BETTER'MARKETS 

February 4, 2011 

Ms. Elizabeth M. Murphy 

Secretary 

TRANSPARENCY ACCOUNMBILITY ~ QVERSIGHT 

Securities and Exchange Commission 

100 F Street, NE 

Washington, DC 20549-1090 

Re: Proposed Rules Governing the End-User Exception to Mandatory Clearing of SecurityBased Swaps- File Number 57-43-10 

Dear Ms. Murphy: 

Better Markets, Inc.l appreciates the opportunity to comment on the above-captioned 

proposed rules ("Proposed Rules") of the Securities and Exchange Commission 

("Commission"). In accordance with Section 763 of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act ("Dodd-Frank Act"), the Proposed Rules would require disclosure 

from parties invoking the end-user exception from the mandatory clearing requirement for 

transactions in security-based swaps ("SBS"). This reporting is intended to accomplish three 

goals: (1) enable market participants to invoke the end-user exception; (2) provide the 

statutorily required information on how such market participants will meet their obligations 

arising from non-cleared SBS; and (3) enable the Commission to comply with its statutory 

mandate to prevent abuse of the end-user exception. 

Introduction 

Mandatory clearing of swaps is the centerpiece of reform embodied in Title VII of the DoddFrank Act. It is one of the core protections intended to prevent another financial crisis and 

taxpayer bailout. Thus, the end-user exception from this mandatory clearing requirement is, 

by design, very narrow and expressly limited. 

The exception is solely for actual end-users and solely for them to hedge or mitigate genuine 

commercial risk, provided they have the ability to satisfy their obligations under the noncleared SBS. 

The Proposed Rules are intended to ensure that this narrow and limited exception in the law 

is implemented properly, but the proposed disclosures are insufficient and will not ensure 

Better Markets, Inc. is a nonprofit organization that promotes the public interest in the capital and commodity 

markets, including in particular the rulemaking process associated with the Dodd-Frank Act. 

1825 K Street. NW, Suite 1080, Washington, DC 20006 (1) 202.618-6464 (1) 202.618.6465 bettermarkets.com 
Ms. Elizabeth Murphy 

Page 2 

compliance with the statutory requirements of the Dodd-Frank Act. For example, the 

Proposed Rules only require an end-user to state whether it expects to use one of four listed 

methods for meeting its financial obligations, but nothing else. Another example is that the 

Proposed Rules only require an end-user to state whether an SBS is being used to hedge or 

mitigate commercial risk, but nothing else. This approach would enable market participants 

who claim the exception based on questionable or evasive practices to conceal illegal 

conduct. Not only would this violate the law in a way that is virtually impossible to detect 

but it would also harm bona fide end-users by allowing unseen speculation to distort the 

market. 

The financial collapse of 2008 made clear that such minimal disclosure will be inadequate to 

protect the markets from excess or, in turn, the public from those excesses. Indeed, a weak 

disclosure regime combined with too much reliance on self-regulation by financial market 

participants has proven to be an abysmal failure, one that has cost the American people 

trillions of dollars and so much more. 

As happened in the years before 2008, requiring such minimal disclosure will also prevent 

regulators from having sufficient information to ensure compliance with the law and fulfill 

their essential oversight role. The Dodd-Frank Act was written to require new and critically 

important disclosures from market participants so regulators would have the informational 

tools they need to conduct meaningful oversight. 

Moreover, a failure to implement the letter and spirit of these new disclosure standards will 

invite further abuses by turning limited and narrow exceptions in the law into gaping 

loopholes. Below, we identify just one such potential loophole: an SBS that hedges a 

commercial risk but includes additional, speculative risks beyond the hedge. There can be no 

doubt that, in very little time, creative market participants will devise many more ways to 

take advantage of the minimal disclosure regime reflected in the Proposed Rules, twisting the 

end-user exception beyond recognition and defeating one of the statute's most important 

intended purposes. 

The Proposed Rules rely too much on trust and leave too much room for abuse. The changes 

suggested below will require sufficient disclosure to allow for real regulatory verification 

and oversight, which will greatly enhance compliance with the law. After all our country has 

gone through, it is the absolute least we must do. 

Summary of Comments 

The reporting requirements in the Proposed Rules focus on two areas: information relating 

to the end-user's ability to meet its obligations associated with non-cleared SBS, and 

information required to prevent abuse of the end-user exception. 

The Proposed Rules must approach the issues associated with how the end-user is to meet 

its obligations with a focus on market realities. Specifically, the common use of Credit 

Support Annexes, in which dealer banks forbear from requiring posted collateral, creates 

enormous, poorly disclosed risks to end-users and those who are exposed to end-users. 

Therefore, there must be greater disclosure regarding these arrangements. 

,il 

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Furthermore, efforts to prevent abuse of the exception must focus more specifically on its 

core requirements: the SBS transaction must be used for hedging or mitigating commercial 

risk. The correlation between the SBS and the hedged risk must be tight, clearly cataloged, 

and reported. Without this specificity, abuse ofthe exception is a virtual certainty. In 

addition, the SBS must not involve any risks (commercial or otherwise) beyond those it is 

intended to hedge. This is the only way to prevent market participants from piggybacking 

speculative transactions onto those which might otherwise qualify for the exception. 

Discussion 

The Proposed Rules Must Require More Reporting About How the End-User Expects to 

Satisfy Its Financial Obligations Associated with the Non-Cleared SBS Transaction. 

Section 763(a) of the Dodd-Frank Act2 requires a party invoking the end-user exception to 

provide an SBS data repository ("SDR") with information regarding how the party meets its 

financial obligations associated with non-cleared SBS transactions. This information is 

critically important for risk assessment purposes. As noted in the proposing release3 

("Release"), non-cleared SBS transactions are not subject to uniform margin and collateral 

requirements, which apply to all cleared SBS and which mitigate the consequences of default 

in SBS transactions. Release at 80006. 

It is therefore necessary for the Commission to determine whether a party relying on the 

end-user exception is taking adequate steps to mitigate the credit risks associated with noncleared SBS. To make this determination, the Commission must have access to sufficient 

information about how the party expects to meet its financial obligations under the SBS. 

That information must include not only the generic types of arrangements that the end-user 

intends to use, but the terms of those arrangements as well. 

The Proposed Rules fail to require the disclosure of essential information, and, therefore, the 

Commission will be unable to discharge its duty of risk assessment with respect to noncleared SBS. Proposed Rule 240.3Cg-1(5) merely requires a party invoking the end-user 

exception to designate whether it expects to use one of four listed methods for meeting its 

financial obligations under a non-cleared SBS transaction. Those four methods are identified 

as credit support agreements, agreements to pledge or segregate assets, third-party 

guarantees, or the party's own financial resources. 

However, the Proposed Rules do not require disclosure of any information regarding the 

substantive terms of those arrangements. In the context of actual market practices, the 

designation of these methods, without any accompanying detail, is meaningless. 

2 Section 3C(g)(l)(C) of the Securities Exchange Act. 3 See Exchange Act Release No. 34-63556 (Dec. 15, 2010), 75 Fed. Reg. 79992 (Dec. 21, 2010). 

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Margining Arrangements 

In practice, there are two categories of contractual arrangements for bi-lateral SBS 

obligations: those which are governed by ISDA Credit Support Annexes to Master Swap 

Agreement ("CSN') and those in which margining arrangements are established in less 

formal short-form confirmations. The most significant are those governed by CSAs. The 

reporting obligations under the Proposed Rules must reflect and address the material 

obligations under the CSAs if the required disclosure is to be meaningful. 

The CSAs typically establish the procedures for collateralizing credit exposures. CSAs apply 

to all swaps between the parties rather than individual swaps. Exposures are measured on a 

net portfolio basis by mark-to-market calculations, plus (in some, but by no means all, cases) 

an "additional amount" that serves as a rough analog to initial margin. 

In many instances, counterparties forbear from collecting collateral up to a cap. Such 

forbearance arrangements are the most significant obligations that end-users must meet 

because they almost invariably include "credit triggers," which are generally based on credit 

ratings. If a credit trigger is tripped, the end-user is required to fully fund collateral 

that has been previously forborne, at the very time it is most difficult to do so. Because 

these forbearance arrangements can have such a dramatic and debilitating impact on an enduser, they must be a primary focus of the Proposed Rules. 

The use of forbearance under a CSA between a dealer and an end-user can be usefully 

understood as a revolving loan of funds from the dealer to the end-user to provide required 

collateral, where the "loan" can be called for repayment upon the occurrence of a credit 

trigger event. In fact, the practice by dealers is to estimate the average daily outstanding (but 

uncollected) collateral (i.e., principal) over the expected life of the SBS (i.e., loan term) and 

calculate an appropriate charge for extending the credit (i.e., interest). That charge is then 

added to and embedded unseen into the cost of the SBS to the end-user. 

Confirming this view, the Comptroller of the Currency requires that bank dealers aggregate 

amounts of forborne collateral with commercial loans extended by the bank dealer to the 

same entities. And, of course, bank dealers typically decrease lending capacity by such 

amounts. 

This analysis is important in identifYing the information that the Commission must collect if 

it is to determine how the end-user will meet its obligations under the non-cleared SBS.4 

Thus, the Proposed Rules must be tailored to reflect these market realities by requiring the 

following disclosure: 

This analysis also shows that end-users are already paying for margin and collateral. Those costs are just concealed 

from end-users and the public because dealers do not break out the costs they charge for swaps. This dealer practice 

also prevents end-users from shopping for better prices. Thus, the argument that requiring the posting of margin or 

collateral will result in a major incremental cost to end-users is baseless. Indeed, there are strong arguments that 

requiring end-users to post margin and collateral will actually decrease their costs. 

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• Each Master Swap Agreement and CSA must be filed in a library maintained by either 

the SEC or an SDR. Margin forbearance and credit trigger provisions should be 

separately disclosed in a linked file that is periodically updated to provide the current 

usage of capped forbearance. Each SBS entered under a Master Swap Agreement and 

CSA should be cross-referenced. 

• The end-user must describe its ability to fund margin fully if all credit triggers are 

tripped, specifYing its access to liquidity. Any other mechanism for disclosing how an 

end-user will meet its obligations is of minimal importance compared with this 

requirement. 

• The end-user must report whether collateral requirements are unilateral or bilateral, 

and must disclose the protections afforded to the end-user in the event that the 

financial condition of a bank or other counterparty deteriorates. 

• The identity and financial condition of any guarantor of the end-user must be 

provided. 

Other Forms of Collateral 

The Release recognizes that collateral other than cash and securities may be transferred to 

the end-user's counterparty to secure the obligations under the SBS. These types of 

arrangements are typically "right way risk transactions" in which margin obligations under a 

CSA are secured by an asset the value of which is, in theory, inversely related to the amount 

of the margin obligation. The reporting to the Commission or the SDR relating to CSAs must 

include information on such collateral, specifically: 

• a description of the collateral and its value in relation to the obligations it secures; 

• the sufficiency of the collateral to cover such obligations, especially considering the 

liquidity and volatility of the amount of the obligations, on the one hand, and the 

collateral on the other; 

• other liens on the collateral, including amount and priority; and 

• disclosure of the right-way risk transactions to investors, bondholders, and lenders. 

Segregation and Re-hypothecation 

The CSA provisions relating to segregation and re-hypothecation also need to be disclosed. 

These provisions are especially important, since they involve protections for the benefit of 

the end-user if the counterparty's credit quality deteriorates and collateral has been rehypothecated. The reports must therefore include a description of provisions designed to 

limit the adverse consequences of re-hypothecation. 

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A related issue is the obligation of the counterparty to post collateral for the protection of the 

end-user under the CSA. For example, such collateral can offset the consequences of rehypothecation of additional amounts, otherwise known as initial margin. This also should be 

disclosed in the required reports. 

Catchall Provision 

The Proposed Rules contain a catchall provision, which requires the party to indicate 

whether it expects to rely on "means other than those" set forth in the Proposed Rules to 

meets its financial obligations under a non-cleared SBS transaction. Proposed Rule 240.3Cg1(a)(S)(v). This too will be meaningless disclosure unless the rule also requires the details 

regarding such "other" means. 

The catchall provision should expressly require each party to describe the specific method or 

methods it will use to meet its financial obligations under the non-cleared SBS, if its chosen 

method is not among those listed in the Proposed Rules. This additional information is 

necessary to satisfy the explicit requirements of the Dodd-Frank Act. Section 7 63 (a) of the 

Dodd-Frank Act5 makes clear that the party invoking the end-user exception must notify the 

Commission of "how" it meets its financial obligations with respect to non-cleared SBS. A 

mere indication that the party expects to use some unspecified method, "other" than the ones 

listed in the Proposed Rule, clearly does not satisfy this statutory requirement. Nor would 

such minimal information enable the Commission to conduct meaningful risk assessment as 

to end-users entering non-cleared SBS. 

The catchall provision in the Proposed Rules would also prevent the Commission from 

achieving its other regulatory objectives. For example, the Release indicates that the catchall 

provision is intended in part "to separately categorize all other methods that may be used in 

the markets today or that may develop in the future" for meeting obligations associated with 

SBS transactions. Release at 79995. According to the Release, this, in turn, will enable the 

Commission to determine if more "granular" rules are necessary concerning the manner in 

which end-users are meeting their financial obligations. Id. Without any information 

regarding the other means that a party is using to meet its financial obligations, the 

Commission will be unable to achieve these regulatory objectives. 

In summary, the Commission cannot meaningfully assess whether a party claiming the enduser exception is taking adequate steps to meet its financial obligations under non-cleared 

SBS transactions unless the Proposed Rules require parties to report much more detailed 

information, as described above. 

The Proposed Rules Should Also Require More Disclosure To Prevent Abuse of the EndUser Exception. 

Section 763(a) of the Dodd-Frank Act6 authorizes the Commission to prescribe rules, issue 

interpretations, or request information from those who invoke the end-user exception, to 

Section 3C(g)(l)(C) of the Securities Exchange Act. 

Section 3C(g)(6) of the Securities Exchange Act. 

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prevent abuse of the exception. This explicit authority reflects Congress's concern that this 

narrow exception to the clearing requirement could become a loophole used to undermine 

one of the fundamental goals of the new regulatory regime governing derivatives: central 

clearing of virtually all SBS transactions. 

To protect against potential abuses, the Commission must have sufficient information to 

confirm that parties invoking the exception are doing so legitimately and in accordance with 

the applicable requirements. That is the basis for the statutory requirement that the 

Proposed Rules must implement. 

One of the core prerequisites for the end-user exception is that the party invoking it must be 

using the SBS "to hedge or mitigate commercial risk." Section 763(a) of the Dodd-Frank Ace 

(emphasis added). This requirement is a fundamentally important limitation on the 

exception, but it is also one of the most difficult elements to police unless the Commission 

requires sufficient disclosure. To ensure that this narrow, limited exception is properly 

invoked, parties must be required to report information regarding the risks that the party is 

hedging and the manner in which the SBS addresses those risks. 

On this issue, the Proposed Rules do not go far enough. They only require the party invoking 

the exception to report "whether" the SBS is being used to hedge or mitigate commercial 

risk. Proposed Rule 240.3Cg-1 (a) ( 4). This representation, without more, does virtually 

nothing to ensure that the exception is being used legitimately. a 

To satisfy both the letter and spirit of the Dodd-Frank Act, the Proposed Rules must require 

parties not only to represent that they are hedging or mitigating commercial risk, but also to 

provide disclosure concerning those hedging activities. That information must include 

identification of the assets, liabilities, or services they seek to protect against a change in 

value, and the manner in which the specific SBS being entered will mitigate those risks. 

This disclosure is essential to prevent another form of abuse: parties may seek to employ the 

end-user exception in situations where their primary purpose is speculation by entering SBS 

transactions that have only a limited hedging component. For example, an exposure to the 

credit risk of Corporation X could be "hedged" by entering into an indexed credit default 

swap ("CDS") that covers Corporation X along with a number of other corporations. Such a 

CDS would expose the end-user to the credit values of the other corporations in the CDS 

market basket, which are speculative and not eligible for the exception. 

This transaction would be nothing more than an attempt to camouflage what is 

predominantly a speculative activity through a minor hedge position, which would violate 

Section 3C(g)(l)(B) ofthe Securities Exchange Act. 

The Proposed Rules incorporate the definition of "hedging or mitigating commercial risk" by reference to a separate 

proposal on the definition of "major security-based swap participant." See Exchange Act Release No. 34-63452, 

Further Definition of "Swap Dealer," "Security-Based Swap Dealer," "Major Swap Participant," "Major 

Security-Based Swap Participant," and "Eligible Contract Participant," (Dec. 7 201 0), 75 Fed. Reg. 80173 (Dec. 

21, 2010). That defmition requires parties who wish to be considered bona fide hedgers to follow certain internal 

protocols for assessing the effectiveness of SBS as a hedge, but it imposes no affirmative reporting obligations on 

the parties. 

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9 

the statute. Concrete disclosure about the risks being hedged, and the correlation between 

those risks and the SBS transaction, is essential to guard against this abuse of the limited, 

narrow exception. Finally, any party seeking to invoke the exception should be required to 

represent that the SBS is not entered for a speculative purpose, either in whole or in part. 

Only with these additional reporting obligations will the Proposed Rules enable the 

Commission to discharge its duty to ensure that the end-user exception is only used as 

provided for in the Dodd-Frank Act. 

The Proposed Rules Should Require Issuers of Registered Securities and Issuers Subject 

to Reporting Requirements Under the Securities Exchange Act to Provide Additional 

Information and to Certi}j! the Accuracy of their Reports. 

The Dodd-Frank Act appropriately requires issuers of registered securities and issuers 

subject to reporting requirements under the Securities Exchange Act ("Issuers") to provide 

additional information as a condition to reliance on the end-user exception. Specifically, a 

committee of the Issuer's board or governing body must review and approve the Issuer's 

decision to enter the SBS transaction that is the subject of the claimed exception. Section 

763(a) of the Dodd-Frank Act9

• The Proposed Rules mirror this requirement. Proposed Rule 

240.3Cg-1(6)(ii). Although this is an important measure aimed at deterring abuse of the enduser exception, it is insufficient to ensure compliance with the law. The following additional 

disclosures are necessary. 

First, the Proposed Rules must require Issuers to include additional information in their 

reports to ensure that the relevant board committee conducts a substantive and meaningful 

review of each SBS transaction and its role in hedging the Issuer's risk. As currently framed, 

the Proposed Rules merely require the Issuer to report "whether" an appropriate committee 

of the board of directors or equivalent body has reviewed and approved the decision to enter 

into the SBS subject to the clearing exception. Proposed Rule 240.3Cg-1(a)(6). This simple 

disclosure-like the other minimal disclosures discussed above-is inadequate to satisfy the 

requirements of the law. 

• The rules should also require the appropriate committee to set forth the justification 

for each non-cleared SBS transaction, including: 

• the specific risks being hedged and the rationale for selecting the particular SBS at 

issue as the method for addressing those risks; 

• the costs of credit extended under collateral forbearance arrangements set forth in 

CSAs; 

• a statement of how the end-user is to meet its obligations under its SBS, including 

obligations related to credit triggers in CSAs; and 

Section 3C(i) of the Securities Exchange Act. 

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Ms. Elizabeth Murphy 

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• a statement that the risks associated with obligations under CSAs related to SBS 

transactions entered into under the end-user exception have been adequately 

disclosed in public filings. 

Second, the Proposed Rules should impose another requirement that will vastly increase the 

reliability of a board committee's review and approval of an Issuer's non-cleared SBS 

transactions. Following the model of the Sarbanes-Oxley Act of 2002, the Proposed Rules 

should require the CEO and CFO of the Issuer to certify that they have reviewed the board 

committee's report on the Issuer's non-cleared SBS and that it is accurate in all material 

respects. 

All of these disclosure requirements will help ensure that the committee's role in overseeing 

an Issuer's transactions in non-cleared SBS will be more than a mere formality. 

The Proposed Rules Should Require Submission of Reports Regarding the End-User 

Exception Directly to the SEC, in Addition to the SDR. 

The Dodd-Frank Act requires that information regarding how an end-user meets its 

obligations under non-cleared SBS transactions must be provided to the Commission. 

Section 763(a) of the Dodd-Frank Act10• Similarly, information necessary to prevent abuse of 

the end-user exception is to be requested by the Commission. Section 763(a) of the DoddFrank Act11• The Proposed Rules implement these provisions by requiring end-users to 

submit their reports to registered SDRs, and to the Commission only if no SDR is available 

to accept the information. Proposed Rule 240.3Cg-1(a). 

These requirements may have a certain logic, insofar as SDRs will be established to collect, 

store, and disseminate transaction data regarding both cleared and non-cleared SBS 

transactions. Therefore, SDRs will presumably be equipped to handle the additional reports 

regarding compliance with the end-user exception. 

Far more important than these issues surrounding reporting mechanics, however, is 

ensuring that the Commission receives complete and timely information regarding reliance 

upon the end-user exception in SBS transactions. The only way to achieve this goal is to 

require that reports relating to the end-user exception be submitted directly to the 

Commission, in addition to the SDRs. Otherwise, the Commission will be left to collect 

reports from different SDRs, a time-consuming and burdensome process. 

Such a parallel reporting requirement would not be necessary if the Commission were to 

establish a system for aggregating all SBS transaction data collected by the SDRs and 

disseminating it to the Commission. However, the Commission's current rule proposals, 

including proposed Regulation SBSR, do not provide for such a data handling mechanism. 

Unless and until the Commission adopts that approach, reports from parties invoking the 

end-user exception must be submitted directly to the Commission. 

10 Section 3C{g)(l)(C) ofthe Securities Exchange Act. 11 Section 3 C(g)( 6) ofthe Securities Exchange Act. 

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Conclusion 

Clearing swaps is the centerpiece of reform embodied in Title VII of the Dodd-Frank Act. The 

law allows only a very few, narrow, and limited exceptions to that core principle. 

In keeping with this approach, the exception for end-users is strictly limited to actual endusers and solely for them to hedge or mitigate commercial risk. The law requires sufficient 

disclosure to ensure that only legitimate end-users invoke the exception, that they have the 

ability to meet their obligations, and that they are engaged in bona fide hedging activities. To 

oversee and enforce compliance with all of these requirements, the Commission must have 

the additional information proposed here. 

We hope that our comments will assist the Commission as it finalizes its regulations. 

Dennis M. Kelleher 

President & CEO 

Stephen W. Hall 

Securities Specialist 

Wallace C. Turbeville 

Derivatives Specialist 

Better Markets, Inc. 

Suite 1080 

1825 K Street, N.W. 

Washington, D.C. 20006 

(202) 618-6464 

dkelleher@bettermarkets.com 

shall@ bettermarkets.com 

wturbeville@bettermarkets.com 

www.bettermarkets.com 

1825 K Street, NW, Suite 1080, Washington, DC 20006 (1) 202.618-6464 (1) 202.618.6465 bettermarkets.com