II-O0015

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Deb Coleman <debbie.coleman@convexitycapital.com>

Friday, September 24, 2010 10:23 AM

OTCDefinitions <OTCDefinitions@CFTC.gov>

File Number $7-16-10: Comments with respect to the definition of Major Swap

Participant

Dodd-Frank Act - Definition of MSP.pdf

Ladies and Gentlemen:

Thank you very much for the opportunity to comment regarding key provisions of the Dodd-Frank Wall Street

Reform and Consumer Protection Act.

Please find attached above our comments with respect to the definition of "Major Swap Participant" in the context

of the interest rate swap markets.

Thank you again for the opportunity to comment.

Respectfully submitted,

CONVEXITY CAPITAL MANAGEMENT LP

Convexity Capital Management LP

200 Clarendon Street; 57th Floor

Boston, MA 02116

617 585 8500 phone

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September 24, 2010

Via Electronic Mail: dfadefinitions~2cftc,gov rule-commentsa~~

OTCDefinitions@CFTC.com

David A. Stawick

Secretary

Commodity Futures Trading Commission

Three Lafayette Centre

1155 21st Street, N.W,

Washington DC 20581

Elizabeth M. Murphy

Secretary

Secm-ities and Exchange Cormnission

100 F Street, NE

Washington, DC 20549

Re: File Number S%16-10: Definition of"M~ ParticiEant".

Ladies and Gentlemen:

Thank yon very much for the opportunity to comment regarding key provisions of the DoddFrank Wall Street Refbrm and Consumer Protection Act. With respect to the definition of

"Major Swap Participant" in the context of the interest rate swap markets, we respectfully

submit the following conm~ents:

Substantial Position in Swaps - Notional amounts should be taken into account

only on a risk-adjusted basis.

In determining whether a person "maintains a substantial position in. swaps"

for any interest rate derivative (including swaps, forwards, options), i~’notional

amount is to be used as one gauge of the substantiality of: position, it should

be included on a duration!risk adjusted basis, such as a 10-year bond

equivalem basis, if it is to be of any usefulness. By way of example:

In the ordinary course of business, one may enter imo a single

transaction or multiple transactions (’pieces’) with the same

counterparty where the sum of the pieces in comparison to the single

transaction has identical risk but a multiple of the notionaL. For

example, one can purchase a 4-year interest rate cap with respect to a
particular interest rate or 16 individual 3-month caps with respect to the

same rate. In aggregate, when compared to the 4-year cap, the 16

individual caps cover the same 4-year period to expiration, have

identical risk, and represent sixteen times the notional amount. The 10-

year bond equivalent notional exposure of the 4-year cap and that of the

sum of the 16 cap ’pieces’ would be identical.

Left unadjusted, a transaction’s notional amount is not instructive, as it

can intentionally be manipulated without altering the risk or economics

of the transaction by altering other terms of the transaction. For

example, consider a swap where the notional is 100. One party will

pay a fixed rate of 4% and the other party will pay a floating rate "X".

Alternatively, the swap could be drafted as having a notional of 10, a

fixed rate of 40% and a floating rate of X* 10.

Further, in the context of interest rate options, for options that are purchased

(i. e., long option positions), the amount taken into account should be the lesser

of the risk adjusted notional amount (e.g., the delta-weighted ten-year bond

equivalent notional amount) of such option and the market value of such

option. (This is because the risk posed by a long option holder is, at most, that

it won’t be able to return the variation margin it has received and, by

definition, this amount cannot exceed the market value of the option.) This

highlights the broader point that in many swaps (particularly options), the risk

is asymmetric and thus the risk presented by a short position should be

regarded differently than the risk represented by a long position.

The notional amounts of positions that are offsetting should be permitted to be

netted provided that they are (x) cleared with the same clearing house and

through the same FCM or (y) for positions that are not yet cleared, entered into

with the same over-the-counter counterparty.

The amount of risk represented by a dollar of notional amount (even when

reported on a bond-equivalent and/or delta-weighted basis) of course varies

depending on the risk characteristics of the particular type of swaps.

Accordingly, it would be helpful to consider applying risk metrics such as

Value at Risk, volatility and a small group of broad-market stress tests in

finally assessing which portfolios are those of Major Swap Participants.

o Finally, as provided in the legislation, risk mitigants such as clearing and highquality collateral should also be taken into account.

Substantial Counterparty Exposure - Positions should be disregarded to the

extent adequately collateralized.

o In determining whether outstanding swaps create "substantial counterparty

exposure that could have serious adverse effects on the financial stability of the
United States barddng system or financial markets", swaps should be taken

into account only to the extent that they are not %dequately collateralized"

with U.S. dollars, U.S. Treasury securities or other high-quality collatera!

consistent with that which is ct~rrently acceptable for listed Rttures and options.

O ~’Adequate collateralization" might be defined as high-quality collateral with a

value (as discounted by the clearing organization through which the swap is

cleared or, for swaps that are not yet cleared, by the swaps dealer that is the

counterparty to such swap)equal to (100 + x)% of the value of the swap (the

"Adequate Collateralization Amount"). "100%" would represent full variation

margin and "x%" would be the appropriate level ofinitia! margin

Independent Amount) for swaps in the general category in which the swap

falls, as set by the Commission~ The Commission might maintain and adjust

ti’om time to time a schedule of adequate initial rnargin levels, based on

information provided by the clearing organizations and major dealers,

consistent with current methodology and risk analytics used in the markets,

such as fl~e SPAN margining system.

O Accordingly, swaps would be counted toward "substantial coumerparty

exposure" only to the extem of the e~vcess of [x) the Adequate Collateralization

Amount over (y) the aggregate value of the high-quality collateral actually

posted (as discounted by the clearing organization through which the swap is

cleared or, for swaps not yet cleared, by tb.e dealer that is the counterparty to

such swap),

Thank you again for the opportunity to submit comments in respect ot; the CFTC’s and

SEC’s Advance Joim Notice on Definitions Contained in Title VII of the Dodd-Frank

Wall Street Reform and Consumer Protection Act. If you have any questions or would

like to discuss our comments, please contact Mike Pradko (Chief Financial Ofificer) or

Deborah Coleman (Legal Counsel at 617-585-8500

Respectf~lly submitted

Convexity Capital Management LP

By:

Lef~al CounSel