Morgan Stan ley 

September 20, 2010 

1221 Ave of the Americas 

New York, NY 10020 

VIA b-MAIL: rule-comments@sec.gov; dfadefinitions@cftc.gov 

Ms. Elizabeth M. Murphy, Secretary 

Securities and Exchange Commission 

1 00 F Street, NE 

Washington, DC 20549-0609 

Mr. David A. Stawick, Secretary 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, NW 

Washington, DC 20581 

Re: Proposed Rules Relating to Definitions Contained in Title VII of Dodd-Frank 

Wall Street Reform and Consumer Protection Act (File No. S7-16-10) 

Dear Ms. Murphy and Mr. Stawick: 

We are responding to Release No. 34-62717 (the "Proposing Release"), in which the 

Securities and Exchange Commission (the "SEC') and the Commodity Futures Trading 

Commission (the "CFTC' and, together with the SEC, the "Commissions") solicited 

comments on certain definitions contained in Title VII of the Dodd-Frank Wall Street 

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

We appreciate the opportunity to comment on the definitions in the Proposing Release. In 

light of the current economic situation, it is imperative that the Commissions draft rules 

and regulations, including defining the terms discussed below, in a manner to avoid market 

disruption and to mitigate systemic risk. In our view, the Commissions should strive to 

provide market participants with the consistency necessary to transition seamlessly into 

compliance with Dodd-Frank. In addition, the Commissions should attempt, at all costs, to 

avoid unintended consequences that would impair, rather than help, the recovery of the 

financial markets and the economy as a whole. 

1. Recommendations Regarding Swap Dealer and Security-Based Swap Dealer 

Definitions 

Section 721(a)(21) of Dodd-Frank amends Section la of the Commodities Exchange Act 

(the "CEA") to add a new paragraph (49) defining "swap dealer;" and Section 761(a)(6) of 

Dodd-Frank amends Section 3(a) ofthe Securities Exchange Act of 1934, as amended (the 

"Exchange Act"), to add a new paragraph (71) defining "security-based swap dealer." The 

definitions are substantially similar and our comments apply to both. 

A. In General 

This section of the definitions include a list of four criteria, and it appears that the 

satisfaction of any one of those criteria could result in a person meeting the definition of a 

swap dealer (or security-based swap dealer). We believe a broad reading of these criteria 
by the Commissions would likely result in many more persons qualifying as a swap dealer 

(or security-based swap dealer) than market participants currently view as swap dealers (or 

security-based swap dealers). 

For example, clause (iii) of the definitions of "swap dealer" and "security-based swap 

dealer," which reads "regularly enters into [swaps/security-based swaps] with 

counterparties as an ordinary course of business for its own account," potentially captures 

many market participants that would not be traditionally viewed as dealers. This provision 

should be interpreted consistently with the traditional dealer/trader dichotomy used in 

interpreting the definition of"dealer" in Section 3(a)(5) of the Exchange Act. 

Historically, a distinction has been drawn between "dealers" and traders, with the former 

being subject to registration under the Exchange Act and the latter not. We believe that 

this dichotomy is equally applicable to clause (iii) since its language is substantially similar 

to the definition of dealer in Section 3(a)(5) of the Exchange Act. Factors that indicate a 

dealer include: 

• typically accommodating customer demand and generally entering into 

transactions to facilitate customer interest, 

• direct transactions with counterparties, as opposed to through 

intermediaries, 

• regular turnover of positions, 

• regular or continuous two-way quotes, and 

• arranging or providing credit. 

On the other hand, a trader would be an ordinary investor who buys and sells for his or her 

own account with some frequency. If interpreted broadly, clause (iii) could be read to pick 

up virtually all market participants (including individuals and smaller entities) who 

arguably trade, but do not deal, in swaps as part of a regular business. This could 

potentially even include entities that would satisfy the "end user" exemption from clearing 

found in Section 723(a)(3) of Dodd-Frank- entities that would be trading swaps as part of 

their regular business but also to hedge or mitigate commercial risk. It would be an odd 

result for persons Congress exempted from the clearing requirements to have to register as 

swap dealers. 

In addition, a broad interpretation of clause (iii) could result in the definitions of "swap 

dealer" and "security-based swap dealer" being so expansive that they capture practically 

every "major swap participant" and "major security-based swap participant," respectively. 

If Congress had intended that result, there would have been no need to create the categories 

of "major swap participant" or "major security-based swap participant" in the first place. 

We believe the Commissions should incorporate some of the "dealer" factors enumerated 

above in interpreting the scope of clause (iii) to ensure this clause does not inappropriately 

capture persons as swap dealers and securities-based swap dealers. 

We would also like to point out that the criteria in clause (ii) of the definitions of swap 

dealer and security-based swap dealer- "makes a market in swaps"- does not necessarily 

translate well from the securities market to the swaps markets. Depending on the liquidity 

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and convention for a particular swap product, "making a market" can span activities from 

continuously providing live, public bids and offers to being willing to provide a bid or 

offer quote from clients upon request. We believe the phrase "makes a market," should be 

interpreted in such a way to avoid capturing those entities that do not routinely make or 

stand ready to make two way markets for other market participants. Merely providing 

occasional quotes on one side of the market for a product should not trigger registration. 

We would also like to note that the Commissions may need to revisit the guidance 

provided under clause (ii) depending on the rules that are adopted for regulated exchanges 

or swap execution facilities or security-based swap execution facilities (collectively, 

"SEFs"). Depending on what functionality is required or made available by a SEF or a 

regulated exchange to its participants, it could be the case that many or all participants on 

certain types of platforms could be viewed as dealers when trading on that particular 

platform. 

B. Inclusion 

This section of the definitions clearly state that an entity should not be treated as a "swap 

dealer" or "security-based swap dealer" generally, but rather have its status as a "swap 

dealer" or "security-based swap dealer" assessed with respect to a particular product or in a 

defined market. 1 This approach is both reflective of the realities of the marketplace and 

consistent with Congressional intent. In a letter from Senator Christopher Dodd, Chairman 

of the Senate Committee on Banking, Housing, and Urban Affairs, and Senator Blanche 

Lincoln, Chairwoman of the Senate Committee on Agriculture, Nutrition, and Forestry, to 

Representative Collin Peterson, Chairman of the Committee on Agriculture, and 

Representative Barney Frank, Chairman of the Financial Services Committee, Senators 

Dodd and Lincoln stressed the importance of differentiating amongst products by stating, 

"[i]t is also imperative that regulators do not assume that all over-the-counter transactions 

share the same risk profile." Cong. Record, June 30, 2010, H5248. 

We believe it necessarily follows from this approach that capital requirements and other 

rules applicable to swap dealers or security-based swap dealers should apply only to those 

activities of a dealer falling within the swap categories for which it is required to register. 

Capital calculations and other requirements for swap dealers or security-based swap 

dealers should not encompass transactions or positions that are not subject to direct 

regulation. This is consistent with the legislative intent of Congress. Senators Dodd and 

Lincoln noted in their letter that "[i]t is imperative that the regulators do not unnecessarily 

divert working capital from our economy into margin accounts, in a way that would ... 

impair economic growth." Cong. Record, June 30, 2010, H5248. If the Commissions 

Section (C) of the definition of"swap dealer" states that "[a] person may be designated as a swap 

dealer for a single type or single class or category of swap or activities and considered not to be a 

swap dealer for other types, classes, or categories of swaps or activities", and Section (B) of the 

defmition of "security-based swap dealer" states that " [a] person may be designated as a securitybased swap dealer for a single type or single class or category of security-based swap or activities 

and considered not to be a security-based swap dealer for other types, classes, or categories of 

security-based swaps or activities." 

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were to apply capital requirements in a broader sense than that which we have suggested, 

funds and capital would be unnecessarily diverted. 

2. Recommendations Regarding Major Swap Participant and Major Security-Based 

Swap Participant Definitions 

Section 721(a)(16) of Dodd-Frank amends Section la ofthe CEA to add a new paragraph 

(33) defining "major swap participant," and Section 761(a)(6) of Dodd-Frank amends 

Section 3(a) of the Exchange Act to add a new paragraph (67) defining "major securitybased swap participant." The definitions are substantially similar and our comments apply 

to both. 

A. In General 

First, the phrase "any person" in these definitions clarifies that the intent is for the test to 

be made on an entity basis and that companies managed by a single manager are not 

aggregated. Chairman Lincoln said as much in a colloquy with Senator Hagan during the 

Senate floor debate on the Dodd-Frank Conference Committee Report. In response to 

Senator Hagan asking, "When considering whether an entity maintains a substantial 

position in swaps, should the CFTC and the SEC look at the aggregate positions of funds 

managed by asset managers or at the individual fund level?", Chairman Lincoln responded, 

"As a general rule, the CFTC and the SEC should look at each entity on an individual basis 

when determining its status as a major swap participant." Congr. Record, June 15, 2010, 

S5907. 

Second, the term "substantial position," found in clause (i) of the definitions of "major 

swap participant" and "major security-based swap participant," should be limited to those 

positions that are large enough to create a systemic risk in the market. A contrary view 

would be inconsistent with the legislative intent. In our view, the best measure of 

"substantial" from a systemic risk perspective would be based on the potential risk of the 

net positions such market participant holds and potential disruption to the financial markets 

if that market participant were to default. Measures based on notional exposures or 

number of trades, while easy to calculate, do not necessarily accurately capture market 

risk. While a risk-based measure would be best, using fair values determined in 

accordance with GAAP would be a better approximation than notional amount or trade 

count. 

No matter what measure the Commissions determine to utilize, we believe that any 

calculation should be on a net basis and, as is currently the case, netting should be given 

effect across all products and transactions subject to a netting arrangement. Further, 

collateral should also be netted because collateral reduces possible systemic risk? This 

v1ew is consistent with Congressional intent, as evidenced by Chairman Lincoln's 

2 In addition to collateral, the proposed regulations should take into account the netting or offsetting 

effect of other forms of certain acceptable credit risk mitigation, such as letters of credit that satisfy 

minimum requirements as to their terms and conditions and the credit quality of the issuer. 

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statement during the Senate floor debate on the Dodd-Frank Conference Committee 

Report: 

When determining whether a person has a "substantial position," the CFTC 

and the SEC should consider the person's relative position in cleared versus 

the uncleared swaps and may take into account the value and quality of the 

collateral held against counterparty exposures. The committee wanted to 

make it clear that the regulators should distinguish between cleared and 

uncleared swap positions when defining what a "substantial position" would 

be. Similarly where a person has uncleared swaps, the regulators should 

consider the value and quality of such collateral when defining "substantial 

position." Bilateral collateralization and proper segregation substantially 

reduces the potential for adverse effects on the stability of the market. 

Entities that are not excessively leveraged and have taken the necessary 

steps to segregate and fully collateralize swap positions on a bilateral basis 

with their counterparties should be viewed differently. Id. 

We would also suggest that the Commissions consider committing to revisit this definition 

once more information becomes available about the size and liquidity of the relevant 

markets as the reporting aspects of Dodd-Frank are implemented. 

Third, the phrase "substantial counterparty exposure," found in clause (ii) of the definitions 

of "major swap participant" and "major security-based swap participant," should be 

interpreted consistently with "substantial position" in clause (i) discussed above. 

Last, the phrase "highly leveraged," found in clause (iii) of the definitions of "major swap 

participant" and "major security-based swap participant," must be considered in light of 

the industry in which the entity participates. No single leverage test is appropriate due to 

the vast differences in business models. For example, the leverage of an entity's peers 

could be used as the relevant benchmark in determining whether the level of leverage for a 

particular entity is "high." 

B. Definition of Substantial Position 

Our recommendations are discussed above under "Recommendations Regarding Major 

Swap Participant and Major Security-Based Swap Participant Definitions-In General." 

C. Scope of Designation 

As we stated above under "Recommendations Regarding Swap Dealer and Security-Based 

Swap Dealer Definitions-Inclusion," we recommend that the Commissions clarify that 

capital requirements and other rules apply only to the category of swaps or security-based 

swaps as to which a person is designated as a major swap participant or a major securitybased swap participant. Therefore, capital calculations and other requirements should not 

encompass transactions or positions not subject to direct regulation. 

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3. Recommendations Regarding the Forward Contract Exclusion from the Definition 

of a Swap 

Section 721(a)(21) of Dodd-Frank amends Section la of the CEA to add a new paragraph 

(47) defining the term "swap", including a new subparagraph (47)(B) that provides for 

specific exclusions from the term "swap". Among other exclusions, excluded from the 

term "swap" are "(ii) any sale of a nonfinancial commodity or security for deferred 

shipment or delivery, so long as the transaction is intended to be physically settled." In 

order to avoid legal uncertainty, the intent requirement should be read consistently with the 

CFTC's long-standing policy as set forth in its Exemption for Certain Contracts Involving 

Energy Products, 58 F.R. 21286 (Apr. 20, 1993) (the "Energy Contracts Exemption"). 

As recognized by the CFTC in the Energy Contracts Exemption, many market participants 

hedge price risk by entering into forward contracts that require physical delivery. 

Subsequently, due to changing market conditions, the parties to the contract may mutually 

agree to settle or "book out" their delivery obligations such that there is a cash payment but 

no exchange of the physical commodity takes place. The parties may do so in order to 

minimize delivery related expenses or to terminate any further gain or loss on the original 

transaction. The phrase "so long as the transaction is intended to be physically settled" 

may introduce uncertainty as to whether these transactions that initially required physical 

delivery but were subsequently settled financially for legitimate and economically 

beneficial reasons had been excluded from the term "swap". 

This is consistent with the legislative intent of Congress. Senators Dodd and Lincoln 

stated in their letter that "[i]n 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." Cong. Record, June 30, 2010, H5248. 

Thus, to address the risk of legal uncertainty, the CFTC should affirmatively define a 

contract for the "sale of a nonfinancial commodity or security for deferred shipment or 

delivery, so long as the transaction is intended to be physically settled" consistent with the 

factors commonly reviewed with respect to the forward contract exclusion to determine 

whether the requisite intent existed. For example, the definition could adopt the language 

in the Energy Contract Exemption, which includes contracts that "impose binding 

obligations on the parties to make and receive delivery of the underlying commodity or 

commodities, with no right of either party to effect cash settlement of their obligations 

without the consent of the other party (except pursuant to a bona fide termination right), 

provided, however, that the parties may enter into a subsequent bookout, book transfer, or 

other such contract which provides for settlement of the obligation in a manner other than 

by physical delivery of the commodity specified in the contract." 

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4. Recommendations Regarding Mixed Swaps 

Section 721(a)(21) of Dodd-Frank amends Section la of the CEA to add a new paragraph 

(47) defining "swap," and Section 761(a)(6) of Dodd-Frank amends Section 3(a) of the 

Exchange Act to add a new paragraph (68) defining "security-based swap." Each of these 

sections adds the concept of a "mixed swap," and in both the CEA and Exchange Act, 

defines the term "security-based swap" to include agreements, contracts or transactions 

that satisfy the security-based swap definition and which also are based on the value of 

certain enumerated non-securities factors. Section 712(a)(8) of Dodd-Frank requires the 

Commissions to jointly prescribe such regulations regarding mixed swaps as may be 

necessary to carry out the purposes of Title VII of Dodd-Frank. 

In jointly prescribing such regulations, we do not believe the Commissions should 

establish a new, third regulatory regime for over-the-counter derivatives in addition to the 

regimes required under Dodd-Frank for swaps and security-based swaps. Had such a third 

complete regime been intended, we believe Congress would have included more specific 

guidance in the statutory language itself and would likely have referred to the term mixed 

swap more than the four times that the term is used in Dodd-Frank. Comparing the 

specificity and comprehensiveness of the regimes for swaps and security-based swaps in 

Dodd-Frank to the handful of references to the term mixed swap, it seems clear Congress 

intended the Commissions to leverage the swap and security-based swap regimes when 

prescribing rules for mixed swaps. 

Also, as discussed below, we believe that the scope of transaction types that would 

appropriately qualify as mixed swaps should be relatively small, further supporting the 

conclusion that a new, third regulatory regime would be unwarranted. 

The first point we would like to make regarding the scope of mixed swaps is that a 

security-based swap (e.g., a total rate of return swap on an equity security) which includes 

one or more payments calculated by reference to an interest rate (e.g., LIBOR) should not 

be treated as a mixed swap. Such a swap would not be properly viewed as "based on" an 

interest rate. The LIBOR based payments reflect compensation for the financing costs 

associated with total rate of return swaps and are not at the core of what is being 

"swapped" under the contract. 

The CFTC recognized as much in its adopting release for the Regulation of Hybrid 

Instruments (58 Federal Register 5580, Jan. 22 1993). In the adopting release, the CFTC 

recognized that a loan or note whose interest payments were calculated based on a floating 

rate, or even a formula that included a floating rate, should not be treated as a Hybrid 

Security, notwithstanding the fact that such rates constituted "commodities" under the 

CEA. If a security or loan with interest payments based on a formula which references 

floating rates is not a Hybrid Security, it follows that a security-based swap with a floating 

rate payment leg should not be viewed as a mixed swap. 

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Furthermore, if the more expansive reading were applied, only an extremely small category 

of security-based swaps would not qualify as mixed swaps. The vast majority of securitybased swap products also have at least some payment or contingency that is linked to 

something other than the value or yield of a security. Given the detail and 

comprehensiveness of the security-based swap regulatory regime envisioned by DoddFrank, it is difficult to believe Congress intended the universe of pure security-based swaps 

to be a de minim us portion of the swap market. 

Assuming security-based swaps with floating rate payment legs are not defined as mixed 

swaps, we believe the universe of mixed swaps should be relatively small. An example of 

a mixed swap might be a contract under which one party takes long exposure to the 

common stock of a US corporation while simultaneously taking short exposure to the price 

of gold. The question then becomes how to determine which regulatory regime - the one 

for swaps or the one for security-based swaps - should be applied to such a swap. Given 

the relatively small size of this population, and the fact that Dodd-Frank encourages the 

substantive regulation of swaps and security based swaps to be substantially similar, we 

believe the primary goals for creating a determination process should be simplicity, clarity 

and certainty. 

We believe a preponderance type test would fail to meet those goals. Prior to the 

enactment of the Commodities Futures Modernization Act in 2000, the CEA's Part 34 

Hybrid instrument exemption utilized such a regime and required that the commodity 

dependent value of the commodity dependent component of the hybrid instrument be less 

than the commodity independent value of the commodity independent component of the 

hybrid instrument. The test was unwieldy and costly to administer for hybrid instruments, 

which typically have a longer lead time prior to execution than do swap agreements. 

Imposing such a test in the context of fast paced swap markets would likely make certain 

mixed swaps infeasible. 

As no payments may change hands at the inception of a mixed swap, any assessment of the 

value of a component would probably need to be based on a forward looking estimate of 

the likely exposure under each component. In our common stock-gold swap example, this 

could involve estimating potential exposure under each leg as if it were a separate swap 

and comparing the two. As such estimates would necessarily be based on a party's views 

of volatility and individual models for the particular asset class, there would be no 

assurances that each party would come to the same conclusion as to which component was 

greater. More complicated mixed swaps may prove difficult, if not impossible, to 

bifurcate. For example, if we changed the payout formula of our common stock-gold swap 

such that no payment is made referencing the common stock for a particular day unless 

gold prices are within a specific band, bifurcation becomes highly complex. 

With some caveats mentioned below, we think a better approach would be to treat all 

swaps with securities based features as solely security-based swaps. In other words, the 

Commissions should prescribe rules that leave mixed swaps under the SEC's jurisdiction. 

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This is supported by Dodd-Frank, which defines mixed swaps under both the CEA and the 

Exchange Act as security-based swaps. In an indirect and less explicit manner, mixed 

swaps also fall under the swap definition (the provision excluding a security-based swap 

from the definition of swap expressly carves out from the exclusion those swaps falling 

under the provision defining mixed swaps as security-based swaps). It would seem, 

however, that some weight should be given to the fact that Congress took a far more 

straightforward path in expressly including mixed swaps in the security-based swap 

definition. 

Such an approach would be clear, certain and simple to apply. Assuming substantive 

regulation is virtually the same, this approach would not result in materially different 

regulatory treatment than a predominance test. If the Commissions felt swaps which 

included references to a particular asset class (for example, agriculture) needed to be 

subject to direct CFTC oversight, we would not be opposed to a rule that defined all mixed 

swaps that referenced such an asset class as swaps (and not security-based swaps) under 

Dodd-Frank. Our main concern is that any rule be simple to apply and create a clear and 

certain result. 

Finally, while under our suggestion the bulk of regulatory oversight for mixed swaps 

would fall under a single regulator, joint authority with respect to certain provisions of 

Dodd-Frank may still be appropriate. For example, notwithstanding the treatment of 

mixed swaps solely as security-based swaps, we would not be opposed to the CFTC having 

anti-fraud and anti-manipulation authority over the non-securities components of mixed 

swaps. 

* * * * 

We appreciate the opportunity to comment to the Commissions on the definitions, and 

would be pleased to discuss any questions either Commission may have with respect to 

this letter. Any questions about this letter may be directed to Richard Ostrander 

(richard.ostrander@morganstanley.com; 212 762 5346). 

l!Managing D~ irector and Counsel 

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