II-00026

From:

Sent:

To:

Cc:

Subject:

Attach:

Cameron, Tim <tcameron@sifma.org>

Wednesday, November 24, 2010 12:50 PM

’rulecomments@sec.gov’; dfadefinitions <dfadefinitions@CFTC.gov>;

OTCDefinitions <OTCDefinitions@CFTC.gov>; JointSEC

<JointSEC@CFTC.gov>; ’rule-comment@sec.gov’

Fekrat, Bruce <bfekrat@cftc.gov>; Danger, Kenneth L <KDanger@CFTC.gov>;

Littlefield, Thomas L <TLittlefield@CFTC.gov>; Banaei, B. Salman

<BBanaei@CFTC.gov>; Hosseini, Ali <AHosseini@CFTC.gov>; Aron, David

<DAron@CFTC.gov>; ’sanown@sec.gov’; ’eadyt@sec.gov’; ’cranev@sec.gov’;

’grantr@sec.gov’

Follow-Up Letter

SIFMA.AMG.FollowUp.Letter.pdf

Subject: Definitions / Follow-Up to File Number $7-16-10

Attached please find a comment letter on certain issues discussed at the November 1 meeting between members

of the staffs of the Commissions and representatives of the Asset Management Group of the Securities Industry

and Financial Markets Association.

Please feel free to contact me with any questions or comments.

Sincerely,

Tim Cameron
sifma

im’est~d in America

November 24, 2010

Mr. David A. Stawick

Secretary

Commodity Futures Trading Commission

Three Lafayette Centre

1155 21st Street, N.W.

Washington DC 20581

Ms. Elizabeth M. Murphy

Secretary

Securities and Exchange

Commission

100 F Street, N.E.

Washington, DC 20549-1090

Re: Definitions / File Number $7-16-10

Dear Mr. Stawick and Ms. Murphy:

The Asset Management Group (the "AMG") of the Securities Industry and

Financial Markets Association ("SIFMA")1 appreciates the opportunity to supplement

our letter to the Commodity Futures Trading Commission (the "CFTC") and the

Securities and Exchange Commission (the "SEC" and, together with the CFTC, the

"Commissions") dated September 20, 2010 (the "AMG Letter") and provide the

Commissions with additional comments regarding issues raised during a November 1,

2010 meeting held among members of the respective staffs of the Commissions and

representatives of the AMG.2

Objective Test for Major Swap Participants

At the November 1 meeting, meeting participants discussed the AMG’s proposal

to use an objective "aggregate uncollateralized counterparty credit exposure" test to

determine whether an entity is a "major swap participant" or "major security-based swap

participant" (collectively, "MSP"). The AMG continues to believe that this is the

appropriate test for determining whether a swap participant poses systemic risk based on

its swap or security-based swap (collectively, "Swap") positions.

At the meeting, the Commissions asked whether additional factors, including a

measure of future exposure, should be considered in making the MSP determination. The

AMG does not believe that future exposure should be considered. It is standard industry

1 SIFMA brings together the shared interests of hundreds of securities firms, banks and

asset managers. SIFMA’s mission is to support a strong financial industry, investor opportunity,

capital formation, job creation and economic growth, while building tmst and confidence in the

financial markets. SIFMA, with offices in New York and Washington, D.C., is the U.S. regional

member of the Global Financial Markets Association. For more information, visit www.sifma.org.

2 The AMG Letter can be found attached.
practice to mark to market positions in, net and move collateral for Swaps on a daily

basis, all of which mitigates the long-term risk posed by Swap positions.

Nevertheless, if the Commissions were to adopt a standard based on future

exposure, the AMG would suggest that the Commissions explore established market

measures of future exposure. In particular, the Commissions should explore measures

used by clearinghouses to determine initial margin requirements for cleared Swaps,

which have been carefully developed in order to measure the risk of potential future

losses from Swap positions. The AMG believes that the notional value of an entity’s

Swaps is not an appropriate measure of future exposure or the risk created by Swap

positions, since such a measure does not reflect the relative risk of various investments

and does not reflect actual amounts that are likely to be owed by a counterparty to a Swap.

A notional test for MSP would likely overstate the risk and lead to inclusion of some

entities without systemically significant Swap positions or cotmterparty exposure within

the definition of MSP; it could also potentially lead to the exclusion of some entities that

create systemically significant risk from their Swap positions from the definition.

At the November 1 meeting, CFTC staff members also inquired about the

AMG’s views in determining when an entity is "highly leveraged" for purposes of the

third prong of the MSP definitions.3 The AMG believes that Commissions should look

first to established capital measures for leverage, of which many are calculated by entities

subject to prudential regulation.

Appropriate Level to Apply Objective MSP Test

Additionally, as discussed at the November 1 meeting and in the AMG Letter,

the AMG believes it is inappropriate for the test for MSPs to be applied at the level of the

asset manager or across multiple counterparties to a swap that may be managed by the

same asset manager. Asset managers are agents of the cotmterparties to Swaps - not the

counterparties themselves - and therefore do not contribute to the systemic risk that the

regulation of MSPs is designed to address. Individual funds and accounts are separate

legal entities or separate series of a trust or company, with separate investment mandates,

which do not share assets or liabilities. Creditors generally do not have recourse to the

asset manager for the liabilities of the funds they manage. Moreover, regulating asset

managers as MSPs would create unnecessary and duplicative regulation for registered

investment advisers already subject to extensive regulation trader the Investment

Advisers Act of 1940. Registered investment advisers also have fiduciary duties to each

of their clients that they are required to follow in managing each individual account.

Finally, applying capital and margin requirements to asset managers or across multiple

clients of an asset manager would be nearly impossible to do in a meaningful way, and

would be illogical as the individual client is the only party with capital at risk under its

Swaps.

3 The AMG believes that the third prong of the MSP definitions is meant to provide a test

for highly leveraged entities that is the same as the substantial position test in the first prong but

does not carve out hedge positions or positions held by ERISA funds. The AMG believes that

being highly leveraged does not, in itself, qualify an entity as an MSP.
The Definition of"Forei~n Exchange Forward"

As discussed at the November 1 meeting, the AMG believes that the CFTC

should, through rulemaking, clarify that the definition of"foreign exchange forward"

does not include spot foreign exchange transactions ("Spot FX"). There is no indication

in Title VII that Congress meant to regulate spot transactions as part of the regulatory

regime developed for over-the-counter derivatives. However, under one very strict

reading that could be made of the definition of "foreign exchange forward" any exchange

of foreign currencies with a settlement cycle longer than same-day ("T+0") could be

included.4 The AMG does not agree with this interpretation and does not believe that

Spot FX was meant to be included within the definition of "foreign exchange forward" or

"swap." Spot transactions customarily settle within a settlement cycle of six days ("T+6")

or less and are generally executed in order to facilitate international trades or repatriation

of dividends or foreign investments. Spot FX is not entered into for speculative purposes

and it would not be appropriate to treat such transactions as swaps.5 To increase market

and legal certainty, the AMG believes that the CFTC should explicitly carve out Spot FX

from the definitions of "foreign exchange forward" and "swap."

In addition, the AMG believes that the CFTC should clarify, through rulemaking,

that non-deliverable foreign exchange forwards ("NDFs") are "foreign exchange

forwards." The definitions of foreign exchange forward and foreign exchange swap

might technically be read to exclude NDFs and include economically identical foreign

exchange forwards. NDFs and foreign exchange forwards differ only in that the

settlement of NDFs is made in just one currency. Due to their economic similarity, the

AMG believes that these products should be treated similarly and that, in particular,

Congress intended that any determination by the Secretary of the Treasury to exclude

foreign exchange forwards from the definition of "swap" would also include NDFs.6

4 New Commodity Exchange Act § la(25) defines "foreign exchange forward" as "a

transaction that solely involves--(A) an exchange of 2 different currencies on a specific date at a

fixed rate that is agreed upon on the inception of the contract covering the exchange; and (B) a

reverse exchange of the 2 currencies described in subparagraph (A) at a later date and at a fixed

rate that is agreed upon on the inception of the contract covering the exchange."

5 The Spot FX market is large, highly liquid and low risk. Furthermore, its relatively

short settlement cycle does not lend itself well to collateralization or frequent valuations. Treating

such transactions as swaps would be highly dismptive to the normal functioning of the Spot FX

market.

6 It is a general tenet of the Title VII of the Dodd-Frank Wall Street Reform and

Consumer Protection Act that economically similar products be trealed similarly, both within and

across regulatory agencies. See § 712(a)(7).
The AMG again thanks the staffs of the Commissions for the opportunity to

discuss issues relating to the MSP definitions and the definition of "foreign exchange

forward." If you have any question concerning this letter, please do not hesitate to call

the undersigned at 212-313-1389.

Sincerely,

Timothy W. Cameron, Esq.

Managing Director, Asset Management Group, SIFMA
SIFMA

September 20, 2010

Mr. David A. Stawick

Secretary

Commodity Futures Trading Commission

Three Lafayette Centre

1155 21st Street, N.W.

Washington DC 20581

Ms. Elizabeth M. Murphy

Secretary

Securities and Exchange Commission

100 F Street, N.E.

Washington, DC 20549-1090

Re: File Number $7-16-10

Dear Ms. Murphy and Mr. Stawick:

The Asset Management Group (the "AMG") of the Securities Industry and

Financial Markets Association ("SIFMA")1 appreciates the opportunity to provide the

Commodity Futures Trading Commission (the "CFTC") and the Securities and Exchange

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

comments regarding certain key definitions2 in the derivatives title ("Title VII") of the

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

and the joint regulation by the Commissions of "mixed swaps."

The AMG’s members represent U.S. asset management firms whose combined

assets under management exceed $20 trillion. The clients of AMG member firms include,

among others, registered investment companies, state and local government pension

funds, universities, 401 (k) or similar types of retirement funds, and private funds such as

hedge funds and private equity funds. In their role as asset managers, AMG member

1 The Securities Industry and Financial Maackets Association brings together tke shaaced interests of

more tkan 600 securities firms, banks and asset maxmgers. SIFMA’s mission is to promote policies and

practices lkat work to expax~d and perfect maa:kets, foster lke development of new products axed services and

create efficiencies for member firms, while preserving axed enhancing the public’s trust and confidence in the

markets and the industry. SIFMA works to represent its members’ interests locally and globally. It has offices

in New York, Washington D.C., and Eondon axed its associated firm, lke Asia Securities Industry and

Financial Maa:kets Association, is based in Hong Kong.

2 The "key definitions" defined in flae Commissions’ request for comment include "swap,"

"security-based swap," "swap dealer," "security-based swap dealer," "major swap participant," "major

security-based swap participant," "eligible contract participant" and "security-based swap agreement."
firms, on behalf of their clients, may engage in transactions, including transactions for

hedging and risk management purposes, that will be classified as "swaps" and "securitybased swaps" (collectively, "Swaps") under Title VII of the Dodd-Frank Act.

"Swap Dealers," "Security-Based Swap Dealers," "Maior Swap Participants" and

"Major Security-Based Swap Participants"

The AMG believes that the statutory definitions of (1) the terms "swap dealer"

and "security-based swap dealer" (collectively, "Swap Dealers") should be further

defined by regulation to exclude market participants that do not perform the traditional

functions of dealers and (2) the terms "major swap participant" and "major security-based

swap participant" (collectively, "Major Participants") should be further defined by

regulation to exclude persons who neither have, nor present, a level of exposure to their

Swap counterparties that reasonably could be considered to be systemically important or

capable of significantly impacting the financial system of the United States. In addition,

the Commissions’ rules should clarify that it is the entity that is counterparty to Swaps,

on an entity-by-entity basis, that may fall within the major swap participant and major

security-based swap participant definitions (together, the "Major Participant

Definitions") and not the asset manager who manages the assets of such entity. Further,

the AMG believes that registered investment companies and employee benefit plans

subject to the Employee Retirement Income Security Act of 1974 ("ERISA") should be

excluded by regulation from the Major Participant Definitions.

Swap Dealers should be limited to entities engaging in traditional dealing activities.

The AMG does not believe that Congress intended the swap dealer and securitybased swap dealer definitions (together, the "Swap Dealer Definitions") in the DoddFrank Act to be read to encompass market participants who enter into Swaps as part of

investment or hedging strategies but do not engage in the business of dealing in Swaps.

The definitions include any person who "regularly enters into [Swaps] with

counterparties as an ordinary course of business for its own account." The AMG believes

that the term "regularly enters into [Swaps] ... as an ordinary course of business"

contemplates the regular business of engaging on both sides of the market as a market

intermediary and for the purpose of profiting by providing liquidity to counterparties.

The AMG believes that the Swap Dealer Definitions were intended by Congress to

operate in a manner similar to the definitions of "broker" and "dealer" under the

Securities Exchange Act of 1934 (the "Exchange Act") and "futures commission

merchant" ("FCM") under the Commodity Exchange Act. While the statutory

definitions of broker-dealer and FCM are also broadly drawn, the Commissions have,

through interpretation, definitional rulemaking and other forms of guidance, clarified the

activities leading to registration as a dealer or FCM. For example, typical "dealer"

activities have involved the broker-dealer or FCM acting as agent on behalf of clients, or

acting as principal where they were in the business of providing liquidity to other market

participants or as a market intermediary. For instance, the SEC has issued a series of noaction letters identifying factors that differentiate dealers from traders and, accordingly,

most market participants, including active traders, are not required to register as a brokerdealer. In addition, the AMG believes that the statutory creation of the separate

categories of "major swap participant" and "major security-based swap participant,"

which would otherwise be redundant, lends support to our view that the Swap Dealer
Definitions should be similarly limited. Simply put, the AMG believes that the Swap

Dealer Definitions should pick up only those institutions that are known in the markets to

be dealers of Swaps under the well-established definition of what otherwise constitutes a

"dealer."

Members of the AMG manage the assets of funds and other clients that typically

enter into Swaps to execute a particular investment or hedging strategy, similar to traders

of securities or futures contracts. Because the ordinary business of these clients is

financial in nature, it is possible that a strict reading of the plain language of the Swap

Dealer Definitions would include them. The AMG does not believe this was the intent of

Congress. Accordingly, the AMG believes that the Commissions’ rulemaking should

clarify that the definitional prong regarding "enter[ing] into [Swaps] ... as an ordinary

course of business," requires activity on both sides of the market for the purpose of

profiting from providing liquidity to counterparties or acting as a market intermediary.

The Commissions should promulgate a clear, objective test for Major Participants

based on "aggregate uncollateralized counterparty credit exposure."

Sections 721(a)(16) and 761(a)(6) of the Dodd-Frank Act set forth the Major

Participant Definitions. Both of the Major Participant Definitions contain three prongs,

each of which looks to the systemic risk posed by a market participant with respect to its

Swap activity. In particular, the first and third prongs of each definition look to whether

the market participant "maintains a substantial position" in Swaps. Each of the

Commissions is required to define "substantial position" for purposes of these prongs "at

the threshold that [it] determines to be prudent for the effective monitoring, management,

and oversight of entities that are systemically important or can significantly impact the

financial system of the United States." The Dodd-Frank Act provides further that "the

[Commissions] shall consider the person’s relative position in uncleared as opposed to

cleared Swaps and may take into consideration the value and quality of collateral held

against eounterparty exposures." (Emphasis added.) Similarly, the second prong of

each definition looks to whether the market participant’s outstanding Swaps "create

substantial counterparty exposure3 that could have serious adverse effects on the financial

stability of the United States banking system or financial markets.’’4

3 The AMG reads tkfis to mema an entity’s counterparties’ exposure to tk~at entity, ralk~er than

exposure the entity itself holds visa vis its counterparties.

4 In a Senate Colloquy, Senator Blmache Lincoln stated to Senator Kay Hagan lk~at:

When determining whether a person has a "substmatial position," lk~e CFTC mad tk~e SEC

should consider the person’s relative position in cleaxed versus lk~e uncleared swaps and

may take into account lk~e value and quality of the collateral held against counterpaxty

exposures. The committee wmated to make it clear lk~at lk~e regulators should distinguish

between cleared and uncleared swap positions when defining what a "substantial

position" would be. Similarly where a person has uncleared swaps, tk~e regulators should

consider lk~e value and quality of such collateral when defining "substantial position."

Bilateral collateralization mad proper segregation substantially reduces the potential for

adverse effects on the stability of the market. Entities lk~at are not excessively leveraged

and have taken lk~e necessaxy steps to segregate mad fully collateralize swap positions on a

bilateral basis with their counterpaxties should be viewed differently.
The AMG believes that the Commissions should address these considerations by

establishing objective quantitative standards. In particular, the AMG recommends a rule

providing that no person would be deemed a Major Participant unless that person’s

aggregate uncollateralized counterparty credit exposure exceeds, on average for any

calendar quarter, $2.5 billion with respect to all of such person’s counterparties.

"Aggregate uncollateralized counterparty credit exposure" could be defined to

mean,

with respect to any person on any day, the aggregate amount that such person

would owe to its counterparties tf such person’s entire portfolio of swaps and

security-based swaps (other than "Jbreign exchange swaps" and "Jbreign

exchange forwards, ,5 as defined under Title VII of the Dodd-Frank AcO6, tf any,

was terminated on such day as a result of the deJbult of such person. For the

purposes of calculating such amount with respect to any individual counterparty,

the market value of any collateral such person has posted with that counterparty

shall be deducted and all applicable contractual netting provisions shall be given

effect.

This definition draws on well-established understandings of how net credit exposure is

calculated with respect to over-the-counter derivatives portfolios. It also acknowledges

the commercial reality recognized by Congress in the Dodd-Frank Act that collateral

decreases the risks to a Swap counterparty and to the financial system as a whole.

The third prong of the Major Participant Definitions focuses on whether a

financial entity is "highly leveraged relative to the amount of capital such entity holds."

The AMG notes that this prong of the Major Participant Definitions is substantially

similar to the first prong of the definitions and that, therefore, the determination of a

"substantial position" should focus on uncollateralized positions as discussed above.7 In

this regard, the AMG notes that high leverage, in itself, is not sufficient to cause an entity

to be a Major Participant.

5 The AMG recommends that tJae CFTC clarify, flarough rulemaking, flaat spot txansactions flaat

settle within one customaxy settlement cycle (typically T+6 or less) do not constitute foreign exchange

forwaxds or swaps.

6 The AMG has excluded exposures arising from foreign exchange forwards and swaps from this

calculation due to the unique characteristics of flaat maxket. The AMG notes flaat under the Dodd-Frank Act,

flae Secretary offlae Treasury may make a written determination that such inslxuments should be excluded

from the definition of"swap." The AMG believes that such an exclusion is appropriate. If it were

determined that foreign exchange exposures should be included in flae calculation of "aggregate

uncollateralized credit exposure," the AMG believes flaat flae Commissions should evaluate flae differing

characteristics of foreign exchange exposures to determine flae extent to which such exposures should be

discounted and/or the extent to which an appropriate upwaxd adjuslanent should be made to the $2.5 billion

flareshold suggested above.

7 Unlike the first prong of tJae Major Participmat definitions, the tJaird prong which applies to

highly leveraged entities - does not seem to exclude from the determination of whether an entity has a

"substmatial position’’ in Swaps positions maintained (a) for tJae purpose of hedging or mitigating commercial

risk or (b) by aaa ERISA plan for tJae primary purpose of hedging or mitigating the operational risk of tJae plan.

Otherwise, the first and flaird prongs axe substantively identical.
The AMG also believes that the Commissions should promulgate objective

quantitative standards for determining whether a financial entity is "highly leveraged" for

purposes of this third prong. In formulating these standards, the AMG suggests that the

Commissions’ further rulemaking in determining what constitutes "leverage" should take

into account: the difference between non-recourse and recourse obligations; the

difference between notional amounts payable and actual payment obligations; and the

difference between actual financial obligations of an entity and leverage embedded in a

derivative that affects returns but does not result in a payment obligation. Only once the

definition of "leverage" has been established can the industry respond to what might be

considered to be "highly" leveraged.

The designation of a Major Participant should be determined by reference to the

principal counterparty to a Swap; an asset manager should not be required to register

as a Major Participant based on Swap activities of its clients.

Members of the AMG believe, for the reasons discussed below, that the

Commissions’ rulemakings should make clear that an asset manager will not be deemed

to be a Major Participant on the basis that it "maintains" positions in Swaps for the

accounts of its clients, including the funds it advises.8 Similarly, the Commissions should

ensure that individual clients of an asset manager will not be aggregated in determining

that a person maintains a "substantial position" in Swaps.

Focus On Systemic Risk. The AMG believes that the primary goal of regulation

of Swap Participants is the reduction of systemic risk. In a Senate colloquy, Senator Kay

Hagan indicated to Senator Blanche Lincoln, and Senator Lincoln agreed, that "when the

[Commissions] are making the determination as to whether a person dealing in swaps is a

major swap participant or major security-based swap participant, it is the intent of the

conference committee that both the [Commissions] focus on risk factors that contributed

to the recent financial crisis, such as excessive leverage, under-collateralization of swap

positions, and lack of information about the aggregate size of positions.’’9

The AMG does not believe that the goal of reducing systemic risk would be

served by requiting an asset manager to register as a Major Participant solely because it

acts as an agent in transacting Swaps for clients. Asset managers are not the

counterparties to the Swaps entered into by their clients, and the exposure and related risk

created by Swaps is exposure to and for the clients, not the asset manager. Under this

approach, an investment fund that enters into Swaps as principal might be considered a

Major Participant, but an investment adviser to the fund, in its capacity as such, would

not, simply as a result of its advisory services.

Client-level determination of Major Participant status is supported by the

legislative history of Title VII. In a Senate colloquy, Senator Hagan asked Senator

Lincoln: "When considering whether an entity maintains a substantial position in swaps,

8 The AMG notes tk~at tk~e clarifications lk~e AMG is requesting would not apply to lk~e extent that

an asset manager, acting as ~ for its own account (rather than on behalf of clients), enters into Swaps

and as such, could be viewed as a Major Paxticipant.

9 The AMG believes that "aggregate size of positions" refers here to lk~e aggregate positions held by

a particulax counterpaxty (ralk~er tk~ma aggregate positions held by a paxticular asset manager’s clients).
should the [Commissions] look at the aggregate positions of funds managed by asset

managers or at the individual fund level?" Senator Lincoln replied that "[a]s a general

rule, the [Commissions] should look at each entity on an individual basis when

determining its status as a major swap participant."

Certain Regulatory Requirements Applicable to Major Participants are Not

Appropriate for Asset Managers. The regulatory regime applicable to Major Participants

may fit individual funds and other market participants that maintain substantial positions

in Swaps, but is ill-suited to asset managers in their role as advisers. For example,

Sections 73 l(e) and 764(e) of the Dodd-Frank Act require Major Participants to meet

certain capital and margin requirements.1° It would be difficult, if not impossible, to

apply these requirements in a meaningful way at the asset manager level, or across

multiple clients.

Regulation of Asset Managers as Investment Advisers Makes Additional

Regulation as a Major Participant Unnecessary and Duplicative. The Investment

Advisers Act of 1940 (the "Advisers Act"), as amended by the Dodd-Frank Act,

generally requires any asset manager that manages at least $100 million in assets to

register as an "investment adviser" with the SEC. The Advisers Act imposes obligations

on registered advisers that are similar to many of the requirements that will apply to

Major Participants, and gives the SEC significant authority to inspect and examine

registered advisers. The AMG submits that Advisers Act regulation further supports the

view that it is unnecessary for any registered adviser to be separately regulated as a Major

Participant. For example, registered investment advisers are, or will become, subject to

the following requirements, among others:

As a result of the Dodd-Frank Act, advisers to private funds will be required

to comply with the Advisers Act’s obligations to maintain records and

reports regarding each private fund advised by the adviser that include: (i)

amount of assets under management, (ii) use of leverage, (iii) counterparty

exposure, (iv) trading and investment positions, (v) valuation policies and

practices, (vi) types of assets held, (vii) side arrangements or side letters, (viii)

trading practices and (ix) other information deemed by the SEC, in

consultation with the Financial Stability Oversight Council, to be necessary

and appropriate in the public interest, and for the protection of investors or

for the assessment of systemic risk. 11

The Dodd-Frank Act requires the SEC to promulgate rules requiring each

investment adviser to a private fund to file reports containing such

information as the SEC deems necessary and appropriate in the public

interest and for the protection of investors or for the assessment of systemic

risk.

10 Capital and margin requirements are established by the prudential regulator of flaose entities that

have a prudential regulator, mad are established by the Commissions for those entities that do not have a

prudential regulator.

11 Registered investanent advisers were already subject to many of these requirements even prior to

the passage of the Dodd-Frank Act.
The Dodd-Frank Act modified the prior Advisers Act prohibition limiting the

SEC’s ability to require investment advisers to disclose the identity,

investments or affairs of their clients by adding an exception enabling the

SEC to require the disclosure of such information for purposes of assessment

of potential systemic risk.

 ̄ All records of private funds maintained by a registered investment adviser,

not just those required to be maintained by law, will be subject to periodic

and special examination by the SEC.

A registered investment adviser must appoint a chief compliance officer,

establish a compliance program and a code of ethics and comply with

custody and recordkeeping requirements. An adviser is also subject to

examination and inspection by the SEC.

The Major Participant Definitions should exclude registered investment companies

and employee benefit plans subject to ERISA. Such entities are already highly

regulated, and regulation as a Major Participant would impose inconsistent,

unnecessary and duplicative requirements.

Many AMG members are advisers to investment companies registered under the

Investment Company Act of 1940 (the "Investment Company Act") and employee

benefit plans subject to ERISA. Under these regimes, the activities of registered funds

and ERISA plans - including transactions in Swaps - are subject to robust regulation.

Additional regulation as a Major Participant is unnecessary and would likely impose

conflicting or redundant requirements on such entities.12

The AMG believes that excluding such entities from regulation as a Major

Participant is consistent with Congressional intent. In a Senate colloquy, Senator

Blanche Lincoln stated that:

it may be appropriate for the CFTC and the SEC to consider the nature and

current regulation of the entity when designating an entity a major swap

participant or a major security-based swap participant. For instance, entities such

as registered investment companies and employee benefit plans are already

subject to extensive regulation relating to their usage of swaps under other titles

of the U.S. Code. They typically post collateral, are not overly leveraged, and

may not pose the same types of risks as unregulated major swap participants.

12 While "positions maintained by any employee benefit plan (or any contxact held by such a plan)

as defined in paragraphs (3) and (32) of section 3 of tk~e Employee Retirement Income Security Act of 1974

(29 U.S.C. 1002) for the primary purpose of hedging or mitigating may risk directly associated wilk~ the

operation of tlae plan" are explicitly caxved out of the determination of whether a market participant maintains

a "substantial position" in Swaps for purposes of the first prong of the Major Paxticipant Definitions, tlae

AMG believes lkmt the furtk~er definition of these terms by the Commissions should claxify lkmt pension plmas

are explicitly excluded from all three prongs of tlae definitions.
Registered Investment Companies

Registered funds are subject to significant requirements and restrictions relating

to their investments, capital structure and governance, which obviate the need for such

funds to be regulated as Major Participants.13

Restrictions On "Senior Securities. " The Investment Company Act significantly

restricts a registered fund from issuing "senior securities." Under longstanding

interpretations of the SEC and the staff of the SEC’s Division of Investment Management,

many derivative instruments that create explicit or implicit leverage are deemed

prohibited as the issuance of a senior security, unless the registered fund (i) segregates or

earmarks cash, liquid securities or other liquid assets on its books at its custodian in an

amount that, together with amounts deposited as margin, is at least equal to the fund’s

obligation under such instrument, and marks to market daily, or (ii) holds an offsetting

position.14 This requirement has the effect of limiting the leverage that a registered fund

can undertake via Swaps and other derivatives, and makes it unlikely that a fund’s

investments in such transactions will create significant systemic risk.

Limits’ on Investments’ in Securities-Related lssuers. A registered fund may not

invest more than 5% of its total assets in the securities of any single "securities related

 ̄ ,,15 Issuer ̄ A securities related issuer is any issuer that has derived more than 15% of its

gross revenues from activities as a broker, dealer, underwriter or investment adviser in its

most recent fiscal year ̄ As a result of this requirement and other considerations, the

AMG believes that most funds structure their investments in Swaps so that the fund’s

exposure to any single counterparty generally does not exceed 5% of the fund’s total

assets ̄ Such counterparty diversification significantly reduces the risk that a fund’s Swap

exposure will give rise to systemic risk ̄

Limits’ on Illiquid lnvestments for Open-End Funds’. Open-end registered funds,

which issue securities that are redeemable daily, may not invest more than 15% of their

assets in instruments that are "illiquid.’’~ The SEC generally views an instrument as

13 The AMG notes t~at the use of Swaps mad other derivatives by registered investment compmfies

has been ma area of focus for t~e SEC. The Division of Inveslxnent Mmaagement ofl~e SEC has been

studying how registered inveslxnent companies use derivatives, including Swaps, and the mmmer in which

such derivative use is regulated. In April 2009, l~e head oft~e Division proposed l~at the Subcommittee on

Investment Compmfies and Inveslxnent Advisers of l~e Americma Bar Association’s (ABA) Section of

Business Law’s Committee on Federal Regulation of Securities conduct a study of such matters, and in

response, the ABA created a Task Force on Inveslxnent Compmay Use of Derivatives and Leverage. The

Task Force released a report with its recommendations on July 6, 2010 (the "Task Force Report"), which is

available at http://www.abanet.org/buslaw/blgcontengibl/2010/08/0002.pdf.

14 See, e.g., Securities Trading Practices of Registered Investment Compmfies, Investxnent

Compmay Act Release No. 10666, 44 Fed. Reg. 25128 (Apr. 18, 1979); Merrill Lynch Asset Management,

L.P., SEC No-Action Letter, 1996 WL 429027 (July 2, 1996); Dreyfus Slxategic Investing mad Dreyfus

Slxategic Income, SEC No-Action Letter, [ 1987 Trmasfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 48,525 (June 22,

1987).

See Section 12(d)(3) of the Inveslxnent Company Act mad Rule 12d3-1 l~ereunder.

16 The 15% limit on illiquid securities is derived from Guide 4 of the Guidelines to Form N-1A.

The Guidelines were officially repealed by the SEC in 1998; however, open-end funds have continued to

comply wit~ the 15% limit.
illiquid if it cannot be disposed of by the fund in the ordinary course of business within 7

days at approximately the value at which the fund values the instrument for purposes of

calculating its NAV.17 This requirement effectively limits the amount of an open-end

fund’s assets in Swaps that may be illiquid or difficult to value.

Disclosure, Valuation and Reporting Requirements. Registered funds are

required to calculate and publish their NAV. They must also disclose substantial

information about their investment strategies, including use of Swaps and other

derivatives, and file quarterly reports with the SEC that include their portfolio holdings,

including swaps and security-based swaps.18 Such reporting leads to greater transparency

into a fund’s investments in Swaps and increases the ability of counterparties and

regulators to provide oversight and assess risk.

Compliance Oversight. Registered investment companies are required to adopt

and maintain substantial compliance programs, designed to assure compliance with the

foregoing requirements. Among other things, a registered fund is required to adopt

policies and procedures to prevent violations of the U.S. securities laws, appoint a Chief

Compliance Officer who is responsible for administering the fund’s policies and

procedures and maintain extensive books and records. A registered fund’s Board of

Directors must approve the compliance policies and procedures of a fund and any

investment adviser to the fund and annually review such policies and procedures (such

review includes a report to the Board by the fund’s Chief Compliance Officer). The

oversight role of the Board is strengthened by the requirement that a majority of the

Board cannot be "interested persons" of the fund.

Board Oversight of Derivatives. The SEC Staff has indicated that directors of

registered funds play a critical role in overseeing registered funds’ use of derivatives. For

example, the Associate Director of the Office of Compliance Inspection and

Examinations at the SEC indicated in a speech that registered fund directors should focus

on the following factors, among other things, when investing in derivative products: (i)

the capacity of the fund’s investment risk management function to regularly identify,

measure, evaluate and manage the fund’s ongoing risk exposure; (ii) the effectiveness of

the process used to measure the liquidity of the fund’s portfolio to ensure that the fund’s

ongoing liquidity needs can be met; (iii) the capacity of the fund’s process for effectively

defining and evaluating embedded or economic leverage associated with the fund’s

positions in derivatives to effectively ensure that the fund’s exposure to leverage is within

statutory limits and consistent with disclosures made to shareholders; (iv) the

effectiveness of the fund’s management of material compliance risks relating to the

fund’s investments in derivatives; and (v) the effectiveness of the fund’s Chief

Compliance Officer in monitoring and overseeing the fund’s exposure to derivatives and

the concomitant risks.~9

17 An open-end fund’s Board of Directors may impose additional restrictions on the ability of the

fund to invest in illiquid instxuments.

18 Although portfolio information is generally disclosed on a delayed basis, such reporting still

provides txansparency into a registered fund’s use of Swaps.

19 Gene Gohlke, Assoc. Dir., U.S. Sec. mad Exch. Comm’n Office of Compliance, Inspection and

Examinations, If I Were a Director of a Fund Investing in Derivatives - Key Areas of Risk on Which I

(... continued)

9
The AMG believes that the substantial compliance requirements and supervision

to which registered funds are subject, combined with the restrictions and requirements

relating to a fund’s investments described above, make regulation as a Major Participant

unnecessary and the Senate colloquy referenced herein provides strong indication that

Congress did not intend such a result. Such regulation would only impose further

compliance and related costs on registered funds, which would ultimately be borne by the

investors in such funds without providing any material benefit in reducing systemic risk.

Plans Subject to ERISA

ERISA plans and governmental benefit plans are subject to an exclusion found in

the first prong of the Major Participant Definitions under the Dodd-Frank Act and most

commentators who followed the legislation have assumed that such plans are per se

excluded from these definitions. This appears to have been the intent of Congress, but, as

with a number of provisions of the Dodd-Frank Act, this is not entirely beyond doubt.

Accordingly, regulatory clarification would be helpful. At a minimum clarification is

required as to the operative words of the exclusion which excludes "positions maintained

by any employee benefit plan ... for the primary purpose of hedging or mitigating any

risk directly associated with the operation of the plan." Under ERISA and general

fiduciary principles, the fiduciaries of a plan are required to invest the plan’s assets

strictly in a manner intended to meet benefit payment obligations under the plan.

Accordingly, all investment activity undertaken by a plan in accordance with ERISA is

for the primary purpose of hedging the risks and liabilities associated with the benefit

obligations under the plan. Regulations should address this point by clarifying that any

Swaps undertaken by a plan in accordance with the fiduciary requirements of ERISA will

be deemed to be for the primary purpose of hedging or mitigating any risk directly

associated with the operation of the plan.

More generally, the rules of the Commissions should make clear that benefit

plans are intended to be generally excluded from the Major Participant Definitions, based

on the legislative history and the extensive, long-standing regulatory regime governing

plans and the unique structure and financial transparency of plans.

Prudence and Diversification. ERISA plans are subject to statutory and

regulatory requirements requiring the assets of such plans to be prudently diversified.

ERISA is based, in part, on the premise that participants may not benefit from retirement

assets ifa plan has all of its "eggs in one basket." ERISA therefore requires a plan to

diversify the investments of the plan "so as to minimize the risk of large losses, unless

under the circumstances it is clearly prudent not to do so." In addition, ERISA requires

plan investments to be managed with the care, skill, prudence and diligence that a prudent

expert would apply to a portfolio that is intended to accumulate assets to meet benefit

obligations. These ERISA requirements have repeatedly been acknowledged by courts

and regulators as the highest standards of prudence and diversification known to the law.

(continued...)

Would Focus, Speech at Muttml Fund Directors Forum Program (Nov. 8, 2007), available at

http://www, sec. gov/news/speech/2007/spch 110807gg.htm.

10
ProfessionalManagement. Underscoring the critical focus that ERISA places on

having investment decisions made by experienced investment professionals, ERISA

requires that investment decisions be made with the skill and care of a "prudent expert."

Assets of ERISA plans are therefore typically managed by registered investment advisers,

banks and state regulated insurance companies. These managers are subject both to

ERISA (including diversification and prudence requirements) and their own relevant

regulatory regime. The penalties for failing to satisfy ERISA’s high standard of care are

strict and extreme. Advisers can also be held liable for the acts of other fiduciaries.

Trust Overlay. ERISA plan investments must be held in trust, subject to the

oversight of an institutional trustee, most commonly a bank or similar entity, again

regulated by a prudential regulator. At a minimum, the trustee is responsible for the safe

keeping of the plan’s assets. Trustees may also in certain circumstances be subject to cofiduciary liability for breaches by other plan fiduciaries.

UnleveragedAsset Pool. ERISA plans are unleveraged asset pools. While plans

may engage in some leveraged investing and short strategies, ERISA plans are managed

under modern portfolio theory with the focus on maximizing plan returns with low

volatility of the plans’ portfolios. Therefore, the preponderance of plan assets are

typically invested in long, unleveraged positions in various traditional asset classes with a

view to asset accumulation and preservation to meet long-term benefit liabilities.

Transparency. ERISA plans typically can and do regularly report their net asset

and financial position to derivative dealers with whom they transact. ISDAs with plan

counterparties will often contain ERISA-specific reporting, early termination or event of

default provisions that provide early warning signals, credit enhancement or early

termination rights in the event that a plan exceeds specified volatility threshold

difficulties (e.g., a decline in a plan’s net assets below an specified absolute dollar

amount or, in the alternative, a decline below a percentage of such net assets as measured

in the prior month, quarter or year). ERISA plans also report their assets and financial

positions annually in filings with the U.S. Department of Labor. These filings are often

publicly available.

No Operating Risks. ERISA plans are asset pools held separately and remotely

from the companies that sponsor such plans. As such, the asset pools are not subject to

the business line and balance sheet risks typical of operating companies. Under ERISA,

plans are subject to strict rules that require the sponsoring employer to fund the plan on at

least an annual (and, in many cases, quarterly) basis. Failure to meet minimum funding

requirements can have severe consequences for all members of the sponsor’s controlled

group.

No Avoidance of Obligations Under Investments. Because ERISA plans are asset

pools and not operating companies, there is no provision for bankruptcy of a plan under

bankruptcy law. Even in the case of a termination or liquidation of an ERISA plan,

including when a plan has been taken over by the PBGC, obligations to derivatives

counterparties of the plan are required to be settled out of the general assets of the plan

before the plan can make payouts to the plan’s participants and beneficiaries.

Termination events under a Swap contract with a derivatives dealer will also typically

include an amendment to the plan’s governing documents that could provide for the

incurrence of indebtedness or other obligation that would rank senior to the obligations of

the plan under the Swap agreement.

11
Stable Asset Base. Defined benefit plans are stable and relatively static longterm asset pools and are not subject to withdrawals or transfers in the same manner as

hedge funds or similar investment vehicles experience.

Secure Credit. Dealers typically treat plans as triple A credits for purposes of

financial transactions.

Although benefit plans sponsored by U.S. federal, state and local governments

are not technically subject to ERISA, based on other applicable rules and principles,

governmental plans are subject to many of the same requirements and constraints

applicable to ERISA plans. Any treatment applied to ERISA plans under regulations

should apply equally to governmental plans. Further, to the extent a pension plan subject

to the pension law regulations of Canada, the United Kingdom or the European Union

enters into a swap in the United States for the primary purpose of hedging or mitigating

any risk associated with the operation of the plan, such plan’s position should qualify by

regulation for the same exclusion. Each of such jurisdictions has extensive pension law

regulations and the policy reasons behind the exclusion for U.S. pension plan swap

positions which are "for the primary purpose of hedging or mitigating any risk directly

associated with the operation of the plan" are, in our view, equally applicable to pension

plans operating in such jurisdictions.

"Mixed Swaps"

The scope of products regulated as "mixed swaps" should be clarified, and the mixed

swap regulatory regime should avoid duplicative regulation.

The AMG believes the joint regulations promulgated with respect to "mixed

swaps" should limit the scope of products that fall into this category to avoid unnecessary

and duplicative regulation. In particular, the AMG believes that the Commissions should

promulgate rules that would impose a predominance test on mixed swaps such that a

security-based swap that has only incidental or de minimis characteristics of a swap

would be treated as a security-based swap, and that a swap that has only incidental or de

minimis characteristics of a security-based swap would be treated as a swap.

For example, the primary purpose of many "plain vanilla" equity swaps is to

transfer from one counterparty to the other economic risk with respect to the underlying

equity asset. The party that is "synthetically long" the underlying asset is in a position

that is economically similar to having borrowed the notional amount of the swap from its

counterparty to invest in the underlying asset. In fact, it is typical in the over-the-counter

equity derivatives market for one party to hedge its exposure under the equity swap by

acquiring a hedge position in the underlying asset. To compensate this party for its

required use of capital, these transactions may contain a "financing leg" which obligates

the synthetically long counterparty to make a payment calculated as the notional amount

multiplied by a LIBOR-based or other variable interest rate. This financing component is

merely incidental to the transaction. In fact, the value of a swap for margin and capital

purposes is based only on the equity price of the underlying asset and does not change

based on movements of the interest rate. The AMG believes that a financing component

of a "security-based swap" should not cause such transaction to be viewed as a "mixed

swap."

12
In addition, Section 712(a) of the Dodd-Frank Act requires the Commissions to

jointly regulate "mixed swaps," but that does not mean that they should be subject to two

sets of rules. The AMG believes that, as a matter of regulatory efficiency and legal

certainty, it should be a fundamental principle that, whenever possible, transactions

should be regulated under a single set of rules. As a result, the AMG believes that the

regulatory system put in place by the Commissions for mixed swaps should reflect the

specific nature of these products, rather than simply a system by which "mixed swaps"

are doubly regulated as "swaps" by the CFTC and "security-based swaps" by the SEC.

For example, to avoid unnecessary and costly regulatory duplication, the AMG suggests

that the Commissions jointly develop a single form for reporting of information related to

mixed swaps.

The AMG thanks the Commissions for the opportunity to comment in advance of

their joint rulemaking on further definition of the key terms and the regulation of mixed

swaps and for the Commissions’ consideration of the AMG’s views. The AMG’s

members would appreciate the opportunity to further comment on these topics, as well as

other rulemakings the Commissions will undertake under Title VII of the Dodd-Frank

Act. If you have any questions, please do not hesitate to call either Daniel N. Budofsky,

Davis Polk & Wardwell LLP, at 212-450-4907 or the undersigned at 212-313-1389.

Sincerely,

Timothy W. Cameron, Esq.

Managing Director, Asset Management Group

Securities Industry and Financial Markets Association

13