly analyze all of the data received in response to the 

Special Call. Given the short time frame of the data collection upon which the September 2008 

Report is based, the CFTC may not have received the full data sets needed to make a 

comprehensive analysis. As the CFTC has continued to gather this data after the publication of 

the September 2008 Report, ISDA urges the CFTC to re-examine the recommendations from the 

Report based on the additional data collected but not included in the September 2008 Report, 

before moving forward with any regulatory changes. 

Discussion 

ISDA appreciates the opportunity to express its views on the Release and the 

ability to work with the CFTC and others to craft a system that allows swap dealers to continue 

to facilitate the risk management of market participants, while allowing the CFTC additional 

transparency into swap transactions that are based on futures market prices and futuresequivalent positions. However, ISDA cautions that eliminating or limiting bona fide hedge 

exemptions for derivative exposures would seriously impact market participants that rely on 

swap transactions to transfer their commodity price risks to swap dealers that have experience, 

appropriate infrastructure and expertise in managing such risks. Replacing hedge exemptions 

with limited, risk-based exemptions would undermine the ability of dealers to manage risk 

consistently across counterparties and portfolios, which would likely cause dealers to be less 

willing to participate in the swap market, reducing the efficiency and utility of that market and, 

as a result, the futures markets. Reducing access to swap counterparties would expose market 

participants to commodity price fluctuations with only limited ability to hedge against price 

volatility. As a result, noncommercial market participants, and certain commercial participants, 

may decide not to participate in these markets, reducing the liquidity of commodity futures, 

thereby further impairing the ability of commercial participants to hedge their price exposure. 

Since hedging arrangements are often a prerequisite for loans to smaller oil and gas exploration 

and production companies, restrictions that reduce access to swaps could very well limit the 

availability of capital required to develop the resources that will be needed to promote price 

stability. 

Of course any changes, whether creating a new reporting requirement or 4l 

transitioning to a risk management exemption, will impose burdens on both swap dealers and 

their counterparties that the CFTC should carefully consider before moving forward. The 

relative benefit of any new system may be lost as the interruption of the risk management tool 

creates additional market instability and price volatility. ISDA encourages the CFTC to carefully 

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IS D A International Swaps and Derivatives Association, Inc. 

evaluate the need for regulatory changes, as we strongly believe that any systemic changes to 

current hedge exemptions will be very difficult, for a variety of reasons outlined below. 

Reporting Requirements. ISDA believes that appropriately tailored reporting 

requirements, as called for in Recommendation Five, can have a beneficial impact on the 

commodity markets and market participants. However, there are a variety of means of 

accomplishing the objectives identified in the Release, and we believe that a number of 

alternative approaches would be more effective in doing so than the proposal outlined in 

Recommendation Five of the September 2008 Report. For example, the CFTC could obtain 

aggregate position information with respect to the OTC positions of a particular end-user, 

through the implementation of a reporting requirement for OTC transactions analogous to the 

Large Trader Reporting ("L TR") system that the CFTC currently has in place with respect to 

participation in the futures markets. Under this approach, each swap dealer would be required to 

report to the CFTC once an end-user's open OTC position reached a certain level with that swap 

dealer, in terms of futures equivalents. This requirement would apply regardless ofthe 

commercial or non-commercial status of the counterparties. This reporting system would allow 

the CFTC to track the open positions of swap counterparties effectively and efficiently and to 

evaluate any potential effect of such positions on the futures markets. This system would also 

provide the CFTC with the information necessary in order to enable it to take any appropriate 

action. We believe that this approach is supportive ofthe objectives to achieve additional 

transparency, outlined by Commission Chairman Gensler in his recent testimony to the Senate 

Committee on Agriculture, Nutrition and Forestry. 

Exemptions for Noncommercial End-Users; Well Defined Rule For Granting 

Hedge Exemptions. The elimination of the current hedge exemptions or cessation in granting 

hedge exemptions for transactions with noncommercial end-users could be harmful to the 

commodity markets, would restrict the hedging capability of commercial as well as 

noncommercial entities and would impair market liquidity. Specifically, such elimination or 

cessation of exemptions for transactions with noncommercial end-users will create market 

inefficiencies by preventing swap dealers from offsetting commercial positions with 

noncommercial positions, which allows dealers to manage risks across portfolios without regard 

to the line of business of a particular counterparty or the motivation of such entity for entering 

into derivative transactions. This approach to risk management enables the swap dealers to 

reduce their exposure to commodity prices and volatility, thereby promoting stability ofthe 

markets. 

By way of example, a swap dealer may have matching long and short positions 

for a commercial and a noncommercial counterparty. If the commercial counterparty liquidates 

its position, the swap dealer will have no place to hedge its exposure without appropriate futures 

exemptions. Moreover, a swap dealer may have positions with noncommercial counterparties 

that allow it to hedge for commercial counterparties more efficiently. Eliminating or limiting 

hedge exemptions for transactions with noncommercial end-users will also limit the ability of the 

swap dealer to acquire a sufficient number of positions in its portfolio in advance to enable the 

swap dealer to provide robust and efficient pricing to a commercial counterparty. 

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IS D A International Swaps and Derivatives Association, Inc. 

Eliminating or limiting hedge exemptions for swap dealers hedging transactions 

with noncommercial end-users in swap transactions and subjecting dealers to speculative 

position limits in connection with such transactions will likely result in swap dealers, and their 

counterparties, curtailing their participation in the swap markets. This will reduce the liquidity 

of the futures market, harming commercial counterparties looking to hedge their price exposure. 

This as well could reduce liquidity on U.S. exchanges and result in a migration of trading onto 

foreign exchanges that continue to provide hedge exemptions for swap transactions involving 

noncommercial end-users. Ifthe CFTC's objective is additional transparency into swap 

transactions and the reduction of price volatility in futures markets, a limited risk management 

exemption conditioned on the commercial status of the counterparty, in our view, will not 

achieve this objective. 

Certification by Swap Dealers. ISDA does not believe that swap dealers are the 

appropriate parties to certify that a counterparty is a commercial or a non -commercial and has 

not exceeded position limits. If required to certify the status and aggregate position of their 

counterparties, swap dealers will clearly need to rely, in most instances, on the end-users' 

certifications, because end-users will not be willing to share proprietary information with the 

swap dealer for competitive or other reasons. As a result, the swap dealer will merely serve as an 

unnecessary, and potentially less reliable, intermediary, by passing along documentation from 

the end-user to the CFTC. 

Coordination with Other Regulatory Reforms. ISDA believes that 

Recommendation Five and the proposals in the Release must be examined in light of and 

coordinated with other regulatory and legislative initiatives under consideration. The CFTC 

should coordinate this undertaking with other regulatory reforms that are in progress, in order to 

ensure consistency across the various approaches. The CFTC should ensure that any system for 

the reporting of positions by swap dealers, and for hedge exemptions, does not result in any 

duplication, overlap, or inconsistency with other rulemakings. For example, the Administration 

released its regulatory reform proposal for OTC derivatives on May 13th. CFTC Chairman 

Gensler recently provided testimony to Congress with respect to these initiatives. Also, many 

bills have been introduced in Congress that propose significant regulatory reforms including 

revising the hedge exemption definition, restricting position limits and imposing record keeping 

and reporting requirements. As the Administration and Congress develop legislative language 

for the regulation of OTC derivative transactions, we urge the CFTC to coordinate the proposals 

in the Release with these legislative efforts and other ongoing regulatory efforts. 

For the reasons set forth in this letter, we believe that limited risk management 

exemptions should be reconsidered and therefore, we will not be addressing the specific 

questions. 

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IS D A International Swaps and Derivatives Association, Inc. 

Conclusion 

ISDA understands and appreciates the need for additional transparency into the 

swap markets to prevent market manipulation and price manipulation and to reduce price 

volatility in the futures markets. However, we are concerned that the implementation of the 

proposals made in the Release will in fact, have the opposite effect. As briefly outlined in our 

letter, swap dealers perform a valuable market function by helping a wide variety of end-users 

manage their financial risk, through the creation of specialized swap transactions that address 

their specific commodity hedging and price exposure needs. By eliminating hedge exemptions 

for exposures incurred through derivatives with non-commercial market participants, swap 

dealers will no longer be able to provide this service to non-commercial end-users, which in turn 

will limit the services swap dealers can provide to commercial end-users. This will reduce 

liquidity in the futures markets, and may lead to an increase in commodity price volatility. ISDA 

believes that such an outcome is counter to the stated objective of the Release. ISDA cautions 

the CFTC that the elimination of hedge exemptions will undermine the objectives of the Release, 

to increase transparency into swap markets, an objective that ISDA supports. Finally, we urge 

the CFTC to reconsider the data it gathered under the Special Call, published in the September 

2008 Report, as it made clear that non-commercial market participants did not exacerbate energy 

price volatility, and to consider any actions it takes in this area only in the context of broader 

regulatory reforms currently being considered by the CFTC and Congress. 

ISDA appreciates the opportunity to provide these comments. Should you require 

any further information, please do not hesitate to contact the undersigned. 

Sincerely, 

£~c!Z~ Robert G. Pickel 

Executive Director and Chief Executive Officer 

International Swaps and Derivatives Association, Inc. 

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