September 28,2010 

Mr. David Stawick, Secretary 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, NW 

Washington, DC 20581 

Natural Gas Supply Association 

Subject: Pre-Proposal Comments on OTC Derivatives Rulemakings Regarding 

Subject Areas II, V, VIII and XXVI 

Dear Mr. Stawick: 

In response to the U.S. Commodity Futures Trading Commission ("CFTC" or 

"Commission") August 26, 2010, Notice of Acceptance of Public Submissionsl , the 

Natural Gas Supply Association ("NGSA") submits the following comments. 

References made herein to the Commodity Exchange Act (the "CEA") refer to that 

statute as amended by the Dodd-Frank Wall Street Reform and Consumer Protection 

Act of 2010 (the" Act.") 

Established in 1965, NGSA represents integrated and independent companies 

that produce and market approximately 40 percent of the natural gas consumed in the 

United States. Because of the potential for the Act to unnecessarily impede what is and 

has been a healthy and resilient natural gas market, NGSA was an active participant in 

shaping the Act during its passage and wishes to take an active role in the Act's 

successful implementation. 

The United States natural gas market is a well-functioning, competitive market. 

Congressional changes, such as the passage of the Wellhead Decontrol Act of 19892 and 

regulatory reform implementing those changes (i.e., separating a competitive natural 

gas supply market from a regulated cost-based pipeline transportation sector) resulted 

in the liquid, modern wholesale natural gas market where prices are established by the 

competitive forces of supply and demand. In the July 2009 white paper titled Price 

1 Acceptance of Public Submissions on the Wall Street Refonn and Consumer Protection Act and the Rulemakings 

that will be Proposed by the Commission, 75 Fed. Reg.52,512 (Aug. 26, 2010). 2 Pub. L. 101-60,103 Stat. 157 (1989). 

Clean Natural Gas: Smart, Secure and Essential 

1620 Eye Street, NW • Suite 700 • Washington, DC 20006 • (202) 326-9300 • www.ngsa.org 

Representing the Nation's Producers of Natural Gas 
Transparency in the U.S. Natural Gas Market, Dr. William Albrecht noted, " .. . the U.S. 

natural gas market, unlike any other natural gas market in the world is very 

competitive, liquid, transparent and efficient. Natural gas prices over the long-term 

reflect supply and demand, leading to efficient use of natural gas by all sectors of the 

economy." 3 

As such, there are no captive customers in the wholesale natural gas market. 

Competition exists not only among natural gas suppliers, but also from suppliers of 

alternative fuels, such as coal and fuel oil. Most participants in the natural gas market 

are large, sophisticated entities with the market expertise to forecast and hedge risk 

with respect to their physical natural gas positions and which possess strong balance 

sheets anchored by substantial physical assets. In addition, the natural gas industry is 

capital-intensive and requires long-term investments. Industry participants have long 

hedged the risks associated with these lengthy investment time horizons by using 

bilateral contracts. 

The continuation of a robust, cost-effective bilateral market for hedging risk is 

essential to the health and continued growth of U.S. natural gas supplies. Congress 

recognized the importance of cost-effective financial instruments to end-users and other 

non-financial entities in passing the Act. The CFTC should implement regulations that 

reflect Congress's recognition of the importance of these, and should do so in a manner 

that does not impede the ability of financial markets to continue to serve as a cost 

effective risk mitigation tool that supports continued investment in energy and the 

economy. 

NGSA members are in the business of producing and marketing natural gas in 

the United States. While NGSA members may enter into swaps, they do so primarily 

to hedge or mitigate commercial risk. Thus, NGSA members do not "deal" in or make 

markets in swaps as those terms are commonly understood. Due to some ambiguity in 

the Act, the statute does not confirm that commercial risk hedging activities of some 

NGSA members would not result in them being designated Swap Dealers or Major 

Swap Participants even though these members engage in swaps to hedge commercial 

risk or accomplish other permissible purposes. The continued health and development 

of the physical natural gas market hinges on the adoption of a regulatory framework 

that resolves this ambiguity. At a minimum regulations should be adopted that protect 

physical market participants from increased costs that would divert capital from 

productive uses - particularly where such diversion would not further the goal of 

protecting consumers. 

In addition to resolution of the ambiguity regarding the definitions of the Swap Dealer 

and Major Swap Participant, rules regarding four key issues are critical to maintaining 

3 William P. Albrecht, Price Transparency in the U.S. Natural Gas Market at 2 (July 14, 2009) (white paper on file 

with NGSA). 

2 
the long-term health of the U.S. natural gas industry and the integrity of the Act's 

provisions aimed at addressing end-user concerns. The significance of these four issues 

to the health of the physical natural gas market is even more critical depending on how 

the Swap Dealer and Major Swap Participant definitions are decided. In that regard, 

NGSA urges the Commission to consider the following: 

1. Swap Dealer. The de minimis exclusion within the Swap Dealer definition 

should be based on the percentage of an entity's swap transactions with 

customers relative to its total swap transactions (i.e., swap transactions with 

customers and counterparties) within the applicable swaps category. 

2. Capital & Margin Requirements for Non-Bank Swap Dealer. Non-bank 

Swap Dealer capital and margin requirements should be based on an 

evaluation that recognizes differences among market participants that affect 

their overall risk profiles, including factors such as the presence of physical 

assets, the relative strength of their balance sheet and parent company 

support. Entities with low risk profiles should face lower capital and margin 

requirements than those that present greater risk. 

3. Review Process for Swaps Subject to Mandatory Clearing Requirements. 

Within the statutory criteriar the liquidity test for the process of identifying 

swaps subject to mandatory clearing should be based on the full term of the 

swap agreement, rather than a portion of the term. If the liquidity test cannot 

be satisfied for the full term of the agreement,~ the swap must not be subject to 

mandatory clearing. 

4. Position Limits. The bona fide hedging exemption with respect to position 

limits must be applied in a manner that avoids (1) rigid categorization of 

market participants that would limit business flexibility with respect to 

hedging commercial risk and (2) using hindsight to "second-guess" entities' 

attempts to hedge. 

1. Swap Dealer. The de minimis exclusion within the Swap Dealer definition should be 

based on the percentage of an entity's swap transactions with customers relative to 

its total swap transactions {i.e., swap transactions with customers and 

counterparties) within the applicable swaps category. 

Paraphrasing the CEA, section 1(a)(49)(A) defines the term "swap dealer" as any 

person who: 

i. holds itself o~t as a dealer in swaps; 

ii. makes a market in swaps; 

iii. regularly enters into swaps with counterparties as an ordinary course of business for 

its own account; or 

3 
iv. engages in any activity causing the person to be commonly known in the trade as a 

dealer or market maker in swaps .... 

Congress provided a de minimis exception to the categorization of a Swap Dealer 

in section la(49)(D) of the CEA: "The Commission shall exempt from designation as a 

Swap Dealer an entity that engages in a de minimis quantity of swap dealing in 

connection with transactions with or on behalf of its customers." Importantly, Congress 

made the exception applicable to those engaged in a de minimis quantity "of swap 

dealing in connection with transactions with or on behalf of its customers." CEA, 

section la(49)(D) narrows the Swap Dealer definition to include only entities where the 

majority (technically, more than a de minimis amount) of their swap transactions are 

with or on behalf of customers. Those entities regularly engaging in swaps, unless 

more than a de minimis amount represents swap dealing with customers, are exempt 

under CEA, section 1a(49)(D). Even if one of the other criteria arguably applies to an 

entity, if the swap activity with or on behalf of customers is de minimis, the entity is 

exempt. As stated above, the de minimis exclusion within the Swap Dealer definition 

should be based on the percentage of a Swap Dealer's swap transactions with customers 

relative to that Swap Dealer's total swap transactions within the applicable category. 

NGSA members are in the physical natural gas business. While most engage in 

swaps, unlike a Swap Dealer, the majority of their swaps are with counterparties, not 

customers. Thus, the use of the term 'customer' in the de minimis exception is 

significant. It indicates that Congress sought to subject those swap dealers entering into 

transactions with or on behalf of customers to the new requirements imposed on swap 

dealers but sought to exclude those entities engaging swap transactions where swap 

transactions with customers reflect a relatively small portion of those entities' overall 

swap transactions. 

NGSA recommends that the CFTC rely on the contractual agreements between 

transacting parties to determine whether those parties have a "customer" relationship. 

Given the sophistication of entities that engage in over-the-counter derivatives 

transactions,4 the CFTC should adopt a presumption that parties to such transactions 

are not customers unless an agreement between those parties explicitly states that the 

parties intend their relationship to be a customer relationship. NGSA appreciates that 

this presumption could be used by a traditional swap dealer to evade being deemed a 

Swap Dealer under the Act, and suggests that the CFTC could adopt a threshold test 

within the de minimis exception to prevent such evasion. For example, the CFTC could 

adopt a presumption that entities that are bank holding companies and non-bank 

financial companies subject to regulation under Title I of the Act do not qualify for the 

de minimis exception. 

4 See Commodity Futures Trading Commission v. Zelener, 373 F. 3d 861 (7th Cir. 2004) (""Eligible contract 

participants" under the Commodity Exchange Act are the equivalent of ' accredited investors' in securities markets: 

wealthy persons who can look out for themselves directly or by hiring experts."). 

4 
2. Capital & Margin Requirements for Non-Bank Swap Dealers. Non-bank Swap 

Dealer capital and margin requirements should be based on an evaluation that 

recognizes differences among market participants that affect their overall risk 

profiles, including factors such as the presence of physical assets, the relative 

strength of their balance sheet and parent company support. Entities with low risk 

profiles should face lower capital and margin requirements than those that present 

greater risk. 

Regulations implementing the Act's capital and margin requirements should be 

drafted consistent with the language of the statute and with congressional intent 

regarding mitigation of systemic risk and avoidance of unnecessarily tying up capital 

from beneficial forms of investment. As Senators Dodd and Lincoln stated in their 

letter to House leadershipS: 

It 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. 

Regarding entities such as "energy companies who produce and distribute power" the 

Senators went on to state: 

These entities did not get us into this crisis and should not be punished for 

Wall Street's excesses. They help to finance jobs .... 6 

Regulations addressing the capital and margin requirements for non-bank Swap 

Dealers and Major Swap Participants will impact the level of working capital in the 

economy. To avoid unnecessarily tying up capital used for investment, NGSA urges 

the Commission to adopt regulations that recognize differences among market 

participant balance sheets and other factors that affect overall risk profile such as the 

nature of the entity's business, the presence of physical assets and, when applicable, 

parent company support. Where such differences exist, the CFTC' s regulations should 

require significantly lower levels of capital and margin. Finally, the regulations should 

provide flexibility to non-bank Swap Dealers to recognize commercially acceptable 

forms of collateral. 

This approach recognizes physical asset investment and strong balance sheets 

and avoids increasing the risk management costs of those entities that do not pose a 

5 Letter from Sen. Christopher Dodd and Sen. Blanche Lincoln to Rep. Barney Frank and Rep. Colin 

Peterson 1 Oune 30, 2010) (the "Dodd-Lincoln Letter") 6 ld. at2. 

5 
systemic risk. Absent such an approach, capital and margin requirements effectively 

will have a capital-draining effect on the economy. 

3. Review Process for Swaps Subject to Mandatory Clearing Requirements. The 

liquidity test for identifying swaps subject to mandatory clearing should be based on 

the full term of the swap agreement, rather than a portion of the term. If the 

liquidity test cannot be satisfied for the full term of the agreement, the swap must 

not be subject to mandatory clearing. 

Although Congress put clearing at the heart of the derivatives market reform in 

the Act, Congress also acknowledged that: 

... clearing may not be suitable for every transaction or every 

counterparty. End users who hedge their risks may find it challenging to 

use standard derivative contracts to exactly match up their risks with 

counterparties willing to purchase their specific exposures. Standardized 

derivative contracts may not be suitable for every transaction.? 

Such is the case in the natural gas industry, where many swaps, by virtue 

of their long terms, are customized and relatively illiquid. Yet those swaps are 

particularly important in supporting long-term infrastructure investments in 

production and pipeline capacity. As such, the Commission should ensure that, 

in its review of swaps and its rules regarding such review, it does not subject 

such customized, long-term swaps to the Act's mandatory clearing requirement. 

Section 2(h)(2) of the CEA requires the Commission to (1) review, on an ongoing 

basis, swaps and classes of swaps to determine whether they should be required to be 

cleared, (2) review submissions from derivatives dearing-organizations regarding 

which such swaps they plan to accept for clearing, and (3) adopt rules for such review. 

In this regard, one of the considerations that the Act expressly requires the Commission 

to take into account in determining whether a swap or class of swaps should be 

required to be cleared is its "trading liquidity," i.e., the existence of markets where such 

swaps can be bought or sold with relative ease. 8 

In the natural gas market in which NGSA members participate, long-term swaps 

are often used to hedge long-term contracts in the physical commodity or physical 

transportation market. The long terms of such swaps often make them very illiquidi.e., almost no "market" exists with respect to such swaps other than the very limited 

ones between the particular pairs of entities transacting with each other on bilateral 

7 ld 

8 See CEA § 2(h)(2)(D)(ii) 

6 
bases. By definition, such long-dated swaps are "customized," as opposed to 

"standardized," and thus represent the kind of swap that Congress did not intend to be 

subject to mandatory clearing by derivatives-clearing organizations. 

Congress recognized that required clearing of such illiquid transactions would 

be extremely inefficient, considering the paucity of equivalent contracts with which 

they could be cleared, which would effectively "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. )"9 Along those same lines, 

forcing swap participants to break up customized swaps into standardized and 

customized components in order to centrally clear some portion lies outside the scope 

of the Act and would promise to increase transaction costs contrary to congressional 

intent. For these reasons, Congress has effectively provided for the exclusion of illiquid 

swaps from the mandatory clearing requirement. In its future review of such swaps 

and in its rulemakings with respect to such review, the Commission should ensure that 

contracts that are illiquid by virtue of their long terms should not be subjected to the 

Act's mandatory clearing requirement. 

4. Position Limits. The bona fide hedging exemption with respect to position limits 

must be applied in a manner that avoids (1) rigid categorization of market 

participants that would limit business flexibility with respect to hedging commercial 

risk and (2) using hindsight to "second-guess" entities' hedging practices. 

Section 4a(a) of the CEA requires the Commission to establish aggregate position 

limits across various kinds of contracts, including positions in swaps exclusive of "bona 

fide hedge" positions. As Congress has made clear, the Commission must implement 

this bona fide hedging exemption in a manner that does not impede companies from 

appropriately managing their risk. On April26, 2010, the NGSA filed comments10 on 

the Commission's Notice of Proposed Rulemaking regarding Federal Speculative 

Position Limits for Referenced Energy Contracts and Associated Regulations.11 In those 

comments, NGSA offered recommendations to the Commission's then current proposal. 

Among those recommendations was that the Commission avoid adopting "crowding 

out" provisions that limit diverse portfolio approaches and harm liquidity. As 

proposed by the Commission, the crowding out proposal would preclude those market 

participants that use hedge exemptions from holding speculative positions, which 

would materially and negatively impact the role of the bona fide hedge exemption. As 

the Commission prepares to implement the position limits provisions of the Act, NGSA 

incorporates its previous comments by reference and makes two additional points. 

9 Dodd-Lincoln Letter at 2 10 See attached NGSA comments (Apr. 26, 2010). 11 75 Fed. Reg. 4144 (Jan. 26, 2010). 

7 
First, any modifications to the Commission's definition of "bona fide hedging 

transactions and positions" in section 1.3(z) of the Commission's regulations12 must 

maintain or enhance the flexibility of that definition with respect to the countless 

manners of transactions and positions that entities might find necessary or useful in 

hedging risk. Therefore, the Commission must avoid establishing rigid classifications 

of the kinds of transactions and positions that qualify as bona fide hedges. 

Second, in considering what positions are hedges, and what positions might be 

speculative, the exemption must be applied by the Commission using the forwardlooking, situation-specific perspectives of individual swap participants. As an 

example from the natural gas market, consider a natural gas supplier hedging against 

predictions of a disruptive hurricane season in the Gulf of Mexico. In the event that the 

hurricane season is significantly less disruptive than predicted, the position the supplier 

took to hedge its perceived risk, as perceived at the time it entered into the subject 

transaction(s), should not be second-guessed in hindsight by the regulator as 

"speculation" on hurricane activity. Such second-guessing would effectively 

undermine swap participants' confidence in, and beneficial utilization of, the bona fide 

hedge exemption. 

In summary, successful implementation of the Act to avoid harming investment 

in the U.S. natural gas market hinges on the rules surrounding these four key issues. 

The CFTC has the statutory authority to adopt rules that protect the U.S. financial 

system, but should do so in a manner that does not negatively impede continued robust 

investment in U.S. energy infrastructure or natural gas market liquidity. 

NGSA stands ready to work with the Commission regarding these important 

issues concerning implementation of the Act. Please do not hesitate to contact us if we 

can provide any additional information. 

Sincerely, 

J hnifer Fordham 

Vice President, Markets 

Natural Gas Supply Association 

1620 Eye Street, NW 

Suite 700 

Washington, DC 20006 

Direct: 202-326-9317 

Email: jfordham@ngsa.org 

12 17 C.F.R. § 1.3(z) (2010). 

8