[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]


 
  DEFINING THE MARKET: ENTITY AND PRODUCT CLASSIFICATIONS UNDER TITLE 
  VII OF THE DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT 

=======================================================================

                                HEARING

                               BEFORE THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 31, 2011

                               __________

                            Serial No. 112-7


          Printed for the use of the Committee on Agriculture
                         agriculture.house.gov

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                        COMMITTEE ON AGRICULTURE

                   FRANK D. LUCAS, Oklahoma, Chairman

BOB GOODLATTE, Virginia,             COLLIN C. PETERSON, Minnesota, 
    Vice Chairman                    Ranking Minority Member
TIMOTHY V. JOHNSON, Illinois         TIM HOLDEN, Pennsylvania
STEVE KING, Iowa                     MIKE McINTYRE, North Carolina
RANDY NEUGEBAUER, Texas              LEONARD L. BOSWELL, Iowa
K. MICHAEL CONAWAY, Texas            JOE BACA, California
JEFF FORTENBERRY, Nebraska           DENNIS A. CARDOZA, California
JEAN SCHMIDT, Ohio                   DAVID SCOTT, Georgia
GLENN THOMPSON, Pennsylvania         HENRY CUELLAR, Texas
THOMAS J. ROONEY, Florida            JIM COSTA, California
MARLIN A. STUTZMAN, Indiana          TIMOTHY J. WALZ, Minnesota
BOB GIBBS, Ohio                      KURT SCHRADER, Oregon
AUSTIN SCOTT, Georgia                LARRY KISSELL, North Carolina
STEPHEN LEE FINCHER, Tennessee       WILLIAM L. OWENS, New York
SCOTT R. TIPTON, Colorado            CHELLIE PINGREE, Maine
STEVE SOUTHERLAND II, Florida        JOE COURTNEY, Connecticut
ERIC A. ``RICK'' CRAWFORD, Arkansas  PETER WELCH, Vermont
MARTHA ROBY, Alabama                 MARCIA L. FUDGE, Ohio
TIM HUELSKAMP, Kansas                GREGORIO KILILI CAMACHO SABLAN, 
SCOTT DesJARLAIS, Tennessee          Northern Mariana Islands
RENEE L. ELLMERS, North Carolina     TERRI A. SEWELL, Alabama
CHRISTOPHER P. GIBSON, New York      JAMES P. McGOVERN, Massachusetts
RANDY HULTGREN, Illinois
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois
REID J. RIBBLE, Wisconsin

                                 ______

                           Professional Staff

                      Nicole Scott, Staff Director

                     Kevin J. Kramp, Chief Counsel

                 Tamara Hinton, Communications Director

                Robert L. Larew, Minority Staff Director

                                  (ii)






























                             C O N T E N T S

                              ----------                              
                                                                   Page
Lucas, Hon. Frank D., a Representative in Congress from Oklahoma, 
  opening statement..............................................     1
    Submitted letter.............................................    73
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     2

                               Witnesses

Gensler, Hon. Gary, Chairman, Commodity Futures Trading 
  Commission, Washington, D.C....................................     3
    Prepared statement...........................................     5
    Submitted questions..........................................   159
Allison, James C., Gas and Power Risk Manager, North America, 
  ConocoPhillips, Houston, TX; on behalf of Working Group of 
  Commercial Energy Firms........................................    32
    Prepared statement...........................................    34
    Supplemenatry material.......................................    73
Cvrkel, Mark J., Chief Financial Officer, Susquehanna Bank, 
  Lititz, PA.....................................................    38
    Prepared statement...........................................    40
Field, James M., Senior Vice President and Chief Financial 
  Officer, Deere & Company, Moline, IL...........................    42
    Prepared statement...........................................    44
    Submitted question...........................................   164
McMahon, Jr., Richard F., Vice President, Finance and Energy 
  Supply, Edison Electric Institute, Washington, D.C.; on behalf 
  of American Gas Association; Electric Power Supply Association.    46
    Prepared statement...........................................    48
Trakimas, Ann E., Chief Operating Officer, CoBank, Greenwood 
  Village, CO; on behalf of Farm Credit Council..................    55
    Prepared statement...........................................    56
    Submitted question...........................................   165


  DEFINING THE MARKET: ENTITY AND PRODUCT CLASSIFICATIONS UNDER TITLE

  VII OF THE DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT

                              ----------                              


                        THURSDAY, MARCH 31, 2011

                          House of Representatives,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Committee met, pursuant to call, at 2:14 p.m., in Room 
1300, Longworth House Office Building, Hon. Frank D. Lucas 
[Chairman of the Committee] presiding.
    Members present: Representatives Lucas, Goodlatte, Johnson, 
King, Neugebauer, Conaway, Fortenberry, Schmidt, Thompson, 
Rooney, Stutzman, Gibbs, Austin Scott of Georgia, Fincher, 
Tipton, Southerland, Crawford, Roby, DesJarlais, Gibson, 
Hultgren, Hartzler, Schilling, Peterson, Holden, McIntyre, 
Boswell, Baca, David Scott of Georgia, Cuellar, Costa, Kissell, 
Owens, Courtney, Welch, Sewell, and McGovern.
    Staff present: Tamara Hinton, John Konya, Kevin Kramp, Josh 
Mathis, Ryan McKee, Matt Schertz, Debbie Smith, Liz 
Friedlander, Clark Ogilvie, and Jamie Mitchell.

 OPENING STATEMENT OF HON. FRANK D. LUCAS, A REPRESENTATIVE IN 
                     CONGRESS FROM OKLAHOMA

    The Chairman. This hearing of the Committee on Agriculture, 
entitled, Defining the Market: Equity and Product 
Classifications Under Title VII of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, will come to order.
    Today the Committee will continue its efforts in a series 
of hearings to review the implementation of the derivatives 
provisions of the Dodd-Frank Wall Street Reform Act. Already we 
have heard from diverse market participants, from farmer 
cooperatives to manufacturers to global financial institutions. 
Rarely does Congress consider an issue that has an impact on 
such diverse segments of the economy. That is why the oversight 
role of this Committee is so important, and that is why I am 
deeply concerned with the speed at which CFTC is crafting a new 
regulatory regime for a marketplace that is important all the 
way from the countryside to Wall Street, and for the U.S. 
economy as a whole.
    Under the current time frame, the CFTC can't possibly 
comprehend the cumulative impact that over 40 proposed 
regulations will have on the markets, on the economy, or 
adequately evaluate and weigh the costs and the benefits of 
each rule. With an economy that is still fragile and under a 
directive from the American public that job growth should be 
our top priority, we simply cannot impose a wave of new 
regulations that are rushed and poorly vetted.
    I have no doubt that today's hearing will identify 
potential consequences of a rushed rulemaking process. Dodd-
Frank requires several new regulatory designations that will 
define the market and, very importantly, shape the ability for 
end-users across the country to affordably hedge their risk. 
While Congress gave CFTC broad discretion in defining key 
terms, it also directed the CFTC to provide exemptions where 
appropriate, to avoid imposing unjustified and unnecessary 
costs on market participants.
    Yet, what we are seeing, and what we are going to hear 
today, is that CFTC has proposed very broad, far-reaching 
definitions, but very narrow interpretations of the exemptions 
Congress authorized. The result of this approach will be a 
spectrum of market participants subject to a new and sweeping 
regulatory regime that far exceeds the risks those entities 
pose to the financial system or to their counterparties.
    One of Congress' principal objectives in Title VII was to 
mitigate risk to the financial system and to prevent another 
financial crisis. Yet, entities that do not come close to 
threatening the financial stability and who had no role in the 
financial crisis may be regulated in the same way that those 
that do. That simply doesn't make sense, and that is not what 
Congress intended.
    Now we need to be cautious. The derivatives markets serve 
an important risk mitigation role across the economy and we 
cannot create significant economic disincentives to using those 
markets, especially for end-users and smaller entities that can 
least afford the cost of new regulation. We need to make sure 
we are not eliminating these tools for commercial hedgers, 
shifting more of the trading volume to the largest financial 
players, or sending activity to our competitors overseas.
    I look forward to hearing our witnesses today.

Prepared Statement of Hon. Frank D. Lucas, a Representative in Congress 
                             from Oklahoma
    Today, this Committee continues its series of hearings to review 
the implementation of the derivatives provisions in the Dodd-Frank Wall 
Street Reform Act. Already, we've heard from diverse market 
participants, from farmer cooperatives to manufacturers to global 
financial institutions. Rarely does Congress consider an issue that has 
an impact on such diverse segments of the economy.
    That is why the oversight role of this Committee is so important. 
And, that is why I'm deeply concerned at the speed with which the CFTC 
is crafting a new regulatory regime for a marketplace that's important 
from the countryside to Wall Street, and for the U.S. economy as a 
whole.
    Under the current timeframe, the CFTC can't possibly comprehend the 
cumulative impact over 40 proposed regulations will have on the markets 
and the economy, or adequately evaluate and weigh the costs and the 
benefits for each rule. With an economy that is still fragile, and 
under a directive from the American public that job growth should be 
our top priority, we simply cannot impose a wave of new regulations 
that are rushed and poorly vetted.
    I have no doubt that today's hearing will identify potential 
consequences of a rushed rulemaking process. Dodd-Frank requires 
several new regulatory designations that will define the market, and 
very importantly--shape the ability for end-users across the country to 
affordably hedge their risks. And while Congress gave the CFTC broad 
discretion in defining key terms, it also directed the CFTC to provide 
exemptions where appropriate to avoid imposing unjustified and 
unnecessary costs on market participants.
    Yet what we're seeing, and what I think we're going to hear today, 
is that the CFTC has proposed very broad and far-reaching definitions, 
but very narrow interpretations of the exemptions Congress authorized.
    The result of this approach will be a spectrum of market 
participants subject to a new and sweeping regulatory regime that far 
exceeds the risks those entities pose to the financial system or their 
counterparties.
    One of Congress' principal objectives in Title VII was to mitigate 
risks to the financial system and to prevent another financial crisis. 
Yet entities that do not come close to threatening financial stability 
and who had no role in the financial crisis may be regulated in the 
same way as those that do. That simply doesn't make sense, and it's not 
what Congress intended.
    We need to be cautious. The derivatives markets serve an important 
risk mitigation role across the economy, and we cannot create 
significant economic disincentives to using these markets--especially 
for end-users and smaller entities that can least afford the costs of 
new regulation. We need to make sure we're not eliminating these tools 
for commercial hedgers, shifting more of the trading volume to the 
largest financial players, or sending activity to our competitors 
overseas.
    I look forward to hearing from our witnesses today.

    The Chairman. And with that, the chair would recognize the 
Ranking Member, Mr. Peterson, for his opening statement.

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE 
                   IN CONGRESS FROM MINNESOTA

    Mr. Peterson. Thank you, Mr. Chairman, for holding today's 
hearing. And Chairman Gensler, welcome back to the Committee.
    We are here again reviewing the provisions of Title VII of 
the Dodd-Frank Act. When writing this legislation, the 
Committee's goal was to bring greater transparency and 
accountability to the derivatives marketplace. For too long, 
the over-the-counter swap market operated in darkness, and as a 
consequence, the actions of some financial institutions 
contributed to the worst recession our country has seen since 
the Great Depression. The Dodd-Frank Act gave regulators new 
tools to monitor derivatives trading. To accomplish this, we 
had to identify the market activities and participants that 
merited greater oversight.
    However, we also worked very hard to ensure that those not 
responsible for the financial collapse, such as end-users using 
the market to mitigate risk, would not bear the burden of 
further oversight. After all, as was mentioned, they weren't 
the ones that got us into this mess in the first place.
    Given that these markets have been hidden for so long, the 
challenge was to distinguish the products and the persons to 
which regulation should apply and to those to which it should 
not. I have heard from a lot of folks their concerns about how 
the CFTC proposed rules, or lack thereof, classifying certain 
entities and products could potentially impact them. I am 
sympathetic to those concerns, since they have been coming from 
groups that were not responsible for the financial crisis. We 
need to look closely at the situation before us to make sure 
that this is not the case.
    However, I am equally concerned that some of the big 
financial firms whose irresponsible behavior Dodd-Frank seeks 
to address are looking at ways to use the end-user concerns to 
create loopholes for themselves. While I am not a big fan of 
regulation, the requirements under Title VII are necessary to 
ensure we don't get into another situation where the American 
taxpayer has to bail out large financial firms.
    I hope the second panel of witnesses will speak to how 
their concerns can be addressed in a manner that precludes the 
possibility of inadvertently creating a loophole that renders 
the law obsolete.
    Additionally, I would like to remind everyone that the 
process of implementing a law has to have a starting point. 
While not everybody may like where the CFTC is starting, these 
are proposed rules, not final rules.
    Interested parties, and even Members of Congress, have and 
will continue to share their thoughts with the CFTC both in 
person and through the comment process. I have some optimism 
that at the end of the day, the resulting rules are going to be 
acceptable. If they aren't, it will definitely be an area for 
the Committee to address.
    Again, I want to thank the chair for holding today's 
hearing and I look forward to hearing from our witnesses.
    The Chairman. Absolutely.
    The chair would request that other Members submit their 
opening statements for the record so the witnesses might begin 
their testimony to ensure there is ample time.
    With that, I would like to welcome our first witness to the 
table, the Honorable Gary Gensler, Chairman of the Commodity 
Futures Trading Commission in Washington, D.C., a gentleman who 
has shown great patience in working with our schedule and 
timing for the hearing.
    Now, Chairman Gensler, we have a series of votes beginning. 
I would ask perhaps with your agreement, you provide your 
opening testimony and then we will break for our series of 
votes and then return to begin the questioning, if that is 
agreeable, Mr. Chairman.

           STATEMENT OF HON. GARY GENSLER, CHAIRMAN,
             COMMODITY FUTURES TRADING COMMISSION,
                        WASHINGTON, D.C.

    Mr. Gensler. I thank you, Mr. Chairman, and that is 
certainly agreeable, anything that helps you do your work and 
vote.
    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee I thank you. Good afternoon.
    I am pleased to testify on behalf of the Commodity Futures 
Trading Commission regarding our progress thus far on a number 
of rules you asked us to chat about. This is about the entity 
and product definitions and the end-user exception.
    The Dodd-Frank Act was actually very detailed with regard 
to entity and product definitions as well as the exemption from 
clearing for the end-users. But Congress did direct the CFTC 
and the SEC, working together and jointly consulting with the 
Federal Reserve, to further define these entity and product 
definitions, though they were quite detailed in statute.
    So the CFTC and SEC first put out what is called an 
advanced notice of proposed rulemaking, a list of questions, in 
essence. We received 80 comments, very helpful. Based on that 
and based on the statute, in December, we put out a joint rule 
on entity definitions. We received about 180 comments, some of 
them coming in after the comment period. Even this hearing, in 
essence, is a comment on those proposals, which will be very 
helpful.
    The proposed swap dealer definition closely followed the 
criteria laid out by Congress. That criteria included whether 
an entity makes a market in swaps or it holds itself out as a 
swap dealer, is commonly referred to as a swap dealer, 
regularly enters into swaps in the ordinary course of business. 
I am actually reading statutory text. That is what Congress 
said.
    So we have tried to further give some guidance to the 
market. Those 180 comments will be taken into consideration. 
The final rule will change from the proposal based on those 
comments.
    The Dodd-Frank Act also defines something called a major 
swap participant. It was really an entity that was not a swap 
dealer but otherwise might prove to have systemic ramifications 
if it failed. So we put in the proposed rule various numbers 
and criteria trying to follow Congress' will that it would be a 
very small handful. And, in fact, the major swap participant 
category would be measured in the single digits. And so that 
proposed rule is out and we are waiting to think through. We 
are not going to move forward until we can summarize all the 
comments, we can get Commissioner input, other regulatory input 
and so forth.
    We also put out a rule in December on the end-user 
exception. The Dodd-Frank Act is very clear, the intent of 
Congress is very clear, that if you are a nonfinancial entity 
hedging a commercial risk, you don't have to use a 
clearinghouse.
    We have also said that even though we have not yet put out 
a rule on margin and capital; that when we do so, we are going 
to follow Congressional intent there as well, and the same 
nonfinancial end-users will not have to post or receive margin. 
I just want to cover that point because I know it is an 
important one.
    The proposed rule went out in December. We have gotten 
1,300 comments on that. It will take us a little longer to 
summarize those comments, but I think they are very helpful.
    Last, I know you wanted me to chat a little bit about 
product definitions. Based upon the 80 comments to that 
advanced notice of proposed rulemaking, the SEC and CFTC are 
working on a product definition rule. The statute is very 
clear. Interest rate swaps, currency swaps, a swap, credit 
default swaps and so forth, these are swaps. But we are sorting 
through comments to make sure that people understand, as 
Congress intended, that insurance is not a swap, for instance, 
or commercial loans are not swaps. And very importantly to the 
community that you all oversee, that forwards and options 
embedded in forwards, just as they have been excluded from the 
definition of futures for many, many decades, they are also to 
be excluded from the definition of swap. And this is a very 
important point to the agriculture community and the energy 
community. And we will put that together in this proposal, but 
consistent with what the Congress has done.
    I thought I would, for one moment, just say that on timing, 
we know that the Congress did say that we were supposed to 
complete this task in 360 days. But we are right now at a 
pause. We are analyzing all the comments.
    We have two important rules still to propose: margin and 
capital and the product definitions. We are not moving forward 
on any final rules until we adequately summarize all the 
comments, get Commissioner feedback, get regulatory feedback. 
So, realistically we will start doing some final rules this 
spring. But the final rules will fall well into the Fall of 
this year. We are human; even that may change. But we are 
committed not to do anything until we actually can summarize 
the comments, summarize the cost-benefit analyses, get the 
feedback that is so important, and move forward.
    Congress did give us some authorities on implementation 
phasing. Phasing of the effective dates is really important as 
well, to look at the whole mosaic of rules so that we can lower 
the cumulative cost. A rule might be finalized this summer, but 
you gave us the latitude that it might not have an effective 
date until much later. And we are looking at having effective 
dates for some of the rules to only go effective after other 
rules are effective; for instance, until a product definition 
rule is finalized, maybe some other rules shouldn't be 
effective. That would be one example. Or that for clearing and 
other transaction mandates, that they happen for the swap 
dealers early on, and then other market participants, hedge 
funds and the like and asset managers maybe a little later. Of 
course, there is no clearing mandate on the true end-users, the 
commercial end-users.
    So with that I would be happy to take any questions after 
your break to go take a vote.
    [The prepared statement of Mr. Gensler follows:]

 Prepared Statement of Hon. Gary Gensler, Chairman, Commodity Futures 
                  Trading Commission, Washington, D.C.
    Good morning, Chairman Lucas, Ranking Member Peterson, and Members 
of the Committee. I thank you for inviting me to today's hearing on the 
Commodity Futures Trading Commission's (CFTC) progress thus far on 
rules relating to entity and product definitions under Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act. I am pleased 
to testify on behalf of the CFTC. I also thank my fellow Commissioners 
for their hard work and commitment on implementing the legislation.
    The Dodd-Frank Act for the first time brought oversight to the 
swaps market. By bringing comprehensive regulation to swap dealers and 
mandating that standardized swaps be brought to clearing and 
transparent trading, the Dodd-Frank Act helps lower risk to the 
American public and bring transparency, openness and competition to 
these markets.
    The Dodd-Frank Act was very detailed with regard to entity and 
product definitions as well as the exception from clearing for 
nonfinancial end-users. Congress did direct the CFTC, however, working 
with the Securities and Exchange Commission (SEC) and in consultation 
with the Federal Reserve, to further define those entities and 
products. The Dodd-Frank Act further provides the CFTC with authority 
to write rules with regard to the nonfinancial end-user clearing 
exception.
    This afternoon I will discuss the joint rule on entity definitions 
that was proposed last fall, the CFTC's and SEC's work to propose a 
product definitions rulemaking and the CFTC's proposed rule with regard 
to the nonfinancial end-user exception from clearing. I also will 
briefly discuss the CFTC's rule-writing process and authority to phase 
effective dates of final rules. The CFTC and the SEC jointly released 
an advance notice of proposed rulemaking in September to seek public 
comment on entity and product definitions. Those comments informed both 
agencies as we worked to propose a joint rule on entity definitions and 
as we continue to work on a product definitions proposed rulemaking.
Entity Definitions Rulemaking
    The Dodd-Frank Act defined two categories of market participants 
that would be subject to comprehensive regulation by the CFTC: swap 
dealers and major swap participants. This comprehensive regulation 
includes capital and margin requirements, business conduct standards 
and record-keeping and reporting requirements.
    On December 1, 2010, the CFTC proposed a rule jointly with the SEC 
to fulfill Congress's direction to further define the terms ``swap 
dealer,'' ``major swap participant,'' ``security-based swap dealer,'' 
``security-based major swap participant'' and ``eligible contract 
participant.'' The comment period ran through February 22, 2011. There 
are presently 180 comments in the comment file, including those that 
were received after the comment period closed. The Commission is 
considering all of these comments.
    The proposed swap dealer definition closely follows the criteria 
laid out by Congress. These criteria include whether an entity makes a 
market in swaps, holds itself out as a swap dealer, is commonly 
referred to as a swap dealer or regularly enters into swaps in the 
ordinary course of business.
    The proposed rule identified characteristics to be considered in 
determining whether persons are swap dealers, including whether they 
tend to accommodate demand for swaps from other parties; are generally 
available to enter into swaps to facilitate other parties' interest; 
tend not to request that other parties propose the terms of swaps; tend 
to enter into swaps on their own standard terms or on terms they 
arrange in response to other parties' interest; and tend to be able to 
arrange customized terms for swaps upon request, or to create new types 
of swaps at their own initiative.
    The Dodd-Frank Act and the proposed joint rule provide an exclusion 
for an insured depository institution ``to the extent it offers to 
enter into a swap with a customer in connection with originating a loan 
with that customer.'' The exclusion in the proposed rule would apply to 
swaps that are connected to the financial terms of the loan itself.
    The Dodd-Frank Act and the Commissions' joint proposed rule provide 
an exemption for a person who ``engages in a de minimis quantity of 
swap dealing in connection with transactions with or on behalf of its 
customers.''
    The Dodd-Frank Act also defined another category of market 
participants that would be subject to comprehensive regulation, called 
major swap participants. These entities were defined as those that are 
not otherwise swap dealers and whose failure would have systemic 
ramification given their substantial participation in the swaps market.
    The major swap participant definition relies on Congress's three-
prong test. In each of the three prongs, the Dodd-Frank Act spoke to an 
entity that has a substantial position in swaps or substantial 
counterparty exposure. The proposed rule focuses on net 
uncollateralized current exposure and potential future exposure. 
Therefore, it takes into consideration entities' uncleared versus 
cleared swaps as well as any netting or collateral arrangements that 
they may have with their counterparties.
    Under the statute and the proposed rule, the major swap participant 
category is very clearly limited only to those non-swap dealer entities 
that have risk large enough to pose a threat to the U.S. financial 
system. It is likely that, under the joint proposed rule, this category 
will include only a handful of entities.
    The joint proposed rule includes two changes to the definition of 
eligible contract participant (ECP). First, the proposed rule 
explicitly includes swap dealers and major swap participants within the 
definition of ECP. Second, the rule proposes clarifications to how 
certain commodity pools use retail foreign exchange products. These 
commodity pools must meet certain specific requirements of the current 
ECP definition.
Product Definitions
    The Dodd-Frank Act was very specific in defining derivatives 
products that will be required to be regulated. The Act covers the 
entire swaps marketplace--both bilateral and cleared--and the entire 
product suite, including interest rate swaps, currency swaps, commodity 
swaps, equity swaps and credit default swaps.
    The CFTC is working closely with the SEC on a proposed rule to 
further define swaps, security-based swaps, mixed swaps and security-
based swap agreements, which are defined terms in the Dodd-Frank Act. 
We hope to jointly propose the products definitions rule in the near 
future.
    In preparing the proposed rule, staff has been working to address 
the more than 80 comments that were submitted by the public in response 
to the joint advance notice of proposed rulemaking on definitions. Many 
of the commenters asked that the Commissions specifically provide 
guidance on what is not a swap or security-based swap.
    Though staff is yet to make a formal recommendation to the two 
Commissions, I would like to address some thoughts on three areas.
    Under the Commodity Exchange Act, the CFTC does not regulate 
forward contracts. Over the decades, there has been a series of orders, 
interpretations and cases that market participants have come to rely 
upon regarding the exception from futures regulation for forwards and 
forwards with embedded options. Consistent with that history, the Dodd-
Frank Act excluded from the definition of swaps ``any sale of a 
nonfinancial commodity or security for deferred shipment or delivery, 
so long as the transaction is intended to be physically settled.'' I 
believe it would be appropriate to interpret that exclusion in a manner 
that is consistent with the Commission's previous history of the 
forward exclusion from futures regulation, including the Commission's 
treatment of bookouts.
    Further, commenters have expressed the view that Congress did not 
intend that the swap definition include state or federally regulated 
insurance products that are provided by regulated insurance companies. 
The staffs of the Commissions are working to address these comments in 
a way that clarifies what products are insurance and therefore would 
not be considered swaps. In addition, commenters have suggested that 
the Commissions clarify that certain consumer and commercial 
arrangements that historically have not been considered swaps, such as 
consumer mortgage rate locks, contracts to lock the price of home 
heating oil and contracts relating to inventory or equipment, also 
should not be considered within the swap definition. The staffs of the 
Commissions also are working to address these comments in a way that 
clarifies that these products are not swaps.
End-User Exception
    A central component of the Dodd-Frank Act is its provision to lower 
risk in the financial system by generally requiring the clearing of 
standardized swaps through regulated clearinghouses. Central clearing 
has been a feature of the U.S. futures markets since the late-19th 
century. Clearinghouses have functioned both in clear skies and during 
stormy times--through the Great Depression, numerous bank failures, two 
world wars and the 2008 financial crisis--to lower risk to the economy. 
Congress excepted swaps transactions involving nonfinancial end-users 
from the clearing requirement because they do not pose the same risk as 
transactions between two financial entities.
    The CFTC proposed a rule on December 9, 2010 relating to the end-
user exception. We have received 1,039 comments in response to the 
proposal. In essence, the proposal says that, if a nonfinancial company 
is using a swap to hedge an asset, liability, input or service that it 
currently has or uses or anticipates having or using, it would qualify 
for the end-user exception. In addition, the proposal says that if a 
swap meets generally accepted accounting principles as a hedge or if it 
is used for bona fide hedging, then the transaction would qualify for 
the end-user exception. Non-financial entities would be able to hedge 
interest rate risk, currency risk, physical commodity risk or other 
types of risk.
    The proposed rule does, however, say that if an entity is taking a 
position to speculate, the transaction would not qualify for the end-
user exception.
    The Dodd-Frank recognized that swaps transactions involving 
nonfinancial end-users do not pose the same risk as transactions 
between two financial entities. Thus, the CFTC does not intend to 
impose margin requirements with regard to these transactions.
CFTC Rule-Writing Process
    At this point in the process, the CFTC has come to a natural pause 
as we have now promulgated proposals in most of the areas required by 
the Dodd-Frank Act. As we receive comments from the public, we are 
looking at the whole mosaic of rules and how they interrelate. We will 
begin considering final rules only after staff can analyze, summarize 
and consider public comments, after the Commissioners are able to 
discuss the comments and provide direction to staff, and after the 
Commission consults with fellow regulators on the rules. We hope to 
move forward in the spring, summer and fall with final rules.
Phasing of Implementation
    The Dodd-Frank Act gave the CFTC flexibility as to setting 
implementation or effective dates of the rules to implement the Dodd-
Frank Act. For example, even if we finish finalizing rules in a 
particular order, that doesn't mean that the rules will be required to 
become effective in that order. Effective dates and implementation 
schedules for certain rules may be conditioned upon other rules being 
finalized, their effective dates and the associated implementation 
schedules. For instance, the effective dates of some final rules may 
come only after the CFTC and SEC jointly finalize the entity or product 
definitions rules.
    The Commission has the authority to phase implementation dates 
based upon a number of factors, including asset class, type of market 
participant and whether the requirement would apply to market 
platforms, like clearinghouses, or to specific transactions, such as 
real time reporting. For example: a rule might become effective for one 
asset class or one group of market participants before it is effective 
for other asset classes or other groups of market participants. We are 
looking to phase in implementation, considering the whole mosaic of 
rules. We look forward to hearing from market participants and 
regulators, both in the U.S. and abroad, regarding the phasing of 
implementation.
    Regardless of the eventual effective dates of the swaps rules, to 
provide regulatory certainty to the market, rules relating to mandatory 
clearing, real time reporting, the trading requirement, margin and 
business conduct standards will apply only prospectively to those 
transactions that are executed after the rules go into effect.
Conclusion
    I again thank you again for inviting me to testify today. I'd be 
happy to take questions.

    The Chairman. Thank you, Chairman Gensler, and the 
Committee now stands in recess until the conclusion of these 
two votes.
    [Recess.]
    The Chairman. The Committee will reconvene. A number of our 
colleagues are still proceeding back from the floor. They will 
be here shortly and join us in a timely fashion.
    With that, the Chairman having concluded his opening 
statement, we will now turn to questions, and it gives me the 
great honor and privilege of beginning.
    Mr. Chairman, in a recent speech, you put forth a timetable 
for the finalization of the rules that would have them 
completed by early fall. No similar indication has come from 
the Securities and Exchange Commission. Do you intend to move 
forward, Mr. Chairman, with the final rules even if the SEC is 
not on your timetable?
    Mr. Gensler. We have been working very closely with the 
Securities and Exchange Commission. And, in fact, our staffs 
even had a meeting yesterday about some of those schedules, 
both sequencing final rules and then implementation and phasing 
of the rules into the effective dates. Where we have joint 
rules, naturally we would work together with the Securities and 
Exchange Commission. Their agenda is much busier than ours, so 
we might finalize some rules before they do because they have a 
lot of other topics they are dealing with. But what we are 
trying to do in working with them is to align the effective 
dates and the phasing in of these in a consistent manner.
    The Chairman. Let's talk for a moment, Chairman, about 
the--in your testimony you noted you had received 180 comments 
on the proposed definitions. And I would like to highlight some 
of those comments and then give you a chance to respond.
    From the Coalition of Derivative End-Users, ``The 
Commission's interpretation of the swap dealer and security-
based swap dealer definitions could sweep a large number of 
derivative end-users into these categories.''
    Another quote from a letter signed by the Farm Bureau, the 
Soybean Association, the Wheat Growers, the National 
Cattlemen's Beef Association, the Corn Growers, the Farmers 
Cooperatives, the Grain and Feed Association, the Milk and Pork 
Producers: ``We are concerned that the proposed definition of 
swap dealer is overly broad and would capture entities that 
were never intended by Congress to be regulated as swap 
dealers. If regulatory requirements intended for large 
financial firms are applied to those that offer risk management 
products to farmers, those tools would become less available 
and more expensive.''
    And then one final quote, and then your response, of 
course, Chairman, from the National Association of Regulatory 
Utility Commissioners, ``We are concerned that if regulated 
utilities are swept into the swap dealer definition, this will 
result in unnecessary increases in consumer cost and reduce the 
capital available for essential investments''.
    Chairman, can you respond to these concerns from the 
comments?
    Mr. Gensler. The 180 comment letters are very helpful. We 
are trying to summarize them now. They have been in for a few 
weeks now. And you are correct on those three comment letters.
    If I might just take the middle one as an example, the farm 
cooperatives, we have been working very closely and meeting 
with a number of the different cooperatives. We are hoping to 
have additional meetings with them. Whether it be--because of 
the very nature of these farm cooperatives as they deal almost 
exclusively with their members, and in some cases how they 
almost act as the farmers themselves, on their behalf, to get 
the feed and grain, and, in this case, risk management done--we 
are seeking a way to think through with them under the statute 
and consistent with what Congress did, this swap dealer 
definition. I think that we are working along with them to try 
to take those comments in line.
    With regard to the energy participants--and they were in 
the first and the third category--tens of thousands of people 
use these products and need to use these products as end-users, 
and they are not swap dealers. There may be some handful of 
energy companies that actually do provide services very similar 
to Wall Street, and they may be swap dealers as Congress has 
defined it. But we are working closely with energy companies, 
we even have a meeting tomorrow with a group of energy 
companies, again on this very topic, the swap dealer 
definition.
    The Chairman. But you would acknowledge that the concerns 
brought up by these three comments of the 180 comments that you 
mentioned in your testimony, there is the potential, then, for 
some of these entities to be defined as swap dealer, and their 
concerns are legitimate.
    Mr. Gensler. Well, it depends on their activities, because 
Congress had four tests in the statute about what is a swap 
dealer. We have given some further clarification on that, but 
it is really the test of whether you are making markets in 
swaps, whether it be interest rate swaps or oil swaps, if you 
are making a market in these swaps, and if you are known in the 
trade as dealing in these swaps and the like. I think that that 
is not a large group of companies, but there are companies that 
we are working very closely with and hearing their concerns. 
And we are not going to move forward on a final rule until we 
can adequately hear from them and work through this with our 
Commission.
    The Chairman. Chairman Gensler, before my time expires, 
when should we anticipate the proposed rule on margin and 
capital?
    Mr. Gensler. I would anticipate in the next few weeks. This 
is one that we have been working very closely with the bank 
regulators as well, and the statute says, ``To the greatest 
extent possible''--but it might have said to the maximal extent 
possible we are supposed to be consistent. So we are looking to 
try to do this in mid-April.
    The Chairman. So then, when I follow that with a question 
along the line of what you have just addressed, will the rules 
proposed by CFTC and the Fed be similar in nature, your 
response would be?
    Mr. Gensler. Yes.  Yes. Not identical, because we also 
have--and this is important--we have nonbank parties that might 
be dealers and they might even be nonfinancial entities, and so 
we have been really sorting through this in a way so that we 
don't just apply bank capital rules to companies that might be 
nonbanks.
    The Chairman. You have made helpful comments, but you don't 
intend to apply margin transactions to transactions involving 
nonfinancial end-users. If the Fed does propose to impose 
margin transactions involving nonfinancial end-users, how will 
the agencies resolve that inconsistency?
    Mr. Gensler. I can't speak for the Federal Reserve, but I 
can speak for the Commodity Futures Trading Commission. We are 
not going to have a rule proposed that either requires a swap 
dealer to pay or collect margin, either direction, from these 
nonfinancial end-users. We think that is consistent with what 
Congress directed us.
    The Chairman. My time has expired. I now turn to the 
Ranking Member for his questions.
    Mr. Peterson. Thank you, Mr. Chairman.
    Chairman Gensler, welcome back again. The first question I 
have is, have you watched the movie Inside Job?
    Mr. Gensler. I am under oath, so I have to say no, I have 
not had the opportunity to see it.
    Mr. Peterson. I was hoping we could get a movie review 
here, but you need to watch it.
    Mr. Gensler. All right. I will commit to you to watch it 
before I appear to testify before you the next time. And I will 
try to open my statement with a review.
    Mr. Peterson. I imagine you have been a little busy.
    Some of the witnesses in the next panel will ask Congress 
to push back the implementation date now scheduled for mid-
July, because they believe that you need more time to consider 
views, and they need more time to see the whole picture of the 
new regulatory framework.
    Do you need more time?
    Mr. Gensler. I don't think Congress needs to push back the 
date, but we are going to take more time. We are not going to 
move forward with these final rules and finish them all by 
July. We have already proposed 28 of the topic areas, but for 
two very important topic areas we have yet to propose, so we 
would not finalize those, at the earliest, until this fall. And 
you have already given us great latitude to phase the 
implementation dates.
    But, the regulatory framework is largely out there, and it 
helps lower regulatory uncertainty that people see this whole 
mosaic. And they are commenting on it, obviously, right now.
    Mr. Peterson. That was my other question. So you think that 
the flexibility is there for you to do this in the right way 
and----
    Mr. Gensler. Yes. I am told by General Counsel of the CFTC 
that you all won't have me sent to jail if we miss the July 
deadline; maybe for other reasons, but not that.
    Mr. Peterson. And on the uncertainty issue, if Congress did 
push back this date with legislation, how much will this impact 
the regulatory uncertainty? Can you speculate about that?
    Mr. Gensler. Well, we have heard from many commenters about 
the specifics, but a broad overview as people want us to get on 
with--thoughtfully, just thoughtfully--get on with the job and 
then give them time to implement, and Congress gave us a lot of 
latitude to give time to implement.
    But there was a crisis in 2008, and there also are a lot of 
people that want to bring greater transparency to the market, 
and the core of the statute is to bring greater transparency to 
these markets.
    Mr. Peterson. We have heard many complaints about the 
Commission not putting forth its proposed further definition of 
several terms, including swap and mixed swap. Congress directed 
you to further define these terms in conjunction with the SEC. 
I think you maybe touched on this a little bit, but how is that 
working with the SEC in terms of are you able to--are they 
bogging you down, or is that----
    Mr. Gensler. Let me say it has been an interesting process. 
But it is constructive. We are getting very close. I think that 
we are--I would say probably within 6 weeks that we will have 
something to propose. The most important thing, we had a lot of 
people commenting, and they wanted further clarification that 
insurance wasn't a swap. Well, we didn't think it was, but you 
have to write that all up--or that commercial loans aren't 
swaps--we had to write that all up--and forwards, and this is 
very important to the agriculture community, that forwards 
aren't swaps, just like they aren't futures. And I know you had 
a colloquy on this on the floor, I think other Members did, and 
we are following those colloquies and so forth.
    Mr. Peterson. Are the disagreements between the agencies 
the cause for this delay or is that what--you say it is an 
interesting process. Is it just you are not, you guys, there is 
just not agreement between you and the SEC?
    Mr. Gensler. We are now down to one small issue in a 
document that is over 100 pages long. So I am focusing forward. 
A lot of the delay has been that the 80 comments that came in 
asked for a lot of bright line tests and clarifications on 
these insurance issues, these forward issues, and these 
commercial loan issues. People asked questions on some very 
specific issues that we are trying to provide guidance on.
    Mr. Peterson. I think I recall that there was--this was 
something that kind of got in there at the end--but I think 
initially our position was that you were going to make this 
definition by yourself, and not the SEC. So I assume the 
answer, if we would have stuck with that and if it was you, you 
would have been given the responsibility for defining these 
terms, it would probably be done by now.
    Mr. Gensler. Well, you are kind to compliment us like that. 
But, it is going to be a very strong product and it is 
benefited by the SEC and CFTC sorting it through together. So 
it has taken a little longer, but it will be hopefully a good 
product and it will benefit from hundreds of public comments as 
well.
    Mr. Peterson. Thank you. Thank you, Mr. Chairman.
    The Chairman. The chair now recognizes the gentleman from 
Illinois, Mr. Johnson, for 5 minutes.
    Mr. Johnson. Thank you, Mr. Chairman.
    Let me preface my comments, Mr. Gensler, by saying there is 
a relatively small number of people I would suggest who truly 
understand the nuances and the details of not only this bill 
but of its progeny. I, quite frankly, am not one of them, so 
you will forgive me if I ask questions that appear to be a 
little amateurish, but I will do the best I can here.
    The first is, speaking as a Member of Congress, when we 
enacted this legislation a bit ago, I don't think anybody 
intended that end-users would be designated as swap dealers.
    Under your proposed definition, is it possible for an end-
user to be a swap dealer?
    Mr. Gensler. I don't think that an end-user will be a swap 
dealer. But there may be some nonbanks that are swap dealers, 
and Congress anticipated that because it gave the CFTC some 
authority over those, but it will be a very small number.
    Mr. Johnson. You also in the past and otherwise have 
focused--and it is good--on the de minimis exception of the 
swap dealer definition. And you have also indicated that you 
are receiving and have received public comment since you last 
testified.
    I can't speak for other Members of the Committee, but I 
don't think the Committee has heard from any entity that would 
actually qualify for the de minimis exception. Does that impact 
your thought and your analysis of this definition and the 
issue?
    Mr. Gensler. We did get comments. Congress asked us to have 
a de minimis exception. We made a proposal. It had three tests 
to it. I suspect, just as with many things, it will change; 
that the final rule will be reflective of many of the comments 
on the de minimis. This is particularly important in the farm 
co-op area. A number of the farm cooperatives have raised this 
and we are looking at that very closely.
    Mr. Johnson. A lot of us, in fact a majority of Members of 
this Committee, represent districts that have a lot of small or 
mid-sized banks. Is it your intention, as you look forward, to 
exempt those small farm credit banks and credit unions, 
community banks, from the mandatory clearing requirement, as we 
authorized you to do?
    Mr. Gensler. Congress did ask us to consider it. We asked 
the public for some comments. We received about 15 comments on 
that, and so what we are doing now is working with the bank 
regulators, the Farm Credit Administration--I saw Russell here 
earlier with Lee Strom and his folks, and Debbie Matz over at 
the credit union. So we are working with them and sorting this 
through and looking to see how to best fulfill what Congress 
asked us to do.
    Mr. Johnson. Just anticipating, without knowing that the 
second panel, very distinguished individuals like yourself, are 
going to have some significant concerns about their designation 
as swap dealers, specifically the Farm Credit Bank, the 
community bank. As you were here at the last Committee meeting, 
and I am quoting you as best I can, you indicated that the 
small--again, I am quoting specifically now, ``The small 
entities, by and large, are not swap dealers. There may be one 
or two exceptions; I doubt many of them are swap dealers.'' Is 
that still your attitude?
    Mr. Gensler. It is still my understanding. I am not--there 
may be some out there, but I am not aware of community banks 
that have concerns--they haven't knocked on our door, and they 
have been focused, as your earlier question, on the clearing 
exception. But I haven't heard many community banks come in.
    And in fact, Congress provided something in the statute 
explicitly, that if you are doing swaps in connection with 
originating a loan, just because you were doing a swap in 
connection with originating a loan, that does not make you a 
swap dealer. And it is something we included in our proposed 
rule in December. We have gotten some very thoughtful comments 
on the specificity of that exclusion, and like many things, we 
will probably change a little bit because of those comments.
    Mr. Johnson. Let me just conclude because my time is 
running short here. Let me just conclude by making an 
observation more than a question.
    Oftentimes we enact legislation that is implemented very 
differently than we intended it to be implemented. Quite 
frankly, sometimes we enact legislation that gets implemented 
the way we wrote the language of the bill, but not our 
intention.
    There is a lot of impact that this legislation and your 
Commission is going to have on the future of the country and 
certainly of rural America. And I would just urge you to use 
good common sense, practicality, and good business sense in how 
you implement; because if you don't, the ramifications of what 
we did and what you do are going to be felt for a long, long 
time.
    Mr. Gensler. I appreciate that and I will try to do my best 
to follow that guideline.
    The Chairman. The gentleman's time has expired. And the 
chair now recognizes the gentleman from Connecticut, Mr. 
Courtney, for 5 minutes.
    Mr. Courtney. Thank you, Mr. Chairman and thank you 
Chairman Gensler for your testimony today. I think all your 
comments about the fact that we have to be smart about 
implementing the Wall Street Reform Act are to me just common 
sense. And I don't envy your job. This is a big task ahead of 
you. But on the other hand, it is also important to remember 
that not acting swiftly enough, aside from exposing us to what 
happened in 2008, frankly, there are things happening out there 
in the economy right now where not acting, is already causing 
real trouble.
    And I would just again focus on energy contracts right now, 
which again the timeline has slipped in terms of limiting 
position limits on energy contracts.
    We have a situation, I am going to give you a really small 
example, but I think it is connected to this. In New London 
County, Connecticut, right now oil dealers are refusing to do 
any lock-in contracts for next winter's home heating oil, 
because the market right now is just completely out of control. 
And these are guys who follow this stuff like a box score. 
Every day they follow what is going on in Cushing, Oklahoma, 
and I am just going to read you a quote from an oil dealer, 
Wilcox Fuel, Dave Foster: ``We don't have a clue anymore. It is 
really driven by media news and Wall Street and it is 
disconnected from supply and demand.''
    They are, again, are calling folks like me and they just 
are apoplectic about the fact that we have not recognized that 
there are forces in the market there that have nothing to do 
with them being able to run a real business. And so I just want 
to share that with you, that there are folks out there, they 
are not asking me about when are these rules going to be 
issued; they are asking me when are these rules going to be 
enforced.
    And I would like, first, to give you an opportunity to give 
us an update in terms of where you are with that. Again, this 
affects consumer confidence all through the economy, by the 
way. I think this is bigger than New London County.
    Mr. Gensler. If I am allowed to, this is very much like 
what Congressman Johnson was saying, maybe from a different 
perspective. I think that what Congress has done is basically 
said this very large market, this swaps market, that is seven 
times the size of the futures market, should have the 
transparency, and so that the public, that fuel oil company in 
Connecticut, or anyone in rural America could have the 
confidence in these markets. Because at the core, if they don't 
have confidence in the markets, they might not use them as 
much.
    These products are actually critical to our economy. They 
are critical to lock in a price and gain certainty so you can 
focus on what you are good at in your business, whether it is 
planting the crops or buying the oil or refining the oil, or 
just being a retailer.
    Mr. Courtney. The irony is that these are the guys for whom 
this market was supposed to operate so they could hedge a risk 
and actually do a long-term contract and use it.
    Mr. Gensler. So realistically, if we are able to finish the 
rule sometime this fall--and we might slip from that too--but 
if we are able to, this marketplace will start to get more 
transparency in 2012. It won't all happen at once, because we 
do plan to use the authority you gave us to phase this. There 
will be some phasing-in on this.
    Mr. Courtney. Again, there are folks that are really 
looking to you, frankly, very seriously for assistance.
    The other point I just want to make real quick. My other 
committee is Armed Services. Secretary Mabus of the Navy was 
testifying before us the other day, and he pointed out that 
every $10 increase in a barrel of oil costs the U.S. Navy's 
annual fuel bill $300 million. Now society in general is 
calculating that speculation accounts for $20 of the price per 
barrel. I don't know if that is right or wrong, but I just 
throw that out there. It is a fairly credible source.
    When we look at your budget and what is being proposed in 
terms of the H.R. 1 and the savings just to the Navy--Air Force 
uses even more fuel. Stabilizing in a rational market, fuel 
costs is not just for consumers out there, it is also for the 
taxpayer. And, again, we should hopefully put that in 
perspective about the importance of your agency and its 
mission.
    Mr. Gensler. I thank you. Our $168 million budget and what 
the President asked for in this year's budget of $261 million, 
or next year's budget of $308 million, I think is a good 
investment to the American public. I know it is a hard thing to 
ask for more money, but I know it is a good investment.
    Mr. Courtney. Well we are going to pay for it, again in our 
DOD costs, which is the number one consumer of fossil fuels in 
the world, if we don't have a market that actually functions 
the way they can count on. With that, I yield back.
    The Chairman. The gentleman yields back. The chair now 
turns to the gentleman from Texas, Mr. Conaway, to be 
recognized for his 5 minutes.
    Mr. Conaway. Thank you, Mr. Chairman.
    Chairman Gensler, welcome. Given the extensive comments on 
the swap dealer definition, do you have any intention of re-
proposing that rule before you go final with it in order to 
make sure you get it right?
    Mr. Gensler. We are taking those comments in. We are going 
to be working with the Securities and Exchange Commission and 
our goal is to try to finalize this amongst one of the earlier 
rules, because a great many people in the market look for that. 
Again, Congress was very detailed in what a swap dealer was. We 
will modify----
    Mr. Conaway. On the four tests, Mr. Gensler, do you have to 
beat all four tests? Because the last one says if you are just 
dealing, if you enter into swap transactions of a certain 
volume that captures you as a dealer. Is that your attitude 
that--we had a milk co-op sit there last time, after you left, 
and said they fall under the definition. And they simply do 
swap-like--some dealer-like stuff for their members. And so if 
the four tests include just doing it on behalf of yourself and 
your members, how do you get out from under the swap?
    Mr. Gensler. You are right. The Congressional statute was 
an or not an and and it is the fourth test. You are correct, it 
has this term about in the ordinary business or something. And 
so then we were trying to give some more meaning to that, to 
limit it in a sense, to give more clarity to that. But we have 
continued to meet with the farm co-ops, not just in dairy but 
in grain as well, because I think that----
    Mr. Conaway. The idea, though, just to make sure you get it 
right. You mentioned earlier in the conversation that you are 
going to implement these rules in over a period of time. Will 
you expose that implementation scheme that you put in place, as 
you understand how these things roll out, for public comment to 
see that you have the wisdom of the collective group? I know 
that would be fully under your authority, but it would make 
some sense to me if you would expose that implementation scheme 
to the general public for some period of comment so that we 
will have a chance to----
    Mr. Gensler. That is something we are looking at. In each 
of our rules, we have asked for implementation phasing--or 
implementation dates from people. We have had a lot of people 
come in. We are looking at whether to have some public 
roundtables or, as you say, exploring how best to expose it.
    Mr. Conaway. I do think it would be helpful for all of us 
to see what your team had proposed from an implementation issue 
to make sure that there wasn't something that you all are blind 
to that the rest of us might see.
    We had some conversation the last time we were here about 
the cost-benefit analysis that you do, either under the CMA Act 
or under the President's Executive Order and all that kind of 
good stuff, but in one of your recent rulemakings on the cost-
benefit, the statement was: For costs the Commission has 
determined that the cost to market participants and the public, 
if not adopted, are substantial. But then on the benefits you 
said: The Commission is determined that the benefits of the 
proposed rule are many and substantial.
    Pretty casual swipe at a really important piece. Now many 
laws where agencies, not just yours, but other agencies who 
have done a cavalier approach to cost-benefit analysis, have 
been challenged in court. Can you help us understand that there 
is more depth to the cost-benefit analysis under these rules 
than just they are substantial, and if we don't do them or if 
we do do them, pretty cavalier comments just on the way you 
phrased it.
    Mr. Gensler. Well, one of the best ways of getting comments 
from the public is a hearing. And each of our teams summarizing 
public comments, one of the things they are specifically doing 
is summarizing all of the cost-benefit comments from the 
public, so that the Commissioners can take those into 
consideration, and whether it be qualitative or quantitative, 
that we can include that before we go to any final rule, and as 
you say, to include anything that we have heard from the public 
with that regard.
    Mr. Conaway. There are some pretty dramatic differences 
between your cost--your expected cost to participants and folks 
that deal--in what they themselves see under these proposed 
rules. So making sure that we have not done something that 
costs way too much money versus the benefit that we get, would 
be helpful.
    And one final comment. As you roll out this entire scheme 
when we get it in place, can we do an interim final rule for 
the whole package so that the industry, the participants, 
everyone can see how all of this matrix of new regulations fit 
together to make sure we get it right? I understand going at it 
a piece at a time, but it seems to me beneficial to the agency, 
as well as those who try to comply with your rules, if they saw 
the whole matrix at some final point, it would still allow for 
some fine-tuning, so to speak.
    Mr. Gensler. We have nearly completed all the proposals. 
There are these two that I think will be out to the public, 
capital and margin, hopefully in the next few weeks, and the 
product definition may be a few weeks after that. We don't plan 
to move on any final rules in April. There may be some very 
noncontroversial, small rules that we start to move on in May. 
We have the discretion to continue to take public comment and 
include it in public comment files, and have done so. We have 
used that discretion very liberally.
    This meeting right here, this Committee meeting, will be 
part of our public comment file as well. So the mosaic will be 
out there really before we move on final rules of any 
substance.
    Mr. Conaway. Thank you, Mr. Chairman, I yield back.
    The Chairman. The gentleman's time has expired.
    The chair now recognizes the gentleman from Pennsylvania, 
Mr. Holden.
    Mr. Holden. Thank you, Mr. Chairman.
    Chairman Gensler, it is nice to see you again. I had two 
issues I wanted to raise, but you more or less have addressed 
them; so I will just make a couple of comments about agreeing 
with my colleagues that we are, on this Committee, hearing a 
great deal from the agriculture sector and the energy sector, 
particularly public utilities, about the definition. So I am 
glad to hear you are going to be working with them.
    And following up on Mr. Johnson's comments about the 
exemption for small banks, Farm Credit System, and credit 
unions, I would just encourage you to stay engaged and listen 
to their concerns, because it is my understanding that the 
overwhelming majority, over 90 percent of the swap dealing, is 
in the hands of 25 entities or fewer. So you will have to be 
very careful with smaller banks.
    As a matter of fact, on the next panel, Mr. Cvrkel from 
Susquehanna Bank, headquartered in Pennsylvania, will be 
testifying. It is a bank of about $14 billion in assets, I 
believe, and I will ask him when he is testifying or taking 
questions. In the last 3 or 4 years, they have only done about 
54 swaps compared to the overwhelming majority. I think you 
need to be careful that these are useful instruments in smaller 
banks and other entities, but at the same time if we are too 
burdensome on them, they are not going to participate.
    So I just would encourage you to stay at the table and 
listen to what they have to say. Thank you. I yield back. Do 
you want to comment?
    Mr. Gensler. No. I appreciate the comment. I read the 
testimony and look forward to working not just with Susquehanna 
but many banks of similar ilk.
    Mr. Holden. Well, this is a Pennsylvania interest here.
    The Chairman. The gentleman yields back.
    The chair turns to the gentleman from Texas, Mr. 
Neugebauer.
    Mr. Neugebauer. I thank you, Mr. Chairman.
    Chairman Gensler, thank you for being here. Yesterday you 
and I talked--just a while ago, one of your cohorts, Ms. 
Sommers, testified before my hearing that I had on the 
Financial Services Committee. She said some things that were 
very concerning to me. Kind of one of the things that she 
alluded to here, she says that we are voting on proposals 
containing a very short, boilerplate, cost-benefit analysis 
section. And she referred to the President's Executive Order, 
although it does not apply to your agency, and taking into 
account both quantitative and qualitative issues and the cost 
and the benefits of those. And one of the things that she 
brought up was an interesting point, is that when you do a 
better job of those cost-benefit analyses, and as you quantify 
those various proposed regulations and you put numbers onto 
them, that she feels like, she said, that she thinks 
Commissioners make better decisions. I think we would all agree 
that that would be hopefully the goal of every agency is that 
when we put people to serve in the capacity of Commissioners, 
that they avail themselves of every opportunity to make the 
best decisions.
    And as I didn't get to hear all of my friend from Texas' 
testimony, but what we are talking about with Dodd-Frank is we 
are not talking about just a little tweaking here of the 
financial markets.
    We are talking about a major change in those financial 
markets and maybe even influencing the way capital moves and 
how capital is priced and how capital is distributed in this 
country, which equates to jobs. Basically, the way we create 
jobs in this country is people have an idea and they find the 
capital to do that, or they have a business and they expand it. 
And these markets have become a very effective tool for many of 
the people that use them. They have created jobs and they have 
created more certainty in their companies.
    And so I am a little concerned. What would be your response 
to Ms. Sommers' response, that you all aren't doing a good job 
over there doing your cost-benefit analysis?
    Mr. Gensler. I am very proud of the work of the staff and 
the five Commissioners. We are in compliance with the 
Commodities and Exchange Act, section 15(a), which Commissioner 
Sommers also said yesterday, and we are looking very closely at 
the comments that people have put forward on cost-benefit 
analysis. I can assure you we are not going to move forward on 
final rules until they are summarized and Commissioners get to 
deliberate with each other about that and with the staff.
    I think that what the Dodd-Frank Act does at its core is it 
brings transparency to these markets and lowers risk in these 
markets, and competition and open competition in these markets 
will lower some of the barriers to entry to many banks. If a 
small bank wanted to actually enter the market in a way, right 
now this is a highly concentrated market where the information 
advantages are more towards the financial community in New York 
than to the tens of thousands of users, whether they be in 
Texas, my home State of Maryland or elsewhere.
    And I think you all in passing the Act tried to tip that 
balance a little bit to most of the corporations that use these 
products.
    Mr. Neugebauer. I don't think she said that you weren't in 
compliance, but she said compliance is, to that particular 
section, is a relatively interpretive term. You can be in 
compliance or you can do a good job. I think what she was 
saying is that somehow within the agency, you all have come to 
the conclusion, hey, we are complying with that section.
    But, as she said, as complicated and as important as many 
of these things are and with the speed with which they are 
coming out, that there is really not any way that the kind of 
comprehensive analysis that should be done for the potential 
impact and the consequences that these changes could make on 
the market. And as you say, I don't think anybody here 
disagrees with the fact that markets should operate with 
integrity and transparency.
    But many of the rules that you are putting out will 
actually determine the people who can use some of these tools 
and how they can use them, and whether they can afford to use 
them and whether those tools continue to be advantageous to 
their organization.
    And so I would just say that I think Mr. Bachus and I wrote 
all of you a letter here recently and said, Do you know what? 
We are not interested in speed here. We are interested in doing 
the right thing.
    And if a lot of people think that Dodd-Frank is the right 
thing to do, I think all those same people who voted for it 
would probably also, without speaking on their behalf, would 
say, yes, we voted for it but we hope it does what we intended 
for it to do. We hope that the consequences and the outcome has 
been measured, and we know what we are getting before we go 
down that road. And some people say, well, Mr. Frank said 
today, ``Well, we will fix it if we made a mistake.''
    The problem is when you start changing the behavior in a 
lot of these markets, then going back and trying to, ``fix 
it,'' has even more dire consequences than taking a little 
extra time to make sure that we get this right.
    And so what you are going to continue to hear from me is 
that I am concerned about the speed, I am concerned about the 
sequence, and I am certainly concerned about the analysis and 
thought that is going in in this rulemaking process.
    With that, Mr. Chairman, I yield back.
    The Chairman. The gentleman's time has expired.
    The chair now turns to the gentlelady from Alabama, Ms. 
Sewell, and recognizes her for 5 minutes.
    Ms. Sewell. Thank you so much.
    First, welcome, Mr. Chairman. I admire what you are doing 
and really feel that the Commission has been charged with a 
very special duty, and I know it is to get it done in a timely 
fashion is what we all want, as well as to be fair.
    I have one question really. Where are you in the decision 
making process when it comes to determining whether to exempt 
the Farm Credit System institutions from the definition of end-
user?
    Mr. Gensler. We asked the public for some comments. We 
received about 15 comments on this. And now we are working with 
the Farm Credit Administration, as well as the banking 
regulators and the credit union folks, as to how to piece this 
together.
    If we were to move forward, we would have to do a proposal 
under the statute and get further public comments on that. But 
right now we are in--similar to the rules, we are sort of 
taking the comments that we received and are working with the 
other regulators on how to craft something.
    Ms. Sewell. Where do you think you will come out on that?
    Mr. Gensler. I don't want to get ahead of the process and 
my fellow Commissioners. But we take seriously what Congress 
said, that we shall consider this, so I take it seriously in 
the entire statute, but this was the direction from Congress.
    Ms. Sewell. Absolutely. Thank you. I yield back the rest of 
my time.
    The Chairman. The chair now turns to the gentleman from 
Alabama, Mr. Goodlatte, for his 5 minutes.
    Mr. Goodlatte. Except I am going to stay in Virginia.
    The Chairman. Virginia. Virginia. Very good point.
    Mr. Goodlatte. I thank you, Mr. Chairman. I thank you for 
holding this hearing. And, Mr. Gensler, I thank you for 
participating today.
    I understand that my colleague, Mr. Peterson, asked you if 
you had seen the movie, Inside Job. And you said you hadn't 
seen it yet. I recommend you see it.
    And let me just ask you a question about my main concern 
here, why I voted against Dodd-Frank, and why I am concerned 
about where you are headed. I think that what we should be 
doing is clearly defining what you can and can't do and 
throwing the book at the bad guys who do what they are told 
they can't do, and not going into the amount of regulations 
that you are imposing on people who are trying to conduct a 
legitimate business and making it all that more difficult to do 
that.
    So my first question is, one of the things revealed in that 
interesting documentary is the fact that apparently a number of 
the major investment banking firms sold various derivatives to 
their customers at the same time they were betting against 
their customers themselves.
    What can you tell us about that? And what is being done to 
cure that?
    Mr. Gensler. Your question and much of what happened in 
that was in credit default swaps. Some of that jurisdiction 
will be at the Securities and Exchange Commission, but I will 
speak more broadly. Because what Congress gave the Securities 
and Exchange Commission and the Commodity Futures Trading 
Commission is new authorities on anti-manipulation and to 
protect the markets from abusive practices. And I don't know 
how the Securities and Exchange Commission will deal with that 
on these single name and these basket of credit default swaps 
where a lot of that, you are right, occurred.
    What we are doing at the CFTC is we have proposed a new 
anti-manipulation standard which is consistent with what 
Congress did. Congress gave us a new anti-manipulation 
standard, and that is out for comment. We would like to 
finalize that to make sure that we can pursue actions in this 
marketplace.
    Mr. Goodlatte. One of the issues that--I don't know how 
related to that is--but attempting to cure some of this is--the 
categories of swap dealer and major swap participant are 
mutually exclusive. If an entity is a swap dealer, that entity 
may not be a major swap participant. This makes sense, because 
swap dealers are the sell-side of swaps and major swap 
participants are the buy-side, basically the largest customers. 
Sellers and buyers should not be in the same regulatory 
category, and Dodd-Frank appropriately provides for that.
    Do your regulatory proposals take this basic difference 
into account?
    Mr. Gensler. Yes. I would think that there would be only, 
at most, a handful of major swap participants; that somebody 
who is not a swap dealer, but yet for some reason is so large 
or substantial--is what Congress used the term--that their 
failure would have a systemic effect on the economy.
    And I should say on your first question, we do also have 
authorities on business conduct standards for selling swaps to 
pension funds and municipalities. And Congress asked us to be 
very focused on the sales practices in that regard as well.
    Mr. Goodlatte. I know that some have expressed concerns 
that swap dealers and major swap participants will be regulated 
the same. Do you propose to regulate them the same, even though 
one is the seller and one is the buyer? And why should buyers 
and sellers be subject to the same sales practice rules, when 
the buyers are not indeed sellers?
    Mr. Gensler. You raise a very good question, and I am going 
to go back and think about that and ask about that on the sales 
practices. But the basic answer is because the statute did not 
differentiate between the two. Once one is designated a major 
swap participant, one of these handful of companies that are so 
large, the statute just regulates them the same. But you raise 
a very good question about sales practices.
    Mr. Goodlatte. So are you suggesting that we need to take 
further legislative action because your hands are tied; or are 
you able to make a difference there?
    Mr. Gensler. Could I get back to you on that in terms of 
the sales practices for major swap participants?
    Mr. Goodlatte. My time is limited, so let me go on to 
another question.
    I have heard from some businesses that they are uncertain 
about how they will be designated and which rulemaking will 
apply to them. Is there any documentation that provides various 
market entities, and specifically end-users, guidance regarding 
which of the various rulemakings are applicable to them?
    Mr. Gensler. Well, for the vast majority of end-users, they 
are not going to be swap dealers, they are not going to have to 
use a clearinghouse unless they choose to, and they will 
benefit from the transparency in the marketplace. There will be 
changes in the marketplace, of course, because the financial 
companies will be using these clearinghouses, but they will be 
out of it.
    Mr. Goodlatte. With the leave of the Chairman, I will ask 
you one more question.
    I am concerned that the CFTC is putting out rules piecemeal 
for comment. Many of these regulations are highly 
interdependent, and I am concerned that we will not get to see 
the full picture of how they work together or a meaningful 
analysis of the cost and the impact of the regulations. Would 
you be willing to put forward a full package of proposed 
regulations for comment before they are all adopted, or at 
least put them in packages so that we and market participants 
are able to fully appreciate their cost and their impact?
    Mr. Gensler. I think, actually, that is nearly what we have 
done. We haven't finalized anything and we have two major rules 
left, which we will probably do in the next 4 to 6 weeks.
    Mr. Goodlatte. Will those rules be out and evaluated before 
the first rules you issued take effect?
    Mr. Gensler. Yes.
    Mr. Goodlatte. That is helpful.
    Thank you, Mr. Chairman. I appreciate it
    The Chairman. With that, the gentleman's time has expired. 
The chair will now try in a more accurate fashion to turn to 
the gentleman from Iowa, Mr. Boswell, and recognize him for his 
5 minutes.
    Mr. Boswell. Thank you, Mr. Chairman.
    Just briefly, I wasn't here for all that you have been 
through already, but thank you for coming. You have a big job. 
And I am wondering if you want to comment on are we giving you 
the tools to do what you have to do. Have you got the tools to 
follow through?
    Mr. Gensler. Well, you are kind to ask. We have the tools 
to write the rules and excellent staff, but we do not have the 
tools to oversee the market. We have estimated that we need 
about 45 percent more people to oversee a market that is seven 
times the size of what we----
    Mr. Boswell. We have talked about this before. Can you give 
us some kind of a figure--dollars, number of people?
    Mr. Gensler. The President has put forward a budget of $308 
million for our agency for 2012, and $261 million for this 
year. We are currently funded at $168 million. In terms of 
people, we have about 675 people now, and the President has put 
forward 983 people.
    We only spend $31 million on technology a year. We have 
asked to go up to about double that. That is less than about 1 
day of technology spending for some of the biggest Wall Street 
banks.
    Mr. Boswell. So what happens if we are going to have to--
you can't do the job, you don't have the tools, you don't have 
the personnel if we continue with this; or do we back off and 
we don't do the regulation, or what happens?
    Mr. Gensler. I think the challenge for the agency is if we 
even kept flat on funding, is that we will have to shift 
resources that currently oversee the futures market, or even 
agricultural futures and energy futures, over to some of these 
financial swaps. The mission is, right now, far broader. The 
market is seven times its size and far more complex. And so we 
will not be able to pursue the Ponzi schemes. We will not be 
able to promote the transparency in the markets that I think 
the public deserves.
    Mr. Boswell. Well, I will yield back, Mr. Chairman, in just 
a moment. But it just seems to me like we have to lay this out 
in broad daylight and decide what we want to do with it, 
whether we are going to give up the oversight, or whatever. I 
don't know. I don't envy your job here. I am not sure what we 
are going to do.
    Thank you. I yield back.
    The Chairman. The gentleman yields back.
    The chair now turns to the gentlelady from Ohio, Mrs. 
Schmidt, for 5 minutes.
    Mrs. Schmidt. Thank you, Mr. Chairman. And thank you, Mr. 
Gensler, for coming.
    I want to focus a little bit on farm credit and community 
banks. Is it your intention to extend the insured deposit 
institution's swaps in connection with loans exemption to the 
farm credit banks?
    Mr. Gensler. I know that a number of comment letters have 
come in on this. The statute speaks of insured depository 
institutions and did not speak in a broader way, so I am 
familiar with the comments that have come in. I know that our 
staff and General Counsel's office is taking a close look at it 
because the statute actually just uses the term insured deposit 
institutions.
    Mrs. Schmidt. So you don't know how you are going to handle 
that?
    Mr. Gensler. I don't know. I am apprised of it. I know that 
staff is looking very closely at it.
    Mrs. Schmidt. Because I believe during the last hearing 
when you appeared before the Committee, you were asked about 
small banks and farm credit institutions. And I believe you 
said that the small entities, by and large, are not swap 
dealers; there may be one or two exceptions. And you further 
said you couldn't speak for thousands. And then you said, I 
doubt that many of them are swap dealers.
    And in light of the fact that we have a farm credit bank 
and a community bank here today that have expressed concerns in 
their testimony--or will be expressing concerns, because we 
have received the written testimony--about being designated as 
swap dealer, what would you say in light of that response?
    Mr. Gensler. My answer was trying to answer a question 
about banks smaller than $10 billion. I think the banks you are 
hearing from today are $14 billion and maybe--I am sure they 
can tell you how large, $50 or $60 billion.
    Mrs. Schmidt. You think $14 billion is a large bank?
    Mr. Gensler. Congress actually defined it in the statute. 
They used the term small bank, and then right below it it said 
$10 billion or less. So I was using a Congressional term.
    Mrs. Schmidt. So do you think we should change that 
benchmark?
    Mr. Gensler. I am just using it----
    Mrs. Schmidt. Because, sir, I come from a banking 
background, and $14 billion is not a large bank. I don't know 
why $10 billion was the threshold. That would be a very small 
bank, in my opinion, but it is certainly not a large bank. So 
should we change the benchmark, the definition?
    Mr. Gensler. I think the statute is a strong statute; I am 
not asking Congress for any changes.
    Mrs. Schmidt. Okay. And then I just want to go back to the 
swap issue. We have heard concerns, and I know you have 
received public comments, that active trading in the swap 
market by itself could make an entity a swap dealer. Is that 
your intention?
    Mr. Gensler. What we have put forward is a rule that 
further defines what Congress laid out, four provisions for 
what a swap dealer is, and so we are taking those comments in. 
But the statutory language was, ``if you make a market in 
swaps, or you are commonly known as a `swap'.''
    And then the fourth prong, which was one that talked about 
in the ordinary course, is where we thought there was some need 
for further definition. But in essence, if you are 
accommodating demand or facilitating customers in swaps, it 
would be sort of part of the facts and circumstances.
    Mrs. Schmidt. So again, back to this Act that you are now 
trying to implement rulemaking on, it appears there is a lot 
more ambiguity or questions that arise from the Act itself, and 
maybe we should revisit the Act.
    Let me go on again. In the definition of security-based 
swap dealer, the SEC plans to adopt their dealer trade 
distinction with respect to who must register as a security-
based swap dealer. The CFTC appears to have rejected this 
distinction for the swap dealer definition, and now again there 
seems to be some sort of tension. Can you clarify this?
    Mr. Gensler. Yes. We did not, as our markets are different. 
They have in that definition, that dealer and trader 
definition, they talk about inventory and the like; inventory 
of securities, which is not easily or readily adaptable to the 
interest rate swap market; what is the inventory of interest 
rates, for instance? Or even, for instance, in the oil markets, 
which is not like an inventory of securities. So there are some 
challenges just because of the specificity in their rule.
    Mrs. Schmidt. I yield back, but----
    Mr. Holden. Will the gentlewoman yield on her point about 
$10 billion for me to ask the Chairman a question?
    Mrs. Schmidt. Yes, please.
    Mr. Holden. I thank the gentlewoman.
    Chairman, you do have the authority to exempt above $10 
billion, correct? It is just below $10 billion you must?
    Mr. Gensler. Again, as I understand, the statute asked us 
that we shall consider exempting from the clearing requirement 
the small banks, and then it lists banks under $10 billion, 
credit unions under $10 billion, and of course farm credit 
institutions under $10 billion.
    Mr. Holden. But you have the authority above $10 billion as 
well.
    Mr. Gensler. I am just speaking to what--I mean, Congress 
directed us to take this up. We are taking it up right now, 
working with the institutions. I believe that the 
Congresswoman's question about swap dealers, what I said 
earlier and I will say now, I am not aware of institutions less 
than $10 billion. There may be some out there, but I am not 
aware of them. They haven't been knocking on our doors, that 
say they would be a swap dealer or anything like that.
    Mrs. Schmidt. May I have just an additional 30 seconds?
    The Chairman. The gentlelady reclaims her time. The 
gentlelady has an additional 30 seconds.
    Mrs. Schmidt. Sir, you said that $10 billion was the 
threshold. I believe you said it is a suggestion, not an 
absolute benchmark of $10 billion. And I believe you have the 
authority to go above that, the way this law was written.
    So, again, there is a lot of ambiguity in this Act, but $10 
billion was not the absolute benchmark. You could go above that 
to $14 or $15 billion.
    I yield back.
    The Chairman. The gentlelady's time has expired.
    The chair now recognizes the gentleman from California, Mr. 
Costa, for 5 minutes.
    Mr. Costa. Thank you very much, Mr. Chairman.
    I want to first kind of revisit a subject that we discussed 
the last time you testified, as it related to the potential of 
regulating of foreign currency swaps. My understanding is that 
the Secretary of the Treasury is considering or leaning toward 
a decision that foreign currency swaps should be regulated. We 
are all following very closely what is happening with the Euro 
and a number of countries within the EU, and of course 
situations with China and other foreign currencies that 
obviously impact our trade.
    And so I guess my question, my first question, is what 
impact would such a decision have, if any, on producing a 
definition of a swap, or any other rulemaking that is already 
underway, if we start to regulate foreign currency swaps?
    Mr. Gensler. I think we have contemplated that in our 
rulemaking and are contemplating it in the product side as 
well, that Congress gave the Secretary the determination; he 
could determine that foreign currency swaps are out, but we 
have sort of contemplated that in our rulemaking.
    Mr. Costa. Can that occur on a separate track?
    Mr. Gensler. I believe it can in terms of our rulemaking. 
We would take it into consideration in terms of phasing 
implementation. For instance, there is not a swap data 
repository for foreign currency right now. There are swap data 
repositories, for instance, in credit default swaps. That is 
one of the things we are taking into consideration. It might 
just take more time to stand up, for instance, some of the 
infrastructure.
    Mr. Costa. Can you tell us this afternoon, at this time, 
what you think you are going to do?
    Mr. Gensler. Well, it is the Secretary of the Treasury's 
determination.
    Mr. Costa. I understand.
    Mr. Gensler. No. I don't believe it would be prudent for 
me----
    Mr. Costa. Not before its time, right?
    Mr. Gensler. It wouldn't be prudent for me to----
    Mr. Costa. Following up on Mr. Boswell's line of 
questioning on resources, under the Dodd-Frank law there are a 
host of issues that we have discussed here this afternoon, from 
applications for new swap execution facilities, designated 
clearing organizations and swap data repositories, swaps to see 
if clearing mandates should apply, requests for exemptions to 
the law's provisions, and other requests from the business 
community.
    You made a comment earlier on your current resources 
available and your fine staff and what your capabilities are 
today. When you go down that list that I just stated, what gets 
included or excluded based upon how much your budget is?
    Mr. Gensler. It really depends on where the budget is. If 
we were cut, a lot of it goes away; we can't even oversee the 
futures market much. If we just stay flat, we will have to 
start reallocating people. We did have a very real crisis in 
2008. These markets are not as transparent as Congress has 
wished them to be. We would be relying on the markets to be 
complying with Dodd-Frank, but we wouldn't be able to actually 
examine for it and oversee the markets with regard to swaps, as 
you have directed us to.
    Mr. Costa. Well, to use a medical terminology, first, do no 
harm, when a surgeon is in ER, on a serious case they triage, 
and so they deal with the most urgent matters first. So on that 
list, I assume that when you do get a chance to sit down on a 
Friday afternoon with your staff and figure out, now that we 
have these rules almost presented and we are moving to the next 
stage, where are your priorities going to be?
    Mr. Gensler. Well, the biggest priority is to increase our 
technology budget so we can aggregate the data and actually 
make it public. We have proudly put out, every Friday, 
Commitments of Traders Report in the futures market. We would 
like to do something similar in the swaps market if we could 
actually have the technology and aggregate data.
    For the hundreds of applications that will come in, we 
would like to be responsive. We would like to have a 
professional on the end of the phone to answer the questions 
and try to walk people through some very new rules and give 
them regulatory guidance. I don't see how we will be able to do 
that.
    Mr. Costa. So if you get the President's full request, you 
can do all of the above?
    Mr. Gensler. I think that if we get the President's full 
request we can grow into it, and it will take a couple of years 
to grow into it. But, yes, the President's request helps us 
grow into these responsibilities.
    Mr. Costa. And if you get half of it or something less, you 
will have to do the prioritization.
    Mr. Gensler. That is correct. That is correct. And if we 
are cut from where we are now, at some point I would have to 
tell this Committee we could not fulfill our mission. We 
certainly could not fulfill it if we were cut back to 2008 
funding levels.
    Mr. Costa. Well, I think that needs to be clear. And you 
should also tell this Committee if it is something less, half 
or less, what you can do and what you can't do. I think that is 
an area--when you try to create an expectation for a 
transparency level and for all elements of these derivatives, I 
just think people need to know what they can expect and what 
they can't.
    Mr. Gensler. Part of the investment in an agency like ours 
is it is like investing, and you don't know when--to use your 
medical analogy, it is like the doctor saying, ``Stay on a diet 
and maybe don't smoke or something.''
    I can't tell you that in 2012 there will be a crisis. But 
we know in 2008 there was a crisis and swaps were part of it. 
And Congress reacted appropriately. We are trying to implement 
the law consistent with the intent, but if we don't oversee 
this market, the American public is prone to risk.
    Mr. Costa. I would like to quickly, before my time expires, 
move over to another area. You touched upon it, Mr. Conaway 
touched upon it. When we are dealing with some of the various 
commodities, whether we talk about wheat, soybean, milk, 
others--anecdotally, and I have nothing to base this on because 
I don't deal with these trades, but I get complaints from a lot 
of my farmers that there is a lack of transparency, there is a 
lack of activity, that it seems to be an in-house game.
    It is hard from my perspective to really determine whether 
or not these anecdotal stories really--to what degree they are 
accurate. Have you got any sense, based upon getting back to 
the whole purpose on why this was created, going back to the 
1930s--not the exotic sorts of mechanisms that you deal with 
today--but getting back to what is important out on the farm to 
see what is going on in Chicago and see what is going on 
elsewhere for our farmers and ranchers?
    Mr. Gensler. Well, hedgers meet speculators in a 
marketplace. If a farmer needs to lock in a price at harvest 
time, it is usually a speculator on the other side of that 
transaction.
    But it is true that over the decades that the markets have 
been--the percent has gone up that are financial actors or 
speculators in that marketplace. And it is why people want the 
transparency, so they can still have the confidence that the 
price they get for their corn or wheat or soy or milk, as you 
said, is actually reflective of supply and demand, and that 
there is integrity in the market.
    Mr. Costa. A lot of my dairymen complain, they just think 
there is a total lack of transparency, that it is an in-house 
deal, and they have little way to really get a sense that 
prices aren't set without their ability to have the input.
    Thank you.
    The Chairman. The gentleman's time has expired.
    The chair now turns to the gentleman from Colorado, Mr. 
Tipton, to be recognized for 5 minutes.
    Mr. Tipton. Thank you, Mr. Chairman. Thank you, Mr. 
Gensler, for being here.
    I just have a few questions that I would like to get some 
clarification on.
    You commented earlier that you are seeking to work with the 
various entities in terms of some of the resolution in regards 
to the rulemaking. Can you describe what it means to be working 
with them? Is it just taking the comment; they put out an idea 
and you say, well, here is the problem? Is there that give-and-
take going back and forth, or is it just receiving comment; we 
will consider it and we will make up our own mind.
    Mr. Gensler. If I might, there is some of both. We have had 
well over 600 meetings. I had one on the end here with the good 
gentleman at ConocoPhillips that is about to testify that we 
will put on our website as well. So he will be able to answer 
you whether there was give-and-take, but it is some of both, if 
I want to be----
    Mr. Tipton. Well, I appreciate that. I guess one of the big 
concerns that I always have--small business guy--and we are 
probably hearing that in terms of an underlying theme through 
some of the questioning that is going on--is really some of the 
cost-benefit analysis that is really going in that. Can you 
describe for me how you approached cost-benefit analysis in 
this process?
    Mr. Gensler. Many years ago in our statute a section you 
will hear about, it is called 15(a) was added, and it has five 
criteria, five characteristics we have to look at. And it talks 
about the integrity of the market and the price discovery 
function and the lowering of risk. So it is around those things 
that somewhat inherently are qualitative. Commenters have come 
in with some quantitative figures as well. And so we try to 
take all of that into consideration.
    One thing for me, as one Commissioner, is trying to find 
what Congress asks us to do in a way that lessens the burden or 
cumulative cost, because there are things in the statute that 
will cost money, that is true. But then there is a way to find 
a least-cost way, or find a way that we can spread it out and 
have it phased in terms of implementation, to take into 
consideration the cost as well.
    Mr. Tipton. Can you maybe just tie that in just a little 
closer here? Like an electric utility, as a swaps dealer being 
designated, how are you going to approach the cost-benefit 
analysis on that?
    Mr. Gensler. The swap dealer definition is very precise in 
the statute. So many electric utilities wouldn't be; but if 
they were, then it is really trying to walk through with them 
what are the capital margining requirements--because we are 
supposed to set the capital and margin regime for these 
nonbanks. And it doesn't have to be the same as the banks. The 
statute says that to the maximum extent practical we have to be 
consistent, but it didn't say we have to be the same.
    It is walking through the business conduct standards and 
how they might apply to some of these nonbank swap dealers, 
whether it is phasing the timing or whether they apply 
differently, to try to walk that through.
    Mr. Tipton. It sounds a little iffy to me in terms of 
setting some of those capital requirements. It just sounds a 
little iffy to me in terms of how you are trying to define 
those capital requirements for entities that are nonbanks.
    Mr. Gensler. Well, one of the challenges is that those 
capital rules have been done for banks, insurance companies, 
broker-dealers, and so Congress gave us a task and it was 
specific to nonbanks. We are hoping to propose that in the next 
few weeks. We are very much looking forward to public comment 
on it, because we will be assisted by that public comment. We 
have already been assisted by many of the meetings we have had 
with industry people.
    Mr. Tipton. Okay. And I appreciate that assistance.
    I want to go back to an earlier question that was raised in 
regards to the packaging, the entire package. Did I understand 
you correctly that you are willing to be able to bring that 
back as a package for comment? Because I deeply respect the 
comments of do no harm, and unintended consequences.
    Mr. Gensler. Well, I just want to be precise. We have 
already put out rules on 28 of the 30 topic areas. There are 
two significant ones. There is capital and margin, there is a 
product definition, which will be out in a number of weeks. We 
don't intend to move on any final rules in April. So the mosaic 
is largely out there and will be, in essence, out there before 
we move on any major rule. There might be one or two very small 
rules that we move on--an example is the definition of 
agricultural commodity. This is one rule we might move on 
early, but it is not the same category.
    Mr. Tipton. I guess my point on this is it is not so much 
how I am viewing it as mosaic, as impressionistic art. When we 
are up close, we aren't really seeing it, it is coming in in 
little bits and pieces; when we step back, we see the whole 
picture. Being able to come back in and revisit these, once we 
then have that interaction with industry, the actual impacts 
that are going to be there.
    Mr. Gensler. We have used the discretion we have under the 
Administrative Procedures Act to continue to consider comments, 
just like this hearing is a comment. And we have gotten many 
comments we have put in even after it is out there.
    With all respect, industry does know Dodd-Frank is a full 
mosaic itself, and now we are almost there; that we have 
finalized this proposal stage, and then we will move to the 
finalization stage.
    Mr. Tipton. Thank you, Mr. Chairman. Thank you, Mr. 
Gensler.
    The Chairman. The gentleman's time has expired.
    The chair turns to the gentleman from Pennsylvania, Mr. 
Thompson, for 5 minutes.
    Mr. Thompson. Thank you, Mr. Chairman.
    Chairman Gensler, thank you for being here and for your 
testimony.
    My question has to do with the National Futures 
Association's petition to the CFTC to narrow the Rule 4.5 
exemptions provided in mutual funds, among others, from the 
definition of the commodity pool operator. Now, the petition 
was based on the activities of three firms, yet your recent 
Rule 4.5 proposal would capture large swaps of mutual funds and 
subject them to duplicative and potentially conflicting CFTC 
regulation, when mutual funds are already highly regulated by 
the SEC.
    Now this rule proposal seemed to have nothing to do with 
Dodd-Frank. And at a time when the CFTC has extensive new 
responsibilities under Dodd-Frank and is before Congress asking 
for additional financial resources to meet its new regulatory 
burden, why would the CFTC attempt to drastically expand its 
regulatory jurisdiction and extensive new responsibilities over 
mutual funds when the SEC already regulates this?
    Mr. Gensler. We have for decades regulated or overseen 
something called, ``commodity pool operators.'' The public 
might just call them hedge funds, or the public might call them 
money managers and so forth. Commodity pool operators pool 
money and invest in futures. They can invest in other things. 
The SEC, for the first time in the Dodd-Frank Act, has 
reporting for hedge funds. Some of those hedge funds are also 
commodity pool operators. So the statute actually said we 
should do a joint rule with the Securities and Exchange 
Commission on information that would go to the SEC.
    So we did choose to propose that joint rule in January. We 
did a sister rule--the one I think to which you are referring--
on commodity pools that wouldn't necessarily be reporting to 
the SEC, to try to align that with what we are doing in that 
joint rule at the SEC. So that is why we took it off, because 
of Congress' mandate on this joint rule and trying to align 
some of that which we have done in these commodity pools. But I 
would be glad to come and see you one on one, and try to dig 
more into some of these issues, because I have to remind myself 
of all the details of each rule too.
    Mr. Thompson. Well, Chairman Gensler, I appreciate it.
    Mr. Chairman, I yield back the balance of my time.
    Mr. Conaway. Would the gentleman yield his minute for one 
follow-up?
    The Chairman. The gentleman--yes.
    Mr. Conaway. Mr. Gensler, does the Administrative 
Procedures Act have any kind of a bright line requirement as to 
major changes to a proposed rule that would in effect require 
you to re-propose it; or is that fully within your discretion 
as to how much change drives going from proposed to final 
versus a re-proposal?
    Mr. Gensler. I think you are probably beyond my personal 
knowledge base and I have to ask my General Counsel.
    Mr. Conaway. If you wouldn't mind providing that for the 
record.
    Mr. Gensler. What I am led to believe is if we are 
proposing something completely new, it hasn't been considered, 
it is not questioned and so forth, we might need to re-propose. 
But if we have laid out enough predicate, enough in the 
proposal, we don't need to re-propose. And often what is 
happening is we are getting comments from people that want us 
to narrow something and so forth.
    I am just being handed a note, it says, ``If it is a 
logical outgrowth''--those are the key words--``a logical 
outgrowth of the proposal.''
    Mr. Conaway. So there is some standard by which to judge 
what you would go final with, as to whether or not you would go 
final or re-propose?
    Mr. Gensler. Yes.
    Mr. Conaway. Thank you, Mr. Chairman. I yield back.
    The Chairman. The gentleman yields back.
    And as the Chairman of the CFTC would know, there are 
sometimes, anymore, not a lot of pleasures that go with being 
Chairman of anything. But in my regard, I have the ability to 
control the time and I have a couple more questions for you, 
sir, if you don't mind. That is one of the few pleasures of 
this job these days.
    As you know, Chairman Gensler, I recently joined Chairman 
Bachus and Chairman Kline in writing you and Chairman Schapiro 
and Secretary Solis about the potential conflict among the 
three agencies' regulatory proposals that could be detrimental 
to pension plans. Swaps are an important risk management tool 
for pension plans, and we need to take every caution not to 
jeopardize the benefits they provide to ensuring the retirement 
security of millions of Americans. In fact, when you appeared 
before the Committee last, you were asked if CFTC would take 
every precaution not to impose significant and additional new 
costs on pension funds. And you said, ``Well, I think we are.''
    Yet shortly thereafter, we heard testimony from the 
American Benefits Council that the business conduct standards 
rules proposed by CFTC conflict with the DOL rule to the point 
that they would require a swap dealer to perform an illegal 
action or refrain from entering into a swap with a plan. In 
short, this would make it impossible for pensions to engage in 
swaps at all.
    If the business conduct standards are finalized before this 
conflict is clearly and officially resolved, there would be 
significant and potentially harmful consequences for our 
pension system. Can you assure me that this conflict will be 
publicly resolved before the business conduct standards are 
finalized?
    Mr. Gensler. We have been meeting with the Department of 
Labor to harmonize the two. So to Congressman Tipton, who asked 
me earlier about how we are working together, this one we are 
really working together with the Department of Labor. I think 
they are going to be able to assist us and assist this 
Committee to harmonize that our business conduct standards, 
which Congress in essence said--the key to this, Mr. Chairman, 
is that Congress said that swap dealers have to, on a daily 
basis, value the swaps with their counterparties. Just because 
they value that swap on the other side's pension fund shouldn't 
make them a fiduciary.
    And we are working with the Department of Labor to ensure 
that this Congressional mandate that we embedded in our 
business conduct doesn't somehow make somebody, solely because 
of that, a fiduciary under this Department of Labor rule. So we 
are working to harmonize it and get clear input from the 
Department of Labor that we can share publicly.
    The Chairman. Thank you.
    One other question. You recently traveled to Europe and 
spoke publicly about the need for international cooperation. 
Specifically you said, ``Effective reform cannot be achieved by 
one nation alone.'' You also stated before this Committee that 
you are working very closely with foreign regulators to ensure 
as best we can--another quote again--``that we are consistent 
in our regulatory treatment.''
    In addition, you made remarks in Europe that it was 
important for them to pursue reforms that were consistent with 
Dodd-Frank in order for CFTC to recognize comparable regulatory 
regimes.
    And I would like to submit for the record a copy of a 
letter submitted to the CFTC by the Financial Services 
Authority in the U.K. Seeing no objection, so ordered.
    [The document referred to is located on p. 73.]
    The Chairman. In the letter, the FSA expresses concern that 
CFTC's proposal to set a $50 million cap on the amount of 
capital clearinghouses can require of potential clearing 
members could actually increase risk to the system.
    So I guess, Chairman, can you respond to the concerns 
expressed from a foreign regulator that your proposal would 
inject more risk into the system?
    Mr. Gensler. I am familiar with the letter. I think that 
currently the clearinghouses in the futures industry are well 
managed and they do not have the limits in the swap market. The 
swap marketplace, frankly, has been an exclusionary practice 
where they say you have to have $5 billion of capital or $1 
trillion of swaps before you are a member of the clearinghouse.
    We proposed in December that there be different limits, 
that it foster competition and not just be exclusively these 
large swap dealers. And we will take into consideration the 
FSA's letter, we will take it into consideration like all other 
letters. But what we think Congress was trying to do was have 
open access to this clearing and open access to these markets, 
and not have it so exclusive as it has been today.
    The Chairman. And I am going to be brave with the time and 
ask one more question: Where else are there significant 
differences between your approach and the approach under 
consideration in Europe?
    Mr. Gensler. Europe is moving forward. In their European 
Parliament I was honored to be in front of a committee--the 
Economic Committee of the European Parliament. They are likely 
to move forward this summer on clearing, on the dealer regime, 
on data repositories. And it is not going to be identical, but 
it is quite similar.
    Their timing on the real-time reporting and on the 
transparency that is brought forward in trading platforms 
called swap execution facilities, they are taking up in a 
reform later in the fall. And just as any legislative process, 
when something is a little later, it is a little less certain. 
They are committed to try to get their implementing rules done 
by next summer, the summer of 2012.
    The Chairman. With that, the time for questions has 
expired. I wish to thank the Chairman of the CFTC once again 
for his time and his patience, and note that I am quite 
confident we will have several more visits before this year is 
over.
    Mr. Gensler. I look forward to it. I think these are 
helpful.
    The Chairman. Absolutely, Chairman Gensler. Thank you.
    I would like to now welcome our second panel of witnesses 
to the table as they prepare for their testimony.
    Mr. James C. Allison, Gas and Power Risk Manager, North 
America, ConocoPhillips, on behalf of the Working Group of 
Commercial Energy Firms, Houston, Texas.
    Mr. Mark J. Cvrkel, Chief Financial Officer of Susquehanna 
Bank, Lititz, Pennsylvania.
    Mr. James M. Fields, Senior Vice President and Chief 
Financial Officer, Deere & Company, Moline, Illinois.
    Mr. Richard J. McMahon, Vice President, Finance and Energy 
Supply, Edison Electric Institute Washington, D.C.
    Ms. Ann Trakimas, Chief Operating Officer, CoBank, on 
behalf of the Farm Credit Council, Greenwood Village, Colorado.
    Whenever you are ready, Mr. Allison, you may begin.

  STATEMENT OF JAMES C. ALLISON, GAS AND POWER RISK MANAGER, 
   NORTH AMERICA, ConocoPhilliips, HOUSTON, TX; ON BEHALF OF 
            WORKING GROUP OF COMMERCIAL ENERGY FIRMS

    Mr. Allison. Chairman Lucas, Ranking Member Peterson, 
Members of the Committee, thank you for inviting me to discuss 
certain key implementation issues regarding Title VII of the 
Dodd-Frank Act.
    I am Jim Allison, North American Gas and Power Risk Manager 
for ConocoPhillips. I am appearing today on behalf of the 
Working Group of Commercial Energy Firms. The Working Group is 
a diverse group of commercial energy firms whose primary 
business activity is the physical delivery of energy 
commodities to others.
    My testimony today reflects the positions of the Working 
Group. It does not necessarily reflect the positions of 
ConocoPhillips or any individual member of the Working Group. 
My oral comments are a summarization of the written testimony, 
and I would like, if the Committee will allow me, to have that 
be part of the record.
    The Working Group supports the policy goals of the Dodd-
Frank Act, but is concerned that several of the CFTC's proposed 
rules will have significant unintended consequences. These 
include concentration of commodity market activity among large 
financial dealers--many of which have been considered too big 
to fail--increased market volatility, increased liquidity risk, 
increased cost for commercial firms and regulations that will 
ultimately lead to higher costs for energy consumers. Before I 
discuss these areas of concern, I would like to briefly 
describe how and why commercial energy firms use swaps.
    Members of the Working Group are engaged in many aspects of 
the energy business, including electricity generation, oil and 
natural gas production, refining, storage and transportation, 
and merchandising and trading energy commodities. These 
activities expose the Working Group's members to many 
commercial risks. Fortunately, commodity derivatives give us 
the ability to manage some of these risks.
    For example, we can buy or sell necessary feedstocks and 
end-products at predictable prices. They provide us with 
greater certainty around the income from our capital 
investments. We can take market positions where we are active, 
physical market participants, and it gives us the ability to 
increase our economic investments in U.S. energy 
infrastructure.
    Managing the commercial risks enables delivery of energy at 
stable and affordable prices. The Working Group believes it was 
the intent of Congress to preserve this ability and to avoid 
market disruptions that would subject consumers to higher 
energy prices. The Working Group highlights three areas of 
concern where the CFTC's implementation efforts may run counter 
to Congressional intent.
    First, the CFTC's proposed definitions of swap dealer and 
major swap participant are unnecessarily broad. As proposed, 
these definitions would impose costly regulation on many firms 
that do not pose a risk to the U.S. financial system. In 
response to these costs, firms will be faced with a choice to 
either pass the costs on to consumers or scale back business 
activities.
    Second, overly broad entity definitions may deny commercial 
firms the benefits of the mandatory clearing exemption that was 
created by Congress to protect them. While clearing will reduce 
counterparty risk for these firms, it will increase liquidity 
risk.
    Third, the CFTC's sequencing of proposed regulations is 
causing significant uncertainty for farms that are trying to 
determine the impact of and potential requirements for 
compliance with the proposed regulations.
    We believe these concerns can be avoided. First, the CFTC 
should use the available statutory tools to avoid unnecessary 
regulation of commercial firms as swap dealers. This can be 
done by, first, adopting a distinction between the terms dealer 
and trader that is similar to the distinction adopted by the 
SEC; and second, implementing the de minimis exception in a way 
that recognizes the statutory distinction between customer and 
counterparty with a meaningful threshold that allows for a 
reasonable amount of customer-facing activity.
    Second, the CFTC should adopt the definition of major swap 
participant that includes only those firms that truly threaten 
the U.S. financial system. Both dollar thresholds and 
assessments of firm exposure based on a percent of market value 
can be used to make those determinations.
    Third, it is imperative that companies have an opportunity 
to evaluate in the aggregate the complex set of rules proposed 
by the CFTC. As of today, final rules defining swap dealer and 
major swap participant have not been issued, and the CFTC has 
not issued even a proposed rule defining swap, a critical 
definition needed to understand the impact of all the proposed 
rules.
    The CFTC should ensure that rulemakings are logically 
sequenced and that effective dates for final rules provide 
firms adequate time to identify and implement the extensive 
systems changes that will be needed to ensure compliance.
    I have highlighted today particular issues that may create 
unintended consequences, ultimately resulting in increased 
energy costs for consumers. The Working Group is confident that 
there are solutions for these issues, and we look forward to 
continuing to work with the CFTC to implement these solutions.
    I thank the Committee for the opportunity to present this 
testimony on behalf of the Working Group of Commercial Energy 
Firms, and I would be pleased to answer any questions.
    [The prepared statement of Mr. Allison follows:]

  Prepared Statement of James C. Allison, Gas and Power Risk Manager, 
North America, ConocoPhillips, Houston, TX; on Behalf of Working Group 
                       of Commercial Energy Firms
I. Introduction
    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee; thank you for this opportunity to discuss certain key issues 
regarding the implementation of Title VII of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act and the regulation of commodity 
derivatives, including the regulation of entities and products in 
commodity derivatives markets.
    I am Jim Allison, North America Gas & Power Risk Manager for 
ConocoPhillips Company, and I am appearing today on behalf of the 
Working Group of Commercial Energy Firms. The Working Group is a 
diverse group of commercial firms in the energy industry whose primary 
business activity is the physical delivery of energy commodities to 
others, including industrial, commercial, and residential consumers. My 
testimony and statements made today reflect the positions of the 
Working Group, and do not necessarily reflect the positions of 
ConocoPhillips or any individual member of the Working Group.
    The Working Group supports the policy goals of the Dodd-Frank Act 
to promote the financial stability of the United States by improving 
accountability and transparency in the financial system and to reduce 
systemic risk. However, achieving these goals without imposing 
excessive costs and burdens on the economy is contingent on successful 
implementation of a regulatory framework that accommodates the 
differences among the new entities, products, and markets that the CFTC 
will regulate under Title VII. Implementation of such regulations will 
be successful only if those regulations do not result in costs that are 
greater than the public benefit of the Dodd-Frank Act, and if those 
regulations are developed in a logical and prudent manner.
    Among the Working Group's specific concerns with the CFTC's 
proposed rules regarding regulation of commodity derivatives markets 
are (1) the vagueness and potential breadth of the definitions of 
``swap dealer,'' ``major swap participant,'' and ``swap,'' and (2) the 
challenges posed by the CFTC's ongoing rulemaking process, including 
the sequencing of the issuance of proposed rules, the interdependent 
nature of many of those rules, and the limited amount of time 
stakeholders will have to analyze and plan for the effects of those 
rules. If these concerns are not appropriately addressed, they are 
likely to decrease the ability of commercial firms to use commodity 
derivatives to manage commercial risks, and, in the case of energy 
markets, are highly likely to result in increased costs for the 
ultimate consumers of energy products and decreased job opportunities. 
This reduction or elimination of involvement by commercial firms in 
commodity derivatives markets is likely to result in reduced 
competition in those markets. In the short-term, this reduction in 
competition would create decreased liquidity in commodity derivatives 
markets as commercial firms reduce their participation in those 
markets. In the long-term, this reduction in competition would create 
concentration of commodity derivatives transactions among the financial 
entities that have traditionally been recognized as swap dealers. Many 
of these are the firms that have been considered ``too big to fail.''
II. How and Why Commercial Firms Use Swaps
    Members of the Working Group are engaged in many aspects of the 
energy business, including: (1) the basic creation or manufacturing 
processes, such as exploring for, producing, and marketing crude oil 
and natural gas; refining feedstocks into gasoline and other products, 
and marketing those products; and generating and marketing electricity, 
including electricity from renewable projects such as wind and solar; 
(2) the logistical activities that are fundamental to the energy 
business, including storing energy commodities and moving energy 
commodities by tanker, pipeline, transmission line, or other means from 
source to market or from one market to another; and (3) the associated 
merchandising and trading of energy commodities.
    All of these activities expose the Working Group's members to a 
wide array of commercial risks, including risks that are similar to 
those experienced by any commercial firm engaged in manufacturing or 
logistics, such as operational risk, market risk, and credit risk. Like 
agricultural firms, the Working Group's members differ from some 
manufacturing firms in that their basic energy products are commodities 
around which financial derivatives have been developed. Those 
derivatives allow each Working Group member to manage the level of 
commercial risk to which it is exposed, scaling the commercial risk 
that has been created through its primary business activity up or down 
to achieve the level of exposure to that risk that the firm believes is 
appropriate for its stakeholders. For example, commercial energy firms 
can use commodity derivatives to:

   Buy or sell necessary commodity products, including 
        feedstocks, end products, and inventories, at predictable 
        prices;

   Provide greater certainty for future cash flow from 
        investments;

   Take market positions in the commodities in which they are 
        active physical market participants; and

   Increase the ability to make economic investments in U.S. 
        energy infrastructure and the development of energy resources.
III. Specific Issues
A. The CFTC's Proposed Definition of ``Swap Dealer'' Could Result in 
        Regulation of Commercial Energy Firms as Swap Dealers Where 
        There Is No Public Benefit
1. The CFTC's Proposed Rule Does Not Recognize a Distinction Between 
        Swaps Used for ``Dealing'' and ``Trading'' Purposes
    The Dodd-Frank Act definition of ``swap dealer'' is based on four 
categories of activity that are comparable to the types of activities 
used to define ``dealer'' in the Securities Exchange Act of 1934. Based 
on that ``dealer'' definition, the SEC has applied a long-standing and 
well-known Dealer/Trader Distinction Rule. In general, the SEC's 
Dealer/Trader Distinction Rule recognizes that certain activities 
involving securities may at first appear to be dealing activities but 
are, in fact, trading activities, and that market participants engaging 
in such trading activities should not be regulated as dealers. There 
are significant similarities between the Dodd-Frank Act definition of 
``swap dealer'' and the Securities Exchange Act of 1934 definition of 
``dealer''; however, the CFTC's proposed definition of ``swap dealer'' 
specifically rejects making a distinction between dealers and traders 
in commodity derivatives markets. The CFTC rejects the application of a 
dealer/trader distinction to these markets, which increases the 
likelihood of commercial energy firms being regulated as swap dealers, 
despite the fact that such firms use commodity derivatives to manage 
risks associated with their primary business activity of delivering 
physical energy commodities to others. The Working Group strongly 
recommends that the CFTC implement a framework that distinguishes 
between dealers and market participants that use commodity derivatives 
for their own hedging or trading purposes.
2. The CFTC's Proposed De Minimis Exception Is So Narrow That It Will 
        Be Unavailable to Commercial Energy Firms That Do Engage in a 
        Relatively Small Amount of Dealing Activity
    The Working Group believes Congress intended the de minimis 
exception to apply to any person that would otherwise be a swap dealer 
but for the fact that it engages in limited amounts of swap dealing or 
whose notional amount of exposure is small. The CFTC's proposed de 
minimis exemption included in the definition of ``swap dealer'' is so 
narrow that commercial firms that may engage in a relatively small 
amount of transactions in a swap dealing capacity will be unable to 
claim the exemption and will be subject to full regulation as swap 
dealers. As noted above, there is no public benefit to regulating such 
firms as swap dealers. The CFTC's proposal inexplicably provides that 
any entity who enters annually into more than twenty swaps, has more 
than fifteen counterparties, or enters into swaps with more than $100 
million in notional amount is a swap dealer regardless of its regular 
business. Such interpretation essentially makes every market 
participant in the swap markets a swap dealer and renders the express 
statutory definition superfluous. The CFTC has proposed this limited de 
minimis exception even when data indicates that the largest 25 bank 
holding companies control more than 90 percent of the U.S. swaps 
market. An appropriate interpretation of ``de minimis'' would provide a 
meaningful exception for entities other than these traditional 
financial institutions. It was not the intent of Congress to create a 
de minimis exception that applies to no one.
3. An Unnecessarily Broad Definition of ``Swap Dealer'' Will Harm 
        Commodity Derivatives Markets
    The Working Group is concerned that an unnecessarily broad 
definition of ``swap dealer'' will harm the liquidity and efficiency of 
commodity derivatives markets. Efficiency requires that regulations be 
designed to result in the least-cost approach to achieve a regulatory 
objective, and to ensure that the public benefit of those regulations 
is greater than the costs of those regulations. These costs include the 
costs for individual market participants to comply with regulations, 
public costs to implement and enforce the regulations, and the public 
and private costs created by the impact of the regulation on the 
regulated market and participants in that market.
    Classification of commercial energy firms that use commodity 
derivatives as swap dealers would have significant implications for 
those firms, including:

   Applying capital and margin requirements that could consume 
        or divert resources that might otherwise be available for 
        infrastructure investment, including investment in the 
        production of new energy resources; and

   Denying those firms the benefits of the end-user exception 
        from mandatory (1) clearing and (2) on-facility execution of 
        swaps.

Further, the excessive breadth of the definition of ``swap dealer'' 
will impose substantial additional and unnecessary burdens on 
regulators. A broad definition of ``swap dealer'' that results in 
regulation of commercial firms as swap dealers will result in a 
dilution of the CFTC's resources that will necessarily result in less 
oversight of large traditional swap dealers.
    Commercial energy firms have not traditionally been considered swap 
dealers, do not cause systemic risk, and were not a cause of the 
financial crisis. The Working Group believes the CFTC has not justified 
the cost, relative to the public benefit, of a broad definition of 
``swap dealer,'' and should adopt a final definition of ``swap dealer'' 
that is tailored to regulate only those firms that truly function as 
swap dealers and not those firms that simply use commodity derivatives 
to manage commercial risks associated with their primary business 
activity of delivering physical commodities to others.
B. The CFTC's Proposed Definition of ``Major Swap Participant'' Could 
        Result in Regulation of Commercial Energy Firms Even When Those 
        Firms Do Not Create Systemic Risk
    The CFTC's proposed definition of ``Major Swap Participant'' is 
overly broad and is likely to result in companies that are not 
systemically risky being unnecessarily subject to prudential 
regulation. Despite the Dodd-Frank Act's limitation on the definition 
of ``major swap participant'' to entities that are ``systemically 
important or can significantly impact the financial system of the 
United States,'' the CFTC has chosen to classify companies as major 
swap participants based upon fixed exposure thresholds that the Working 
Group believes fall well below levels that actually pose a risk to the 
U.S. financial system. Importantly, these thresholds do not appear to 
have any direct relationship to systemic risk and will not adjust to 
changing market prices. Even if one could assume that the current CFTC-
proposed thresholds are reasonable in the present market, over time, as 
commodity prices fluctuate, the CFTC will have to routinely revisit 
these thresholds to make sure they comply with Congressional intent. 
The effort to monitor and adjust these thresholds will be another 
unnecessary use of the CFTC's resources. If commodity prices increase 
as they have over the past several months, more and more companies will 
reach these fixed thresholds despite the fact that the relative market 
positions of these companies would have largely remained unchanged. 
Because of these effects, the Working Group respectfully suggests that 
the CFTC should test the systemic risk of companies in ways that 
account for current market conditions. Evaluating exposures as a 
percentage of market value rather than by relying on fixed thresholds 
is one way to do this. Given that regulation of major swap participants 
is very similar to regulation of swap dealers, many of the negative 
effects of a definition of ``swap dealer'' that unnecessarily results 
in regulation of commercial firms would also apply to unnecessary 
regulation of those firms categorized as major swap participants.
C. Mandatory Clearing Will Not Reduce Risk--It Will Only Transform 
        Counterparty Risk into Liquidity Risk
    The Working Group believes that mandatory clearing will only 
succeed in transforming counterparty risk into liquidity risk. One 
benefit of the end-user exception to mandatory clearing is that 
commercial firms will be protected from this liquidity risk. However, 
if the definitions of ``swap dealer'' and ``major swap participant'' 
are unnecessarily broad and result in commercial firms being regulated 
as swap dealers or major swap participants, then those firms will be 
fully exposed to this liquidity risk.
    Clearing reduces counterparty risk by requiring every party to a 
transaction to provide (1) full cash margin on the change in the value 
of the cleared portfolio every day and (2) initial margin sufficient to 
cover the potential movement in value between daily margin calls. Daily 
margin calls must be settled in cash, on very strict and short 
deadlines, and they apply to changes in value caused by ordinary market 
movement and those caused by extraordinary market events.
    When the financial system is functioning smoothly, a commercial 
firm can manage liquidity requirements caused by ordinary market 
movement through capital reserves and access to lines of credit. 
However, liquidity requirements caused by extraordinary market events 
may require a diversion of capital from other uses. This admittedly is 
an extreme scenario, but it is precisely these extreme scenarios that 
must be analyzed to understand how the CFTC's proposed rules affect 
risk in the financial system.
    When combined with the vagueness and potential breadth of the 
definitions of ``swap dealer'' and ``major swap participant,'' the 
transformation of counterparty risk to liquidity risk and the exposure 
of commercial firms to this liquidity risk may actually thwart the 
policy goals of the Dodd-Frank Act. The CFTC can avoid this by 
appropriately tailoring the definitions of ``swap dealer'' and ``major 
swap participant'' and not unnecessarily including commercial firms in 
either category of regulated entities.
D. The CFTC's Rulemaking Process Does Not Allow Stakeholders to 
        Properly Consider the Interaction of the Rules Required for 
        Regulation of Commodity Derivatives Under Title VII of the 
        Dodd-Frank Act
    Title VII represents a fundamental redesign of the regulatory 
regime applicable to commodity derivative markets, especially the 
commodity derivatives used by the Working Group's members to manage the 
risks associated with their primary business activity of delivering 
physical energy commodities to others. A threshold element of this 
redesign is the determination of which products and market participants 
will be regulated by the CFTC. Notwithstanding the CFTC's aggressive 
efforts to adopt all final rules required by the Dodd-Frank Act, as of 
March 29, 2011, the CFTC has not issued final rules defining ``swap 
dealer'' and ``major swap participant,'' and it has not issued even a 
proposed definition of ``swap.'' A direct result of the lack of final 
rules defining these key terms is that more than 8 months after passage 
of the Dodd-Frank Act, market participants still do not know with any 
certainty the universe of entities and products that will be subject to 
regulation under Title VII's provisions relating to commodity 
derivatives. Without full knowledge of which entities will be regulated 
as swap dealers and major swap participants and which products will be 
regulated as swaps, the Working Group's members and other commercial 
energy firms are not able to determine the impact of these rules on 
their businesses. This uncertainty is likely to result in disruption of 
energy markets and could have negative consequences on the broader 
economy, including, but not limited to, increased prices for ultimate 
consumers of those products. Such consequences are avoidable. Given the 
complexity of the rulemaking process, the Working Group believes it is 
imperative that the CFTC allow interested parties a period of time to 
analyze and comment on all of the rules proposed under Title VII of the 
Dodd-Frank Act in the aggregate. Further, once the CFTC issues final 
rules, the Working Group believes market participants should be given 
adequate time to evaluate their compliance obligations, and to design 
and implement measures to meet such obligations in an efficient manner. 
Many of these rules will require time-consuming and expensive changes 
to systems and processes, so reasonable compliance deadlines are 
critical.
IV. Conclusion
    In closing, the Working Group restates its support for the policy 
goals of the Dodd-Frank Act to promote the financial stability of the 
United States by improving accountability and transparency in the 
financial system and to reduce systemic risk. Under Title VII of the 
Dodd-Frank Act, the CFTC has been asked to take on a significant amount 
of new regulatory oversight for derivative markets and derivative 
market participants. The Working Group appreciates the diligent efforts 
of the CFTC and its staff to understand our businesses and the markets 
in which we operate. However, if the CFTC's rules to implement Title 
VII of the Dodd-Frank Act are not designed to appropriately regulate 
commodity derivatives markets and if those rules are not implemented in 
a coordinated and prudent manner, commercial energy firms may either be 
subject to unnecessary and costly regulation or will reduce their use 
of commodity derivatives to manage commercial risks, each of which 
could ultimately result in increased energy costs for consumers.
    I thank the Committee for the opportunity to present this testimony 
on behalf of the Working Group of Commercial Energy Firms and I will be 
pleased to answer any questions.

    The Chairman. Thank you very much.

     STATEMENT OF MARK J. CVRKEL, CHIEF FINANCIAL OFFICER, 
                  SUSQUEHANNA BANK, LITIZ, PA

    Mr. Cvrkel. Chairman Lucas, and Members of the Committee, I 
appreciate the opportunity to testify today.
    My name is Mark Cvrkel. I am a Chief Financial Officer of 
Susquehanna Bank, headquartered in Lititz, Pennsylvania.
    Susquehanna Bank is a commercial bank with assets of 
approximately $14 billion, deposits of more than $9 billion, 
and more than 3,000 employees in 221 locations. At Susquehanna, 
we are committed to building the economic strength of the 
communities we serve in Pennsylvania, New Jersey, Maryland, and 
West Virginia.
    As is the case with hundreds of community and regional 
banks, Susquehanna Bank's risk management strategy involves 
using interest rate derivatives to prudently manage risks that 
are inherent to the business of commercial banking. 
Additionally, we enter into certain interest rate and foreign 
exchange derivatives with commercial banking customers to 
facilitate their risk management needs.
    My comments today stem from concerns that certain proposed 
rules released by the Commodity Futures Trading Commission 
could unnecessarily jeopardize our ability to manage risk, 
provide the services our clients demand, and remain competitive 
against much larger financial institutions.
    I would like to focus today on four issues: the swap dealer 
definition; the potential exemption for small banks; the 
eligible contract participant definition; and the process and 
timing of rulemaking.
    Several community and regional banks have expressed concern 
that the swap dealer definition in the CFTC's proposed rule 
could capture hundreds of community and regional banks that 
offer risk management products to commercial customers. This 
would hamper the ability for smaller banks to compete with 
larger financial institutions without any appreciable benefit 
in terms of enhanced market oversight or reduction in systemic 
risk.
    Congress provided an exemption from the swap dealer 
definition for any swap offered by a bank to a customer in 
connection with originating a loan with that customer; however, 
the CFTC's proposed rule interpreting this exemption is very 
narrow.
    In addition, we are concerned that the CFTC's proposed 
thresholds for the so-called ``de minimis exception'' from the 
swap dealer definition are extremely low. These low thresholds 
could have the effect of either subjecting many small banks to 
the substantial regulatory burden imposed on swap dealers, or 
causing them to cease offering certain risk management services 
to their customers.
    We urge regulators to compare the thresholds for the de 
minimis exception against the volume of dealing done by large 
financial institutions that control the vast majority of the 
OTC derivatives market. Even an extremely conservative analysis 
of available data suggests that the CFTC could substantially 
increase the thresholds without running afoul of Congressional 
intent.
    Congress provided the regulators with the authority to 
exempt small banks from the financial entity definition. If 
such an exemption were granted, these small banks still would 
have to meet certain conditions required for end-user exception 
to the clearing requirement.
    Moreover, small banks already are subject to existing 
regulations, including rules that require adequate capital to 
be held against all assets, including derivatives. In addition, 
existing regulations allow examiners to take certain actions to 
prevent default or to limit bank losses in the event of 
default. These protections adequately mitigate risks associated 
with an exception for too-small banks. We respectfully ask that 
the Committee urge the regulators to exercise the authority to 
exempt small banks from the financial entity definition.
    We appreciate Congress' efforts to ensure that OTC 
derivatives are not marketed to unsophisticated customers. 
However, we would urge the regulators to clarify that smaller, 
sophisticated firms could continue to enter into hedges over-
the-counter, providing that they meet specific criteria already 
established by the CFTC and observed by market participants for 
more than 20 years.
    Finally, community and regional banks are concerned with 
the aggressive pace of rulemaking. We would urge Congress to 
extend the statutory effective date for Title VII and set a 
sequence for rulemaking that supports thorough cost-benefit 
analysis and productive public comment.
    Community and regional banks are essential to support job 
creation at small, middle-market businesses that forms the 
foundation for any economic recovery. We caution against 
finalizing rules that would place undue burdens on small banks 
that had nothing to do with the financial crisis, do not pose 
systemic risk, and collectively engage in a fraction of the 
derivatives traded by the large dealers.
    Thank you for the opportunity to testify today, and I will 
answer any questions that you may have.
    [The prepared statement of Mr. Cvrkel follows:]

    Prepared Statement of Mark J. Cvrkel, Chief Financial Officer, 
                      Susquehanna Bank, Lititz, PA
    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee, I appreciate the opportunity to testify today on the key 
definitions in Title VII of the Dodd-Frank Act. My name is Mark Cvrkel 
and I am the Chief Financial Officer of Susquehanna Bank 
(``Susquehanna'').
    Headquartered in Lititz, PA, Susquehanna is a commercial bank with 
assets of approximately $14 billion, deposits of more than $9 billion 
and more than 3,000 employees in 221 locations. At Susquehanna we are 
committed to building the economic strength of the communities we serve 
in Pennsylvania, New Jersey, Maryland and West Virginia.
    As is the case with hundreds of community and regional banks, 
Susquehanna's risk management strategy involves using interest rate 
derivatives to prudently manage risks that are inherent to the business 
of commercial banking. We do not use credit default swaps or use 
derivatives for speculation. At Susquehanna, we use derivatives to add 
stability to our interest income and expense and to modify the duration 
of specific assets and liabilities. In short, we use derivatives to 
manage exposure to fluctuations in interest rates over which we have no 
control.
    Additionally, we enter into a relatively small amount of interest 
rate and foreign exchange derivatives with commercial banking customers 
to facilitate their risk management needs. For example, we are able to 
offer a borrower a competitive long-term financing at a fixed rate by 
pairing a variable-rate loan with an interest rate swap--thereby 
providing the customer with the fixed rate they desire without taking 
on any incremental interest rate risk at the bank. As another example, 
we may have a middle-market customer that sells its products in Canada. 
We can offer to enter into an FX forward with the customer so that when 
they are paid in Canadian dollars, they can fix the exchange rate and 
know the exact amount they will receive in U.S. dollars.
    Neither our use nor our customers' use of derivatives poses 
systemic risk. As was shown during the financial crisis, systemic risk 
in the derivatives market is concentrated among a few very large and 
interconnected financial institutions. According to the Office of the 
Comptroller of the Currency's Quarterly Report on Bank Trading and 
Derivatives Activities, while more than 1,000 banks in the U.S. use 
derivatives, 96% of the notional and 86% of the credit exposure is held 
at the top five banks in the U.S.\1\
---------------------------------------------------------------------------
    \1\ Please refer to page 1 of the report at: http://
www.occ.treas.gov/topics/capital-markets/financial-markets/trading/
derivatives/dq410.pdf.
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    My comments today stem from concerns that certain proposed rules 
released by the Commodity Futures Trading Commission (``CFTC'')--
including those relating to the key definitions in Title VII--could 
unnecessarily jeopardize our ability to manage risk, provide the 
services our clients demand and remain competitive against much larger 
financial institutions.
    I would like to focus today on four issues: the swap dealer 
definition, the potential exemption from the financial entity 
definition for small banks, the eligible contract participant 
definition and the process and timing for rulemaking.
(1) Swap Dealer Definition
    Several community and regional banks have expressed concern that 
the swap dealer definition in the CFTC's proposed rule could capture 
hundreds of community and regional banks that offer risk management 
products to commercial customers. This would hamper the ability for 
many smaller banks to compete with larger financial institutions 
without any appreciable benefit in terms of enhanced market oversight 
or reduction in systemic risk.
    Congress provided an exemption from the swap dealer definition for 
any swap offered by a bank to a customer in connection with originating 
a loan with that customer; however, the CFTC's proposed rule 
interpreting this exemption is very narrow. While not required by Title 
VII, the CFTC is considering whether to limit the exemption to swaps 
offered contemporaneously with origination of the loan. As it is very 
common for a borrower to enter into an interest rate swap before or 
after origination of the corresponding loan, the exemption should not 
be limited to any swap entered into contemporaneously with a loan. In 
addition, we would urge the CFTC to consider excluding from the swap 
dealer definition swaps offered by a bank in connection with 
syndications, participations and bond issuances that are facilitated by 
the bank.\2\
---------------------------------------------------------------------------
    \2\ Please refer to pages 3-4 of the comment letter submitted by 
Susquehanna Bank and 18 other community and regional banks to the CFTC 
for examples.
---------------------------------------------------------------------------
    In addition we are concerned that the CFTC's proposed thresholds 
for the so-called ``de minimis exception'' from the swap dealer 
definition are extremely low. For example, if a bank were to offer just 
21 FX hedges \3\ to customers in one year, they would be required to 
register as a swap dealer. These low thresholds could have the effect 
of either subjecting many small banks to the substantial regulatory 
burden imposed on swap dealers, or causing them to cease offering 
certain risk management services to customers.
---------------------------------------------------------------------------
    \3\ Note that the Secretary of the Department of the Treasury has 
the authority to make a written determination exempting certain FX 
derivatives from certain regulatory requirements. Such a determination 
has not been made as of the writing of this statement.
---------------------------------------------------------------------------
    We urge regulators to compare the thresholds for the de minimis 
exception against the volume of dealing done by the large financial 
institutions that control the vast majority of the OTC derivatives 
market. For example, while executing more than 20 trades with customers 
in one year would require a bank to register as a swap dealer, it is 
known that Lehman Brothers had 900,000 trades in place at the time of 
its bankruptcy. Available data \4\ suggests that the CFTC could 
substantially increase the thresholds without running afoul of 
congressional intent. We do not believe the benefit of regulatory 
oversight over smaller financial institutions engaged in a relatively 
infinitesimal level of dealing activity outweighs the cost associated 
with registration and compliance for such firms.
---------------------------------------------------------------------------
    \4\ Please refer to pages 5 and 6 of the comment letter submitted 
by Susquehanna Bank and 18 other community and regional banks to the 
CFTC for additional comparative data: http://www.chathamfinancial.com/
wp-content/uploads/2011/02/Coalition-Comments-Small-Banks.pdf.
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(2) Potential Exemption for Small Financial Institutions
    Congress provided the regulators with the authority to exempt small 
banks from the financial entity definition. If such an exemption were 
granted, these small banks still would have to meet the same conditions 
required for the end-user exception to the clearing requirement. 
Moreover, small banks already are subject to existing regulations, 
including rules that require adequate capital to be held against all 
assets, including derivatives. In addition, existing regulations allow 
examiners to take certain actions to prevent default, or to limit bank 
losses in the event of default. These protections adequately mitigate 
risks associated with an exception for small banks. We respectfully ask 
that the Committee urge the regulators to exercise the authority to 
exempt small banks from the financial entity definition.
(3) Eligible Contract Participant Definition
    Section 723 of Title VII includes a Limitation of Participation 
provision prohibiting any firm that is not an ``eligible contract 
participant'' from entering into a hedge over-the-counter.\5\ We 
appreciate Congress' efforts to ensure that OTC derivatives are not 
marketed to unsophisticated customers; however, many community and 
regional banks are concerned that certain customers--including small 
businesses and other firms that execute hedges out of pass-through 
entities--may not be able to use the customized, OTC derivatives that 
they require for risk management purposes. We would urge the regulators 
to clarify that smaller, sophisticated firms could continue to enter 
into hedges over-the-counter, providing that they meet specific 
criteria already established by the CFTC and observed by market 
participants for more than 20 years.\6\
---------------------------------------------------------------------------
    \5\ Firms that are not eligible contract participants will only be 
permitted to enter into derivatives on regulated exchanges. In addition 
to other criteria, corporations and partnerships that have at least $10 
million in assets or are hedging and have $1 million in net worth 
qualify as eligible contract participants under the Commodity Exchange 
Act.
    \6\ Certain firms have been able to enter into over-the-counter 
hedges if they meet the criteria set forth in the CFTC's 1989 Policy 
Statement Concerning Swaps Transactions.
---------------------------------------------------------------------------
(4) Process and Timing
    Finally, while the regulatory agencies are to be commended for 
running an open and transparent rulemaking process, community and 
regional banks are very concerned with the aggressive pace of 
rulemaking. We would urge Congress to extend the statutory effective 
date for Title VII and set a sequence for rulemaking that supports 
thorough cost-benefit analysis and productive public comment. We would 
recommend a sequence for rulemaking that defines entity and product 
definitions and other key terms first, duties and obligations second 
and then the specific regulatory requirements that apply based on these 
terms, duties and obligations. Additionally, we would recommend that 
the regulators permit market participants to consider the entirety of 
the proposed rules for all of Title VII, once they are available, and 
provide additional comment before finalizing any of the proposed rules.
Conclusion
    Community and regional banks are essential to support the job 
creation at small and middle-market businesses that forms the 
foundation of any economic recovery. We applaud the work of the 
regulators to strengthen the OTC derivatives market, but we urge 
caution against finalizing rules that would place undue burdens on 
small banks that had nothing to do with the financial crisis, do not 
pose systemic risk and collectively engage in a fraction of the 
derivatives traded by the large dealers. It is critical to get these 
definitions right in order to ensure that regulation of the derivatives 
market is effective and unintended consequences are minimized. I thank 
you for the opportunity to testify today, and I am happy to answer any 
questions that you may have.

    The Chairman. Thank you. Mr. Field.

 STATEMENT OF JAMES M. FIELD, SENIOR VICE PRESIDENT AND CHIEF 
              FINANCIAL OFFICER, DEERE & COMPANY,
                           MOLINE, IL

    Mr. Field. Good afternoon. My name is Jim Field. I am the 
Senior Vice President and Chief Financial Officer of Deere & 
Company, perhaps better known as John Deere.
    I am pleased to have this opportunity to share our 
perspectives on the implementation of Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act.
    As with most major multinational companies, the new law 
will impact many aspects of our business, especially our 
captive finance business. Through our captive finance business, 
John Deere Financial Services, Inc., we provide literally tens 
of millions of dollars of liquidity into rural America each and 
every day. We provide essential financing to agricultural 
producers, construction contractors, commercial landscapers, 
and foresters seeking to purchase high-quality John Deere 
equipment. This source of financing is essential to our 
customers' success and directly contributes to the growth and 
prosperity of local economies across this country.
    As the Committee knows, derivatives are an essential tool 
for companies like Deere to manage commercial risks inherent in 
our business, such as interest rate risk and foreign exchange 
risk. We do not use the derivatives for speculative purposes at 
Deere. The prudent use of derivatives supports our ability to 
provide high-quality products and services to U.S. farmers and 
other customers around the world.
    John Deere worked closely with the Congress on the 
derivatives reform legislation and commends this Committee for 
its leadership on that important title. While we believe the 
statutory direction is generally clear, the current rulemaking 
process has not yet adequately settled several implementation 
issues and concerns. I would like to highlight several areas 
for the Committee, all of which are subject to ongoing 
rulemaking proceedings.
    Congress provided an exception for captive finance 
companies from the major swap definition. This exception--often 
referred to as the 90:90 exception--is explicitly provided for 
in the statute. However, we are concerned that the statutory 
language is imprecise and could be interpreted in a manner to 
inadvertently preclude many end-users for whom this exception 
was or is intended.
    We are currently seeking guidance to clarify the 
application of the captive finance provision to ensure it 
reflects how we operate and practice. For instance, as a 
captive finance company, we facilitate the sale of all products 
sold by the parent and its dealers, not just those manufactured 
by the parent or another subsidiary. For instance, we may 
finance an implement manufactured by another company, along 
with one of our tractors, as part of an entire sales package.
    We also facilitate the financing for parts and services on 
John Deere equipment. For example, we provide financing for 
significant overhauls on Deere equipment. This work is done at 
a John Deere dealership for a John Deere customer using both 
Deere and non-Deere parts. A significant portion of the finance 
covers the labor cost or the technician's hours. We interpret 
the exception to include the full value of these notes, but 
others might interpret this differently.
    We are seeking more clarity that reflects the legislative 
intent while not adding burdensome requirements. Regulations 
that provides either a broader exception or additional clarity 
reflecting ordinary business activities are necessary.
    In addition to the major swap participant exemption for 
captive finance companies, the CFTC proposed a rulemaking to 
include an exemption for a captive finance company. We want to 
ensure that the definition of a captive finance company, as it 
applies to the clearing exemption, is consistent with the 
definition of a captive finance company as it applies to the 
major swap participant exemption.
    A second area of concern relates to the exemption from 
mandatory clearing requirements for derivatives end-users such 
as Deere. While it appears that this exemption would apply to 
our trades, a regulatory requirement on swap dealers and major 
swap participants to collect margins from end-users could 
effectively eliminate the benefits of the clearing exemption. 
Hence, we strongly support a statutory provision that prohibits 
regulatory agents from requiring swap dealers or major swap 
participants to post or collect capital or margin on trades 
that are executed with a financial or nonfinancial end-user 
counterparty.
    If John Deere is required to clear swaps, independently or 
post margin through our transactions with a major swap 
participant, we would need to divert working capital to comply 
with this requirement. Furthermore, the requirements of posting 
margin on a daily basis could create additional costs and 
administrative burdens.
    We are also seeking clarification that unintended parties 
are not defined as a swap dealer or major swap participant. The 
CFTC and the SEC propose to consider the economic reality of 
transactions between wholly-owned affiliates, including whether 
the swaps and security-based swaps simply represent an 
allocation of risks within a corporate group. John Deere 
supports this interpretation and would note further that the 
regulator should not limit an interpretation of inter-affiliate 
transactions to those between wholly-owned affiliates.
    Transactions between commonly controlled affiliates, as 
well as swap transactions done by one corporate treasury entity 
to hedge the commercial risk of another entity in the same 
corporate group, merely represent the shifting or hedging of 
risk within a corporate group, and do not pose any more or any 
less risk to the economy as a whole. Including such inter-
affiliate swaps or affiliate risk-hedging swaps for purposes of 
calculating the major participant definitions would effectively 
``double count'' the same swaps.
    Last, John Deere wishes to emphasize the importance of 
getting this regulation right for all derivatives end-users. We 
recognize the substantial efforts being made by the regulatory 
agents to advance several concurrent rulemakings in order to 
meet the timelines provided by Congress. However, given the 
complexity of the business issues involved, the number of 
potentially affected market participants, and the potential 
disruption to legitimate risk mitigation strategies, we believe 
that an extension of the date by which the rules must be 
promulgated, as well as a workable implementation schedule, 
should be considered.
    Let me again reiterate John Deere's appreciation for the 
opportunity to appear before this Committee today.
    [The prepared statement of Mr. Field follows:]

 Prepared Statement of James M. Field, Senior Vice President and Chief 
             Financial Officer, Deere & Company, Moline, IL
    Good afternoon.
    My name is Jim Field, and I am Senior Vice President and Chief 
Financial Officer of Deere & Company.
    I am pleased to have this opportunity to share Deere & Company's 
perspectives on the implementation of Title VII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act. Deere & Company is also a 
member of the Coalition for Derivatives End-Users who share our 
perspective. As with most major multi-national companies, the new law 
will impact many aspects of our business, especially our captive 
finance business.
    Deere & Company is a leading global manufacturer of agricultural, 
construction, forestry and turf care equipment, and provides advanced 
products and services, including financial services, to customers whose 
work is linked to the land--those who cultivate, harvest, transform, 
enrich and build upon the land to meet the world's dramatically 
increasing need for food, fuel, shelter and infrastructure. We are 
headquartered in Moline, Illinois, with sales in over 100 countries and 
employing over 56,000 people. Since 1837, John Deere has delivered 
innovative products of superior quality built on a tradition of 
integrity.
    Through our captive finance business, John Deere Financial 
Services, Inc., we provide literally tens of millions of dollars of 
liquidity into rural America each and every day. We provide essential 
financing to agricultural producers, construction contractors, 
commercial landscapers and foresters seeking to purchase high-quality 
John Deere equipment. This source of financing is essential to our 
customers' success and directly contributes to the growth and 
prosperity of local economies across the country.
    My testimony today will focus on the impacts of Title VII on 
derivatives end-users and, in particular, the End-Use Exception and 
Captive Finance Provision that were added to the Commodity Exchange Act 
through the Dodd-Frank Act.
    As the Committee knows, derivatives are an essential tool for 
companies like John Deere to manage commercial risks inherent in our 
business, such as interest rate and foreign exchange risks. We do not 
use derivatives for speculative purposes. The prudent use of 
derivatives supports our ability to provide high-quality products and 
services to U.S. farmers and to customers around the world.
    We provide financing for our customers on a significant percentage 
of our sales in both good and bad economic times. Our financial 
services operations have over $25 billion in assets. We offer fixed and 
variable rate financing to meet the various long and short-term 
financing needs of our customers. We issue debt in the commercial 
paper, medium term note, and asset-backed securitization markets to 
fund our loan and lease portfolios. Institutional debt investors 
purchase the majority of our debt securities, and the demand for these 
securities varies as economic conditions change. Derivatives enable us 
to match the interest rate characteristics of the funding available in 
the capital markets with the financing needs of our customers. This was 
especially critical during the credit crisis. John Deere's volume of 
new loans to customers and dealers increased during the credit crisis 
as we were able to provide product financing when other financial 
institutions curtailed lending. During the crisis, we were able to 
issue long-term fixed rate notes in the capital markets and use 
interest rate swaps to match the fixed and floating rate loans and 
leases that we provided to our customers. We employ this strategy of 
issuing longer-termed debt even in good economic times to reduce our 
refunding risk.
    For a swap to be effective, it must match the timing and amount of 
the cash flows of the hedged exposure. Therefore, the terms of our 
interest rate swaps are customized to match the terms of the debt we 
issue. They will match the currency, principal or notional amount, 
interest rates, and maturity dates. Standardized contracts with 
predetermined terms would be a far less effective tool for hedging our 
risk exposure.
    Derivatives provide stability to our business. At the end of our 
most recent first quarter, John Deere had over $15 billion notional 
amount of derivative transactions outstanding. That is a large number, 
but it corresponds to the more than $25 billion of credit we have 
extended to our customers and dealers to purchase the equipment they 
need to help drive the economy. The fair value of these derivatives, 
which represents the price to terminate or settle the positions, was 
approximately $253 million, and was a receivable for John Deere--our 
counterparties would owe us that amount if we terminated the 
derivatives.
    John Deere worked closely with the Congress on the derivatives 
reform legislation and commends this Committee for its leadership on 
that important title. While we believe the statutory direction is 
generally clear, the current rulemaking process has not yet adequately 
settled several implementation concerns. I would like to highlight 
several areas for the Committee, all of which are subject to ongoing 
rulemaking proceedings.
    Congress provided an exception for captive finance companies from 
the major swap participant definition. This exception is defined as:

        ``entities whose primary business is providing financing and 
        use derivatives for the purpose of hedging underlying 
        commercial risks related to interest rate and foreign currency 
        exposures, 90 percent or more of which arise from financing 
        that facilitates the purchase or lease of products, 90 percent 
        or more of which are manufactured by the parent company or 
        another subsidiary of the parent company.''

    We are concerned that the statutory language is imprecise and could 
be interpreted in a manner to inadvertently preclude many end-users, 
for whom the exception is intended, from qualifying.
    We are currently seeking guidance to clarify the application of the 
captive finance provision to ensure it reflects how we operate in 
practice. For instance, as a captive finance company we facilitate the 
sale of all products sold by the parent and its dealers, not just those 
that are manufactured by the parent or another subsidiary. We may 
finance an implement manufactured by another company along with one of 
our tractors as part of the entire sale. We also facilitate the 
financing for parts and service on John Deere equipment. For instance, 
we provide financing for significant overhauls on pieces of equipment. 
This work is done at a John Deere dealership, for a John Deere 
customer, using both Deere and non-Deere parts. A significant portion 
of the financing covers the labor costs. We interpret the full value of 
these notes to fall under the exception, but others might interpret 
this differently.
    We are seeking further clarity that reflects Congress' intent while 
not adding burdensome requirements. Regulations that provide either a 
broader exception or additional clarity reflecting ordinary business 
activities are necessary.
    In addition to the major swap participant exemption for captive 
finance companies, the Commodity Futures Trading Commission (CFTC) 
proposed a rulemaking to include a mandatory clearing exemption for a 
captive finance company. We want to ensure that the definition of a 
captive finance company as it applies to the mandatory clearing 
exemption is consistent with the definition of a captive finance 
company as it applies to the major swap participant exemption.
    A second area of concern relates to the exemption from mandatory 
clearing requirements for derivatives end-users, such as John Deere. 
While it appears that the exemption would apply to our trades, a 
regulatory requirement on swap dealers and major swap participants to 
collect margin from end-users could effectively eliminate the benefits 
of the clearing exemption. Hence, we strongly support a statutory 
provision that prohibits regulatory agencies from requiring swap 
dealers or major swap participants to post or collect capital or margin 
on trades that are executed with a financial or nonfinancial end-user 
counterparty.
    If John Deere is required to clear swaps independently or post 
margin through our transactions with a swap dealer or major swap 
participant, we would need to divert working capital to comply with 
this requirement. Furthermore, the requirements of posting margin on a 
daily basis could create additional costs and administrative burdens on 
an end-user engaged in derivatives primarily to manage risk.
    We are also seeking clarification that unintended parties are not 
defined as a swap dealer or major swap participant. The CFTC and SEC 
propose to consider the ``economic reality'' of transactions between 
wholly-owned affiliates, ``including whether the swaps and security-
based swaps simply represent an allocation of risk within a corporate 
group.'' John Deere supports this interpretation and would note further 
that the regulators should not limit an interpretation of inter-
affiliate transactions to those between wholly-owned affiliates.
    Transactions between commonly-controlled affiliates, as well as 
swap transactions done by one corporate treasury entity to hedge the 
commercial risk of another entity in the same corporate group, merely 
represent the shifting or hedging of risk within a corporate group and 
do not pose any more or any less risk to the economy as a whole. 
Including such inter-affiliate swaps or affiliate risk-hedging swaps 
for purposes of calculating the major participant definitions would 
effectively ``double-count'' the same swaps, as swaps subsequent to the 
market-facing transaction simply transfer a swap's risk-mitigation 
qualities to affiliated entities.
    We also have some concerns with potentially conflicting rules from 
the U.S. Department of Labor regarding utilization of swaps by pension 
plans that could, unintentionally, restrict the ability of ERISA-
covered plans like John Deere's from utilizing derivative markets to 
manage risks.
    Last, John Deere wishes to emphasize the importance of getting this 
regulation right for all derivative end-users. We recognize the 
substantial efforts being made by the regulatory agencies to advance 
several concurrent rulemakings, in order to meet the timelines provided 
by Congress. However, given the complexity of the business issues 
involved, the number of potentially affected market participants, and 
the potential disruption to legitimate risk mitigation strategies, we 
believe that an extension of the date by which rules must be 
promulgated, as well as a workable implementation schedule, should be 
considered.
    Let me again reiterate John Deere's appreciation for this 
opportunity to appear before the Committee today. I would be pleased to 
answer your questions.
    Thank you.

    The Chairman. The gentleman has been very thorough.
    Mr. McMahon.

     STATEMENT OF RICHARD F. McMAHON, Jr., VICE PRESIDENT,
           FINANCE AND ENERGY SUPPLY, EDISON ELECTRIC
    INSTITUTE, WASHINGTON, D.C.; ON BEHALF OF AMERICAN GAS 
         ASSOCIATION; ELECTRIC POWER SUPPLY ASSOCIATION

    Mr. McMahon. Chairman Lucas and Members of the Committee, I 
am Richard McMahon, Vice President of Energy Supply and Finance 
for the Edison Electric Institute. I am testifying on behalf of 
EEI, AGA, and EPSA. Together, our members serve most of our 
nation's electric and gas consumers.
    Thank you for this opportunity to discuss the role of OTC 
derivatives markets in helping our utilities and our customers, 
and specifically our implementation concerns with Title VII of 
the Dodd-Frank Act.
    Our members' goal is to provide our customers with reliable 
and affordable electric and gas service. Therefore, it is 
essential to manage the significant price volatility inherent 
in wholesale commodity markets for natural gas and electricity. 
The derivatives market is an extremely effective tool in 
insulating our customers from this price volatility. Our 
members are the quintessential commercial end-users of swaps 
and in no way contribute to systemic risk.
    Utilities and energy companies are financially stable and 
highly creditworthy. As a result, utilities and their customers 
get a significant cost-benefit from little or no margin 
collateral requirements for their OTC derivatives transactions.
    Exchanges and clearinghouses demand expensive cash margin 
deposits from all participants, irrespective of their credit 
standing. A margin requirement on all OTC swaps for utilities 
would have an average annual cash flow impact of between $250 
million and $400 million per company. If our members were 
forced to post margin on all their OTC swaps, or their 
transaction costs go up significantly for other reasons, we 
will have three equally undesirable choices--redirect dollars 
from our core infrastructure capital spending programs, or 
borrow the money and pass that cost through to our customers 
and rates, or curtail our derivatives hedging programs and pass 
the commodity price volatility through to our customers.
    We were pleased to hear Chairman Gensler today regarding 
margin and end-users. It is essential that this approach be 
fully implemented. However, we are concerned that our 
transaction costs may go up significantly as a result of other 
aspects of Dodd-Frank implementation. For example, the yet-to-
be-promulgated rulemaking on capital and margin requirements 
for bank and nonbank swap dealers could impose incremental 
capital requirements on those dealers that engage in non-
cleared OTC swaps with end-users. Undoubtedly, swaps dealers 
would pass along this additional cost to end-users, thereby 
more or less nullifying any benefit of having an end-user 
exemption from clearing margin.
    Dodd-Frank left many important issues to be resolved by 
regulators and set impractically tight deadlines on 
rulemakings. To further complicate matters, many of the complex 
issues raised by scores of rulemakings are interrelated. As a 
result, interested parties are unable to provide meaningful 
comments to the proposed rules because they do not know the 
full effect of the complete universe of proposed rules.
    For instance, the CFTC has not yet issued the proposed 
rules on the definition of swap. This definition is critical to 
many of the current rulemakings of Dodd-Frank and could 
significantly expand the reach and impacts of these 
regulations.
    For the end-user exception provision of the Dodd-Frank Act, 
the CFTC's proposed rule would require an end-user to report 
roughly a dozen items of information to the CFTC each and every 
time it elects to rely on the end-user clearing exemption for a 
swap. The CFTC does not need such representations from end-
users about each and every one of their non-cleared swaps to 
prevent abuse of the end-user clearing exemption.
    We request that the Committee emphasize to CFTC that it 
should implement the end-user clearing exemption by 
streamlining their proposed requirements in the following ways: 
by requiring end-users to represent to the CFTC, once, that 
they intend to rely on the end-user clearing exemption, and by 
informing the CFTC, once, how they generally intend to meet 
their financial obligations associated with entering into non-
cleared swaps, and by maintaining a record showing that an 
appropriate committee of the board of directors--assuming they 
are a public company--has reviewed and approved their overall 
decision not to clear.
    We are also concerned with how the CFTC plans to define 
swaps dealer. CFTC's proposed rule includes very expansive 
language about the types of activities that the CFTC views as 
dealing. At the same time, the Commission has proposed to 
implement the not as part of a regular business and de minimis 
exceptions in a very restrictive manner. The result could be 
that commercial end-users are inappropriately miscast as 
dealers.
    Since the enactment of Dodd-Frank, the CFTC has promulgated 
dozens of proposed rules. Commercial end-users like our members 
have struggled mightily just to keep pace and have filed 
comments in more than 17 different Dodd-Frank rulemakings to 
date. We do not believe that the end-user clearing exemption 
was intended to result in this burdensome outcome.
    We believe that under the current timetable, it is 
impossible for the CFTC to promulgate workable rules; 
therefore, we ask that the Congress extend the statutory 
deadline for the promulgation of derivatives rules of Dodd-
Frank under Title VII. We also urge Congress to direct the 
regulatory agencies to promulgate those rules so that the basic 
definitions are issued prior to other rules that they rely 
upon.
    I am happy to answer any questions. Thank you.
    [The prepared statement of Mr. McMahon follows:]

Prepared Statement of Richard F. McMahon, Jr., Vice President, Finance 
   and Energy Supply, Edison Electric Institute, Washington, D.C.; on
 Behalf of American Gas Association; Electric Power Supply Association
    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee, thank you for this opportunity to discuss the role of over-
the-counter (OTC) derivatives markets in helping utilities and energy 
companies insulate our customers from the volatility of commodity price 
risk, and specifically our implementation concerns regarding the entity 
and product classifications under Title VII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act (Dodd-Frank), about which 
there remains great uncertainty.
    I am Richard McMahon, Vice President of Energy Supply and Finance 
for the Edison Electric Institute (EEI). EEI is the trade association 
of U.S. shareholder-owned electric utilities, with international 
affiliates and industry associates worldwide. EEI's U.S. members serve 
95 percent of the ultimate electricity customers in the shareholder-
owned segment of the industry, and represent approximately 70 percent 
of the total U.S. electric power industry.
    I also am testifying on behalf of the American Gas Association 
(AGA) and the Electric Power Supply Association (EPSA). AGA represents 
199 local energy companies that deliver clean natural gas throughout 
the United States. There are more than 70 million residential, 
commercial and industrial natural gas customers in the U.S., of which 
91 percent receive their gas from AGA members. EPSA is the national 
trade association representing competitive power suppliers, including 
generators and power marketers.
Utilities and Energy Companies Hedge Risk
    Wholesale natural gas and electric power are, and have been 
historically, two of the most volatile commodity groups. Our members 
use natural gas extensively as a fuel to generate electric power, and 
distribute natural gas to consumers in their homes. Additionally, 
utilities generate and purchase wholesale electricity from generators 
and marketers to meet consumer demand.
    The goal of our members is to provide their customers with reliable 
service at affordable and stable rates. Therefore, it is essential to 
manage the price volatility inherent in wholesale commodity markets for 
natural gas and electric power. Our members purchase fuel and sell 
power at thousands of delivery points throughout the U.S. They need the 
ability to use OTC swaps because existing futures contracts cover only 
a limited number of natural gas and electricity delivery points. The 
derivatives market has proven to be an extremely effective tool in 
insulating our customers from this risk and price volatility. Utilities 
and energy companies use exchange-traded and OTC natural gas and 
electric power swaps to hedge commercial risk. About 40% of our gas 
swaps and about \1/3\ of our power swaps are traded on exchanges.
    In sum, our members are the quintessential commercial end-users of 
swaps.
Why the Margin Issue Is Critically Important
    Utilities and energy companies are financially stable and highly 
creditworthy. On average, EEI's members are rated BBB. As a result, 
utilities and their customers get a significant cost benefit from low- 
or no-collateral requirements for their OTC derivatives transactions. 
In some cases, our members provide a letter for credit or a lien on 
assets as collateral to support their obligations on swaps. Exchanges 
and clearinghouses are generally blind to the financial health of their 
participants and demand cash margin deposits, both initial and 
variation margin.
    Our industry is in the midst of a major capital spending program to 
enhance the electric grid, make our generation fleet cleaner and bring 
new technologies to our customers. Last year, shareholder-owned 
electric utilities' capital expenditures (CAPEX) were $83 billion, 
while gas distribution utilities' CAPEX was $5 billion. We expect this 
pace of capital investment to continue throughout the decade. The 
capital investments of all of our members are contributing to our 
nation's economic recovery and job growth.
    A margin requirement on all utility OTC swaps would have an average 
annual cash flow impact of between $250 million and $400 million per 
company for EEI members. This ``dead capital'' tied up in margin 
accounts at clearinghouses would need to be funded by our retail 
customers.
    If our members are forced to post margin on all of our OTC 
transactions, we have three equally undesirable choices:

   Re-direct dollars from our core infrastructure capital 
        spending programs to margin accounts at clearinghouses;

   Borrow the money to post in margin accounts and pass that 
        cost through to our customers in rates; or

   Curtail our derivatives hedging programs and pass the 
        commodity price volatility in natural gas and electricity 
        through to our customers.

    Because of these undesirable consequences, the National Association 
of Regulatory Utility Commissioners (NARUC) passed a resolution in 
support of the industry's goal of maintaining our ability to use OTC 
derivatives without cash margining requirements (see attached).
    We were very pleased to hear Commodity Futures Trading Commission 
(CFTC) Chairman Gensler's recent testimony earlier this month before 
Congress in which he stated, ``Proposed rules on margin shall focus on 
transactions between financial entities rather than those transactions 
that involve nonfinancial end-users.'' It is essential that this now 
unambiguous direction from the CFTC Chairman be carried through fully 
in implementation of the Dodd-Frank Act. We believe this was the clear 
intent of the Congress, and it was confirmed in the Dodd-Lincoln 
letter, which was drafted as part of the conference committee to 
clarify the intent of Congress to fully exempt end-users from margining 
and burdensome CFTC compliance obligations. (see attached).
    However, there remains significant concern that our transaction 
costs may go up significantly as the result of Dodd-Frank 
implementation. For example, the yet-to-be promulgated rulemaking on 
capital and margin requirements for bank and nonbank swap dealers could 
impose incremental capital requirements on those dealers that engage in 
non-cleared OTC swaps with end-users. Undoubtedly, swap dealers would 
pass this additional cost along to end-users, thereby nullifying any 
benefit of having an end-user exemption from clearing margin.
Need for a Proper Sequencing and an Extension of the Implementation 
        Timetable
    We support the overarching goals of the Dodd-Frank Act to bring 
greater transparency and oversight to derivatives markets and to 
address systemic risk to the economy. Additionally, we compliment the 
CFTC Chairman, Commissioners and staff for their hard work and openness 
in seeking input from different market participants during the 
implementation process. But, like the CFTC and other market 
participants, we are overwhelmed by the pace and scope of rulemakings.
    Since the enactment of Dodd-Frank, the CFTC has established 30 
rulemaking teams and has promulgated dozens of proposed rules. Energy 
swaps are a small fraction of the more than $650 trillion swaps market. 
We believe that, under the current timetable, it is impossible for the 
CFTC to adequately understand the energy swaps market, the other 
segments of the commodity-based swaps (metals and agriculture) market, 
and the much larger other classes of swaps (rates and credit), and to 
promulgate workable rules.
    Therefore, we ask that Congress extend the statutory deadline for 
the promulgation of derivatives rules set forth in section 712 of the 
Dodd-Frank Act. Also, we urge Congress to direct the regulatory 
agencies to promulgate these rules so that the basic definitions are 
issued prior to other rules that rely upon them.
    The Dodd-Frank Act left many important issues to be resolved by 
regulators and set impractically tight deadlines on rulemakings by the 
agencies charged with implementation. To further complicate matters, 
many of the complex issues raised by scores of rulemakings are 
interrelated. As a result, interested parties are unable to comment on 
the proposed rules in a meaningful way, because they cannot know the 
full effect of the complete universe of proposed rules. For example, it 
is very difficult to comment on the proposed swap dealer definition, 
position limits, and record-keeping and reporting rules for swaps 
before the proposed definition of a swap has been issued.
    Commercial end-users like our members have struggled mightily just 
to keep pace, and have been compelled, because of the aforementioned 
uncertainty, to file comments in more than 17 different Dodd-Frank 
rulemakings in the past 6 months. We do not believe that the end-user 
clearing exemption was intended to result in this burdensome outcome.
Concerns Regarding Entity Designation and Implementation Burdens on 
        End-Users
    In a provision of the Dodd-Frank Act known as the ``end-user 
clearing exception,'' Congress gave our members and other end-users of 
swaps the flexibility to elect not to clear swaps that they use to 
hedge commercial risk.
    The CFTC's proposed rule implementing this provision would require 
an end-user to report roughly a dozen items of information to the CFTC 
every time it elects to rely on the end-user clearing exception for a 
swap. The required information for each swap includes representations 
that:

   it is a nonfinancial entity,

   the swap is hedging commercial risk,

   it has certain credit arrangements in place, and

   in the case of publicly-traded companies like most of our 
        members, that an appropriate committee of the board of 
        directors (or equivalent body) has reviewed and approved its 
        decision not to clear.

    The CFTC does not need repeated representations from our members 
and other end-users about every one of their non-cleared swaps to 
prevent abuse of the end-user clearing exception. Our members and other 
end-users understand that knowingly providing the CFTC with inaccurate 
information is a very serious violation of the Commodity Exchange Act 
(CEA). That is more than sufficient incentive for end-users to rely on 
the end-user clearing exception only when they are authorized to do so.
    We request that the Committee emphasize to the CFTC that it can 
implement the end-user clearing exception, consistent with Congress's 
intent, by requiring end-users to:

   represent once that they will only rely on the end-user 
        clearing exception for swaps that hedge commercial risk;

   inform the Commission once how they generally meet their 
        financial obligations associated with entering into non-cleared 
        swaps (coupled with an obligation to provide notice of material 
        changes); and

   in the case of publicly-traded companies, maintain a record 
        that shows that an appropriate committee of the board of 
        directors (or equivalent body) has reviewed and approved their 
        decision not to clear.

    In addition to our concerns about the CFTC's proposed 
implementation of the end-user clearing exception, we have serious 
concerns about how the CFTC plans to define ``swap dealer.'' The CFTC's 
proposed rule includes very expansive language about the types of 
activity--including ``accommodating'' the demand of third parties for 
swaps--that the CFTC views as dealing activity. At the same time, the 
Commission has proposed to implement the ``not as part of a regular 
business'' and ``de minimis'' exceptions to the definition of ``swap 
dealer'' in a very restrictive manner. The result could be that 
commercial end-users are inappropriately miscast as swap dealers. If 
our members, who primarily engage in hedging activities, are caught 
within the definition of ``swap dealer,'' they will face not only the 
costs of registration and margin requirements, but they also will be 
subject to additional capital requirements (not yet defined by the 
CFTC), cost of IT systems for additional record-keeping and reporting, 
and other costly requirements not appropriate for end-users.
    The CEA, prior to the passage of the Dodd-Frank Act, excluded 
physical forward transactions from the CFTC's jurisdiction over futures 
contracts. The definition of swap in the Dodd-Frank Act includes 
options for the purchase or sale of commodities, but excludes ``any 
sale of a nonfinancial commodity . . . so long as the transaction is 
intended to be physically settled.'' The CFTC has issued proposed rules 
on swap position reporting and commodity options that indicate the CFTC 
intends to regulate options that, when exercised, require the delivery 
or receipt of physical commodities as swaps or ``swaptions.'' The end-
user community is concerned about the CFTC's proposal because many 
contracts for the delivery of power in the electric industry, such as 
capacity and requirements contracts, include price, volume or other 
optionality. Including these end-user to end-user contracts in the 
definition of swap would greatly expand the scope of the CFTC's 
regulation over the electric utility industry, conflict with the 
jurisdiction of the Federal Energy Regulatory Commission, and 
potentially would subject end-users to a number of burdensome 
regulatory requirements. We urge Congress to restrain CFTC's regulatory 
authority in this critical area of our business.
Conclusion
    Thank you for your leadership and interest in implementation of the 
Dodd-Frank Act. We appreciate your role in helping to ensure that 
shareholder-owned and community-owned utilities and energy suppliers 
can continue to use OTC derivatives to cost-effectively help protect 
our nation's consumers from volatile wholesale natural gas and power 
commodity prices. We ask that the Congress extend the statutory 
deadline for the promulgation of derivatives rules set forth in section 
712 of the Dodd-Frank Act. Also, we urge Congress to direct the 
regulatory agencies to promulgate these rules in a logical order so 
that the basic definitions are issued prior to other rules that rely 
upon them.
    Again, I appreciate the opportunity to testify and would be happy 
to answer any questions.
                              Attachtments
Resolution on Financial Reform Legislation Affecting Over-the-Counter 
        Risk Management Products and Its Impacts on Consumers
    Whereas, There is a diverse group of end-users, consisting of 
electric and natural gas utilities, suppliers, customers, and other 
commercial entities who rely on over-the-counter (``OTC'') derivative 
products and markets to manage electricity and natural gas price risks 
for legitimate business purposes, thereby helping to keep rates stable 
and affordable for retail consumers; and

    Whereas, The United States Congress is considering financial reform 
legislation with the goal of ensuring that gaps in regulation, 
oversight of markets and systemic risk do not lead to economic 
instability; and

    Whereas, Previous NARUC resolutions support Federal legislative and 
regulatory actions that fully accommodate legitimate hedging activities 
by electric and natural gas utilities; and

    Whereas, The proposed legislation would, among other things, 
provide the Commodity Futures Trading Commission (CFTC) with oversight 
of OTC risk management products, including mandatory centralized 
clearing and exchange trading of all OTC products; and

    Whereas, Mandatory centralized clearing of all OTC contracts will 
increase expenses associated with hedging activity, and ultimately end-
user prices, due to increased margin requirements; and

    Whereas, A report by the Joint Association of Energy End-Users 
stated that the effect of margin requirements resulting from mandatory 
clearing for electric utilities would have the unintended effect of 
reducing or eliminating legitimate hedging practices and could 
jeopardize or reduce investments in Smart Grid technology; and for 
natural gas utilities and production companies could reduce capital 
devoted to infrastructure and natural gas exploration; and

    Whereas, The laudable goals of reform that ensure market 
transparency and adequate regulatory oversight can be accomplished by 
means other than mandatory clearing of OTC risk management contracts 
and the anticipated extra expense. For example, a requirement that 
natural gas and electric market participants engaging in legitimate 
hedging report all OTC derivative transactions to a centralized data 
repository, like the CFTC, provides sufficient market transparency 
without the costs associated with mandatory clearing; and

    Whereas, Proposed reforms would cause regulatory uncertainty with 
regard to the oversight of Regional Transmission Organizations (RTOs) 
and Independent System Operators (ISOs), where such uncertainty and/or 
overlapping jurisdiction can lead to negative impacts on liquidity, 
market confidence and reliability; and

    Whereas, The Federal Energy Regulatory Commission (FERC), and the 
Public Utility Commission of Texas (PUCT) for Texas/ERCOT, as the 
regulators with the necessary expertise and statutory mandates to 
oversee electricity and natural gas markets to protect the public 
interest and consumers, should not be preempted by the financial reform 
legislation from being able to continue exercising their authority to 
ensure reliable, just and reasonable service and protect consumers; and

    Whereas, Energy markets currently regulated by FERC or the PUCT 
(for Texas/ERCOT) under accepted tariffs or rate schedules should 
continue to be subject to FERC's and the PUCT's (for Texas/ERCOT) 
exclusive Federal jurisdiction, including jurisdiction over physical 
and financial transmission rights, and market oversight; and should 
themselves not be subject to CFTC jurisdiction as a clearinghouse due 
to the financial and other settlement services they provide those 
transacting in regional electricity markets; now, therefore be it 

    Resolved, That the Board of Directors of the National Association 
of Regulatory Utility Commissioners, convened at its 2010 Winter 
Committee Meetings in Washington, D.C., supports passage of financial 
reform legislation ensuring that electric and natural gas market 
participants continue to have access to OTC risk management products as 
tools in their legitimate hedging practices to provide more predictable 
and less volatile energy costs to consumers; and be it further

    Resolved, That new financial legislation being considered by 
Congress should weigh the costs of potential end-user utility rate 
increases versus the benefits of new standards for the clearing of OTC 
risk management contracts used by natural gas and electric utilities 
for legitimate hedging purposes; and be it further

    Resolved, That any Federal legislation addressing OTC risk 
management products should provide for an exemption from mandatory 
clearing requirements for legitimate hedging activity in natural gas 
and electricity markets; and be it further

    Resolved, That any exemption to the mandatory clearing requirement 
for OTC derivatives be narrowly tailored as to not allow excessive 
speculation in natural gas and electricity markets; and be it further

    Resolved, That the FERC, and the PUCT for Texas/ERCOT, charged with 
the statutory obligation to protect the public interest and consumers, 
should continue to be the exclusive Federal regulators with authority 
to oversee any agreement, contract, transaction, product, market 
mechanism or service offered or provided pursuant to a tariff or rate 
schedule filed and accepted by the FERC, or the PUCT for Texas/ERCOT; 
and be it further

    Resolved, That NARUC authorizes and directs the staff and General 
Counsel to promote with the Congress, the Commodity Futures Trading 
Commission and other policymakers at the Federal level, policies 
consistent with this statement.

    Sponsored by the Committee on Gas, Consumer Affairs, and 
Electricity Adopted by the NARUC Board of Directors February 17, 2010.
                                 ______
                                 
June 30, 2010

Hon. Barney Frank,
Chairman,
House Committee on Financial Services,
Washington, D.C.;

Hon. Collin C. Peterson,
Chairman,
House Committee on Agriculture,
Washington, D.C.

    Dear Chairmen Frank and Peterson:

    Whether swaps are used by an airline hedging its fuel costs or a 
global manufacturing company hedging interest rate risk, derivatives 
are an important tool businesses use to manage costs and market 
volatility. This legislation will preserve that tool. Regulators, 
namely the Commodity Futures Trading Commission (CFTC), the Securities 
and Exchange Commission (SEC), and the prudential regulators, must not 
make hedging so costly it becomes prohibitively expensive for end-users 
to manage their risk. This letter seeks to provide some additional 
background on legislative intent on some, but not all, of the various 
sections of Title VII of H.R. 4173, the Dodd-Frank Act.
    The legislation does not authorize the regulators to impose margin 
on end-users, those exempt entities that use swaps to hedge or mitigate 
commercial risk. If regulators raise the costs of end-user 
transactions, they may create more risk. It is imperative that the 
regulators do not unnecessarily divert working capital from our economy 
into margin accounts, in a way that would discourage hedging by end-
users or impair economic growth.
    Again, Congress clearly stated in this bill that the margin and 
capital requirements are not to be imposed on end-users, nor can the 
regulators require clearing for end-user trades. Regulators are charged 
with establishing rules for the capital requirements, as well as the 
margin requirements for all uncleared trades, but rules may not be set 
in a way that requires the imposition of margin requirements on the 
end-user side of a lawful transaction. In cases where a Swap Dealer 
enters into an uncleared swap with an end-user, margin on the dealer 
side of the transaction should reflect the counterparty risk of the 
transaction. Congress strongly encourages regulators to establish 
margin requirements for such swaps or security-based swaps in a manner 
that is consistent with the Congressional intent to protect end-users 
from burdensome costs.
    In harmonizing the different approaches taken by the House and 
Senate in their respective derivatives titles, a number of provisions 
were deleted by the Conference Committee to avoid redundancy and to 
streamline the regulatory framework. However, a consistent 
Congressional directive throughout all drafts of this legislation, and 
in Congressional debate, has been to protect end-users from burdensome 
costs associated with margin requirements and mandatory clearing. 
Accordingly, changes made in Conference to the section of the bill 
regulating capital and margin requirements for Swap Dealers and Major 
Swap Participants should not be construed as changing this important 
Congressional interest in protecting end-users. In fact, the House 
offer amending the capital and margin provisions of Sections 731 and 
764 expressly stated that the strike to the base text was made ``to 
eliminate redundancy.'' Capital and margin standards should be set to 
mitigate risk in our financial system, not punish those who are trying 
to hedge their own commercial risk.
    Congress recognized that the individualized credit arrangements 
worked out between counterparties in a bilateral transaction can be 
important components of business risk management. That is why Congress 
specifically mandates that regulators permit the use of non-cash 
collateral for counterparty arrangements with Swap Dealers and Major 
Swap Participants to permit flexibility. Mitigating risk is one of the 
most important reasons for passing this legislation.
    Congress determined that clearing is at the heart of reform--
bringing transactions and counterparties into a robust, conservative 
and transparent risk management framework. 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 a 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. Congress recognized that imposing the clearing and 
exchange trading requirement on commercial end-users could 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.)
    Congress recognized this concern and created a robust end-user 
clearing exemption for those entities that are using the swaps market 
to hedge or mitigate commercial risk. These entities could be anything 
ranging from car companies to airlines or energy companies who produce 
and distribute power to farm machinery manufacturers. They also include 
captive finance affiliates, finance arms that are hedging in support of 
manufacturing or other commercial companies. The end-user exemption 
also may apply to our smaller financial entities--credit unions, 
community banks, and Farm Credit institutions. These entities did not 
get us into this crisis and should not be punished for Wall Street's 
excesses. They help to finance jobs and provide lending for communities 
all across this nation. That is why Congress provided regulators the 
authority to exempt these institutions.
    This is also why we narrowed the scope of the Swap Dealer and Major 
Swap Participant definitions. We should not inadvertently pull in 
entities that are appropriately managing their risk. In implementing 
the Swap Dealer and Major Swap Participant provisions, Congress expects 
the regulators to maintain through rulemaking that the definition of 
Major Swap Participant does not capture companies simply because they 
use swaps to hedge risk in their ordinary course of business. Congress 
does not intend to regulate end-users as Major Swap Participants or 
Swap Dealers just because they use swaps to hedge or manage the 
commercial risks associated with their business. For example, the Major 
Swap Participant and Swap Dealer definitions are not intended to 
include an electric or gas utility that purchases commodities that are 
used either as a source of fuel to produce electricity or to supply gas 
to retail customers and that uses swaps to hedge or manage the 
commercial risks associated with its business. Congress incorporated a 
de minimis exception to the Swap Dealer definition to ensure that 
smaller institutions that are responsibly managing their commercial 
risk are not inadvertently pulled into additional regulation.
    Just as Congress has heard the end-user community, regulators must 
carefully take into consideration the impact of regulation and capital 
and margin on these entities.
    It is also imperative that regulators do not assume that all over-
the-counter transactions share the same risk profile. While uncleared 
swaps should be looked at closely, regulators must carefully analyze 
the risk associated with cleared and uncleared swaps and apply that 
analysis when setting capital standards for Swap Dealers and Major Swap 
Participants. As regulators set capital and margin standards on Swap 
Dealers or Major Swap Participants, they must set the appropriate 
standards relative to the risks associated with trading. Regulators 
must carefully consider the potential burdens that Swap Dealers and 
Major Swap Participants may impose on end-user counterparties--
especially if those requirements will discourage the use of swaps by 
end-users or harm economic growth. Regulators should seek to impose 
margins to the extent they are necessary to ensure the safety and 
soundness of the Swap Dealers and Major Swap Participants.
    Congress determined that end-users must be empowered in their 
counterparty relationships, especially relationships with swap dealers. 
This is why Congress explicitly gave to end-users the option to clear 
swaps contracts, the option to choose their clearinghouse or clearing 
agency, and the option to segregate margin with an independent third 
party custodian.
    In implementing the derivatives title, Congress encourages the CFTC 
to clarify through rulemaking that the exclusion from the definition of 
swap for ``any sale of a nonfinancial commodity or security for 
deferred shipment or delivery, so long as the transaction is intended 
to be physically settled'' is intended to be consistent with the 
forward contract exclusion that is currently in the Commodity Exchange 
Act and the CFTC's established policy and orders on this subject, 
including situations where commercial parties agree to ``book-out'' 
their physical delivery obligations under a forward contract.
    Congress recognized that the capital and margin requirements in 
this bill could have an impact on swaps contracts currently in 
existence. For this reason, we provided legal certainty to those 
contracts currently in existence, providing that no contract could be 
terminated, renegotiated, modified, amended, or supplemented (unless 
otherwise specified in the contract) based on the implementation of any 
requirement in this Act, including requirements on Swap Dealers and 
Major Swap Participants. It is imperative that we provide certainty to 
these existing contracts for the sake of our economy and financial 
system.
    Regulators must carefully follow Congressional intent in 
implementing this bill. While Congress may not have the expertise to 
set specific standards, we have laid out our criteria and guidelines 
for implementing reform. It is imperative that these standards are not 
punitive to the end-users, that we encourage the management of 
commercial risk, and that we build a strong but responsive framework 
for regulating the derivatives market.
            Sincerely,

            [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
            
Hon. Christopher Dodd,
Chairman,
Senate Committee on Banking, Housing, and Urban Affairs;

            [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Hon. Blanche L. Lincoln,
Chairman,
Senate Committee on Agriculture, Nutrition, and Forestry.

    The Chairman. Thank you.
    Ms. Trakimas.

         STATEMENT OF ANN E. TRAKIMAS, CHIEF OPERATING
   OFFICER, CoBANK, GREENWOOD VILLAGE, CO; ON BEHALF OF FARM 
                         CREDIT COUNCIL

    Ms. Trakimas. Thank you. Good afternoon, Chairman Lucas, 
Ranking Member Peterson, and Members of the Committee. Thank 
you for your leadership in overseeing the CFTC's implementation 
of the derivatives title of the Dodd-Frank Act and for the 
opportunity to testify today.
    My name is Ann Trakimas and I am the Chief Operating 
Officer of CoBank. I am testifying today on behalf of the Farm 
Credit System. New derivatives regulation has the potential to 
affect the Farm Credit System's ability to offer cost-
effective, dependable financing to farmers, farm-related 
businesses, rural home buyers and rural energy, water and 
communications companies.
    Farm Credit supports Congress' goal of making the U.S. 
financial system safer and more transparent. We believe, 
however, that some of the new proposed regulations would impose 
unwarranted costs on Farm Credit institutions, ultimately 
increasing the cost of credit to our customers without making 
the financial system safer.
    The provisions on derivatives in the Dodd-Frank Act were 
designed to reduce and control systemic risk in the financial 
system. In passing the Act, Congress made clear its view that 
Farm Credit institution derivative activities do not pose a 
systemic threat. As a result, we believe Congress' intent is 
for new regulation to be focused on institutions that engage in 
derivatives activity that do create systemic risk.
    Farm Credit institutions should be exempt from the 
mandatory swap clearing requirements of the Act. System 
institutions are end-users and use them solely for hedging the 
risks inherent in making loans to their customers and in 
managing their liquidity and funding costs. Farm Credit 
institutions primarily use plain vanilla, fixed for floating 
interest rate, swaps and caps. We do not use swaps to 
speculate; we are not market makers, and we do not use the 
credit default swaps that contributed to the financial crisis.
    The System's swaps are an extremely small portion of the 
overall derivatives market. We have robust procedures in place 
today, closely overseen by our Federal regulator, that ensures 
our swaps post no significant risk to us or to our 
counterparties.
    The recent global financial crisis conclusively 
demonstrated that Farm Credit's strong risk controls 
effectively limited our exposure to financial stress resulting 
from derivatives activities. Congress recognized all of this in 
the Dodd-Frank Act when it directed CFTC to consider exempting 
small banks, credit unions, and Farm Credit institutions for 
mandatory swap clearing.
    The CFTC's final regulations in this area should provide an 
exemption from mandatory swap clearing for derivatives 
activities that do not possess systemic risk.
    In addition, no Farm Credit institution should be 
considered a swap dealer. Only one Farm Credit institution, 
CoBank, offers swaps to its customers.
    CoBank does a limited number of these transactions each 
year, and all of these transactions are executed in conjunction 
with loans made to our customers. All of our customers' 
derivative transactions are nonspeculative, and we offset the 
risk associated with each. These customer transactions pose no 
systemic risk and are critical to helping our customers 
economically manage the risks inherent in their loans.
    Additionally, because CoBank is the only lender to many of 
its borrowers, we may be the only counterparty able to enter 
into a swap with that customer, because we already hold the 
customer's collateral via our loan agreements.
    Congressional intent in this area is clear: The Dodd-Frank 
Act specifically gives CFTC the authority to exclude these 
types of customer swap transactions from the swap dealer 
definition. CoBank's customer derivatives are the same as the 
customer derivatives that commercial banks provide to their 
customers, and Congress has exempted commercial banks from 
designation as a swap dealer.
    There is no reason that the same exemption should not apply 
to the Farm Credit System.
    On behalf of the members of the Farm Credit System, thank 
you for holding this hearing and for considering our views on 
this important topic.
    The Chairman. Thank you.
    Ms. Trakimas. Can I just complete? Farm Credit institutions 
rely on the safe use of derivatives to manage our interest rate 
liquidity and balance sheet risks. These instruments in turn 
help us provide cost-effective, dependable financing to 
farmers, ranchers, ag co-ops and other farm-related and rural 
infrastructure businesses that serve rural America. It is 
essential that in implementing Dodd-Frank, the CFTC does not 
impose unwarranted, duplicative, and costly regulations on the 
Farm Credit System. Mandatory clearing or swap dealer 
regulation would increase our borrowers' financing costs.
    We look forward to working with the Committee as well as 
the CFTC to strike the appropriate balance between improving 
the safety of the financial system and preserving rural 
America's access to credit.
    Thank you, Mr. Chairman. And I would be very happy to 
answer any questions that you or the Committee have.
    [The prepared statement of Ms. Trakimas follows:]

Prepared Statement of Ann E. Trakimas, Chief Operating Officer, CoBank, 
        Greenwood Village, CO; on Behalf of Farm Credit Council
    Good afternoon, Chairman Lucas, Ranking Member Peterson, and 
Members of the Committee. I appreciate the opportunity to testify today 
on behalf of the Farm Credit System, and I commend the Committee for 
its leadership in overseeing the rulemaking process as the Commodity 
Futures Trading Commission (``CFTC'') implements the derivatives title 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act 
(``Dodd-Frank'').\1\
---------------------------------------------------------------------------
    \1\ Pub. L. No. 111-203, 124 Stat. 1376 (2010).
---------------------------------------------------------------------------
    I am the Chief Operating Officer of CoBank, a member bank of the 
Farm Credit System. Before joining CoBank, I served as a director of 
the Federal Farm Credit Banks Funding Corporation, the entity that 
issues debt securities that CoBank and other Farm Credit banks use to 
fund loans to farmers and ranchers, farm-related businesses, 
agricultural cooperatives, and rural electric, water, and 
communications providers.
    As you know, the Farm Credit System provides 40% of agricultural 
lending in the United States. New derivatives regulation has the 
potential to affect the Farm Credit System's ability to offer cost-
effective, dependable financing to farmers, farm-related businesses, 
and rural America. The Farm Credit System supports Congress's goal of 
making the financial system safer. We believe, however, that new 
regulation should not impose unwarranted costs on Farm Credit System 
institutions, which would ultimately raise the costs of loans to our 
member-borrowers and diminish rural America's access to credit, without 
making the financial system safer.
    In explaining how proposed regulations will affect the Farm Credit 
System and what steps we believe the CFTC should take in implementing 
Dodd-Frank, I would like to make three points:
    First, the Farm Credit System already has in place important 
protections for safety, soundness, and consumer protection. These 
attributes illustrate that many of Dodd-Frank's regulatory concerns do 
not apply with equal force to the Farm Credit System. In passing the 
Act, Congress concluded that the Farm Credit System did not pose a 
systemic threat and specifically excluded them from oversight by the 
new systemic risk regulatory agency.
    Second, Farm Credit System banks and associations should qualify 
for the end-user exemption to Dodd-Frank's clearing requirement. 
Congress authorized and instructed the CFTC to consider exempting Farm 
Credit System institutions, regardless of size, from mandatory clearing 
since they do not pose a systemic risk to the financial system and they 
were not the cause of the problems that resulted in the recent 
financial crisis. Imposing higher costs, through unnecessary 
derivatives regulations, on Farm Credit System institutions ultimately 
leads to higher credit costs for farmers and ranchers, their 
agricultural cooperatives, rural infrastructure providers and others in 
rural America. While Dodd-Frank places special emphasis on exempting 
institutions with less than $10 billion in assets, Congress also made 
it clear that it should not be viewed as a limit by CFTC. If the CFTC 
adopts an asset test, it must be applied in a manner that appropriately 
recognizes the unique cooperative structure of the Farm Credit System 
to ``look through'' Farm Credit Banks to the smaller Farm Credit 
associations that own them. Alternatively, the CFTC should adopt a 
risk-based approach to mandatory clearing in a manner similar to the 
definition of major swap participant.
    Third, no Farm Credit System institution should be considered a 
swap dealer. Farm Credit System institutions enter into customer 
derivative transactions that are linked to the financial terms of the 
loans they issue. All customer derivative transactions are non-
speculative in nature with risk immediately eliminated through 
appropriate risk management activities and controls. These customer 
derivative transactions pose no systemic risk to the financial system 
and are critical to helping our customers economically manage interest 
rate and foreign currency risk. In this way, the Farm Credit System's 
customer derivatives activity is the same as the same sort of customer 
derivatives activity of commercial banks, which Congress has exempted 
from designation as a swap dealer. There is no reason that the same 
exemption should not apply to the Farm Credit System.
Background
    I would like to begin with an overview of the Farm Credit System, 
which comprises five banks and 84 cooperative lending associations. As 
you know, Congress created the Farm Credit System ``to accomplish the 
objective of improving the income and well-being of American farmers 
and ranchers by furnishing sound, adequate, and constructive credit and 
closely related services to them, their cooperatives, and to selected 
farm-related businesses necessary for efficient farm operations.'' \2\ 
Congress also intended ``to encourage farmer- and rancher-borrowers 
participation in the management, control, and ownership of a permanent 
system of credit for agriculture which will be responsive to the credit 
needs of all types of agricultural producers having a basis for 
credit.'' \3\ Today, the Farm Credit System is safe, sound, and 
responsive to its customer-owners. This is due, in part, to the 
following aspects of the Farm Credit System.
---------------------------------------------------------------------------
    \2\ 12 U.S.C.  2001(a).
    \3\ Id.  2001(b).
---------------------------------------------------------------------------
    The Farm Credit System uses safe, non-speculative swaps and already 
effectively addresses counterparty credit risk. Farm Credit System 
institutions primarily use plain vanilla, fixed-for-floating interest 
rate swaps, and virtually all of our derivatives qualify for hedge 
accounting treatment. Farm Credit System institutions do not use swaps 
to speculate, and do not use the credit default swaps that contributed 
to the financial crisis. And Farm Credit System institutions already 
effectively manage counterparty credit risk. We deal with 
counterparties that have an investment grade or better long-term credit 
rating, and we monitor the credit standing of and levels of exposure to 
individual counterparties. Substantially all of our derivative 
contracts are supported by credit support agreements requiring the two-
way posting of collateral in the event certain dollar thresholds of 
exposure are reached. These thresholds are small relative to the Farm 
Credit System capital. As of December 31, 2010, the net 
uncollateralized exposure of Farm Credit System institutions to swap 
dealers was only $232 million. As of that same date, Farm Credit Bank 
capital stood at $12.3 billion.
    Farm Credit System institutions are regulated by the Farm Credit 
Administration, an independent Federal agency that effectively 
mitigates the risk of Farm Credit System institutions to the United 
States financial system. The Farm Credit Act gives the Farm Credit 
Administration broad powers ``for the purpose of ensuring the safety 
and soundness of System institutions.'' \4\ These powers include 
suspending or removing directors or officers of Farm Credit System 
institutions who engage in unsafe or unsound practices, and the ability 
to place unsafe or unsound institutions in conservatorship or 
receivership.
---------------------------------------------------------------------------
    \4\ Id.  2252(a)(10).
---------------------------------------------------------------------------
    The Farm Credit Administration also effectively oversees the 
capital adequacy and derivatives activity of Farm Credit System 
institutions. The Farm Credit Administration sets minimum capital 
standards and rates the safety and soundness of each Farm Credit System 
institution, and it requires Farm Credit System institutions to limit 
their exposure to single or related counterparties and to establish 
policies that ensure that counterparty risks are consistent with the 
institution's risk-bearing capacity.
    The Farm Credit System is not so interconnected with other 
financial entities to raise systemic risk concerns. Because Farm Credit 
System institutions do not take deposits, Farm Credit System banks and 
associations cannot experience a ``run on the bank.'' And the 
Systemwide Debt Securities used to fund the Farm Credit System are (1) 
insured by the Farm Credit System Insurance Corporation, a government-
controlled, independent entity, that administers a more than $3 billion 
insurance fund paid by premiums imposed on System institutions, and (2) 
issued by the five Farm Credit System banks, which are jointly and 
severally liable for these Systemwide debt obligations. In short, these 
layers of investor protection ensure that the Farm Credit System will 
not cause a run on the funding of other entities.
    The Farm Credit System is a cooperative enterprise. Farm Credit 
System associations are cooperatives owned by their borrowers, and Farm 
Credit System banks are cooperatives primarily owned by their 
affiliated associations and other borrowers organized as cooperatives. 
Borrowers purchase equity in the institutions with which they do 
business, and Farm Credit System institutions return a portion of their 
earnings to their borrower-owners in the form of patronage 
distributions. Farm Credit Administration regulations further govern 
our standard of conduct, requiring, among other things, that Farm 
Credit System institutions monitor and avoid conflicts of interest.
    Finally, Farm Credit System institutions are uniquely well suited 
to provide derivatives to their customers. To the extent that a System 
institution is a customer's only lender, that customer will likely be 
unable to enter into a swap with another party that would not have 
access to the loan collateral. New regulation would raise the costs of 
derivatives to the Farm Credit System's customers and could cause 
System institutions to stop offering these products. This would deprive 
some farmers, farm-related businesses, and rural America of the ability 
to manage risk, and drive others to Wall Street swap dealers that are 
less familiar with their unique needs.
    In sum, Farm Credit System institutions are safe and sound, and 
they operate with high standards of conduct for their customers. Before 
determining that new regulation is warranted, regulators must therefore 
consider the Farm Credit Administration's effective current regulation 
of safety and soundness, the low risk profile of Farm Credit System 
institutions, and the unique relationship those institutions have with 
their borrower-owners.
    With these principles in mind, I would like to discuss two 
significant areas of potential new regulation: (1) whether Farm Credit 
System institutions will qualify for the end-user exemption as we 
believe Congress, and this Committee, intended; and (2) whether Farm 
Credit System institutions will be designated as swap dealers, which we 
believe Congress, and this Committee did not intend and if it occurred 
would be unfair and unnecessary.
End-User Exemption
    As you know, Dodd-Frank provides an exemption to mandatory clearing 
for end-users entering into swaps to hedge or mitigate commercial risk. 
Although Dodd-Frank generally defines end-users as nonfinancial 
entities, Congress also directed the CFTC to ``consider whether to 
exempt small banks, savings associations, farm credit system 
institutions, and credit unions.'' \5\ Because the Farm Credit System 
is already safe and sound, and because our derivatives are already 
collateralized, we believe Congress gave the CFTC broad authority to 
permit Farm Credit System institutions, including those with total 
assets of more than $10 billion, to use the end-user exemption. We have 
urged the CFTC to clarify in its final rules that Farm Credit System 
institutions will qualify for the end-user clearing exemption.
---------------------------------------------------------------------------
    \5\ Pub. L. No. 111-203,  723(a)(3), 124 Stat. at 1680 (CEA  
2(h)(7)(C)(ii)).
---------------------------------------------------------------------------
    First, we have asked the CFTC to provide the maximum flexibility to 
adopt an equitable solution for exempting Farm Credit institutions from 
mandatory swaps clearing if they do not pose a systemic risk to the 
U.S. financial institutions. Consistent with what we believe to be 
Congress's intent, the Dodd-Frank Act authorizes CFTC to exempt any-
sized Farm Credit System institution from mandatory clearing 
requirements, which is appropriate given Farm Credit System 
institutions' derivatives use does not pose a systemic risk to the 
financial system. More troubling to us is the CFTC may take a more 
narrow approach, particularly with respect to how it interprets the 
Dodd-Frank Act's reference to the $10 billion asset limit, which would 
make even more critical that it at least recognize the unique 
cooperative structure of the Farm Credit System where the cooperative 
district banks are generally owned by cooperative lending associations, 
which engage in most of the System's retail lending. Under this 
structure, the cooperative lending associations are smaller than their 
affiliated banks that provide them funding and use derivatives to 
manage liquidity and other balance-sheet risks. For example, AgriBank, 
FCB, is the largest district bank, and its assets exceed $10 billion. 
But the 17 associations that own 99% of AgriBank have average assets of 
$3.6 billion. This is well below the $10 billion threshold that some 
have suggested.\6\ Congress did not intend the $10 billion as a size 
limitation for exempting Farm Credit institutions from mandatory 
clearing. If, however, CFTC decides to implement an exemption test that 
included size, the agency must then also recognize the unique 
cooperative structure of the Farm Credit System and ``look through'' 
Farm Credit Banks to the smaller Farm Credit associations that own 
them. One consequence of our unique structure is that each bank 
centrally funds loans for its district. Centralized funding enables the 
associations to benefit from lower administrative and operational 
costs. Swaps that hedge risk on behalf of Farm Credit System 
associations are executed by the district bank to gain hedge 
accounting, to minimize administrative costs, and to minimize 
counterparty credit risk and margin requirements via district-wide 
netting of offsetting exposures. This is more cost effective and 
strengthens the liquidity of the System. As a result, Farm Credit 
System associations have a lower risk profile than the small commercial 
banks.
---------------------------------------------------------------------------
    \6\ As the Farm Credit Council noted in its February 22 comment on 
the CFTC's proposed end-user exception rules, although the majority of 
Farm Credit System associations have assets of less than $10 billion, 
the few associations with greater assets do not present risk requiring 
mandatory clearing. Even the failure of a large association would have 
no material impact on the Farm Credit System's ability to meet its debt 
obligations because the five Farm Credit System banks are jointly and 
severally liable for the System's notes and bonds. Thus, no association 
is so large that it would impact System debt holders if it were placed 
in receivership. By contrast, if a standalone bank fails, its 
bondholders will likely face losses.
---------------------------------------------------------------------------
    We believe the increased costs of mandatory clearing will 
ultimately be borne by farmers and ranchers because of the higher cost 
of credit, and will put our cooperative lending associations at a 
disadvantage with respect to the small commercial banks with which they 
compete. The increased costs of mandatory clearing will be passed on 
from the banks to their associations, reducing their capital and 
liquidity, which in turn will either reduce the funds available for 
loans or increase borrowing costs. That result would be unfair and 
unnecessary given that Congress intended to give regulators maximum 
flexibility in implementing the end-user exemption.
    Second, we have asked the CFTC to consider the risk of an 
institution's derivatives activity instead of simply its total assets. 
To the extent clearing is designed to address credit risk, large 
institutions may in fact be less risky than smaller institutions. Risk 
is a function of the type and amount of derivative activity after 
netting offsetting positions and collateral, not simply of total 
assets. Accordingly, we have urged the CFTC to consider a risk-based 
measure of which financial entities should be eligible for the end-user 
clearing exemption.
    One such approach could draw on the framework proposed by the CFTC 
and the Securities and Exchange Commission (``SEC'') for determining 
whether an entity has a ``substantial position'' in a major swaps 
category warranting regulation as a major swap participant. A similar 
test measuring uncollateralized current exposure or current exposure 
plus potential future exposure would also be appropriate for 
determining which financial institutions pose enough risk to warrant 
mandatory clearing. Specifically, we have proposed that current 
uncollateralized exposure of $2 billion in rate swaps and $1 billion in 
other categories of swaps--or current uncollateralized exposure and 
potential future exposure of $3 billion for rate swaps or $1 billion 
for other swaps--would be appropriate. These proposed thresholds, which 
are lower than the thresholds the CFTC has proposed for identifying 
major swap participants, would address risk among financial entities 
and would more accurately capture financial institutions whose swap 
exposure poses risk to the financial system. We are convinced that 
implementing a risk-based test using current and potential exposures is 
more equitable and appropriate way to determine when financial 
institution derivative activities, including Farm Credit System 
institutions, may pose a systemic risk to the financial system and, 
therefore, require mandatory clearing of derivative transactions.
    Alternatively, the CFTC could adopt a test based on an 
institution's uncollateralized exposure to swaps as a percentage of 
capital. The Farm Credit System has suggested to the CFTC that 
appropriate risk limits would be current uncollateralized exposure to 
swaps of 10% of capital, or current uncollateralized exposure plus 
potential future exposure to swaps of 20% of capital. These limits 
would appropriately identify which small financial institutions pose 
systemic risk warranting mandatory clearing.
    In the end, it is critically important that Farm Credit System 
banks, associations, and their members can make use of the end-user 
clearing exemption. Clearing will raise costs for Farm Credit System 
institutions that will ultimately be borne by our agricultural 
borrowers in the form of higher interest rates. We do not believe that 
new costs on agricultural borrowers are justified.
Swap Dealer Regulation
    Finally, I would like to address the issue of whether any Farm 
Credit System institution will be defined as a ``swap dealer'' and 
therefore will be forced to register with the CFTC and comply with 
potentially costly new capital, margin, and business conduct standards.
    Farm Credit System institutions do not use swaps speculatively and 
we are not market makers. CoBank does, however, enter into swaps with 
customers as a service that enables them to modify or reduce their 
interest rate and foreign currency risk related to their loans with the 
bank or its related associations. For example, a floating-rate loan 
agreement may require the customer to hedge fluctuations in interest 
rates. The most efficient way for the customer to do so is to enter 
into an interest rate swap or cap. By requiring the customer to hedge 
against changing interest rates and by providing the customer a swap 
for that hedge, CoBank reduces the risk that higher interest rates may 
cause excessive interest expense that the customer cannot afford. Thus, 
the hedging requirement mitigates risk for both the bank and the 
customer.
    All of the Farm Credit System's customer derivatives transactions 
are non-speculative, and Farm Credit System institutions offset the 
risk associated with them. For example, CoBank concurrently enters into 
offsetting agreements with approved counterparties, and customer 
derivatives are secured under the related loan agreements with CoBank 
or its related association. CoBank's customers--which include 
agricultural cooperatives; rural energy, communications, and water 
companies; farmer-owned financial institutions including agricultural 
credit associations; and other businesses that serve rural America--
depend on these swaps to hedge risk and allow them to access credit. 
Indeed, because CoBank is the only lender to many of its borrowers, it 
may be the only counterparty able to enter into a swap backed by the 
loan collateral.
    We believe that Congress intended to clarify that ``community banks 
aren't swap dealers or major swap participants'' \7\--at least not when 
they enter into a swap with a customer that is linked to the financial 
terms of the customer's loan. To accomplish this objective, Dodd-Frank 
states that ``in no event shall an insured depository institution be 
considered to be a swap dealer to the extent it offers to enter into a 
swap with a customer in connection with originating a loan with that 
customer.'' \8\ Although the statute says ``insured depository 
institution,'' we believe Congress intended to exclude swaps offered in 
connection with loans and did not intend to confer a peculiar market 
advantage on commercial banks. To effectuate the intent that community 
banks not be designated swap dealers, the members of the Farm Credit 
System have urged the CFTC to clarify that this exemption applies 
equally to Farm Credit System institutions when they offer derivatives 
to customers in connection with loans, even though our institutions do 
not accept deposits.
---------------------------------------------------------------------------
    \7\ 156 Cong. Rec. S5922 (daily ed. July 15, 2010) (statement of 
Sen. Lincoln) (``The definition of swap dealer was adjusted in a couple 
of respects so that a community bank which is hedging its interest rate 
risk on its loan portfolio would not be viewed as a Swap Dealer. In 
addition, we made it clear that a bank that originates a loan with a 
customer and offers a swap in connection with that loan shouldn't be 
viewed as a swap dealer. It was never the intention of the Senate 
Agriculture Committee to catch community banks in either situation. We 
worked very hard to make sure that this understanding came through in 
revised statutory language which was worked out during conference.'').
    \8\ Pub. L. No. 111-203,  721(a)(21), 124 Stat. at 1670 (adding 
CEA  1a(49)(A)).
---------------------------------------------------------------------------
    First, the Farm Credit System's customer interest rate derivatives 
are identical to swaps offered by community banks in connection with 
loans. For example, CoBank customizes customer swaps to match the terms 
of loans and to ensure that the customer is effectively hedged against 
changes in interest rates. Because the swaps are connected to the 
financial terms of the loan, CoBank's customer interest rate swaps are 
consistent with the CFTC's preliminary interpretation of the community 
banks exemption.
    Second, Farm Credit System institutions are subject to similar 
regulatory requirements as insured depository institutions. As an 
example, the Farm Credit Administration uses the same FIRS, or CAMELS, 
rating system for Farm Credit System institutions that the Federal 
Deposit Insurance Corporation uses for commercial banks.
    Third, although Farm Credit System institutions do not accept 
deposits, the Systemwide Debt Securities they use to finance loans are 
insured, just as deposits of commercial banks are insured. If a bank 
cannot pay principal or interest on an insured debt obligation, the 
investors are paid from an independently administered insurance fund 
supported by premiums paid by Farm Credit System institutions. In the 
event that the entire insurance fund is exhausted, investors have 
further recourse to the five Farm Credit System banks, which are 
jointly and severally liable for Systemwide Debt Securities. All of the 
Farm Credit System's debt financing is insured in this manner.
    Finally, unless Farm Credit System institutions were able to use 
it, the community bank exemption would give commercial banks an 
unwarranted competitive advantage in the market for agricultural 
lending. In determining whether an entity is a swap dealer, the rules 
currently proposed by the CFTC and the SEC do just that. The proposed 
rules exempt derivatives offered by commercial banks, while counting 
the same derivatives offered by the Farm Credit System, simply because 
System institutions do not accept deposits. This is unfair, and we do 
not believe that Congress intended this result in exempting community 
banks from additional regulation. Accordingly, we have urged the CFTC 
to provide this same exemption to the Farm Credit System in its final 
rules.
          * * * * *
    On behalf of the members of the Farm Credit System, I thank the 
Committee for holding for this hearing and for considering our views on 
these very important issues. Farm Credit System institutions rely on 
the safe use of derivatives to manage interest rate, liquidity, and 
balance sheet risk. These instruments, in turn, help us to provide 
cost-effective, dependable financing to farmers, farm-related 
businesses, and rural America. It is essential that, in implementing 
Dodd-Frank, the CFTC does not impose unwarranted, duplicative, and 
costly regulation on the Farm Credit System. Mandatory clearing or swap 
dealer regulation would raise costs of financing for our borrowers. We 
look forward to working with the Committee, as well as with the CFTC, 
to strike the appropriate balance between improving the safety of the 
financial system and preserving rural America's access to credit. 
Again, I thank the Committee for its leadership on these important 
matters.

    The Chairman. Thank you again.
    I now recognize myself for 5 minutes.
    Mr. Allison, if ConocoPhillips were no longer providing 
swaps to its physical customers because of the cost associated 
with regulation as a swap dealer due to that activity, how do 
you anticipate the demand for those swaps would be met? If you 
can't do it, what is going to happen?
    Mr. Allison. The customers that were unable to acquire 
swaps from us would either have to increase the risk they were 
willing to bear, or they would go to an entity that I would 
think of--probably one of the big financial firms. The well-
known financial firms are the biggest swap dealers in the 
energy space as in the other derivatives markets, and that 
would be the most likely firm to pick up any business that we 
weren't doing.
    The Chairman. So they simply expose themselves to more 
risk, or they increase their cost by finding some entity that 
would?
    Mr. Allison. Yes.
    The Chairman. Mr. Fields, Mr. McMahon, how would you 
respond to the assertion that central clearing shifts the 
informational advantage from Wall Street to the end-users and 
that the result from end-users of a central clearing mandate 
would be better pricing? How do you respond to that comment by 
some people?
    Mr. McMahon. I will start first. Our members utilize 
exchanges and central clearing for some of their transactions 
in electric swap transactions and electric power and natural 
gas. So it is not that we don't use clearing in exchanges, but 
only where it makes sense. Oftentimes there are a lot of 
customized transactions that need to be done that don't lend 
themselves to central clearing. So we need the ability to 
utilize all the options.
    I think that for us, that is the key, having that 
flexibility and also where it makes sense; because of our 
credit standing, oftentimes we don't need to post any margin, 
and that benefit flows directly to our customers.
    The Chairman. Mr. Field?
    Mr. Field. I would reply to that in the sense that when we 
are bidding a transaction, we will have a very, very 
transparent and a very significant process where we are getting 
lots of market information from many different Wall Street 
banks. And so we feel that actually it is very, very 
transparent from our perspective today and we don't see that 
advantage. In fact, we see an advantage where oftentimes the 
banks are bidding very aggressively for our business, because 
they like a swap with a nonfinancial institution, a non-Wall 
Street bank. They like having us as the counterparty.
    The Chairman. Mr. Cvrkel, Ms. Trakimas, as the bankers at 
the table, how is the credit profile of a potential borrower 
impacted by whether or not they are hedging their exposure to 
risk? I know it is a simple question but it is one of those 
things we need to point out and discuss in public.
    Ms. Trakimas. I guess I will start. Our customers typically 
borrow in the floating rate market, and essentially they use 
interest rate swaps to cap the interest rate risk on that 
floating rate loan. So to the extent that we do not offer this 
product because of increased costs and regulation, they will be 
increasing their risk profile to us and themselves. So it is a 
disadvantage.
    Mr. Cvrkel. When we look at our customers, one thing we 
need to evaluate credit risk exposure is fixed-debt service 
cost so the cost will be consistent over the next 5 years or 10 
years. If we are unable to offer those customers that fixed-
rate debt service cost, chances are we would not make any loans 
greater than 10 years. That would be out. Lending would be shut 
off.
    The Chairman. I suspected that was the case, and thank you 
for pointing that out.
    Mr. Field, one last question. Does your pension fund engage 
in swaps and are you concerned about the CFTC's business 
conduct rules?
    Mr. Field. Yes, we do engage in swaps and we are concerned 
about the rule. Let me, if you can indulge me for a minute.
    The Chairman. Please.
    Mr. Field. John Deere has a defined benefit plan that 
covers more than 40,000 participants. And we are very, very 
proud that we are able to provide a defined benefit plan in 
this environment; and in fact, as you all know, that is the 
minority of companies that do that anymore.
    And we use swaps basically to discharge our fiduciary duty 
to reduce the risk to manageable levels. So we have a payment 
obligation to our beneficiaries that has a very long tail on 
it. And what we are trying to do is go out and get assets that 
match up against that long tail. And the only way that we can 
do that cost effectively is through the use of swaps. So we are 
very concerned about this.
    The Chairman. It is an important issue.
    My time has expired.
    I now turn to the gentleman from Pennsylvania, Mr. Holden, 
and recognize him for 5 minutes.
    Mr. Holden. Thank you, Mr. Chairman.
    Mr. Cvrkel and Ms. Trakimas, following up on the Chairman's 
question, basically if you are not exempted, the services you 
provide your customers now, you will not do in the future 
because of the regulation and because of the costs; or is more 
staff needed to comply.
    Mr. Cvrkel. The way I look at it is we started swaps in 
2007; we have done 54 transactions. And currently with the 
additional regulation come on us, we don't have the staff nor 
would I get the staff. So chances are we would stop using swaps 
to fix our debt service cost and help our customers. And that 
lending opportunity would go away.
    Mr. Holden. They would have to go to larger entities?
    Mr. Cvrkel. That is correct.
    Ms. Trakimas. From our perspective, it is clear that the 
costs to our customers will increase and the potential negative 
there is that the availability of credit will also diminish. We 
would be looking at higher capital requirements and higher 
margin requirements.
    The other issue to think about here is that our customers 
may not have access to another swap counterparty because our 
swaps are made in connection with the loans that we make to 
them and we hold the collateral against those loans. So from a 
collateral perspective, the customers posting to us collateral 
on our loan, which we also use to collateralize our swap 
position. So the marketplace is not prepared to, and our 
customers are not prepared to, technically and operationally 
post collateral to anyone else other than their lender.
    Mr. Holden. To the extent that such exemptions are granted, 
could such exemptions be based on the same standard regardless 
of the type of entity? Suppose the CFTC determines that an 
exemption is warranted for Farm Credit banks with less than $20 
billion in assets, could the CFTC set a different threshold for 
small banks and credit unions?
    Ms. Trakimas. Yes. From our perspective, it is not the size 
of the institution that is the question; the question to us is 
what is the risk in the transaction. And also all swaps are not 
created equal. Some are more risky than others. And the type of 
swaps that we use are plain vanilla, interest-rate swaps that 
are risk mitigation tools.
    And from our perspective, you could be a very large 
institution and have very small swap exposure. And I would 
probably put us in that category. We are a good-sized 
institution, but the size of our portfolio of swaps from a risk 
perspective is just very, very small.
    On the other hand, you could be a small institution with a 
very, very high volatility swaps portfolio.
    So to us, it is not necessarily the size that counts.
    If I just might. To the extent that that is the way the 
rules will be written, however, we do--a lot of our lending 
associations are small. When you look at the System on a 
combined basis, we are large. So if it does come down to a 
numbers, a size perspective, we do think that we would 
appreciate a sizeable threshold so our lending associations 
could be excluded.
    Mr. Holden. Do you care to comment, Mr. Cvrkel?
    Mr. Cvrkel. I think one thing you have to look at is even 
the size of the organization. For instance, for banks under $10 
billion, they have .04 percent of the swap market; for banks of 
$30 billion and under, that goes up to .1 percent. The top five 
banks in the country have 96 percent of the notional value of 
the swap portfolio.
    So the risk is not into smaller banks. It is not banks of 
$14 billion or $20 billion. That is not where the risk exposure 
is.
    Also when you look at swap risk, I think it is somewhat 
misleading, everyone is looking at the big numbers of the $600 
billion market; that is not the risk exposure. The risk 
exposure is the uncollateralized portion of that swap. When we 
do a swap, and if it is an asset to our counterparty, we have 
to post collateral. So the risk is the difference that is not 
posted.
    And one thing, one comment I want to make, too, as I 
mentioned we made 54 transactions since 2007. When Lehman 
Brothers went bankrupt they had 900,000 transactions compared 
to 54. Why should we get regulated like them?
    Mr. Holden. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The chair 
now recognizes the gentleman from Illinois for 5 minutes, Mr. 
Johnson.
    Mr. Johnson. Thank you, Mr. Chairman.
    Let me just say I don't expect any of you to comment on my 
comment, but the fact that you have to be here today and 
subject yourself not only to questions but also to this whole 
incredibly complicated labyrinthine process is an indication to 
me how Congress overreaches in regard to a problem and then 
causes innumerable problems as a result of it. So that is just 
my parenthetical. I don't expect Members of the Committee or 
you to respond, but this is a good example of bureaucracy run 
amok and over-regulation and over-legislation run amok. So take 
that as you will.
    I wish Mr. Gensler were still here, but since he isn't let 
me direct this question to Mr. Cvrkel. And I don't mean--this 
is not an adversarial question to you. I remember in response 
to one of my questions, that he indicated that they hadn't 
received any public comment in regard to one particular area.
    I am specifically now directing you--maybe you don't have 
awareness of this--to a letter of February 22nd of this year, 
in which at some point in the letter--this is a letter that 
Susquehanna signed and a number of other entities signed. I am 
quoting, ``These low thresholds, especially when coupled with 
narrow interpretation of the statutory exclusion for IDIs, 
could have the effect of either subjecting many small banks to 
the substantial regulatory burden imposed on swap dealers or 
causing them to cease offering certain risk management services 
to customers.''
    I think I heard him correctly. The Chairman, maybe he 
overlooked this letter, indicated he hadn't received any input 
in that regard.
    Would you agree with me that this is a pretty definitive 
letter from you and your coalition?
    Mr. Cvrkel. That is correct.
    Mr. Johnson. And that maybe the Chairman just overlooked 
this public input?
    Mr. Cvrkel. Apparently he has.
    Mr. Johnson. Mr. Field, you are a corporate citizen of my 
State of Illinois, and we are very happy and proud to have you, 
and I know Congressman Schilling who represents your district 
just does an extraordinary job of advocating on your behalf and 
your employees' behalf.
    But let me just ask you specifically whether you think that 
the captive finance exemption that we have referenced in 
questions in response, was intended for a business like yours. 
And a follow-up question is: What would be the impact of your 
specific ability to lend to farmers and others if they don't 
qualify for that exemption?
    Mr. Field. Well, first let me thank you for the comments 
about Deere, and I am very privileged to be here and represent 
Deere, and we are privileged to be in the great State of 
Illinois.
    Mr. Johnson. Even though we are trying to tax you and 
Caterpillar and everybody else out of the state, in the state 
legislature. But that is another issue.
    Mr. Field. Yes. We believe that the captive finance 
exemption is--and the legislative intent was clearly to capture 
companies like Deere. And as we mentioned, we were very active 
in the process. And the reason why we are active in the process 
is because this is a critically important offering for us and 
for our customers.
    And the reason why it is critically important is because 
the farm sector isn't always the world's most favorite sector 
in the world. And neither is the construction sector. But we 
are there through thick and thin. We are in the finance 
business not to be in the finance business; we are in the 
finance business to help sell pieces of John Deere equipment. 
And if we did not have that exemption, well, one thing for sure 
is that there would be an increased cost, increased regulatory, 
burdensome requirements for us, and ultimately impacted in the 
wallets of our farmer customers, or through us by having to 
take costs out of the system somewhere else. Because we need to 
be in the finance business and we need to be there through 
thick and thin.
    Mr. Johnson. Let me just encourage you to continue to 
communicate with us specifically through Congressman Schilling, 
who is your advocate here, and we hope to be responsive to what 
you want us to do.
    One last question for Ms. Trakimas.
    Ms. Trakimas. Yes.
    Mr. Johnson. Can you give me some examples, I have only 
about 20 seconds, so your 20 second examples of some of the 
particular swaps that you provide to customers, and why you 
think that should be distinguished from swaps dealing in 
general?
    Ms. Trakimas. Our swaps are what we call plain vanilla 
swaps fixed or floating, and caps. And essentially this is just 
to manage the interest rate risk that we as lenders have on our 
balance sheet. It helps us manage our liquidity and our costs. 
And we also provide these swaps to our customers. These are 
extremely low-volatility swaps and they are merely there to cap 
the interest rate risk that is either connected with our loans 
or our customers' loans.
    Mr. Johnson. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The chair 
now recognizes the gentleman from Texas, Mr. Conaway, for 5 
minutes.
    Mr. Conaway. Thank you, Mr. Chairman. And, panel, thank you 
for sitting here all afternoon.
    You all heard Chairman Gensler's comments to our questions, 
several different directions in trying to understand his idea 
of a swap dealer. Can any of you say with any degree of 
certainty how you are classified under these new rules? Just 
right down the list. Mr. Allison.
    Mr. Allison. I don't think I can say with certainty how we 
ought to be classified. I think I know where Chairman Gensler 
thinks we are, but I don't know that that is the outcome 
necessarily dictated by the rules.
    I will not claim to understand fully how all of the rules 
work. But, I know where Chairman Gensler thinks the answer is 
for us.
    Mr. Conaway. Okay. Mr. Cvrkel.
    Mr. Cvrkel. I think we would be considered a swap dealer.
    Mr. Conaway. Okay. Mr. Field.
    Mr. Field. I don't think we could say with a level of 
certainty that I would be comfortable answering.
    Mr. Conaway. Mr. McMahon.
    Mr. McMahon. I don't think any of our members should be 
classified as swaps dealers; but, again, there was a question 
asked about utilities, and the Chairman answered that question 
to say that most aren't, but some may be. So that would be my 
interpretation of what he said.
    Ms. Trakimas. We really have no idea. But to the extent 
that we are like commercial banks and our business is like 
commercial banks, we think we should be treated like commercial 
banks and be exempt.
    Mr. Conaway. The point being is that that level of 
uncertainty and/or certainty is pervasive across the folks you 
represent, your members or whatever, and so that is a pretty 
telling indication that we don't have a lot of granularity yet. 
We made a big deal about the cost-benefit analysis that we 
think has not been done at CFTC. At least the comments included 
in their proposed rules are pretty cavalier with respect to the 
decision making process.
    Can you comment on what the estimates that the CFTC has 
said you will bear in terms of cost versus your own internal 
analysis of what you think it is going to cost to comply as you 
understand the rules today, Mr. Allison?
    Mr. Allison. In certain of the rulemakings, the Working 
Group has been able to do fairly detailed comparisons of our 
estimate versus the CFTC's estimate, and our perspective is 
that the costs we would expect to bear are very, very, very 
much larger than what the CFTC has.
    Mr. Conaway. A factor of what?
    Mr. Allison. Up to a factor of 100, depending on exactly 
what costs element you are looking at.
    Mr. Conaway. Thank you. Mr. Cvrkel.
    Mr. Cvrkel. Yes. As far as if it goes the way it is written 
now, we would be out of the swap business. We would not take on 
the added cost, and we would not be able to provide long-term 
fixed rate debt service cost to our customers.
    Mr. Conaway. Okay. Mr. Field.
    Mr. Field. We have not done a detailed analysis, but 
suffice to say that our presence here today is because we 
believe the cost is quite significant to Deere.
    Mr. Conaway. Significant beyond what the estimate that the 
CFTC is providing?
    Mr. Field. No. No. Not beyond.
    Mr. Conaway. So you think the CFTC got it right as to what 
it would cost you?
    Mr. Field. Let me get back to you on that.
    Mr. Conaway. It is a leading question.
    Mr. Field. We haven't done a comparison.
    Mr. Conaway. Okay, thank you. Mr. McMahon.
    Mr. McMahon. I am not aware of an estimate in terms of the 
impact on the utility industry. But what I will say, as I 
pointed out in my statement, is assuming that we are end-users, 
this transactional approach that they appear to be going in 
terms of the end-user exemption would be costly in and of 
itself, and it shouldn't be like that for end-users.
    Mr. Conaway. But the information in the proposed rule, does 
it give you enough information to be able to--for your members 
to guess at what their implementation cost would be?
    Mr. McMahon. Again, if some of them fall into this category 
of swaps dealer, it would be profound. And, we don't have all 
the information we will need at this point because there is 
reporting and a lot of different things and systems changes and 
governance changes. So there are a lot of issues.
    Mr. Conaway. Any indication you have in the proposed rules 
that they are getting it right; or is it just a broad statement 
you think understated what the costs will be?
    Mr. McMahon. We just feel that the costs are going to be 
very significant.
    Mr. Conaway. Ms. Trakimas.
    Ms. Trakimas. We have attempted to make an estimate of the 
costs, but the rules are so vague that we, with no confidence 
or accuracy, can come up with a number. But it is clear that 
costs will go up, and credit availability to our customers will 
decline and farmers and ranchers will suffer.
    Mr. Conaway. Okay. Just for the record, does anybody think 
those are good results, that costs go up and services go down? 
Just official.
    Mr. Allison. For the record, no.
    Mr. Conaway. Mr. Field?
    Mr. Cvrkel?
    Mr. Cvrkel. No.
    Mr. Conaway. The transcriber can't put down nods of the 
head, so I need you to say in the record. Mr. Field.
    Mr. Field. No.
    Mr. Conaway. Mr. McMahon.
    Mr. McMahon. No.
    Ms. Trakimas. No.
    Mr. Conaway. Mr. Chairman, I yield back.
    The Chairman. The gentleman yields back the balance of his 
time. I now turn to the gentleman from Illinois, for 5 minutes, 
Mr. Schilling.
    Mr. Schilling. Thank you, Chairman. First and foremost I 
would like to welcome you all here, and I am with 
Representative Johnson and we have a lot better things that we 
could be doing right now. And I am part of the freshman class, 
the 87 that were swept in, and I come here basically for the 
same reason that I believe that you folks might be here, is the 
over-regulating.
    You know, I look at Mr. Field's company which is in the 
17th Congressional District. It has been the backbone of our 
district for over 100 years. I believe we have close to 60,000 
employees there. And the thing that we are finding in Illinois 
is because of over-regulating and overtaxing, we are losing 
lots of people from our great state. And people are finally 
rising up to that challenge.
    But I just have a couple of questions for Mr. Field 
specifically. Could you just comment maybe on the timing 
sequencing and the analysis of the SEC and the CFTC on their 
proposed rulemaking?
    Mr. Field. Yes. Maybe I will answer that question a little 
bit more from--contrast it with at least how we would approach 
it from a business perspective, because I can't sit here and be 
as presumptuous that I understand exactly all these regulatory 
processes as some of the folks that are very involved in it. 
But I would say from our perspective, when we are doing a 
product program, we always say never, ever put quality--put 
schedule, rather, ahead of quality. I think the analogy in this 
particular piece of legislation and rulemaking is dead-on.
    I think what we would like to see is, first of all, that we 
come out with a quality product that has the appropriate level 
of public conversation, discussion, and exposure prior to going 
into adoption. I think it is vitally important that we settle 
on these definitions first and foremost, and then we can start 
to see how this mosaic comes together, because we understand 
what definitions apply to who and what, and where we are going 
to be in this whole process. Right now, it is a little bit like 
from our perspective; and from others' perspective, it is a 
little bit like trying to put your finger on a bead of mercury, 
because you might fall out of this one and then you are in here 
and then you are over here. So, getting buttoned down in 
aggregate and a holistic view of the definitions, so then we 
can start to understand what provisions apply to whom, would be 
very, very important.
    Mr. Schilling. So basically you would say that just let us 
know what our environment is, what cards are on the table, so 
we know what we are doing.
    Mr. Field. Yes. And let's not shortchange this. This is a 
very, very sweeping piece of legislation for corporate America 
and for all that are involved in the financial process. I think 
from our perspective, we think it would be a grave injustice to 
put schedule ahead of quality here.
    Mr. Schilling. And then finally, and being one of the less 
senior people here, a lot of my questions get asked by the time 
it gets to me. So finally, do you think that the agencies will 
meet their 1 year deadline or even should meet the 1 year 
deadline?
    Mr. Field. I think Chairman Gensler indicated that they 
most likely are not going to. And I would say that, from my 
perspective, is probably a good thing because at least it shows 
we are taking a little bit of time. But, having that 1 year 
deadline out there in terms of a sort of a backdrop is 
something that I think we might be better off if we were to 
remove that or suspend it.
    Mr. Schilling. Thank you, Mr. Field, and thank you all for 
what you do for your communities. And I yield back my time.
    The Chairman. The gentleman yields back. And the chair now 
recognizes the gentleman from Pennsylvania, Mr. Thompson, for 
the concluding 5 minutes.
    Mr. Thompson. Thank you, Mr. Chairman. Thanks to the panel, 
everyone on the panel for your testimony and weighing in on 
this.
    My first question actually really has to do more with the 
sequencing in the process by which the CFTC has used in rolling 
this out. And have the proposed rules impacted your ability to 
participate in the process, and how has it impacted your 
ability to evaluate how the proposed regulations will impact 
your business?
    Mr. Allison. The sequencing has, in fact, had a detrimental 
effect on our ability to evaluate the rules and respond 
sensibly to the CFTC with comments on them. The Working Group 
had filed with the CFTC, before the rulemakings came out, a 
letter proposing an order for the rules. The CFTC followed a 
different order. And we recently filed another comment with the 
CFTC about the sequence we think they should use from here, and 
I would be happy to get those added into the record if that 
would be helpful.
    Mr. Thompson. Thank you.
    Mr. Cvrkel. As far as when we look at the proposal, in my 
job I have multiple tasks to do other than this. So to spend my 
time to understand all the proposed regulations and go down 
that road is--I just really don't have the time. The concern I 
have, it is going to affect our customers, and I believe if you 
are a bank you want to have good customer service, and that is 
how you keep your customers. And being defined as a swap 
dealer, we would have a disservice to our customers and also to 
economic growth in our region because credit will no longer be 
there for the long term.
    Mr. Thompson. Thank you. Mr. Field.
    Mr. Field. I think the sequencing has had an impact. I 
think, to my earlier comment, not having all the definitions as 
the starting point, speaks to that. I think earlier today a 
Member of Congress said, ``You know, it would be nice to have 
all the pieces together so that we can see how this all 
interrelates rather than piecemeal at some point in time.''
    The Chairman. Mr. McMahon.
    Mr. McMahon. I would concur. I think the sequencing has had 
an impact and a negative impact. I would suggest that we should 
start with the fundamental definitions, particularly with a 
swap, and work our way out. Our view kind of coming in was that 
we would mostly be, we would be end-users and that we would 
only be engaged in one or two of these rulemakings, not 17 as 
we have to this point. So, yes, it has.
    Ms. Trakimas. My response to your question is that I would 
encourage the CFTC to go back to what it was tasked with by 
Congress, and that is to ensure that systemic risk is reduced 
and controlled. How long that takes, if it is a year, clearly 
we don't think they should be bound by a time frame, but we 
would really ask them to focus on the main purpose of what we 
are doing here today, and that is to control and reduce 
systemic risk.
    Mr. Thompson. I appreciate, actually, all of your thoughts 
not only on how it impacts your business, but specifically all 
the suggestions of how this could have been done in a better 
way to minimize negative impacts and the consequences.
    Mr. Cvrkel, why should community and regional banks receive 
different treatment under Title VII, and why is your derivative 
use distinguishable from those that are the target of the new 
regulation under Dodd-Frank?
    Mr. Cvrkel. I guess the way I look at it is, here again, 
banks like ours didn't cause the meltdown. We don't have any--
the swaps we do are vanilla swaps. There is no additional risk 
exposure. And here again, there is some confusion on defining 
risk related to swaps. And the risks should be defined as the 
uncollateralized portion of that swap, not the notional. And 
under Dodd-Frank I don't believe under the proposals, opinions 
of banks our size and how we use bank swaps with our customers 
were taken into consideration.
    Mr. Thompson. Very good. I would assume that most you would 
agree with the thoughts that this is actually a solution in 
search of a problem as it was proposed.
    Thanks, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The time 
for all questions has expired.
    Before we adjourn, I would like to thank our panel's 
participation. Many times in this body we become so focused on 
grandiose pieces of legislation that we forget that there are 
dramatic effects on you, your customers, your businesses, your 
pensioners, on the entire economy as a whole. And that is why 
we need to hear from you in the straightforward fashion that 
you have come today to discuss the potential impact.
    With that, under the rules of the Committee, the record for 
today's hearing will remain open for 10 calendar days to 
receive additional material and supplemental written responses 
from the witnesses to any question posed by a Member.
    This hearing of the Committee on Agriculture is adjourned.
    [Whereupon, at 5:20 p.m., the Committee was adjourned.]
    [Material submitted for inclusion in the record follows:]
      
      Supplementary Material Submitted by Hon. Frank D. Lucas, a 
                Representative in Congress from Oklahoma
21 March 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Re: Risk Management Requirements for Derivatives Clearing 
Organizations--Federal Register Vol. 76, No. 13 3698 (January 20, 2011) 
RIN 3038-AC98

    Dear Mr Stawick:

    The Financial Services Authority (``FSA'') is submitting this 
letter in response to the request for comment in respect to the rule 
proposals by the Commodity Futures Trading Commission (``the 
Commission'') regarding risk management requirements for derivatives 
clearing organisations (``DCOs'').
    The FSA supports the September 2009 G20 commitment to improving the 
over-the-counter (``OTC'') derivatives markets and the clearing through 
central counterparties (``CCPs'') of standardised OTC derivative 
contracts. Regulatory authorities need to consider how existing market 
infrastructures can best play a role in meeting these commitments in an 
environment where CCPs are becoming increasingly systemically 
important. There is a clear need for stronger international standards 
for CCPs and the FSA is contributing to the work currently underway in 
developing such standards through, for example, the CPSS-IOSCO \1\ work 
on principles for financial market infrastructure.\2\
---------------------------------------------------------------------------
    \1\ Committee on Payment and Settlement Systems (CPSS), 
International Organization of Securities Commissions (IOSCO).
    \2\ CPSS IOSCO Principles for financial market infrastructures--
consultative report 2011.
---------------------------------------------------------------------------
    Risk management standards for CCPs must be anchored in the 
characteristics of the products being cleared, and the FSA recognises 
that different product types may require different clearing models. 
This can extend to participant eligibility in models where the clearing 
members are required to perform specific actions to assist in a member 
default, for example Interest Rate Swap clearing models that include an 
obligation to bid for, or be allocated, portfolios from the defaulting 
clearing member.
    The Commission has requested comment on whether establishing a 
capital threshold on participants is an effective approach to promoting 
fair and open access to DCOs.\3\ The FSA supports transparent and non 
discriminatory rules, based on objective criteria, governing access to 
CCPs. We note the CPSS-IOSCO proposed principle that CCPs should allow 
``fair and open access to its services . . . based on reasonable risk-
related participation requirements''.\4\ However whilst capital 
thresholds or other participation eligibility threshold \5\ limitations 
may be a potential tool to help ensure fair and open access to CCPs, to 
impose them on clearing arrangements for products that have complex or 
unique characteristics could lead to increased risk to the system in 
the short to medium term.
---------------------------------------------------------------------------
    \3\ Federal Register Vol. 76, No. 13 page 3701.
    \4\ CPSS IOSCO Principles for financial market infrastructures--
consultative report 2011, Principle 18, Key consideration 1.
    \5\ Such as the Commission's proposals 39.12(a)(1)(iv) ``A 
derivatives clearing organization shall not require that clearing 
members must be swap dealers'', ibid (v) ``A derivatives clearing 
organization shall not require that clearing members maintain a swap 
portfolio of any particular size, or that clearing members meet a swap 
transaction volume threshold.'', and ibid (2)(iii) ``A derivatives 
clearing organization shall not set a minimum capital requirement of 
more than $50 million.''
---------------------------------------------------------------------------
    Participation requirements sometimes need to be tailored to take 
into account the types of products being cleared by a CCP. For example 
the less liquid derivative markets typically require more complex 
default management processes that impose more onerous obligations on 
the participants than the exchange traded futures market. The ability 
of the surviving clearing members to meet their obligations in relation 
to default management is important in mitigating systemic risk in the 
event of a clearing member default.
    As noted by CPSS-IOSCO in its consultation, a CCP should ensure 
that its participants ``have the requisite operational capacity, 
financial resources, legal powers, and risk-management expertise so 
that their activities do not generate unacceptable risk for the [CCP] 
and other participants''.\6\ Capital requirements, the ``swap dealer'' 
criteria and portfolio size or volumes have previously served as 
proxies for establishing that a clearing member meets these criteria. 
If such criteria are to be excluded, then CCPs must develop alternative 
membership criteria that ensure the CCP's own safety. Consideration 
should be given to the time required to develop such criteria.
---------------------------------------------------------------------------
    \6\ CPSS IOSCO Principles for financial market infrastructures--
consultative report 2011, Principle 18, 3.18.1.
---------------------------------------------------------------------------
    CCPs must therefore set appropriate risk based membership criteria 
that test a clearing member's financial and operational ability to:

        (i) manage the default of one of their own clients (i.e., to 
        hedge and liquidate positions); and

        (ii) participate in the CCPs default management process without 
        introducing risk to the system (for example bid accurately in a 
        default auction, hedge any portfolios acquired in a default 
        auction, or manage any risks presented by the forced allocation 
        of a portfolio in a default process).

    Potential clearing members who lack the requisite operational 
capacity, financial resources, legal powers or risk-management 
expertise to participate in a default management process might consider 
that they could source these capabilities from a more experienced third 
party in the event of a default. Outsourcing the clearing member 
responsibility to partake in the default management process to a third 
party could present additional risk to the system \7\ and increase the 
cost for the participant.
---------------------------------------------------------------------------
    \7\ As well as adding legal and operational complexity at a time 
market stress, there is the risk that third parties might act 
differently than clearing members acting for themselves, given their 
different incentives.
---------------------------------------------------------------------------
    A CCP may seek to reduce the relative impact of the default process 
on participants with lesser financial and operational ability by 
providing that their role in a default be proportional to the risk they 
introduce. As this would only limit the relative and not the absolute 
size of the risk (for example the size of portfolio that could be 
allocated to a clearing member in a default) this approach does not 
reduce the CCP's need to set the appropriate membership criteria needed 
to gauge the ability of the clearing member to engage fully in the 
default management process (including loss allocation).
    Increasing the amount of margin called or contributions to the 
default fund does not compensate for the risk that a participant cannot 
participate in the default management process. Margin and default funds 
increase the time available to a CCP to liquidate its positions, but 
they do not directly assist the actual liquidation.
    We note that the Commission proposes that CCPs may exclude or limit 
certain types of market participant if the CCP can demonstrate that 
``the restriction is necessary to address credit risk or deficiencies 
in the participants' operational capabilities that would prevent them 
from fulfilling their obligations as clearing members''.\8\ If capital 
requirements, the ``swap dealer'' criteria and portfolio size or 
volumes are to be subject to limitation as criteria then we believe the 
Commission's exclusion should specifically extend to address clearing 
members whose operational capabilities would prevent them from 
fulfilling their obligations to the CCP to participate in a default 
management process.
---------------------------------------------------------------------------
    \8\ Federal Register Vol. 76, No. 13 39.12(a)(1)(iii).
---------------------------------------------------------------------------
    The FSA therefore requests that when the Commission finalises its 
rules it takes into account that access should be based on 
proportionate risk-related participation requirements and that risks 
may be introduced into the system by universally prohibiting certain 
participant eligibility criteria.
            Yours sincerely,

Alexander Justham,
Director, Market Division,
Financial Services Authority.
                                 ______
                                 
  Supplementary Material Submitted by James C. Allison, Gas and Power 
Risk Manager, North America, ConocoPhillips, Houston, TX; on behalf of 
                Working Group of Commercial Energy Firms
February 22, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: End-User Exception to Mandatory Clearing of Swaps, RIN 3038-AD10

    Dear Secretary Stawick:
I. Introduction
    On behalf of the Working Group of Commercial Energy Firms (the 
``Working Group''), Hunton & Williams LLP hereby submits these comments 
in response to the request for public comment set forth in the 
Commodity Futures Trading Commission's (the ``CFTC'' or ``Commission'') 
Notice of Proposed Rulemaking, End-User Exception to Mandatory Clearing 
of Swaps (the ``Proposed Rule''), published in the Federal Register on 
December 23, 2010,\1\ which proposes to provide ``non-financial 
entities,'' i.e., commercial firms, with an exception from the 
mandatory clearing requirements (``End-User Exception'') pursuant to 
new Section 2(h)(7) of the Commodity Exchange Act (``CEA''), as 
established by Section 723 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act of 2010 (the ``Act'').\2\
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    \1\ End-User Exception to Mandatory Clearing of Swaps, Notice of 
Proposed Rulemaking, 75 Fed. Reg. 80747 (Dec. 23, 2010).
    \2\ Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. 
L. 111-203, 124 Stat. 1376 (2010).
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    The Working Group considers and responds to requests for public 
comment regarding legislative and regulatory developments with respect 
to the trading of energy commodities, including derivatives and other 
contracts that reference energy commodities. The Working Group 
appreciates the opportunity to provide these comments in response to 
the Proposed Rule and respectfully requests that the Commission 
consider the comments set forth herein. The Working Group looks forward 
to working with the Commission to further develop and define the End-
User Exception prior to the effective date of Title VII.
II. Executive Summary
    The Working Group strongly supports the goals of the Act to enhance 
transparency and reduce systemic risk in the swap markets. To that end, 
the Working Group submits for the Commission's consideration comments 
and recommendations it believes will assist the Commission in 
developing a final rule that preserves the integrity of the swap 
markets and serves the best interests of market participants. 
Specifically, the Working Group requests the Commission adopt the 
following recommendations:
    1. Revise Proposed CFTC Rule 39.6(b) to Require a Single, Omnibus 
Annual Notification Filing. The Working Group submits that requiring 
notification to the Commission each time a non-financial entity elects 
to use the End-User Exception is inconsistent with Section 2(h)(7)(A) 
of the Act. Additionally, such requirement is overly burdensome and 
will disrupt the trade execution process. In light of the foregoing, 
the Working Group strongly suggests that the Commission require a 
single, omnibus annual filing that reports such notification in the 
same prospective, narrative, and comprehensive form as the Commission's 
current Form 40.
    2. Recognize Discretion Granted to the Board in Meeting its 
Obligation to Review and Approve Election to Use End-User Exception. 
Contrary to new CEA Section 2(j), which permits an appropriate 
committee of the board of directors (or equivalent governing body) 
(collectively, the ``Board'') broad discretion in meeting its 
obligation to review and approve the use of the End-User Exception by 
an SEC Filer,\3\ proposed CFTC Rule 39.6(b)(6)(ii) requires board 
review and approval on a transaction-by-transaction basis. As such, the 
Commission should reconcile the proposed rule with the clear and 
unambiguous new CEA Section 2(j) to permit the board (i) to adopt a 
single, continuing resolution approving any decision by an SEC Filer to 
use the End-User Exception and (ii) to delegate its obligation to 
appropriate supervisory personnel with direct knowledge and oversight 
responsibility of swap trading activities.
---------------------------------------------------------------------------
    \3\ An ``SEC Filer'' refers to an issuer of securities that is 
registered under section 12 of the Securities Exchange Act of 1934 (15 
U.S.C. 781) or that is required to file reports pursuant to Section 
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 780).
---------------------------------------------------------------------------
    3. Adopt a Definition of ``Hedging'' or ``Mitigating Commercial 
Risk'' that Appropriately Reflects Commonly Used Practices In Energy 
Markets. Because the unambiguous language of the proposed definition of 
``commercial risk'' eliminates the need to adopt regulatory text 
identifying transactions that fall outside of the scope of this 
definition, proposed CFTC Rule 39.6(c)(2)(i) should be struck from any 
final rule adopted in this proceeding. Further, commercial energy firms 
do not generally execute swaps transactions to hedge a particular 
underlying physical trade. Indeed, in order to mitigate commercial 
risk, commercial energy firms hedge their underlying physical positions 
dynamically and on a portfolio basis, which do not involve the matching 
of hedges to specific underlying physical positions. Thus, any 
definition of ``hedging'' adopted by the Commission must contemplate 
such market practices.
    4. Exempt Inter-Affiliate Swap Transactions from Mandatory 
Clearing. Because inter-affiliate transactions do not have any bearing 
on, or reflection of, swap markets, these transactions should be exempt 
from the mandatory clearing requirements. At a minimum, the Working 
Group recommends that the Commission confirm that otherwise qualified 
non-financial entities may engage in uncleared swap transactions with a 
swap dealer or major swap participant affiliate.
III. Comments of the Working Group of Commercial Energy Firms
    The Working Group is a diverse group of commercial firms in the 
energy industry whose primary business activity is the physical 
delivery of one or more energy commodities to others, including 
industrial, commercial, and residential consumers. Members of the 
Working Group are energy producers, marketers, and utilities. As 
commercial firms, the Working Group members function primarily as 
principals, not intermediaries, by transacting futures and energy-
related derivatives on a daily basis, among other things, to mitigate 
or hedge the commercial risk associated with their core businesses of 
delivering electricity, heating oil, crude oil, natural gas, propane, 
gasoline, and other energy commodities to U.S. consumers.
    The Working Group generally supports the intent of the Proposed 
Rule implementing new CEA Section (2)(h)(7). By exempting qualifying 
transactions involving ``non-financial entities'' from the mandatory 
clearing requirements, this exception permits the continuation of a 
well-established and long-standing practice in the energy markets of 
accommodating the unique credit profiles of certain market 
participants. Unlike centralized clearing arrangements that demand 
uniformity in credit support based upon each underlying exposure, 
current practice in energy markets is for market participants to extend 
credit based on fundamental analysis of the ability of each 
counterparty to continue as a going concern, or through the use of 
alternative collateral support.\4\
---------------------------------------------------------------------------
    \4\ For instance, certain commercial firms in the energy sector use 
asset-based collateral arrangements (i.e., first liens in generating 
facilities). These collateral arrangements are accepted in energy 
markets as an appropriate form of credit support for liabilities and 
derivatives exposures.
---------------------------------------------------------------------------
    The ability to transact swaps on an uncleared basis provides a 
significant cost benefit by permitting commercial energy firms to 
preserve capital and operating cash flow. This is particularly critical 
in such firms' efforts to implement major capital spending programs 
designed to (i) enhance and expand energy infrastructure, (ii) develop 
and deploy technologies that promote energy independence, and (iii) 
comply with new environmental rules, regulations, and policies. More 
importantly, the ability of commercial energy firms to transact swaps 
on an uncleared basis is the most effective and efficient means to 
protect both themselves and consumers from the effects of volatility in 
physical energy markets.
    In recognition of the above factors, the Working Group respectfully 
recommends that the Commission adopt the revisions proposed herein to 
ensure that any final rule will promote efficient and orderly energy 
markets while ensuring transparency in accordance with the requirements 
of new CEA Section 2(h)(7).
A. An Annual Filing Is Sufficient To Meet the Notice Requirement 
        Regarding the Election To Use the End-User Exception
    New Section 2(h)(7)(A) of the CEA provides counterparties to a swap 
an exception from mandatory clearing if one of the counterparties ``(i) 
is a non-financial entity; (ii) is using swaps to hedge or mitigate 
commercial risk; and (iii) notifies the Commission, in a manner set 
forth by the Commission, how it generally meets its financial 
obligations associated with entering into non-cleared swaps.'' Proposed 
CFTC Rule 39.6(b) requires the ``reporting counterparty'' to provide 
notification of the manner in which the non-financial electing party 
expects to meet its financial obligations associated with the 
qualifying, non-cleared swap.
    Specifically, such notification must be submitted to a swap data 
repository (``SDR'') pursuant to the protocol for ``reporting 
counterparties'' set forth in the proposed rule for Swap Data 
Recordkeeping and Reporting Requirements (the ``Proposed General 
Reporting Rule'') \5\ and must contain several items of information 
associated with a non-financial entity's election to use the End-User 
Exception.\6\ Where the counterparty electing to use the End-User 
Exception is an SEC Filer,\7\ the notification must include two 
additional items of information: (i) the relevant SEC Central Index Key 
number for that counterparty; and (ii) whether the Board has reviewed 
and approved the decision not to clear the swap.
---------------------------------------------------------------------------
    \5\ Proposed Rule at 80748. See Swap Data Recordkeeping and 
Reporting Requirements, Notice of Proposed Rulemaking, 75 Fed. Reg. 
76574 (Dec. 8, 2010).
    \6\ See proposed CFTC Rule  39.6(b). These items generally 
include: (1) the identity of the electing counterparty to the swap; (2) 
whether the electing counterparty is a ``financial entity'' as defined 
in new CEA Section 2(h)(7)(C)(i); (3) whether the electing counterparty 
is a finance affiliate meeting the requirements of new CEA Sections 
2(h)(7)(C)(iii) or 2(h)(7)(D); (4) whether the swap is used by the 
electing counterparty to hedge or mitigate commercial risk as defined 
in proposed CFTC Rule  39.6(c); (5) the method or mechanism by which 
the electing counterparty generally expects to meet its financial 
obligations associated with its non-cleared swaps; and (6) whether the 
electing counterparty is an issuer of securities registered under 
section 12 of, or is required to file reports under section 15(d) of, 
the Securities Exchange Act of 1934.
    \7\ Unlike the Act, the Proposed Rule defines an issuer of 
securities to include a counterparty that is controlled by a person 
that is an issuer of securities. See Proposed Rule at 80750 n. 15. That 
is, the Proposed Rule broadens the definition of an issuer of 
securities as set forth in the Act to include subsidiaries. The Working 
Group submits that there is no policy or purpose that supports the 
expansion of the definition of issuer of securities beyond that which 
is provided under the Act. Indeed, while the Working Group acknowledges 
the Commission's concern in ensuring proper Board oversight of a non-
financial entity's swap trading activity, the Commission required such 
only for an SEC Filer. If the Commission were seeking to accomplish 
such an objective, then it should have imposed the requirement on all 
non-financial entities that use swap trades. Because it did not, the 
Proposed Rule results in unreasonable disparate treatment of market 
participants.
---------------------------------------------------------------------------
    The Proposed Rule states that the submission of information 
required by proposed CFTC Rule 39.6(b) must be submitted to an SDR on a 
transaction-by-transaction basis.\8\ Notwithstanding this requirement, 
the Proposed Rule requests comment on whether it would be difficult or 
prohibitively expensive for persons to report the information that must 
be included in the notification required by proposed CFTC Rule 39.6(b). 
The Working Group submits that it would be prohibitively expensive for 
persons to do so and suggests a much less burdensome approach.
---------------------------------------------------------------------------
    \8\ In relevant part, the Proposed Rule states:

      The Commission proposes in  39.6(b) to require non-financial 
entities to notify the Commis-
    sion each time the end-user clearing exception is elected by 
delivering specified information
    to an SDR in the manner required by proposed rules for swaps data 
recordkeeping and re-
    porting.

    Proposed Rule at 80748 (emphasis added; footnote omitted).
---------------------------------------------------------------------------
1. A Single, Omnibus Annual Filing Is Consistent with, and in 
        Furtherance of, the Statutory Objectives of New CEA 2(h)(7)(A)
    To maximize efficiency, minimize administrative burdens and costs, 
and ensure consistency with the express language of new CEA Section 
2(h)(7)(A), the Working Group submits that this notification only be 
submitted annually and recommends that such notification should be 
reported in the same manner and form as the Commission's current Form 
40 applicable to large traders with reportable futures positions. 
Specifically, the Working Group envisions that the notification would 
be (i) prospective in nature (i.e., for the forthcoming calendar year 
beginning on January 1), and (ii) provide all information required by 
proposed CFTC Rule 39.6(b) on a narrative and consolidated basis.
    Proposed CFTC Rule 39.6(a) requires submission of the notification 
of the election of the End-User Exception to be on a transaction-by-
transaction basis. Moreover, the Proposed Rule interprets this 
provision to require market participants to determine whether a swap 
qualifies for the End-User Exception at the time of execution. As noted 
below, these requirements conflict with the plain language of new CEA 
Section 2(h)(7)(A). This apparent conflict should be reconciled by the 
Commission in any final rule issued in this proceeding.
    Proposed CFTC Rule 39.6(a) states, in relevant part:

        (a) A counterparty to a swap (an ``electing counterparty'') may 
        elect to use the exception to mandatory clearing under section 
        2(h)(7)(A)(iii) of the Act if the electing counterparty is not 
        a ``financial entity'' as defined in section 2(h)(7)(C)(i) of 
        the Act, is using the swap to hedge or mitigate commercial risk 
        as defined in  39.6(c), and provides or causes to be provided 
        to a registered swap data repository or, if no registered swap 
        data repository is available, the Commission, the information 
        specified in  39.6(b) . . . .

(emphasis added).\9\
---------------------------------------------------------------------------
    \9\ Notwithstanding the statement in proposed CFTC Rule 39.6(a) 
that ``a counterparty to a swap (the `electing counterparty') may elect 
to use the exception to mandatory clearing under section 
2(h)(7)(A)(iii) of the Act,'' new CEA Section 2(h)(7)(A) is drafted in 
the conjunctive and, therefore, should be read in its entirety as the 
End-User Exception. The Commission's reliance on new CEA Section 
2(h)(7)(A)(iii) as the specific End-User Exception is misplaced. This 
interpretation effectively swallows the other statutory criteria that 
must be satisfied by a market participant to avail itself of the End-
User Exception. The Working Group respectfully submits that new CEA 
Section 2(h)(7)(A)(iii) constitutes only the ``notice'' element of the 
End-User Exception that must be interpreted consistent with the express 
language of, and Congressional intent, underlying the other statutory 
elements.

---------------------------------------------------------------------------
    In contrast, new CEA Section 2(h)(7)(A) states:

          (A) In general.--The requirements of paragraph (1)(A) shall 
        not apply to a swap if 1 of the counterparties to the swap--

                  (i) is not a financial entity;
                  (ii) is using swaps to hedge or mitigate commercial 
                risk; and
                  (iii) notifies the Commission, in a manner set forth 
                by the Commission, how it generally meets its financial 
                obligations associated with entering into non-cleared 
                swaps.

(emphasis added).

    The language of new CEA Section 2(h)(7)(A)(ii) and (iii), 
highlighted above, demonstrates a clear and unambiguous intent by 
Congress to permit a non-financial entity to make a general election to 
use the End-User Exception. Use of the singular form of the word 
``swap'' in proposed CFTC Rule 39.6(a) is in direct conflict with the 
statutory use of ``swaps'' in CEA Section 2(h)(7)(A)(ii) and (iii). The 
conjunctive requirements of CEA Section 2(h)(7)(A) make clear that the 
election to use the End-User Exception will not be required on a 
transaction-by-transaction basis. That is, this language cannot be 
reasonably construed by the Commission to require market participants 
to identify or provide notification that a particular swap qualifies 
for the End-User Exception at the time it is entered into. 
Consequently, since the election is not on a transaction-by-transaction 
basis, notification cannot be on a transaction-by-transaction basis 
unless the statute indicates otherwise. As stated above, however, new 
CEA Section 2(h)(7)(A)(iii) references ``swaps'' in the plural, which 
does not contemplate notification on a transaction-by-transaction 
basis. Accordingly, although new CEA Section 2(h)(7)(A)(iii) provides 
the Commission with the discretion to prescribe the manner (i.e., the 
form and format) in which such notification may be provided to it, the 
Commission must interpret this provision consistent with the express 
language of, and the Congressional intent underlying, new CEA Section 
2(h)(7)(A)(ii) and (iii), which clearly permits the use of the Working 
Group's proposed annual omnibus notification in the form described 
above.
2. Notification Should be Submitted by the Non-Financial Entity 
        Electing to Use the End-User Exception
    The Working Group submits that it is not appropriate to impose an 
obligation on a ``reporting counterparty,'' as that term is defined in 
the General Reporting Rule, to submit information to an SDR associated 
with a non-financial entity counterparty's election to use the End-User 
Exception.\10\ In order to minimize the potential for administrative 
errors or conflicts between parties that could disrupt the trade 
execution process, proposed CFTC Rule 39.6(b) should be revised to 
require the counterparty electing to use the End-User Exception to 
submit any required information to an SDR, not the reporting 
counterparty.
---------------------------------------------------------------------------
    \10\ The Working Group believes that placing this obligation on the 
reporting counterparty is improper as it could create an inherent 
conflict of interest between the parties to a commercial transaction 
that should be avoided by the Commission.
---------------------------------------------------------------------------
    To the extent that the Commission has concerns regarding possible 
abuse of this exception, new CEA Section 2(h)(7)(F) provides it with 
the authority to request information from any non-financial entity 
claiming the use of the End-User Exception. The Commission may also 
solicit such information by issuing a formal special call pursuant to 
CFTC Rule 21.\11\ In addition, the Commission's broad statutory 
enforcement authority under the CEA, as enhanced by the enactment of 
Title VII, is a strong deterrent to situations in which the End-User 
Exception could be abused through the knowing and willful submission of 
false information.
---------------------------------------------------------------------------
    \11\ See 17 CFR  21 (2010).
---------------------------------------------------------------------------
B. Board Review and Approval of Use of End-User Exception by an SEC 
        Filer
    As noted above, pursuant to proposed CFTC Rule 39.6(b)(6)(ii), the 
End-User Exception is only available to an SEC Filer if the Board has 
reviewed and approved its decision to enter into swap transactions 
subject to this exception. Further, this provision requires the 
notification submitted to an SDR relating to a counterparty's election 
to use the End-User Exception to include confirmation that the required 
Board review and approval has been obtained.
    The scope and application of proposed CFTC Rule 39.6(b)(6)(ii) 
raises two concerns that should be addressed by the Commission in any 
final rule issued in this proceeding. First, the requirement for an SEC 
Filer to obtain Board review and approval each time a non-financial 
entity elects to use the End-User Exception is inconsistent with the 
statutory language of CEA Section 2(j) requiring a Board to review and 
approve the decision to enter into swaps, not each individual swap. 
Second, the Proposed Rule is not clear whether the Board review and 
approval requirement may be delegated to executive officers or other 
senior managers that have the direct corporate oversight responsibility 
for (i) stand-alone subsidiaries or affiliates of an SEC Filer engaged 
in swap trading activities, or (ii) functional business units of a 
corporate entity in which swap trading activities are organizationally 
housed. The Working Group's concerns are discussed separately below.
1. Board Review and Approval of an SEC Filer's Decision to Use the End-
        User Exception
    Based upon the express language of proposed CFTC Rule 
39.6(b)(6)(ii) and related interpretative guidance in the Proposed 
Rule, it appears that an SEC Filer must obtain on a transaction-by-
transaction basis Board review and approval of each and every election 
to use the End-User Exception.\12\ Specifically, proposed CFTC Rule 
39.6(b)(6)(ii) states, in relevant part, as follows:
---------------------------------------------------------------------------
    \12\ See Proposed Rule at 80748, 80757  39.6(b)(6)(ii) (stating 
that the Commission must be notified ``each time'' the End-User 
Exception is elected, and where the non-financial party is an SEC 
Filer, such notification must include confirmation that the Board has 
approved the decision not to clear the swap).

          (6) Whether the electing counterparty is an entity that is an 
        issuer of securities registered under section 12 of, or is 
        required to file reports under 15(d) of, the Securities 
        Exchange Act of 1934, and if so:
          * * * * *
                  (ii) Whether an appropriate committee of the board of 
                directors (or equivalent body) has reviewed and 
                approved the decision not to clear the swap.

(emphasis added).

    This language violates new CEA Section 2(j) which states:

        (j) Committee Approval by Board.--Exemptions from the 
        requirements of subsection (h)(1) to clear a swap and 
        subsection (h)(8) to execute a swap through a board of trade or 
        swap execution facility shall be available to a counterparty 
        that is an issuer of securities that are registered under 
        section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 
        78l) or that is required to file reports pursuant to section 
        15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o) 
        only if an appropriate committee of the issuer's board or 
        governing body has reviewed and approved its decision to enter 
        into swaps that are subject to such exemptions.

(emphasis added).

    The use of the phrase ``decision to enter into swaps,'' namely, the 
singular form of ``decision'' and plural form of ``swaps,'' in new CEA 
Section 2(j) cannot be reasonably interpreted by the Commission to 
require Board review and approval of an SEC Filer's decision to elect 
the End-User Exception on a transaction-by-transaction basis. In 
contrast, such language actually requires only that a Board review and 
approve an SEC Filer's general decision to enter into multiple swaps 
qualifying for the End-User Exception. Accordingly, pursuant to new CEA 
Section 2(j), a Board of an SEC Filer may adopt a single, continuing 
resolution approving the decision to use the End-User Exception.
    The Working Group's reading of new CEA Section 2(j) is supported by 
a statement in footnote 18 of the Proposed Rule that a ``board 
committee could adopt policies and procedures to review and approve 
decisions not to clear swaps, on a periodic basis or subject to other 
conditions deemed satisfactory to the board committee.''\13\ 
Specifically, this statement demonstrates a recognition by the 
Commission that a Board may review and approve an SEC Filer's decision 
to use the End-User Exception at its discretion. A transaction-by-
transaction review and approval process is not required. Recognizing 
the importance of appropriate and diligent corporate oversight as 
required by applicable state laws, the Board may modify the proposed 
resolution upon determining that a material change in circumstances 
warrants such action.
---------------------------------------------------------------------------
    \13\ Proposed Rule at 80750 n. 18.
---------------------------------------------------------------------------
    Accordingly, to eliminate any regulatory uncertainty created by the 
Proposed Rule, the Commission should reconcile and conform the language 
of proposed CFTC Rule 39.6(b)(6)(ii) with new CEA Section 2(j). In 
doing so, the Commission will ensure that proposed CFTC Rule 
39.6(b)(6)(ii) is consistent with, and gives meaning to, the 
Congressional intent underlying new CEA Section 2(j).
2. Delegation of Board Review and Approval Obligation To Duly 
        Authorized Personnel Should Be Permitted
    The Commission should clarify that, for non-financial entities 
formed as a stand-alone subsidiary or affiliate of a parent holding 
company, the Board, for that subsidiary or affiliate, is permitted to 
review and approve the decision to use the End-User Exception. That is, 
Board review and approval for that non-financial entity is sufficient 
to meet the requirements of proposed CFTC Rule 39.6(b)(6)(ii), and such 
review and approval need not be obtained from the Board of the parent 
holding company.
    The Commission should further clarify that, for any non-financial 
entity operating as a functional business unit within a single 
corporate entity, the obligation to review and approve the use of the 
End-User Exception under proposed CFTC Rule 39.6(b)(6)(ii) may be 
delegated by the Board to duly authorized executive officers or other 
senior managers with direct oversight responsibility for swap trading 
activities.
    The delegation of the Board review and approval requirement in 
proposed CFTC Rule 39.6(b)(6)(ii) to such executive officers and other 
senior managers will ensure that duly authorized supervisory personnel 
with day-to-day knowledge of the operation of the relevant swap markets 
and their participants are in the position to review and approve a non-
financial entity's use of the End-User Exception. Furthermore, such 
delegation is supported by statements in footnotes 16 and 18 of the 
Proposed Rule, which expressly contemplate the review and approval of 
an SEC Filer's decision to use the End-User Exception to be undertaken 
by duly authorized personnel.\14\ The exercise of such delegated 
authority may be guided by internal policies and procedures adopted 
pursuant to proposed CFTC Rule 39.6(b)(6)(ii) or other conditions 
established by the Board itself.
---------------------------------------------------------------------------
    \14\ See Proposed Rule at 80750 nn. 16 & 18.
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C. Scope and Application of End-User Exception to Transactions Intended 
        To Hedge ``Commercial Risk''
    The Working Group supports the Commission's proposed interpretation 
of the term ``commercial risk'' in proposed CFTC Rule 39.6(c)(1), and 
the consistency of this interpretation with the use of the same term in 
the pending joint rulemaking further defining ``Major Swap 
Participant.'' \15\ However, to ensure regulatory certainty, the 
Commission should (i) strictly limit this definition to identifying 
those swaps that hedge or mitigate ``commercial risk,'' as defined in 
proposed CFTC Rule 39.6(c)(1); and (ii) strike proposed CFTC Rule 
39.6(c)(2)(i) from any final regulations implementing this 
definition.\16\ In addition, swaps that are executed to mitigate or 
hedge commercial risk on a dynamic or portfolio basis should 
unconditionally qualify for the End-User Exception.
---------------------------------------------------------------------------
    \15\ Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant,'' 75 Fed. Reg. 80174 
(Dec. 21, 2010).
    \16\ The Working Group supports proposed CFTC Rule  
39.6(c)(1)(iii), which provides that a swap transaction hedges or 
mitigates commercial risk if such swap ``qualifies for hedging 
treatment under Financial Accounting Standards Board Accounting 
Standards Codification Topic 815, Derivatives and Hedging (formerly 
known as Statement No. 133).'' Yet the Working Group submits that other 
accounting regimes exist and are used by market participants. As such, 
any final rule should include those in addition to the standards of the 
Financial Accounting Standards Board.
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1. The Proposed Definition of Commercial Risk Obviates the Need for 
        Proposed CFTC Rule 39.6(c)(2)(i)
    Proposed CFTC Rule 39.6(c)(2)(i) is unnecessary and excessive in 
light of the proper scope and specificity of the proposed definition of 
``commercial risk'' in proposed CFTC Rule 39.6(c)(1). Any transaction 
that does not fall within the definition ``commercial risk'' cannot, by 
definition and in any way, qualify for the End-User Exception. The 
Working Group is concerned that, if adopted, the broad and vague 
regulatory text in proposed CFTC Rule 39.6(c)(2)(i) will dilute and 
weaken the proposed definition of ``commercial risk'' in proposed CFTC 
Rule 39.6(c)(1).
    In addition, the terms ``investing'' and ``trading,'' set forth in 
proposed CFTC Rule 39.6(c)(2)(i) are beyond the scope of the CEA, as 
amended by Title VII of the Dodd-Frank Act. Moreover, these terms, as 
well as the term ``speculation,'' are not defined and are widely used 
in swap markets in a variety of contexts.\17\ In energy markets, for 
instance, the term ``trading'' is often used to describe activity 
involving both bona fide hedging as well as proprietary trading.\18\ 
Notwithstanding that the regulation of ``investing'' and ``trading'' is 
beyond the scope of the CEA, the adoption of regulatory text containing 
such undefined, yet commonly used, terms will lead to conflicting 
interpretations regarding the scope and application of the End-User 
Exception. Confusion as to what constitutes investing, trading, and 
speculation will inject unnecessary and harmful uncertainty into swap 
markets.
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    \17\ Nowhere in Title VII do the terms ``speculation,'' 
``investing,'' or ``trading'' appear together. Further, there are open 
questions about what activity constitutes ``investing'' or ``trading.'' 
Even if such terms were to be defined, it is unclear whether Title VII 
affords the same treatment for swaps used for investing and trading as 
it does for swaps entered into for speculation.
    \18\ The Working Group is particularly concerned that the word 
``trading'' might impermissibly include the buying and selling of 
commodities by parties that are primarily in the business of producing, 
delivering, storing, marketing, and managing physical commodities. This 
is traditional ``commercial activity.'' Yet, it may also come within 
the meaning of ``trading.'' Swaps executed in connection with this 
trading likely would constitute bona fide hedging transactions. In 
other words, proposed CFTC Rule 39.6(c)(2)(i) would effectively nullify 
the force and effect of proposed CFTC Rule 39.6(c)(1)(ii), which cannot 
be the intention of the Commission.
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    The Working Group respectfully submits that such a result is 
neither in the public interest nor is it consistent with the 
Congressional intent underlying the new CEA Section 2(h)(7)(A). Because 
the clear and unambiguous language of the proposed definition of 
``commercial risk'' eliminates the need to adopt regulatory text 
identifying transactions that fall outside of the scope of this 
definition, the Commission should strike proposed CFTC Rule 
39.6(c)(2)(i) from the final regulations implementing the End-User 
Exception.
2. Swaps Used to Offset Risks Associated with Underlying Position in 
        Physical Commodity Markets Hedge or Mitigate ``Commercial 
        Risk''
    Interpretive guidance in the Proposed Rule creates uncertainty 
whether the Commission is attempting to create different categories of 
activity in physical commodity markets in order to distinguish whether 
a swaps transaction is hedging or mitigating commercial risk. Such 
uncertainty arises from interpretive guidance set forth in footnote 23 
of the Proposed Rule:

        The Commission preliminarily believes that swap positions that 
        are held for the purpose of speculation or trading are, for 
        example, those positions that are held primarily to take an 
        outright view on the direction of the market, including 
        positions held for short term resale, or to obtain arbitrage 
        profits. Swap positions that hedge other positions that 
        themselves are held for the purpose of speculation or trading 
        are also speculative or trading positions.\19\
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    \19\ Proposed Rule at 80752 at n. 23.

    The Working Group seeks clarification that the highlighted language 
above is intended to apply to other swaps positions ``that themselves 
are held for the purpose of speculation'', and not any other position 
that would also include physical positions. Otherwise the Working Group 
is concerned that the Commission has adopted a preliminary view that 
certain exposures in physical commodity markets would not fall within 
the definition of ``commercial risk'' in proposed CFTC Rule 39.6(c)(1). 
This view is not supported by any policy rationale, is inconsistent 
with the proposed language under proposed CFTC Rule 39.6, and could 
lead to absurd results that would have material, adverse impacts on 
both physical commodity and swap markets. All physical market 
participants, from car manufacturers, to toy stores, to merchant energy 
companies, are in the business of trying to sell a commodity for more 
than the cost of producing or procuring the commodity. An energy 
company procuring supply in advance of the summer driving season, or a 
toy store stocking its shelves in advance of a holiday, are both 
arguably taking a position in a physical market to trade based on 
speculation that there will be increased demand. If the phrase ``other 
positions'' is interpreted as applying to physical market positions, it 
could have the perverse result of treating certain bona fide hedges of 
positions as outright speculative swap positions. This interpretation 
is not consistent with the Congressional intent underlying new CEA 
Section 2(h)(7)(A).
    In light of the foregoing, the Working Group respectfully requests 
that the Commission clarify that the language in the interpretive 
guidance set forth in footnote 23 of the Proposed Rule is the result of 
imprecise drafting that should be corrected in any final rule issued in 
this proceeding. As long as a swap transaction is intended to (i) 
offset the types of risks, or (ii) meet other qualifying criteria, 
identified in proposed CFTC Rule 39.6(c)(1), it should be viewed as 
hedging or mitigating ``commercial risk.'' To remedy the uncertainty 
created by the above-quoted text in footnote 23 of the Proposed Rule, 
the Working Group requests that the Commission clarify that the phrase 
``other positions'' is intended to mean ``other swap positions.''
3. Swaps that Hedge Commercial Risk on a Portfolio or Dynamic Basis 
        Should Qualify for the End-User Exception
    The Working Group respectfully requests the Commission to recognize 
that, although participants in physical energy commodity markets use 
swaps and futures to hedge underlying physical positions, they do not, 
as a general matter, execute such transactions specifically for the 
purpose of hedging a specified underlying physical position only. With 
this in mind, the End-User Exception should not be interpreted by the 
Commission to implement a ``one-size-fits-all'' approach to hedging by 
requiring an entity claiming use of this exception to match a swap that 
hedges or mitigates commercial risk with a specified underlying 
physical commodity transaction only.
    In physical energy markets, the predominant risk management 
practice used by commercial firms is to hedge underlying physical 
assets and related positions on a portfolio or aggregate basis. In 
order to effectively and efficiently mitigate commercial risk 
associated with underlying physical assets and related positions, 
commercial energy firms will dynamically hedge their aggregate 
exposures on a regular and on-going basis. A commercial firm will 
normally hedge these exposures utilizing physical transactions, 
futures, and swaps, the exact combinations of which will be determined 
by various characteristics which may be unique to such firm. A 
prescriptive one-to-one matching requirement of each swap to a specific 
physical transaction or an asset position is contrary to the statutory 
language, and is unnecessary and overly burdensome.
    Another well-established practice used by commercial energy firms 
to mitigate commercial risk is to hedge dynamically to optimize the 
value of underlying physical assets or portfolios. A key aspect of 
dynamic hedging is the ability to modify the hedging structure related 
to the physical asset or positions when the relevant pricing 
relationships applicable to that asset change.\20\ Dynamic hedging may 
involve leaving an asset or position unhedged when necessary to 
mitigate lost opportunity cost risk, which may require hedges to be 
established, unwound, and re-established on an iterative basis over 
time. The hedging of commercial risk should therefore include all 
hedging activity that maximizes the value of the asset.
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    \20\ The following provides an example of dynamic hedging of 
natural gas and power prices by a commercial energy firm in over-the-
counter swap markets. The dynamic hedging transactions relate to the 
sale of power from a gas-fired, electric generating facility (the 
``Asset''). The impact of the strategy set forth below is to hedge 
commercial risk associated with changing market conditions to (i) 
facilitate a cumulative improvement on the return of the Asset, and 
(ii) allow for a better economic allocation of the underlying physical 
commodities being used or generated by the Asset.

         Step 1: Power Prices Exceed Gas Prices; Asset Hedged 
to Lock in Positive Margin. The
        commercial energy firm purchases fixed price swaps to fix the 
prices for natural gas
        fuel supply and power output produced by the Asset (``Initial 
Hedges''). At the time the
        Initial Hedges are entered into, power prices exceeded natural 
gas prices. This strategy
        locks in a specified positive margin for the Asset.

         Step 2: Power Prices and Gas Prices Reverse; Asset 
Unhedged to Capture Additional
        Positive Margin. At a later date, the relative prices of 
natural gas and power reversed
        (i.e., gas prices exceeded power prices to the point where the 
natural gas was worth
        more sold as gas than it would be if it was converted to 
electricity), the commercial
        energy firm bought back the Initial Hedges to maximize the 
positive margin on the
        Asset. The repurchase of the Initial Hedges left the Asset in 
an unhedged position. The
        repurchase of the Initial Hedges made economic sense because it 
would have been un-
        economic from the physical commodity pricing perspective to run 
the Asset. Specifically,
        it allowed the commercial energy firm to earn an additional 
positive margin on the
        Asset under the then-existing market conditions by mitigating 
lost opportunity costs as-
        sociated with holding gas positions that were worth more than 
the power it could have
        generated.

         Step 3: Power Prices and Gas Prices Reverse Again; 
Asset Re-Hedged to Capture Addi-
         tional Positive Margin. As the relative prices of natural gas 
and power reverse again
        a few months later it becomes economical to produce output from 
the Asset and enter
        into new fixed price natural gas and power price hedges to lock 
in an additional positive
        margin on the Asset.
---------------------------------------------------------------------------
    Given the customary use of portfolio and dynamic hedging in energy 
markets, it would be impracticable, if not impossible, for the vast 
majority of energy market participants to link hedges with specified 
underlying physical positions for purposes of complying with the End-
User Exception. Accordingly, the Working Group respectfully submits 
that, as long as these transactions meet the underlying requirements of 
new CEA Section 2(h)(7)(A) and proposed CFTC Rule 39.6(a), they should 
unconditionally qualify for the End-User Exception. In the alternative, 
the cost burdens would be drastic, and the potential effects on 
liquidity would be severe, without resulting benefits to participants 
or the markets.
D. The Applicability of the End-User Exception to Certain Affiliate 
        Transactions Needs To Be Clarified
    New CEA Section 2(h)(7)(D)(i) permits an affiliate of a non-
financial entity to use the End-User Exception if that affiliate, 
``acting on behalf of the person and as an agent, uses the swap to 
hedge or mitigate the commercial risk of'' the non-financial entity or 
other affiliate that also qualifies as a non-financial entity. 
Notwithstanding this language, new CEA Section 2(h)(7)(D)(ii) prohibits 
an affiliate from using the End-User Exception if it is, among other 
things, a Swap Dealer or Major Swap Participant. These provisions are, 
however, silent with respect to swap transactions between affiliates 
within the same corporate family that are used to manage and allocate 
risk. The Commission should use the authority granted to it under new 
CEA Section 2(h)(2) to explicitly exempt such inter-affiliate swap 
transactions from mandatory clearing and, as applicable, the End-User 
Exception notification requirements set forth in proposed CFTC Rule 
39.6(b).\21\
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    \21\ New CEA Section 2(h)(2) provides the Commission with the 
ability to determine whether a specific swap or group, category, type, 
or class of swaps should be required to be cleared.
---------------------------------------------------------------------------
    The Working Group respectfully submits that there is no benefit to 
the public interest or the Commission to require mandatory clearing or 
(as applicable) reporting of information pursuant to proposed CFTC Rule 
39.6(b) with respect to inter-affiliate swaps that are used to manage 
and allocate risk within a holding company system or other 
organizational structure. Inter-affiliate swaps do not in any way 
enhance systemic risk, nor do they affect liquidity in swap markets. 
Information relating to such swap transactions is neither responsive to 
one of the central policy goals of Title VII of the Act--to enhance 
transparency in swap markets--nor is it necessary to prevent abuse.
    Should the Commission decline to grant the requested explicit 
exception from mandatory clearing and End-User Exception notification 
requirements for inter-affiliate swaps, the Working Group requests 
that, at a minimum, it clarify that otherwise qualified non-financial 
entities are not prohibited from utilizing the End-User Exception when 
engaged in swap transactions with Swap Dealer or Major Swap Participant 
affiliates.
E. Presumption of Status as a Non-Financial Entity
    As noted in other comments filed with the Commission by the Working 
Group, the framework adopted in Title VII for the regulation of over-
the-counter swap markets is based upon the existence of distinct 
classes of market participants.\22\ New CEA Section 2(h)(7) and 
provisions of the Proposed Rule implementing the End-User Exception 
recognize two distinct classes of market participants: (i) financial 
entities that are ineligible for this exception, and (ii) non-financial 
entities that are eligible for this exception upon compliance with 
certain conditions. In order to provide legal and regulatory certainty, 
and to be faithful to the intent of the Act, the Commission should not 
adopt any presumption that a ``financial entity'' as defined in new CEA 
Sections 2(h)(7)(C) and (D)(ii) for one kind of swap is also a 
financial entity for other kinds of swaps. Instead, market participants 
should be permitted to seek the exemption for each swap for which they 
are not registered as a swap dealer. Alternatively, the Commission 
should adopt a presumption that a market participant is a non-financial 
entity until proven otherwise.
---------------------------------------------------------------------------
    \22\ See Working Group, Comment Letter on Joint Notice of Proposed 
Rulemaking on Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant,'' Notice of Proposed 
Rulemaking (Feb. 22, 2011).
---------------------------------------------------------------------------
F. The Proposed Rule Fails to Adequately Consider Anticipated 
        Compliance Costs
    Section 15(a) of the CEA requires the CFTC, before promulgating a 
rule, to ``consider the costs and benefits of the action of the 
Commission.'' \23\ The Proposed Rule does not, as a general matter, 
provide any empirical data regarding the specific costs and benefit 
analysis specific to the implementation of proposed CFTC Rule 39.6 by 
market participants.\24\ The Working Group requests that the Commission 
(i) consider the costs and benefits associated with the Proposed Rule 
in the manner prescribed by CEA Section 15(a), (ii) issue a 
supplemental new rule in this proceeding setting forth empirical data 
supporting its conclusions regarding the costs and benefits of the 
Proposed Rule, and (iii) notice the supplemental rule in the Federal 
Register for public comment.
---------------------------------------------------------------------------
    \23\ 7 U.S.C.  19.
    \24\ Proposed Rule at 80754-55.
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IV. Responses to Specific Requests for Comment
A. Specific Requests for Comment Addressing Notification to the 
        Commission
    Question: Are there clarifications or instructions the Commission 
could adopt that are useful for parties seeking to elect to use the 
end-user clearing exception? If so, what are they and what would be the 
benefits of adopting them?
    Response: As stated under Part III.A, above, the Working Group 
believes the non-financial entity electing to use the End-User 
Exception should be required to submit any relevant information in the 
same manner and form as the Commission's current Form 40.
    Question: Would it be difficult or prohibitively expensive for 
persons to report the information required under the proposed  39.6? 
If so, why?
    Response: As discussed under Part III.A, the Working Group believes 
that notification on a transaction-by-transaction basis will be 
prohibitively burdensome and expensive. Too many entities other than 
the traders would have to be involved in each deal if this cannot be 
handled on an aggregate basis. As such, the ability to hedge with an 
adequate price will be slowed due to data collection and additional 
employees needed to collect and report information.
    Question: Is the information the Commission proposes to collect in 
connection with the Financial Obligation Notice sufficient? Is other 
information needed to achieve the purposes of the Dodd-Frank Act?
    Response: The Working Group believes that no additional information 
is necessary to achieve the transparency objectives of new CEA Section 
2(h)(7).
    Question: Is it necessary or appropriate for the Commission to 
collect additional general information on the credit support agreement 
and the collateral practices under the agreement, such as the level of 
margin collateral outstanding (e.g., less than or equal to a specified 
dollar amount, or greater than a series of progressively higher dollar 
amounts); the types of collateral provided (e.g., cash, government 
securities, other securities, other collateral), or the frequency of 
portfolio reconciliation?
    Response: The Working Group does not believe this additional 
information should be required, as such is not required by the CEA or 
the Act.
    Question: Is it necessary or appropriate for the Commission to 
collect additional general information on specific terms of the credit 
support agreement, such as whether the collateral requirements are 
unilateral or bilateral provisions and whether there are contractual 
terms triggered by changes in the credit rating or other financial 
circumstances of one or both of the counterparties?
    Response: The Working Group does not believe such additional 
information is necessary as such information provides no benefit to the 
Commission.
    Question: Is it necessary or appropriate for the Commission to 
collect additional general information about the guarantor, such as 
whether or not the guarantor is a parent or affiliate of the person 
electing to use the end-user clearing exception?
    Response: The Working Group does not believe such additional 
information.
    Question: Is it necessary or appropriate for the Commission to 
collect additional general information regarding the assets pledged, 
such as the type of security interest or the type of property being 
used as collateral?
    Response: The Working Group does not believe such additional 
information is necessary.
    Question: Is it necessary or appropriate for the Commission to 
collect additional general information regarding the segregation 
arrangements, such as the identity of the collateral agent or other 
third party involved in the arrangement, and information regarding 
whether the arrangement involves a custodian, triparty or different 
type of relationship?
    Response: The Working Group does not believe such additional 
information is necessary.
    Question: Is it necessary or appropriate for the Commission to 
collect additional general information regarding the adequacy of other 
means being used, or the adequacy of the financial resources available, 
to meet the financial obligations associated with the non-cleared swap?
    Response: The Working Group does not believe such additional 
information is necessary as such information provides no benefit to the 
Commission.
    Question: Should the Commission consider requiring parties electing 
to use the end-user clearing exception to report additional types of 
information, either in order to limit abuse of the exception or for 
other reasons? If so, what other information should be reported and 
what would be the benefit of requiring such information to be reported? 
What categories of information, if any, should not be required to be 
reported and why?
    Response: The Working Group does not believe additional information 
is necessary. As discussed under Part III.A.2, above, the Commission 
has adequate authority to limit abuses.
B. Specific Request for Comment Regarding Treatment of Affiliates
    Question: Should the Commission provide additional clarity to the 
terms used in CEA Sections 2(h)(7)(C)(iii) and 2(h)(7)(D) in proposed  
39.6 for affiliates electing to use the end-user clearing exception?
    Response: The Working Group submits its response to this question 
under Part III.D, above.
C. Specific Requests for Comment Addressing Board Approval Requirement
    Question: Should the Commission provide additional clarity to the 
requirements of CEA Section 2(j) [board approval] to facilitate 
compliance with proposed  39.6 by parties electing to use the end-user 
clearing exception?
    Response: The Working Group submits its response to this question 
under Part III.B, above.
    Question: Should the Commission adopt more specific requirements to 
implement the provisions of CEA Section 2(j)? If so, what specific 
rules should the Commission consider and what would be the benefits of 
adopting them?
    Response: The Working Group submits its response to this question 
under Part III.B, above.
D. Specific Requests for Comment Addressing Notification of the 
        Commission
    Question: Does collecting Financial Obligation Notice information 
through SDRs provide sufficient assurance that the end-user clearing 
exception will be available to non-financial entities wishing to use 
the exception? Are SDRs reliable enough to be used for these purposes?
    Response: The Working Group submits its response to this question 
under Part III.A, above.
    Question: Is there a more feasible and cost effective way for the 
Commission to receive notification regarding the use of the end-user 
clearing exception? If so, what is the better alternative and in what 
ways is it better?
    Response: The Working Group submits its response to this question 
under Part III.A, above
    Question: Would the person reporting information to the SDR be in a 
position to have or be able to obtain, in all cases, the information 
the Commission is requiring to be reported under proposed Rule 39.6. If 
not, why not? Are there special considerations in this regard when a 
swap is between two non-financial entities that are each seeking to 
elect to use this exception?
    Response: The Working Group submits its response to this question 
under Part III.A.2, above.
    Question: Should the Commission require persons electing to use the 
end-user clearing exception to follow additional compliance practices 
in some circumstances? For example, should the Commission require 
electing persons to create a record of the means being used to mitigate 
the credit risk of the swap? Would such a requirement be redundant or 
duplicative of other proposed record-keeping requirements?
    Response: The Working Group submits that no additional compliance 
practices are required. The transactions at issue are governed by the 
terms of industry standard bilateral master agreements, which 
incorporate negotiated credit terms.
E. Specific Requests for Comment Address the Hedging of Commercial Risk
    Question: Should swaps qualifying as hedging or risk mitigating be 
limited to swaps where the underlying hedged item is a non-financial 
commodity?
    Response: The Working Group supports the Commission's proposed 
definition of ``commercial risk'' in proposed CFTC Rule 39.6(c)(1). 
Non-financial commodities such as interest rate and foreign currency 
present risk that is central to the effective and efficient operations 
of a commercial enterprise. As such, swaps entered into to mitigate or 
hedge interest rate risk or currency risk should fall within the 
proposed definition of ``commercial risk'' and should be eligible for 
the End-User Exception (assuming the other qualifying requirements are 
satisfied).
    Question: Commenters may also address whether swaps qualifying as 
hedging or risk mitigating should hedge or mitigate commercial risk on 
a single risk or an aggregate risk basis, and on a single entity or a 
consolidated basis.
    Response: The Working Group submits its response to this question 
under Part III.C, above.
    Question: Whether swaps facilitating asset optimization or dynamic 
hedging should be included; and whether hedge effectiveness should be 
addressed.
    Response: The Working Group submits its response to this question 
under Part III.C, above.
V. Open Comment Period
    Given the complexity and interconnectedness of all of the 
rulemakings under Title VII of the Act, and given that the Act and the 
rules promulgated thereunder entirely restructure over-the-counter 
derivatives markets, the Working Group respectfully requests that the 
Commission hold open the comment period on all rules promulgated under 
Title VII of the Act until such time as each and every rule required to 
be promulgated has been proposed. Market participants will be able to 
consider the entire new market structure and the interconnection 
between all proposed rules when drafting comments on proposed rules. 
The resulting comprehensive comments will allow the Commission to 
better understand how its proposed rules will impact swap markets.
VI. Conclusion
    The Working Group supports appropriate regulation that brings 
transparency and stability to the energy swap markets in the United 
States. The Working Group appreciates this opportunity to comment and 
respectfully requests that the Commission consider the comments set 
forth herein as it develops a final rule in this proceeding.
    The Working Group expressly reserves the right to supplement these 
comments as deemed necessary and appropriate.
    If you have any questions, please contact the undersigned.
            Respectfully submitted,

R. Michael Sweeney, Jr.;
Mark W. Menezes;
David T. McIndoe;
Counsel for the Working Group of Commercial Energy Firms.
                                 ______
                                 
February 22, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Dealer'' and ``Eligible Contract Participant''

    Dear Secretary Stawick:

    On behalf of the Working Group of Commercial Energy Firms (the 
``Working Group''), Hunton & Williams LLP respectfully submits this 
letter in response to the Commodity Futures Trading Commission (the 
``CFTC'') and Securities Exchange Commission (the ``SEC,'' and together 
with the CFTC, the ``Commissions'') request for comment concerning the 
Commissions' Notice of Proposed Rulemaking on Further Definition of 
``Swap Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap 
Participant,'' ``Major Security-Based Swap Dealer'' and ``Eligible 
Contract Participant'' (the ``Proposed Rules'').\1\ This comment letter 
provides the Working Group's comments regarding the proposed definition 
of ``major swap participant.''
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    \1\ 75 Fed. Reg. 80174 (Dec. 22, 2010).
---------------------------------------------------------------------------
    The Working Group is a diverse group of commercial firms in the 
energy industry whose primary business activity is the physical 
delivery of one or more energy commodities to others, including 
industrial, commercial and residential consumers. Members of the 
Working Group are energy producers, marketers and utilities. The 
Working Group considers and responds to requests for public comment 
regarding legislative and regulatory developments with respect to the 
trading of energy commodities, including derivatives and other 
contracts that reference energy commodities.
    Title VII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (the ``Act'') vests the Commissions with new and 
expanded authority to regulate a wide array of participants in swap 
markets. Swap dealers, security-based swap dealers, major swap 
participants and major security-based swap participants in particular, 
will be required to develop and implement comprehensive measures to 
assure compliance with both substantive and procedural requirements 
under the Commissions' new regulations set forth under the Act. Such 
regulations have been the subject of several key proposed rulemakings 
for which the Working Group has previously submitted comments. The 
Working Group anticipates submitting comments on the subjects of 
additional key proposed rulemakings.
    The Working Group appreciates the opportunity to provide these 
comments in response to the Proposed Rules and respectfully requests 
that the Commissions consider the comments set forth herein. The 
Working Group looks forward to working with the Commissions to further 
define the term ``major swap participant'' prior to the effective date 
of Title VII of the Act. Because the Commissions have not finalized the 
regulatory definition of the terms that are the subject of the Proposed 
Rules, members of the Working Group have commented on proposed 
rulemakings applicable to swap dealers and major swap participants. 
They are concerned about the potential that one or more aspects of the 
proposed definitions, which are unclear in material respects, could be 
interpreted such that they are deemed to be swap dealers or major swap 
participants. The Working Group would also note that the comments 
supplied herein are incomplete. Without a definition of ``swap,'' the 
Working Group is unable to provide complete comments on the proposed 
definition of ``major swap participant.''
I. Comments of the Working Group
    The Working Group is generally supportive of the objective approach 
taken by the Commissions in further defining ``major swap 
participant.'' The use of objective criteria and tests will provide 
swap market participants with needed clarity and regulatory certainty 
with regard to their status as a potential major swap participant. 
However, multiple aspects of the proposed definition of ``major swap 
participant'' are vague in material respects and must be clarified so 
market participants can properly and consistently apply these aspects 
of the proposed definition to their own swap positions and related 
business activities.
A. Proposed Definitions Must Reflect Congressional Intent To Capture 
        Only Entities Presenting Significant Risk to the U.S. Financial 
        System
    Congress clearly intended the definitions of ``major swap 
participant'' and ``major security-based swap participant'' to cover 
entities with swap portfolios that result in such entities presenting 
risk to the United States financial system. The first prong of the 
definition of ``major swap participant,'' as set forth in Commodity 
Exchange Act (``CEA'') Section 1a(33)(A)(i), deems any entity that 
``maintains a substantial position in swaps,'' excluding, among other 
things, positions ``held for hedging or mitigating commercial risk'' of 
a major swap participant.\2\ In CEA Section 1a(33)(B), Congress 
directed the Commissions to define the term ``substantial position'' at 
``the threshold that the Commission[s] determine 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.'' \3\ In general, this prong identifies as 
``major swap participants'' those entities that have amassed 
speculative positions in swaps that are sufficiently large such that 
losses on these positions could have a materially adverse effect on the 
financial system of the United States.
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    \2\ CEA Section 1a(33)(A)(i).
    \3\ As discussed below, when determining whether a position is a 
``substantial position'' if a position creates ``substantial 
counterparty exposure,'' the following swaps should be excluded: (a) 
swaps that are centrally cleared, (b) swaps to the extent their market 
value is collateralized and (c) swaps entered into between affiliates. 
These swaps do not have any significance to the stability of the 
financial system of the United States or any such risk can be better 
addressed elsewhere, such as the regulation of derivatives clearing 
organizations and clearing agencies.
---------------------------------------------------------------------------
    The second prong of the definition of ``major swap participant'' 
set forth in CEA Section 1a(33)(A)(ii) defines a ``major swap 
participant'' as a party whose ``outstanding swaps create substantial 
counterparty exposure that could have serious adverse effects on the 
financial stability of the United States banking system or financial 
markets.'' Congress clearly intended this standard to be a substantial 
threshold. This prong addresses the risk that an entity could inject 
huge losses into the financial network by defaulting on its swap 
portfolio, whether or not the default is particular to swaps.\4\ In 
contrast to the first prong of the definition, the second prong 
contemplates potential losses beyond those inherent with an entity's 
actual swap positions.
---------------------------------------------------------------------------
    \4\ E.g., a major swap participant that becomes insolvent upon 
suffering massive losses on its portfolio of residential mortgage 
investments.
---------------------------------------------------------------------------
    Implicit in both of these prongs of the definition of ``major swap 
participant'' is Congress' intent for the definition to capture those 
entities that are not swap dealers, but that pose a systemic risk as a 
consequence of their swap activities. An entity is systemically risky 
if its default would significantly impact the financial system. The 
degree of systemic risk an entity poses, therefore, is a function of 
(a) the potential size of its default, (b) the degree to which its 
default would be distributed through out the financial system, and (c) 
the probability of its default. Accordingly, any definition intended to 
capture systemically risky entities should take into account all of 
those factors.
    The tests proposed by the Commissions in the definitions of ``major 
swap participant'' and ``major security-based swap participant'' only 
consider the size of an entity's swap portfolio and, to some extent, 
the degree to which its swaps are margined. To capture only those 
entities whose swap activities can significantly impact the financial 
system, the Commissions should also factor in (a) the assets an entity 
has available to cure any potential default on its swap portfolio and 
(b) the degree to which an entity's potential swap exposures are 
concentrated among systemically important market participants. 
Consideration of those factors might result in the application of any 
potential definitions of ``major swap participant'' and ``major 
security-based swap participant'' being more difficult for the 
Commissions and market participants. However, that additional burden is 
justified. If such definitions account for these additional factors, 
they will be less likely to unduly burden less risky entities than the 
proposed definitions.\5\ Inclusion in the final rule of the additional 
factors would capture only entities that truly pose a systemic risk as 
a result of their swap activities.
---------------------------------------------------------------------------
    \5\ See proposed CFTC Rule 1.3(sss). The Commissions recommend a 
threshold of $3 billion of current unsecured outward exposure or $6 
billion in current outward and potential future unsecured exposure for 
an entity to have a substantial position in rate swaps and $1 billion 
in current outward unsecured exposure or $2 billion in current and 
future potential future unsecured exposure for an entity to have a 
substantial position in each of the other swap categories. For an 
entity's swap positions to constitute a substantial counterparty 
exposure, the Commissions proposed a threshold of $5 billion of current 
uncollateralized exposure and $8 billion of current and potential 
future uncollateralized exposure.
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1. Different Thresholds Across Categories Does Not Reflect Systemic 
        Risk
    The degree of systemic risk posed by an entity's swap activities 
generally is not a function of the markets or products in which it 
transacts. So, the threshold level of swap activities to determine 
whether an entity is a major swap participant should not be different 
for different markets or classes of swaps. An entity, for example, is 
not more systemically risky because it has $1 billion in current 
outward exposure in ``other commodities'' swaps rather than $1 billion 
in current outward exposure in ``rate'' swaps. However, under the 
Proposed Rule, in the first circumstance, the entity is treated as 
systemically important and in the second instance, it is not.
    The Commissions might have made market-by-market distinctions in 
the Proposed Rules because Section 1a(33)(C) of the CEA and Section 
3(a)(67)(C) of the Securities Exchange Act of 1934 contemplate that a 
person may be designated as a major swap participant or major security-
based swap participant for one or more categories of swaps or security-
based swaps without being classified as such for all classes of swaps 
or security-based swaps. Congress likely understood that an entity 
might be a systemically significant participant because of its activity 
in one category of swaps, but might enter into other types of swaps 
from time to time. Prudential regulation would be unnecessary with 
respect to the entity's truly ancillary swap activities. However, the 
need for regulation is triggered by the exposure inherent in an 
entity's portfolio, not which markets a portfolio might cover.
    Accordingly, the Working Group believes that the exposure 
thresholds for the determination of substantial positions should be the 
same for each swap category. Alternatively, if the thresholds differ 
across swap categories, the Commissions must provide sufficient 
rationale to support such differences and such reasons should be solely 
based on concerns about the risk to the U.S. financial system.
2. Proposed Thresholds Do Not Reflect Systemic Risk
    The objective standards outlined in the current definitions, as set 
out in the Proposed Rules, likely will capture entities that do not 
present systemic risk. While the Working Group supports the use of 
objective standards, it respectfully submits that the objective 
standards associated with proposed definitional tests have been set too 
low and should not be set as a static number.
    Though the Commissions conclude otherwise, the proposed thresholds 
used to determine whether an entity holds a substantial position or if 
its positions create substantial counterparty exposure do not fully 
reflect Congress' desire for major swap participants to be limited to 
only those entities that are ``systemically important or can 
significantly impact the financial system of the United States.'' The 
Commissions state:

        The proposed thresholds are intended to be low enough to 
        provide for the appropriately early regulation of an entity 
        whose swap or security-based swap positions have a reasonable 
        potential of posing significant counterparty risks and risks to 
        the market that stress the financial system, while being high 
        enough that it would not unduly burden entities that are 
        materially less likely to pose these types of risks.\6\
---------------------------------------------------------------------------
    \6\ Proposed Rules note 105.

    The instruction of Congress to the Commissions in the Act was to 
set definitions for ``major swap participant'' and ``major security-
based swap participant'' that capture entities that are systemically 
important. The definition was intended to capture those entities that 
(a) for the purposes of the substantial position test ``are 
systemically important or can significantly impact the financial system 
of the United States'' and (b) for the purposes of the substantial 
counterparty exposure test whose swaps and resulting exposures ``could 
have serious adverse effects on the financial stability of the United 
States banking system or financial markets.''\7\ The Act does not 
establish visibility thresholds at which entities might potentially be 
systemically important. The Commissions should correct their 
interpretation of the Act to correctly reflect the statutory text and 
Congress' true intent. Otherwise, the Commissions might regulate 
entities as major swap participants or major security-based swap 
participants that do not have swap portfolios that present risks to the 
U.S. financial system. There is no evidence to show this was Congress's 
interest.
---------------------------------------------------------------------------
    \7\ CEA Section 1a(33).
---------------------------------------------------------------------------
    The Commissions offer no evidence to support why the above 
thresholds were selected. The proposed thresholds do not appear to have 
any direct relationship to systemic risk. There are numerous examples 
of entities sustaining losses well in excess of the proposed limits. 
These entities not only did not cause a financial crisis, but also, in 
some cases, survived such losses. For example, the collapse of Enron is 
cited as an example of a high profile default that did not have a 
substantial systemic impact.\8\ Prior to its collapse, Enron had 
approximately $18.7 billion in derivatives exposure, which constituted 
approximately 3% of the notional outstanding in the global market for 
derivatives on ``other commodities.'' \9\ Enron's share of the market 
for derivatives on ``other commodities'' was more than ten times larger 
than the Commission's proposed threshold. Despite this scale, the 
collapse of Enron did not trigger any systemic failure in the U.S. 
financial system.
---------------------------------------------------------------------------
    \8\ See, e.g., Darryl Hendricks, John Kambhu, and Patricia Mosser, 
Systemic Risk and the Financial System, Background Paper presented at 
Federal Reserve Bank of New York and the National Academy of Sciences 
Conference on New Directions in Understanding Systemic Risk, May, 2006 
and James Bullard, Christopher J. Neely, and David C. Wheelock, 
Systemic Risk and the Financial Crisis: A Primer, 91 Federal Reserve 
Bank of St. Louis Review, Sep./Oct. 2009, Sec. 5, Part 1 at 403-17.
    \9\ Diana B. Henriques, Enron's Collapse: The Derivatives Market 
That Deals in Risks Faces a Novel One, N.Y. Times, Nov. 29, 2001. 
Available at : http://www.nytimes.com/2001/11/29/business/enron-s-
collapse-thederivatives-market-that-deals-in-risks-faces-a-novel-
one.html, and Bank of International Settlements Press Release: The 
global OTC derivatives market at end--June 2001 Second part of the 
triennial Central Bank Survey of Foreign Exchange and Derivatives 
Market Activity, December 20, 2001.
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    Another example of an entity sustaining massive losses in the 
energy derivatives markets, yet not causing the energy markets or U.S. 
financial system to collapse is Amaranth Advisors, LLC. On one trading 
day, September 14, 2006, Amaranth experienced losses of approximately 
$560 million in natural gas futures positions. Amaranth is believed to 
have experienced total losses in connection with such position in 
excess of $4.35 billion.\10\
---------------------------------------------------------------------------
    \10\ Ludwig B. Chincarini, The Amaranth Debacle: A Failure of Risk 
Measures or a Failure of Risk Management?, The Journal of Alternative 
Investments, Winter 2007, at 93.
---------------------------------------------------------------------------
    The Commissions should adopt substantial position and substantial 
counterparty exposure tests that account for current conditions in swap 
markets. Setting thresholds that utilize static numbers will require 
the Commissions to revisit such thresholds over time in order to ensure 
they continue to reflect Congressional intent. For example, prices in 
energy markets are correlated to macroeconomic conditions. So, if the 
U.S. economy were to return to strong growth, the notional size of 
energy swap markets would grow as the prices of the underlying 
commodities rise. Though commercial energy firms' absolute positions 
will rise, their relative positions will remain constant. On the other 
hand, other factors, such as the use of portfolio compression, might 
shrink the notional size of a market while the actual market value 
increases. The recent trend in the credit default swap market is an 
example.\11\ In short, rising energy prices could push many commercial 
energy firms over the proposed major swap participant determination 
thresholds or shrinking notional amounts in other markets could allow 
entities to avoid designation as a major swap participant. In both 
cases, those entity's relative positions in their markets will remain 
unchanged and the risk they pose to the financial system will generally 
remain constant as well.
---------------------------------------------------------------------------
    \11\ See Nicholas Vause, Counterparty risk and contract volumes in 
the credit swap market, BIS Quarterly Review, December 2010.
---------------------------------------------------------------------------
    The Working Group respectfully suggests that the Commissions set 
the following limits with respect to a substantial position in other 
commodities:

   a daily average aggregate uncollateralized outward exposure 
        in excess of 1% of the gross market value of other commodity 
        swaps; or

   a daily average aggregate uncollateralized outward exposure 
        plus daily average aggregate potential outward exposure in 
        excess of 2% of the gross market value of other commodity 
        swaps.\12\
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    \12\ The Working Group respectfully suggests that the Commissions 
base these determinations on the BIS' market size data until the 
Commissions determine the size of the swap markets they will regulate.

Such limits would better reflect Congress' desire for the ``major swap 
participant'' definition to capture entities whose swap activities pose 
a systemic risk and that those limits will not require frequent 
modification as they are a relative measure of an entity's systemic 
risk.
3. Speculation, Investing and Trading Are Different Concepts
    Proposed CFTC Rule 1.3(ttt)(2)(i) \13\ provides that any swap 
``held for a purpose that is in the nature of speculation, investing or 
trading'' will not be considered a hedging transaction for purposes of 
the definitional tests.\14\ The Working Group recommends that this 
provision be deleted in the final rule.\15\
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    \13\ Proposed Rules at 80215.
    \14\ Such categorization is also used in determining whether or not 
the end-user exception from the mandatory clearing requirement is 
available to certain market participants.
    \15\ The Working Group suggests that the CFTC adopt one provision 
in its regulations that defines when swaps are hedges or mitigate 
commercial risk. We note that the CFTC proposes a similar definition in 
proposed CFTC regulation 39.6.
---------------------------------------------------------------------------
    Proposed subparagraph (ttt)(1),\16\ the operative provision, 
describes certain hedging and credit mitigation activities. If a firm 
uses swaps for these activities, then such swaps are deemed to be held 
for ``hedging or mitigating commercial risk'' and excluded when 
determining whether a firm's swap portfolio constitutes a substantial 
position. As hedges, they are not speculative.
---------------------------------------------------------------------------
    \16\ Id. at 80214-15.
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    Proposed subparagraph (ttt)(2)(i) also should be deleted because it 
regulates swaps in connection with ``investing or trading.'' \17\ While 
Congress was clearly concerned with speculation, it showed no similar 
concern for investing or trading. In fact, no where in Title VII do the 
terms ``speculation, investing, or trading'' appear together. Also, the 
phrasing ``investing or trading'' does not appear in Title VII. The 
Commissions have not defined ``investing'' or ``trading'' in the 
Proposed Rules. Thus, there are open questions about what activity 
constitutes investing or trading. For example, even if such terms were 
to be defined, does Title VII require the same treatment for swaps done 
for investing and trading purposes as it does for swaps entered into 
for speculative purposes?
---------------------------------------------------------------------------
    \17\ In the alternative, the Commissions should redraft it to read, 
``Not held for a purpose that is in the nature of speculation.''
---------------------------------------------------------------------------
    Trading and investing, as vernacular concepts, include both 
speculation and hedging. Use of such terms might suggest that hedging 
swaps, which constitute trading or investing activity, would not be 
afforded treatment as hedges under the definitional tests. This 
treatment of hedging swaps would effectively nullify the statutory 
provisions that exclude swaps for hedging purposes when determining 
whether a swap portfolio might constitute a ``substantial position.''
    The Working Group also is concerned that the word ``trading,'' in 
particular, might impermissibly include the buying and selling of 
commodities by parties that are primarily in the business of producing, 
delivering, storing, marketing and managing physical commodities. This 
is traditional ``commercial activity.'' Yet, it might also come within 
the meaning of ``trading.'' Swaps executed in connection with this 
trading likely would constitute bona fide hedging transactions. It 
would make no sense for language in the Commissions' regulations to 
disqualify such swaps from being hedges for purposes of the 
definitional tests.
4. The Commissions Should Not Reclassify Swaps That Hedge Non-Swap 
        Speculative Positions
    The Commissions, in the release to the Proposed Rules, introduced 
uncertainty as to the treatment of swaps entered into by a firm to 
hedge physical market positions. This may simply be a drafting issue, 
but the Working Group would respectfully request the Commissions to 
provide clarification.
    In footnote 128 to the Proposed Rules,\18\ the Commissions state 
that, ``[s]wap positions that hedge other positions that themselves are 
held for the purposes of speculation or trading are also speculative or 
trading positions.'' (emphasis added). There is no clarity as to what 
the Commissions meant by ``other positions.'' Perhaps it was an error, 
and the Commissions meant ``other swap positions.''
---------------------------------------------------------------------------
    \18\ Proposed Rules at 80195. See, also, Proposed Rules footnote 
131 at same.
---------------------------------------------------------------------------
    If the Commission intended to suggest that the hedge of a physical 
market position that is a ``trading'' position (i.e., held as a 
merchant or merchandiser in the commodity) would not qualify for 
treatment as ``hedging or mitigating commercial risk'' under the MSP 
definition, this would have serious consequences to physical market 
participants. All physical market participants, from car manufacturers, 
to toy stores, to merchant energy companies, are in the business of 
trying to sell a commodity for more than the cost of producing or 
procuring the commodity. An energy company procuring supply in advance 
of the summer driving season or a toy store stocking its shelves in 
advance of a holiday are each arguably taking a position in a physical 
market to trade based on speculation that there will be increased 
demand. If the phrase ``other positions'' is interpreted as applying to 
physical market positions, it could have the perverse result of 
treating certain bona fide hedges of positions as outright speculative 
swap positions. Thus, firms would be unable to exclude these swaps from 
the exposure calculations.
    On the other hand, if the footnote was intended to use the phrase 
``other swap positions,'' the sentence in question would be consistent 
with what the Working Group believes the Commission's intent to be.
    Such an interpretation of footnote 128 also is consistent with 
proposed CFTC Rule 1.3(ttt)(2)(ii). This subparagraph, in describing 
swaps that are not hedging or mitigating commercial risk, reads:

        (ii) Not held to hedge or mitigate the risk of another swap or 
        securities-based swap position, unless that other position 
        itself is held for the purpose of hedging or mitigating 
        commercial risk as defined by this rule of  350.4s67-4 of this 
        title.

In this subparagraph, ``other position'' clearly references another 
swap or security-based swap. Unlike footnote 128, subparagraph 
(ttt)(2)(ii) does not refer to swaps held to hedge ``other position,'' 
just those to hedge swaps or securities-bases swaps.
    Accordingly, the Working Group requests that the Commission clarify 
or correct (as appropriate) the phrase ``other positions'' in footnote 
128 to mean ``other swap positions.''
    Separately, the Working Group supports the inclusion of 
subparagraph (ttt)(2)(ii) in the Proposed Rules as it facilitates as 
firm's effective management of it hedge portfolio when that portfolio 
includes swaps entered into in connection with commercial activity 
(e.g., the physical delivery of energy products). We note, however, 
that it prevents a swap intended to offset a speculative swap from 
being considered a hedge for purposes of the definitional tests. Yet, 
entering into an offsetting swap is a very common and efficient way in 
which market participants exit or limit a derivatives position. When 
considered in the context of systemic risk mitigation, the Working 
Group believes that all hedges should be treated as hedges.
5. The Commissions Should Provide More Support for Their Conclusions 
        With Respect to Administrative Law Matters
    The Commissions, in the release to the Proposed Rules, largely 
conclude that the requirements under several administrative statutes 
are satisfied because the Proposed Rules only concern definitional 
matters. As the definitions covered by the Proposed Rules are the 
keystone for Title VII, this conclusory approach to applicable 
administrative statutes is wanting.
    For example, the Commissions do not provide supporting discussion 
about the various thresholds contained in the Proposed Rule. There is 
no analysis as to why any particular threshold represents the best 
selection. There is no discussion of the impact to the U.S. economy 
from the selection of one threshold over another. These definitions 
simply cannot be made in a vacuum. Quantitative, economic analysis is 
required to understand how and why the Commissions fashioned the 
definitions as they appear in the Proposed Rule.
    Title VII and the rules to be promulgated by the Commissions 
thereunder will fundamentally effect the U.S. financial system and the 
U.S. economy. In the energy markets, they will effect the cost of 
electricity, natural gas and heating oil received by nearly every U.S. 
tax payer. The definitions are central to derivatives reform. Without 
them, the other statutory and regulatory provisions largely are 
inoperative. To hold that the definitional rules have little or no 
associated costs or economic impact (perhaps on the theory that it is 
the other statutory provisions or rules that actually impose the 
obligations and constraints) is to truly subvert substance to legal 
finery.
    Thus, among other things, the Working Group does not support the 
Commissions' conclusion under the Small Business Regulatory Enforcement 
Fairness Act of 1996 that the definitions do not constitute a ``major'' 
rule. The Commissions offer no support behind their conclusions that 
the Proposed Rules do not result in or are likely to result in the 
following:

   an annual effect on the economy of $100 million or more 
        (either in the form of an increase or a decrease);

   a major increase in costs or prices for consumers or 
        individual industries; or

   significant adverse effect on competition, investment or 
        innovation.

The Working Group believes that the Proposed Rules will cause each of 
the foregoing to occur.\19\
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    \19\ The Working Group has given notice to Congress and the CFTC on 
several occasions of the potential impact to energy markets and the 
U.S. economy from reform of the energy swap markets. See for example, 
Comments of the Working Group on the CFTC's proposed rule on 
Designation of a Chief Compliance Officer; Required Compliance 
Policies; and Annual Report of a Futures Commission Merchant, Swap 
Dealer, or Major Swap Participant, filed with the CFTC on January 18, 
2011, Comments of the Working Group on the CFTC's proposed rule on 
Regulations Establishing and Governing the Duties of Swap Dealers and 
Major Swap Participants, filed with the CFTC on December 15, 2010, and 
January 24, 2011.
---------------------------------------------------------------------------
    The Commissions should provide economic analysis as to the import 
of the definitions they have selected. This information, however, 
should not appear solely in the final rule. The Working Group therefore 
requests that the Commissions (i) consider the costs and benefits 
associated with the Proposed Rules in the manner prescribed by CEA 
Section 15(a), (ii) issue a supplemental rule in this proceeding 
setting forth empirical data supporting its conclusions regarding the 
costs and benefits of the Proposed Rules, and (iii) notice the 
supplemental rule in the Federal Register for public comment.
B. Suggested Improvements to Exposure Tests
    The definitional tests in the Proposed Rules are highly technical. 
They also are more challenging to use than may appear at first glance. 
Given the potential complexity of and likely interpretive issues with 
any tests set forth under the final definitions of ``major swap 
participant'' and ``major security-based swap participant,'' the 
Working Group requests that the Commissions solicit additional feedback 
from market participants prior to the issuance of a final rule. The 
Commissions also might request volunteers to walk-through the 
determination of whether they are a major swap participant or major 
security-based swap participant to ensure that the proposed tests 
actually function in practice.
    Attached as Exhibit A is an exercise through which members of the 
Working Group attempted to perform the definitional tests for major 
swap participant. The Proposed Rule, as described below, leaves certain 
matters open to interpretation or, in other cases, require entities to 
``fill in the blanks.'' Accordingly, Exhibit A reflects some subjective 
interpretation. Thus, it is possible that the exercise is not how the 
Commissions intended the definitional tests to apply. Accuracy, 
however, was not the primary point of the exercise. Instead, the 
Working Group wants to demonstrate by example the need for the 
Commissions to (a) build and run such models to assure the definitional 
tests work in practice, (b) establish a step-by-step procedure for 
applying the definitional tests and (c) publish a ``worksheet,'' 
perhaps like Exhibit A, to facilitate the definitional analysis by 
market participants.
1. Clarifications Are Necessary for the Exposure Determinations
    Certain aspects of the proposed definitional tests must be further 
clarified or revised to ensure proper and consistent application of 
these tests by market participants. As stated above, the definitions 
should be styled to provide a clear step-by-step method for evaluating 
any given swap portfolio and must include clear definitions of critical 
terms and related calculations.
    There are several instances where descriptions of calculations 
related to the definitional tests are not clear. For example, proposed 
CFTC Rule 1.3(sss)(3)(ii)(A)(1), as currently styled, could be 
interpreted to require notional amounts be summed and then multiplied 
by the appropriate multiplier. However, when the entire regulation is 
read together, it appears that the notional amount of each swap is 
multiplied by the appropriate multiplier, a cap is applied with respect 
to credit default swaps, and then the products are summed. As another 
example, the adjustment for netting agreements in proposed CFTC Rule 
1.3(sss)(3)(ii)(B) is not entirely clear. Is ``NGR'' (a) the net 
outward exposure (after netting) divided by gross outward exposure 
(before netting) or (b) the net exposure regardless of its direction 
divided by the gross exposures without regard to direction? (The 
detailed and technical nature of these examples underscores the need 
for active participation of industry representatives beyond submission 
of prose commentary.)
    To further illustrate, in determining the aggregate potential 
outward exposure of a swap portfolio under the Proposed Rules, the 
aggregate notional amount of a class of swaps in the portfolio is 
multiplied by a factor depending on duration.\20\ What is not clear 
from the text of the Proposed Rules is whether individual swaps 
spanning multiple time horizons should be bifurcated for reporting 
purposes so that the notional amount of the swap is split appropriately 
between applicable time horizons (as the Working Group believes would 
be appropriate), or if the entire notional amount of the swap should be 
reported only in the time horizon corresponding to the final maturity 
of the swap.
---------------------------------------------------------------------------
    \20\ Proposed Rule at 80193.
---------------------------------------------------------------------------
    There are additional instances in which the Commissions must 
further define some of the more basic elements included in prescribed 
calculations. For example, the Proposed Rules do not define the terms 
``notional principal amount'' or ``notional amount,'' which appear to 
be used interchangeably and are integral to the calculation of 
potential outward exposure. Notional amounts for swaps, as understood 
by members of the Working Group, are not always established in dollars, 
but can also be established by reference to units of commodities. Thus, 
when determining an ``aggregate notional amount'' of a ``notional 
principal amount'' of swaps in a market participant's portfolio, some 
conversion is necessary to transform notional amounts measured in units 
of commodities to dollar amounts. In addition, the Commissions should 
clarify whether or not outward exposure includes unpaid amounts under a 
swap. The final rule further defining ``major swap participant'' should 
provide sufficient technical guidance to answer seemingly basic 
questions such as these and provide clarity on the specific mechanics 
and the order in which the calculations in the Proposed Rule 1.3(sss) 
are to be performed.
    Exhibit B provides some specific recommendations of the Working 
Group with respect to language as it appears in the CFTC proposed Rule 
1.3(sss).
2. The Commissions Should Afford Favorable Treatment of Cleared Swaps 
        and Swaps Subject to Daily Margining
    The Proposed Rules consider both cleared and daily margined swaps 
in the determination of potential outward exposure. The notional value 
of these swaps is effectively discounted by 80% when they are included 
in the potential outward exposure calculation to account for the risk 
mitigation benefits of central clearing and daily margining.\21\ The 
Working Group applauds the Commissions for accounting for the risk 
mitigation benefits of central clearing and daily margining, although 
the proposed 80% discount potentially overstates the risk posed by 
daily swings in the value of such swaps.
---------------------------------------------------------------------------
    \21\ Proposed CFTC Rule 1.3(sss)(3)(iii).
---------------------------------------------------------------------------
    Cleared swaps, in particular, should not be considered in the 
determination of whether an entity is a major swap participant. Daily 
settlement of gains and losses on cleared swaps shortens the time 
horizon for exposure to changing market prices to a single day, and 
initial margin required by rules of derivatives clearing organizations 
(``DCOs'') ensures that sufficient funds will be available for 
settlement of daily losses in almost any conceivable circumstance. If 
the Commissions are concerned about the potential risk posed by daily 
price swings of cleared swaps, then the proper place to address this 
concern is in the regulations pertaining to initial margin requirements 
for DCOs and clearing agencies.
    Swaps that are subject to daily margining should also be discounted 
heavily in calculations of potential outward exposure. While the 
Proposed Rules state that ``a swap shall be considered to be subject to 
daily mark-to-market margining if, and for so long as, the 
counterparties follow the daily practice of exchanging collateral to 
reflect changes in the current exposure arising from the swap,'' the 
Working Group believes that the existence of contractual margining 
provisions should be sufficient justification for the discount 
contemplated in the proposed rule in the absence of evidence that the 
applicable party has consistently chosen not to enforce margin 
provisions contained in its agreements. Absent such evidence, the 
Working Group believes that a discount of 98% is appropriate to account 
for the risk that a counterparty cannot meet its daily margin call.\22\ 
\23\
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    \22\ The Working Group notes that it is unable to fully evaluate 
the proper risk discount for swaps subject to daily margining without 
knowing the parameters of margin requirements imposed on major swap 
participants.
    \23\ This proposed discount is appropriate to address systemic risk 
concerns, particularly in respect of the energy swap markets. As 
discussed elsewhere, the Working Group does not know of an example of a 
default in energy swaps triggering a systemic event to the U.S. 
financial system.
---------------------------------------------------------------------------
3. Unused Unsecured Thresholds Should Not Be Included in Definitional 
        Tests
    The method for determining aggregate potential outward exposure, as 
set forth in proposed CFTC Rule 1.3(sss)(3), appears to account for a 
portion of the potential exposure twice.\24\ The calculations require 
any uncollateralized threshold to be added to the aggregate 
uncollateralized outward exposure, which is then added to potential 
outward exposure to reach a representation of potential future 
exposure. It is entirely unclear why any unused unsecured threshold is 
equated to exposure, as it more accurately represents the absence of 
exposure. This proposed treatment is onerous and inconsistent with 
other standard financial measurements of exposure. For example, when 
calculating an entity's debt-to-equity ratio, the indebtedness 
component of the calculation does not incorporate undrawn portions of 
revolving credit facilities or other forms of available but undrawn 
debt. At best, any unused unsecured threshold is a reserve for 
potential outward exposure.
---------------------------------------------------------------------------
    \24\ Proposed Rule at 80188.
---------------------------------------------------------------------------
    The unworkable nature of the proposed inclusion of unused unsecured 
thresholds is even more apparent when considered in the context of 
master agreements under which there are no trades in place in the 
calculation of potential outward exposure. Dormant master agreements 
represent an agreement as to the parameters that will govern any future 
trades between two parties. Such agreements do not represent an active 
credit relationship between the parties. Accordingly, unsecured 
thresholds contained in dormant master agreements should not be 
included in any measure of current or potential future exposure.\25\ 
The Proposed Rules should be clarified to exclude any unsecured 
thresholds under dormant master agreements from the calculation of 
current or potential future exposure. Additionally, the Proposed Rules 
should not require the inclusion of any unsecured threshold amount in 
excess of calculated outward exposure.
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    \25\ Inclusion of dormant trading relationship in the major swap 
participant definition would also serve as an incentive to terminate 
dormant master agreements. Master agreements are left in place even if 
there are no active trades between the counterparties, because, as the 
terms of the trading relationship are already in place, they allow the 
counterparties to enter into new trades quickly and efficiently.
---------------------------------------------------------------------------
    The consideration of unsecured thresholds creates further 
complications in two other significant ways. First, for the purposes of 
determining whether an entity has a substantial position, positions 
entered into to hedge commercial risk are removed from the 
calculations. By including unused unsecured thresholds in the 
determination of substantial position, the CFTC is potentially reading 
the exclusion of hedge positions out of the Proposed Rules. If an 
entity has entered into both speculative and hedge positions under the 
same master agreement, how would an entity determine what portion of 
any unused unsecured threshold should be allocated to hedge positions?
    Second, commercial energy firms often enter into master agreements 
that cover both physical and financial positions. Including both in one 
agreement is done for efficiency purposes. Only one agreement must be 
negotiated, and more importantly, counterparties are able to net 
physical and financial exposures. If unused unsecured exposure is 
required to be included in the determination of whether an entity is a 
major swap participant, then it is uncertain how that unused unsecured 
threshold should be allocated between potential physical positions and 
potential swap positions. A more fundamental legal question is how 
physical positions that are outside the CFTC's jurisdiction should be 
considered.
    The Commissions might have added unused unsecured thresholds to the 
definitional formulas to discourage the use of unsecured trading. The 
Working Group believes that the loss of unsecured trading will result 
in a diminution of liquidity in the overall market. Many commercial 
energy firms rely on some amount of unsecured trading, both for 
administrative considerations and for allocation of cash resources. If 
unsecured trading is removed or receives punitive treatment under the 
Commissions' regulations, then such firms might limit their trading or 
even exit the market all together. This would reduce liquidity for the 
entire market. Accordingly, the Working Group suggests that the 
Commissions not include unused unsecured thresholds in the definitional 
tests.
4. Initial Margin Should Be Deducted From Aggregate Potential Outward 
        Exposure
    In the release to the Proposed Rules, the Commissions specifically 
ask ``if an entity currently has posted excess collateral in connection 
with a position, should the amount of that current over-
collateralization be deducted from its measure of potential future 
exposure?'' \26\ The Working Group believes that such excess collateral 
should be deducted from potential outward exposure. In particular, any 
initial margin posted on a swap should be factored into the 
determination of aggregate potential outward exposure. If initial 
margin, as the CFTC's own definition of the term states, is ``money, 
securities, or property posted by a party to a swap as performance bond 
to cover potential future exposures arising from changes in the market 
value of the position,'' \27\ then the risk mitigation effects of any 
initial margin should logically be considered in the calculation of 
aggregate potential outward exposure under the proposed definition of 
``major swap participant.''
---------------------------------------------------------------------------
    \26\ Proposed Rules at 80183.
    \27\ Proposed CFTC Rule 23.600.
---------------------------------------------------------------------------
5. Adjustments for Netting Agreements in the Calculation of Aggregate 
        Potential Outward Exposure Should Be Revised
    The Proposed Rules provide an adjustment for netting in the 
calculation of aggregate potential outward exposure that relies on a 
specified formula referencing the ratio of net current exposure to 
gross current exposure derived from the calculation of aggregate 
uncollateralized outward exposure. The Working Group believes that this 
formula-based adjustment for netting is unnecessary because off-setting 
positions could be easily reflected directly in calculations of net 
total notional principal amount prior to application of conversion 
factors specified in the Table to  1.3(sss)--Conversion Factor Matrix 
for Swaps.\28\ This approach has been incorporated into example 
calculations provided in Exhibit A.
---------------------------------------------------------------------------
    \28\ Proposed CFTC Rule 1.3(sss).
---------------------------------------------------------------------------
C. Collateral Considerations
    The Working Group supports the broadest definition of collateral 
for determining whether an ``out-of-the-money'' swap is secured for 
purposes of the definition of ``major swap participant.'' The 
Commissions should recognize in the Proposed Rules that collateral for 
a swap might be in forms such as liens on assets and parent guarantees.
    Swaps that are secured by sufficient liens on property should be 
afforded the same discount as swaps subject to daily margining. Often, 
the value of collateral supporting the lien is several times greater 
than the exposure. Given the adequacy of this collateral, the 
Commissions should afford the same treatment to swaps collateralized in 
such a manner. Even if such swaps were subject to daily margining, the 
counterparty effectively would not be subject to delivery obligations 
because it had already delivered collateral far exceeding the exposure.
D. Treatment of Affiliates
1. Aggregation Across Enterprises
    The Commissions state that it would be appropriate to attribute a 
majority-owned subsidiary's swap positions to a parent for the 
determination as to whether the parent is a major swap participant.\29\ 
In many circumstances aggregation would not be consistent with ``the 
concepts of `substantial positions' and `substantial counterparty 
exposure.' '' \30\ Positions of affiliates should not be aggregated to 
the extent that such affiliates are independently controlled and 
capitalized. Under these circumstances, the affiliate's trading is not 
being coordinated with swap activities of other entities and only the 
assets of that entity are at risk in the event of a default. If an 
entity is independently controlled it is unlikely that such entity was 
created in an attempt for a parent to evade classification as a major 
swap participant, and if an affiliate is independently capitalized then 
there is no recourse to the parent entity or another affiliate.
---------------------------------------------------------------------------
    \29\ Proposed Rules at 80202.
    \30\ The Working Group acknowledges that under certain unusual 
circumstances such aggregation would be appropriate. For example, it 
would be appropriate to aggregate positions of affiliated entities if 
an entity were attempting to evade registration as a major swap 
participant by trading swaps out of multiple subsidiaries under common 
control.
---------------------------------------------------------------------------
    The market treats an independently controlled and capitalized 
entity as distinct from its parent and affiliates, so only its 
positions should be considered when attempting to determine if it is a 
major swap participant and should not be considered when determining if 
its parent company or affiliates are major swap participants. This 
approach is consistent with the treatment of affiliated companies under 
bankruptcy law where such companies are considered individually so as 
to not prejudice the rights of creditors to one entity by allowing 
recourse to the assets of such entity to creditors of an affiliate. 
This distinction allows subsidiaries to obtain favorable financing 
independent of any concerns of a corporate parent. The Commissions 
should give deference to the separateness of affiliates so long as they 
are managed as distinct entities.
    If the Commissions choose to aggregate the swap portfolios of 
affiliated entities for the purposes of the major swap participant 
determination, the Working Group respectfully requests that the 
Commissions not aggregate the positions of an entity that on its own is 
a swap dealer or major swap participant with those of its affiliates. 
To do so would eliminate an enterprise's ability to segregate all of 
its regulated swap activities in one entity, and would thereby 
potentially subject that entire enterprise to prudential regulation. To 
the extent that an ultimate parent would be considered a major swap 
participant as a result of aggregation of positions of its 
subsidiaries, the designation should only apply to the parent itself 
and not to individual subsidiaries. Such designation should only apply 
to individual subsidiaries if the positions of such individual 
subsidiaries warrant such designation on a stand-alone basis.
    If the Commissions elect to aggregate swap portfolios of affiliated 
entities, the Commissions should provide a clear process by which 
entities might petition one or both of the Commissions to permit the 
petitioning entities to not aggregate positions. The petitioner should 
be permitted to provide evidence to the applicable Commission that the 
swap portfolios of its affiliates do not reflect a scheme to avoid 
registration as a major swap participant. This approach is consistent 
with the CFTC's Notice of Proposed Rulemaking on Position Limits for 
Derivatives.\31\ In that notice, the CFTC provided a mechanism by which 
certain non-financial entities can disaggregate certain positions if 
the parent company can demonstrate that the owned non-financial entity 
is independently controlled and managed. The Working Group will comment 
separately on specific aspects of the proposed rule on Position Limits.
---------------------------------------------------------------------------
    \31\ 76 Fed. Reg. 4752 (January 26, 2011).
---------------------------------------------------------------------------
    Aggregation of swap portfolios also introduces issues with the 
extraterritorial application of the Commissions' jurisdiction.\32\ Many 
of the Working Group members have affiliates that are not incorporated 
in and do not operate in the United States. These affiliates often 
trade in swaps outside of the United States. The Working Group 
recommends that the swap portfolios of such off-shore affiliates not be 
aggregated with swap portfolios of companies in the same enterprise 
that operate within the U.S.
---------------------------------------------------------------------------
    \32\ The Working Group has submitted comments to the CFTC with 
respect to the extraterritorial application of its rules and regulation 
under Title VII of the Act. Working Group of Commercial Energy Firms 
comments to the CFTC's Proposed Rule on Registration of Swap Dealers 
and Major Swap Participants, filed with the CFTC on January 24, 2011.
---------------------------------------------------------------------------
2. Treatment of Inter-Affiliate Swaps
    Inter-affiliate swaps should not be considered when determining if 
an entity is a major swap participant. Transactions between two 
affiliated entities result in the same corporate family taking both 
sides of the swap. The corporate family's net credit exposure from the 
trade is zero. Given that the net credit exposure is zero, 
consideration of inter-affiliate swaps when determining if an entity is 
a major swap participant would be counting swaps with no counterparty 
risk to the market in tests meant to arrive at some indication of the 
level of risk an entity poses to the U.S. financial system.
E. Legacy Portfolios
    For many market participants, a large number of swaps in their 
portfolios were entered into prior to the enactment of the Act. These 
positions were entered into in the ordinary course of business before 
parties to these swaps could reasonably anticipate the possibility of 
being subject to prudential regulation because of these swap positions. 
The Working Group respectfully requests that the Commissions allow 
market participants whose current portfolios would make them a major 
swap participants to maintain their current positions and allow such 
positions to expire on their own terms without regulating the entities 
as major swap participants.\33\
---------------------------------------------------------------------------
    \33\ For discussion of the treatment of legacy portfolios and how 
they should be considered with regards to registration as a major swap 
participant please see the Working Group's comments on the CFTC's 
proposed rule on Registration Requirements for Swap Dealers and Major 
Swap Participants, filed with the CFTC on January 24, 2011.
---------------------------------------------------------------------------
    Any entity that might be deemed a major swap participant should be 
permitted to not register as such if each of its relevant existing 
transactions expire according with their terms and such entity does not 
enter into any new swaps that would cause it to be deemed a major swap 
participant. This ``grandfathering'' of legacy portfolios would allow a 
smooth regulatory transition and would avoid any market disruption 
caused by entities closing-out a significant number of legacy positions 
in a short period of time to avoid being a major swap participant. We 
anticipate that any entity electing to grandfather a legacy portfolio 
would submit a brief petition to the applicable Commission.
F. Netting of Physical Positions
    The Working Group strongly supports the Commissions' decision to 
consider the risk mitigation effects of netting agreements when 
determining whether an entity is a major swap participant. The 
Commissions recognized that because (a) swaps are not necessarily 
hedged with other swaps and (b) swaps are also used to hedge non-swaps 
exposure, certain other positions should be considered for netting 
purposes. The Commissions state:

        When calculating the net exposure the entity may take into 
        account offsetting positions with that particular counterparty 
        involving swaps, security-based swaps and securities financing 
        transactions (consisting of securities lending and borrowing, 
        securities margin lending and repurchase and reverse repurchase 
        agreements) to the extent that is consistent with the offsets 
        provided by the master netting agreement.\34\
---------------------------------------------------------------------------
    \34\ Proposed Rules at 80189.

    The Working Group respectfully requests that the Commissions 
consider the netting of physical positions in commodities and 
offsetting swaps when calculating net exposure for the purposes of the 
major swap participant definition. Specifically, master netting 
agreements that cover entire trading relationships, not just uncleared 
energy-based swaps and the other listed products, should be considered. 
It is common practice for commercial energy firms to enter into a 
transaction for a physical energy commodity and then enter into a 
related uncleared energy-based-swap transaction with the same 
counterparty as a risk mitigation tool. Any multi-transaction-netting 
agreement between the two counterparties will typically net obligations 
under both the physical energy transaction and the uncleared energy-
based swap. Moreover, trades in physical energy commodities and 
uncleared energy-based swaps are often inextricably linked, and 
counterparties should be able to consider their entire trading 
relationship when determining net exposure for the purposes of the 
definition of major swap participant. If the Commissions were to 
exclude physical positions from the netting calculations under the 
proposed major swap participant definition, then the unsecured exposure 
of many commercial energy firms would be substantially overstated, 
potentially causing such commercial energy firms to incorrectly be 
deemed major swap participants.
G. Limited Purpose Designations
    Section 1a(33)(C) of the CEA clearly states and Congress intended 
that entities can be designated as a major swap participant for only 
one category of swaps. Proposed CFTC Rule 1.3(qqq)(2) requires entities 
to make an affirmative application to the CFTC to be treated as a major 
swap participant for less than all of the major categories of swaps. 
However, the statute expressly presumes that an entity may be deemed a 
major swap participant for one category of swaps without being 
considered a major swap participant for other categories, thus creating 
a presumption in favor of the market participant, meaning an entity 
deemed to be a major swap participant for a category of swaps should be 
presumed to be a major swap participant only for that particular 
category. The Commissions have effectively flipped the statute on its 
head, establishing a presumption in direct contrast to the express 
statutory language. As such, the Working Group respectfully requests 
the Commissions to abandon proposed CFTC Rule 1.3(qqq)(2).
    If the Commissions choose to retain proposed CFTC Rule 1.3(qqq)(2), 
the Working Group believes that it will impose an unnecessary and 
potentially substantial burden on both (a) major swap participants that 
are clearly a major swap participant for one category of swap and (b) 
the Commissions which must process petitions to limit the scope of 
description. In the event that proposed CFTC Rule 1.3(qqq)(2) is 
retained, the Working Group respectfully suggests that the Commissions 
adopt a presumption that if 50% or more of a major swap participant's 
swaps fall within one category of swaps and that entity's swaps in 
other categories would not separately exceed any of the proposed 
thresholds, then that entity is a major swap participant for only that 
one category of swap. For example, the swap portfolios of many 
commercial energy firms that might be major swap participants are 
likely to be predominantly comprised of energy swaps, and the remainder 
of the portfolio are likely to be positions such as foreign exchange or 
interest rate swaps entered into to hedge commercial risk. Accordingly, 
such an entity should not have to file an application to have the scope 
of the application of the major swap participant definition limited.
    By adopting the recommended presumption, the Commissions will avoid 
placing a costly and unnecessary burden on entities that are clearly 
only a major swap participant for one class of swaps. In addition, the 
presumption would eliminate the need for the Commissions to process 
applications that are likely a mere formality.
H. Timing Concerns
    The Working appreciates that the Commissions recognize exogenous 
market conditions could temporarily force a potential major swap 
participant over a threshold during one quarter. Allowing an entity 
that exceeds a threshold by twenty percent or less in one quarter an 
additional quarter as a reevaluation period will avoid market 
disruptions that could result from deeming as major swap participants 
entities that, through factors beyond their control, temporarily exceed 
a given threshold.\35\
---------------------------------------------------------------------------
    \35\ Proposed CFTC Rule 1.3(qqq)(4).
---------------------------------------------------------------------------
    An entity that potentially meets the definition of a major swap 
participant should be given two quarters to register as such. As 
discussed more completely in the Working Group's comments to the CFTC's 
Proposed Rule on Registration of Swap Dealers and Major Swap 
Participants,\36\ the determination of whether an entity is in fact a 
major swap participant will be a complex one. Further, coming into 
compliance with the regulatory obligations imposed on major swap 
participants will likely require a substantial expenditure of 
compliance and risk management resources and might require corporate 
restructuring as well as the restructuring of existing trading 
relationships. This compliance burden will be greatest for commercial 
entities that have never been subject to prudential regulation by a 
financial regulator. Accordingly, the Working Group believes that two 
quarters is the minimum amount of time an entity would need to register 
as a major swap participant.\37\
---------------------------------------------------------------------------
    \36\ Working Group of Commercial Energy Firms comments to the 
CFTC's Proposed Rule on Registration of Swap Dealers and Major Swap 
Participants, filed with the CFTC on January 24, 2011.
    \37\ The Working Group notes that this suggested time frame differs 
from the more extended time frame recommended in its comments to the 
CFTC's Proposed Rule on Registration of Swap Dealers and Major Swap 
Participants. The time frame suggested herein assumes that an entity 
becomes a major swap participant once the entire new regulatory regime 
imposed by Title VII of the Act is in place. Under these circumstances, 
an entity that is not a major swap participant from the outset can 
undertake some, but not all of the requirements imposed on major swap 
participants prior to exceeding the proposed thresholds.
---------------------------------------------------------------------------
I. Open Comment Period
    As the Commissions have proposed the definitions contained herein 
towards the end of releasing proposed rules under Title VII of the Act, 
and have yet to propose a definition of ``swap,'' market participants 
have not been able to offer fully informed comments on the CFTC's and 
SEC's proposed rules, especially comments regarding the cost 
implications of such rules. In addition, given the complexity and 
interconnectedness of all of the rulemakings under Title VII of the 
Act, and given that the Act and the rules promulgated thereunder 
entirely restructure over-the-counter derivatives markets, the Working 
Group respectfully requests that the Commissions hold open the comment 
period on all rules promulgated under Title VII of the Act until such 
time as each and every rule required to be promulgated has been 
proposed. Market participants will be able to consider the entire new 
market structure and the interconnection between all proposed rules 
when drafting comments on all of the proposed rules. The resulting 
comprehensive comments will allow the Commissions to better understand 
how their proposed rules will impact swap markets.
II. Conclusion
    The Working Group supports appropriate regulation that brings 
transparency and stability to the swap markets in the United States. We 
appreciate the balance the Commissions must strike between effective 
regulation and not hindering the uncleared energy-based swap markets. 
The Working Group offers its advice and experience to assist the 
Commissions in implementing the Act. Please let us know if you have any 
questions or would like additional information.
            Respectfully submitted,

David T. McIndoe;
Mark W. Menezes;
R. Michael Sweeney, Jr.;
Counsel for the Working Group of Commercial Energy Firms.

                                                                        exhibit a
                                               Calculation of Aggregate Uncollateralized Outward Exposure
--------------------------------------------------------------------------------------------------------------------------------------------------------
                  a.                              b.                      c.                  e.              f.             g.               f.
---------------------------------------                        d.                      -----------------------------------------------------------------
                                       ------------------------------------------------
                                                    Current Mark-to-Market                                                 Posted      Uncollateralized
             Counterparty              ------------------------------------------------ Master Netting   Net Exposure    Collateral        Exposure
                                        Positive Value  Negative Value  Net Swap Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Example Portfolio:
  Counterparty 1......................    $15,000,000   ($20,000,000)    ($5,000,000)              $0   ($5,000,000)             $0      ($5,000,000)
  Counterparty 2......................     $5,000,000   ($35,000,000)   ($30,000,000)      $5,000,000   ($25,000,000)    $5,000,000     ($20,000,000)
  Counterparty 3......................    $35,000,000    ($5,000,000)     $30,000,000              $0    $30,000,000             $0                $0
  Counterparty 4......................     $1,000,000   ($16,000,000)   ($15,000,000)              $0   ($15,000,000)            $0     ($15,000,000)
  Counterparty 5......................     $5,000,000   ($165,000,000)  ($160,000,000)    $10,000,000   ($150,000,000  $100,000,000     ($50,000,000)
                                                                                                                   )
                                       -----------------------------------------------------------------------------------------------------------------
    Aggregate Uncollateralized Outward                                                                                                  ($90,000,000)
     Exposure.........................
========================================================================================================================================================
    a. Legal entity that is contractual counterparty to swaps...........................................................................................

    b. Sum of mark-to-market value for all individual swaps with a respective counterparty that have a positive mark-to-market value (in-the-money-
     swaps). Amount will be > = $0......................................................................................................................

    c. Sum of mark-to-market value for all individual swaps with a respective counterparty that have a negative mark-to-market value (out-of-the-money
     swaps). Amount will be < = $0......................................................................................................................

    d. Sum of mark-to-market value for all individual swaps with a respective counterparty..............................................................

    e. Amount under valid master netting agreement with a respective counterparty available to offset negative net swap value reported in column d.
     Amount will be > = $0..............................................................................................................................

    f. Net Exposure for a respective counterparty should be calculated as the lesser of $0 and the sum of columns d. and e..............................

    g. Amount of collateral posted to a respective counterparty and available to offset negative net exposure reported in column f. Amount will be > =
     $0.................................................................................................................................................    h. Uncollateralized Exposure for a respective counterparty should be calculated as the lesser of $0 and the sum of columns f. and g.................  Aggregate Uncollateralized Outward Exposure equals the sum of column h. for entire portfolio of swap counterparties...................................                                                    Calculation of Potential Outward Exposure  Notional Principal Amount = notional underlying quantity in units (i.e., MWh, MMBtu, gallons, etc.) multiplied by current market price per unit.......    a. Indicator (Y/N) of daily margining...............................................................................................................    b. Applicable collateral threshold with respect to each counterparty. Amount will be < = $0.........................................................    c. Collateral threshold less uncollateralized exposure..............................................................................................    d. Sum of Notional Principal Amount for all long swaps with a respective counterparty, categorized by applicable time period. For swaps that span
     multiple applicable time periods, report Notional Principal Amount that would be applicable for each time period. Amount reported will be > = $0...    e. Sum of Notional Principal Amount for all short swaps with a respective counterparty, categorized by applicable time period. For swaps that span
     multiple applicable time periods, report Notional Principal Amount that would be applicable for each time period. Amount reported will be < = $0...    f. Sum of amounts reported in d. and e..............................................................................................................    g. Product of amounts for each respective time period in column e. and factors in matrix presented in the proposed rule.............................    h. Absolute value of amount calculated for each counterparty in column g............................................................................    i. Net Swap Value from Aggregate Uncollateralized Outward Exposure calculation......................................................................    j. Column hi. plus column h.........................................................................................................................    k. Column i. minus column h.........................................................................................................................    l. Lesser of $0 and minimum value from columns j. and k.............................................................................................    m. Amount under valid master netting agreement with a respective counterparty available to offset negative net swap value reported in column l.
     Amount will be > = $0..............................................................................................................................    n. Amount of collateral posted to a respective counterparty and available to offset potential negative net exposure reported in column l. Plus
     additional collateral representing initial margin, independent amounts, and the like. Amount will be > = $0........................................    o. Margining Adjustment (see below).................................................................................................................    p. Sum of columns l., m., n., and o. Amount will be < = $0..........................................................................................
--------------------------------------------------------------------------------------------------------------------------------------------------------               Margining Adjustment:                                                    If Daily Margining = ``Y'' and Adjusted NSV (column l.) < 0
                                                                                        Multiply the amount by which PFE Factor (column h.) exceeds
                                                                                                   Available Threshold (column
                                                                                                                    c.) by 0.8
                                                                                        Net effect is that only the PFE factor that exceeds available
                                                                                             unsecured credit gets discounted.
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                        Calculation of Potential Outward Exposure
--------------------------------------------------------------------------------------------------------------------------------------------------------
                      See calculation detail for Aggregate Uncollateralized Outward Exposure                            a.           b.           c.
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        Current Mark-to-Market
              ------------------------------------------    Master         Net         Posted    Uncollateralized     Daily      Collateral   Available
 Counterparty    Positive      Negative      Net Swap       Netting      Exposure    Collateral      Exposure       Margining    Threshold    Threshold
                   Value         Value         Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Example
 Portfolio:
  Counterpart   $15,000,000  ($20,000,000  ($5,000,000)            $0  ($5,000,000           $0    ($5,000,000)              N           $0           $0
   y 1.......                           )                                        )
  Counterpart    $5,000,000  ($35,000,000  ($30,000,000    $5,000,000  ($25,000,00   $5,000,000   ($20,000,000)              Y  ($20,000,00           $0
   y 2.......                           )             )                         0)                                                       0)
  Counterpart   $35,000,000  ($5,000,000)   $30,000,000            $0  $30,000,000           $0              $0              Y  ($20,000,00  ($20,000,00
   y 3.......                                                                                                                            0)           0)
  Counterpart    $1,000,000  ($16,000,000  ($15,000,000            $0  ($15,000,00           $0   ($15,000,000)              Y  ($20,000,00  ($5,000,000
   y 4.......                           )             )                         0)                                                       0)            )
  Counterpart    $5,000,000  ($165,000,00  ($160,000,00   $10,000,000  ($150,000,0  $100,000,00   ($50,000,000)              Y  ($50,000,00           $0
   y 5.......                          0)            0)                        00)            0                                          0)
              ------------------------------------------
                  Aggregate Uncollateralized Outward                                              ($90,000,000)
                               Exposure
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                  Calculation of Potential Outward Exposure--Continued
--------------------------------------------------------------------------------------------------------------------------------------------------------
                        d.                                                  e.                                                 f.
--------------------------------------------------------------------------------------------------------------------------------------------------------
       Notional Principal Amount--Long Swaps              Notional Principal Amount--Short Swaps            Net Aggregate Notional Principal Amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
  < = One Year       1-5 Years        > 5 Years       < = One Year      1-5 Years        > 5 Years       < = One Year      1-5 Years        > 5 Years
--------------------------------------------------------------------------------------------------------------------------------------------------------
   $35,000,000       $20,000,000      $15,000,000    ($25,000,000)    ($15,000,000)     ($5,000,000)      $10,000,000       $5,000,000      $10,000,000
   $45,000,000       $25,000,000      $20,000,000    ($15,000,000)     ($5,000,000)     ($1,000,000)      $30,000,000      $20,000,000      $19,000,000
   $15,000,000        $5,000,000       $1,000,000    ($45,000,000)    ($25,000,000)    ($20,000,000)    ($30,000,000)    ($20,000,000)    ($19,000,000)
  $250,000,000      $100,000,000      $50,000,000    ($25,000,000)    ($10,000,000)     ($5,000,000)     $225,000,000      $90,000,000      $45,000,000
  $950,000,000      $550,000,000     $450,000,000               $0               $0               $0      $70,000,000      $34,000,000      $15,000,000
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                                      Calculation of Potential Outward Exposure--Continued
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                g.  0.1              0.12             0.15                      h.            i.           j.           k.           l.           m.           n.           o.           p.
                                                                           ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------                                                                                                              Pot.
                 Converted Amount per Table to  1.3(SSS)                    PFE Factor     Net Swap     NSV Plus    NSV Minus     Adjusted      Master       Posted     Margining     Outward
---------------------------------------------------------------------------               Value (NSV)   PFE Factor   PFE Factor      NSV        Netting     Collateral   Adjustment    Exposure
   < = One Year        1-5 Years          > 5 Years            Total
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    $1,000,000           $600,000         $1,500,000         $3,100,000       $3,100,000  ($5,000,000  ($1,900,000  ($8,100,000  ($8,100,000           $0           $0           $0  ($8,100,000
                                                                                                    )            )            )            )                                                   )
    $3,000,000         $2,400,000         $2,850,000         $8,250,000       $8,250,000  ($30,000,00  ($21,750,00  ($38,250,00  ($38,250,00   $5,000,000   $5,000,000   $6,600,000  ($21,650,00
                                                                                                   0)           0)           0)           0)                                                  0)
  ($3,000,000)       ($2,400,000)       ($2,850,000)       ($8,250,000)       $8,250,000  $30,000,000  $38,250,000  $21,750,000           $0           $0           $0           $0           $0
   $22,500,000        $10,800,000         $6,750,000        $40,050,000      $40,050,000  ($15,000,00  $25,050,000  ($55,050,00  ($55,050,00           $0           $0  $28,040,000  ($27,010,00
                                                                                                   0)                        0)           0)                                                  0)
    $7,000,000         $4,080,000         $2,250,000        $13,330,000      $13,330,000  ($160,000,0  ($146,670,0  ($173,330,0  ($173,330,0  $10,000,000  $100,000,00  $10,664,000  ($52,666,00
                                                                                                  00)          00)          00)          00)                         0                        0)
================================================================================================================================================================================================
                           Aggregate Uncollateralized Outward Exposure--Continued                                                                                                    ($109,426,0
                                                                                                                                                                                             00)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

                               exhibit b
Proposed Language Changes
Proposed CFTC Rule 1.3(sss)(2)
(2) Aggregate uncollateralized outward exposure.
    (i) In general. Aggregate uncollateralized outward exposure in 
general means the sum of the current exposure, obtained by marking-to-
market using industry standard practices, of each of the person's swap 
positions with negative value in a major swap category, less the value 
of the collateral the person has posted in connection with those 
positions.
    (ii) Calculation of aggregate uncollateralized outward exposure. In 
calculating this amount the person shall, with respect to each of its 
swap counterparties in a given major swap category:

          (A) Determine the dollar value of the aggregate current 
        exposure arising from each of its swap positions with negative 
        value (subject to the netting provisions described below) in 
        that major category by marking-to-market using industry 
        standard practices; and
          (B) Deduct from that dollar amount the aggregate value of the 
        collateral the person has posted with respect to the swap 
        positions.
          The aggregate uncollateralized outward exposure shall be the 
        sum of those uncollateralized amounts across all of the 
        person's swap counterparties in the applicable major category.

    (iii) Relevance of netting agreements.

          (A) If the person has entered into multiple swaps under a 
        single master agreement with a particular counterparty, or has 
        a master netting agreement in effect with a particular 
        counterparty to provide for netting of positions entered into 
        under multiple master agreements, the person may measure the 
        current exposure arising from its swaps in any major category 
        on a net basis, as applicable, applying the terms of the each 
        respective agreement. Calculation of net exposure may take into 
        account offsetting positions entered into with that particular 
        counterparty involving swaps (in any swap category) as well as 
        security-based swaps, and securities financing transactions 
        (consisting of securities lending and borrowing, securities 
        margin lending and repurchase and reverse repurchase 
        agreements), forward contracts, and any other qualified 
        contracts to the extent these are consistent with the offsets 
        permitted by the respective master agreement or master netting 
        agreement , as applicable.
          (B) Such adjustments may not take into account any offset 
        associated with positions that the person has with separate 
        counterparties.

-------------------------------------------------------------------------------------------------------------------------------------------------
Comments:      Calculations of aggregate outward exposure should reflect two
   types of netting:        First, current exposure should be calculated on a net basis for
     all swap positions entered into under the same master agreement
     with a particular counterparty.
        Second, to the extent that the person has a master netting
     agreement in effect with a particular counterparty [as described in
     (iii)(A) above], current exposure for that counterparty should be
     calculated net of any potential offsetting positions under other
     agreements pursuant to the master netting agreement. The Commission
     should not limit the types of offsetting positions that may be
     taken into account to those specifically described in (iii)(A).
------------------------------------------------------------------------

Proposed CFTC Rule 1.3(sss)(3)
(3) Aggregate potential outward exposure.
    (i) In general. Aggregate potential outward exposure in any major 
swap category means the sum of:

          (A) The aggregate potential outward exposure for each of the 
        person's swap positions in a major swap category that are not 
        subject to daily mark-to-market margining and are not cleared 
        by a registered clearing agency or derivatives clearing 
        organization, as calculated in accordance with paragraph 
        (sss)(3)(ii); and
          (B) The aggregate potential outward exposure for each of the 
        person's swap positions in such major swap category that are 
        subject to daily mark-to-market margining or are cleared by a 
        registered clearing agency or derivatives clearing 
        organization, as calculated in accordance with paragraph 
        (sss)(3)(iii) of this section.

    (ii) Calculation of potential outward exposure for swaps that are 
not subject to daily mark-to-market margining and are not cleared by a 
registered clearing agency or derivatives clearing organization.

          (A) In general.

                  (1) For positions in swaps that are not subject to 
                daily mark-to-market margining and are not cleared by a 
                registered clearing agency or a derivatives clearing 
                organization, potential outward exposure equals the 
                total notional principal amount of those positions, 
                calculated on a net basis for swaps entered into under 
                a single master agreement with a particular 
                counterparty, adjusted by the following multipliers on 
                a position-by-position basis reflecting the type of 
                swap. For any swap that does not appropriately fall 
                within any of the specified categories, the ``other 
                commodities'' conversion factors are to be used. If a 
                swap is structured such that on specified dates any 
                outstanding exposure is settled and the terms are reset 
                so that the market value of the swap is zero, the 
                remaining maturity equals the time until the next reset 
                date. In the same respect, if a swap is structured with 
                periodic settlement periods that occur over the life of 
                the swap, where the parties calculate a settlement 
                amount applicable only to that specific settlement 
                period, the total notional amount of such swap should 
                be bifurcated in calculations such that each settlement 
                period constitutes a residual maturity for the notional 
                amount applicable to that settlement period.

                             Table To  1.3(sss)--Conversion Factor Matrix for Swaps
----------------------------------------------------------------------------------------------------------------
                                                                   Foreign
              Residual maturity                Interest rate    exchange rate   Precious metals       Other
                                                                   and gold      (except gold)     commodities
----------------------------------------------------------------------------------------------------------------
One year or less............................            0.00             0.01              0.07             0.10
Over one to five years......................            0.005            0.05              0.07             0.12
Over five years.............................            0.015            0.075             0.08             0.15
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
           Residual maturity                 Credit           Equity
------------------------------------------------------------------------
One year or less......................             0.10             0.06
Over one to five years................             0.10             0.08
Over five years.......................             0.10             0.10
------------------------------------------------------------------------

                  (2) Use of effective notional amounts. If the stated 
                notional amount on a position is leveraged or enhanced 
                by the structure of the position, the calculation in 
                paragraph (sss)(3)(ii)(A)(1) of this section shall be 
                based on the effective notional amount of the position 
                rather than on the stated notional amount.

-------------------------------------------------------------------------------------------------------------------------------------------------
Comments:      The Commission should clarify that ``notional amount'' simply
   means the product of the notional underlying quantity in units (i.e.,
   MWh, MMBtu, gallons, etc.) of the applicable commodity with respect
   to each swap multiplied by current market price per unit of the
   applicable commodity. The term ``notional amount'' should be used
   consistently throughout the description of calculations. Notional
   amount should be calculated on net basis among all swaps entered into
   with a particular counterparty under a single master agreement.
   Additionally, the Commission should clarify that, for a swap that
   spans multiple time horizons specified in the Table to  1.3(sss)--
   Conversion Factor Matrix for Swaps, the total notional amount for
   that swap should be bifurcated among applicable time periods when
   calculating potential outward exposure and not simply reported in the
   last applicable time period.
------------------------------------------------------------------------

                  (3) Exclusion of certain positions. The calculation 
                in paragraph (sss)(3)(ii)(A)(1) of this section shall 
                exclude:

                          (i) Positions that constitute the purchase of 
                        an option, such that the person has no 
                        additional payment obligations under the 
                        position; and
                          (ii) Other positions for which the person has 
                        prepaid or otherwise satisfied all of its 
                        payment obligations.

                  (4) Adjustment for certain positions. Notwithstanding 
                paragraph (sss)(3)(ii)(A)(1) of this section, the 
                potential outward exposure associated with a position 
                by which a person buys credit protection using a credit 
                default swap or index credit default swap is capped at 
                the net present value of the unpaid premiums.
          (B) Adjustment for master (B) Adjustment for master netting 
        agreements. Notwithstanding paragraph (sss)(3)(ii)(A) of this 
        section, for positions subject to master netting agreements the 
        potential outward exposure associated with the person's swaps 
        with each counterparty may be reduced by amounts applicable to 
        offsets permitted by the respective master netting agreement. 
        If such offsets represent physically settled forward contracts 
        pertaining to a non-financial commodity or security for 
        deferred shipment or delivery or similar such contract that is 
        not a swap, total notional amount of those positions calculated 
        on a net basis for such forward contracts entered into under a 
        single master agreement with a particular counterparty, 
        adjusted by the multipliers specified in the Conversion Factor 
        Matrix for Swaps specified above, on a position-by-position 
        basis reflecting the type of swap that would me most applicable 
        to such forward contract. For any forward contract that does 
        not appropriately compare to any of the specified categories 
        for swaps, the ``other commodities'' conversion factors are to 
        be used. The total notional amount of each forward contract 
        should be bifurcated in calculations such that each delivery 
        period constitutes a residual maturity for the notional amount 
        applicable to that delivery period. For other permitted 
        offsets, potential outward exposure may only be reduced by 
        amounts in excess of amounts included in calculations of 
        aggregate uncollateralized outward exposure. equals a weighted 
        average of the potential outward exposure for the person's 
        swaps with that counterparty as calculated under paragraph 
        (sss)(3)(ii)(A), and that amount reduced by the ratio of net 
        current exposure to gross current exposure, consistent with the 
        following equation as calculated on a counterparty-by-
        counterparty basis:

                        PNet = 0.4 ) PGross + 0.6 ) NGR ) PGross

                Note to paragraph (sss)(3)(ii)(B): PNet is the 
                potential outward exposure, adjusted for bilateral 
                netting, of the person's swaps with a particular 
                counterparty; PGross is that potential outward exposure 
                without adjustment for bilateral netting; and NGR is 
                the ratio of net current exposure to gross current 
                exposure.

-------------------------------------------------------------------------------------------------------------------------------------------------
Comments:      The proposed methodology for calculating offsets attributable to
   master netting agreements is overly simplistic and would not likely
   produce reasonable results. Because the most likely type of offset to
   swaps exposure applicable to a valid and enforceable master netting
   agreement will be exposure related to forward contracts, the proposed
   methodology would produce a more reasonable result.
------------------------------------------------------------------------

    (iii) Calculation of potential outward exposure for swaps that are 
subject to daily mark-to-market margining or are cleared by a 
registered clearing agency or derivatives clearing organization. For 
positions in swaps that are subject to daily mark-to-market margining 
or cleared by a registered clearing agency or derivatives clearing 
organization:

          (A) Potential outward exposure equals the potential exposure 
        that would be attributed to such positions using the procedures 
        in paragraph (sss)(3)(ii) of this section multiplied by 0.2.
          (B) For purposes of this calculation, a swap shall be 
        considered to be subject to daily mark-to-market margining if, 
        and for so long as, the counterparties follow the daily 
        practice of exchanging collateral to reflect changes in the 
        current exposure arising from the swap (after taking into 
        account any other financial positions addressed by aoffsets 
        related to a master netting agreement between the 
        counterparties and the existence of any thresholds for which a 
        party is not required to post collateral). If the person is 
        permitted by agreement to maintain a threshold for which it is 
        not required to post collateral, only the total amount of that 
        person's potential outward exposure that, when added to the 
        person's aggregate outward exposure (prior to deducting 
        aggregate value of the collateral the person has posted) would 
        exceedof that threshold, (regardless of the actual exposure at 
        any time) shall be added to the person's aggregate 
        uncollateralized outward exposure for purposes of paragraph 
        (sss)(1)(i)(B), (ii)(B), (iii)(B) or (iv)(B) of this section, 
        as applicablemultiplied by 0.2. In addition, iIf the minimum 
        transfer amount under the agreement is in excess of $1 million, 
        the entirety of the minimum transfer amount shall be added to 
        the person's aggregate uncollateralized outward exposure for 
        purposes of paragraph (sss)(1)(i)(B), (ii)(B), (iii)(B) or 
        (iv)(B), as applicable.
          (C) For purposes of this calculation, the dollar amount the 
        aggregate value of collateral the person has posted with 
        respect to the swap positions in excess of aggregate outward 
        exposure, including amounts that represent initial margin, 
        independent amounts, and the like, may be deducted when 
        calculating potential outward exposure.

-------------------------------------------------------------------------------------------------------------------------------------------------
Comments:      The proposed methodology for addressing master netting agreements
   should be revised to clarify that the lesser of (i) measured exposure
   related to swaps, and (ii) specified threshold amounts, will be
   included in calculations at 100%. Only measured exposure in excess of
   specified amounts will be afforded the 80% discount (0.2 multiplier).
   This would also clarify that threshold amounts with respect to
   dormant master agreements would not be included in calculations. The
   proposed methodology should also be revised to include a deduction
   for initial margin, independent amounts, and the like since these
   amounts would be available to offset potential future exposure on
   applicable swaps.
------------------------------------------------------------------------

                                 ______
                                 
February 22, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Joint Notice of Proposed Rulemaking on Further Definition of ``Swap 
Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap Participant,'' 
``Major Security-Based Swap Participant'' and ``Eligible Contract 
Participant,'' RIN 3038-AD06

    Dear Secretary Stawick:
I. Introduction
    On behalf of the Working Group of Commercial Energy Firms (the 
``Working Group''), Hunton & Williams LLP submits the following in 
response to the request for public comment set forth in the Joint 
Notice of Proposed Rulemaking, Further Definition of ``Swap Dealer,'' 
``Security-Based Swap Dealer,'' ``Major Swap Participant,'' ``Major 
Security-Based Swap Participant'' and ``Eligible Contract Participant'' 
(``Proposed Rule'') issued by the Commodity Futures Trading Commission 
(``CFTC'') and the Securities and Exchange Commission (``SEC'') 
(collectively, the ``Commissions'') and published in the Federal 
Register on December 21, 2010,\1\ proposing to further define the term 
``Swap Dealer.''
---------------------------------------------------------------------------
    \1\ Further Definition of ``Swap Dealer,'' ``Security-Based Swap 
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant,'' 75 Fed. Reg. 80174 
(Dec. 21, 2010).
---------------------------------------------------------------------------
    The Working Group is a diverse group of commercial firms in the 
energy industry whose primary business activity is the physical 
delivery of one or more energy commodities to others, including 
industrial, commercial and residential consumers. Members of the 
Working Group are energy producers, marketers and utilities. The 
Working Group considers and responds to requests for public comment 
regarding regulatory and legislative developments with respect to the 
trading of energy commodities, including derivatives and other 
contracts that reference energy commodities.
    The Working Group appreciates the opportunity to provide these 
comments in response to the Proposed Rule and respectfully requests 
that the Commission consider the comments set forth herein. The Working 
Group looks forward to working with the Commissions to further define 
the term Swap Dealer prior to the effective date of Title VII. The 
comments herein specifically address the proposed further definition of 
Swap Dealer set forth in proposed CFTC Rule 1.3(ppp), pursuant to 
Section 1a(49) of the Commodity Exchange Act (``CEA''), as established 
by Title VII, Subtitle A, Section 721 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (the ``Act'').
II. Executive Summary
    The Proposed Rule fails to consider the differences between the 
energy commodity markets and the financial swap markets. Energy 
commodity markets, in which parties enter into swaps with each other to 
ensure physical delivery and manage price risk, are different from the 
swap markets. The energy commodity markets comprise a minuscule portion 
of the total national notional amount of swap transactions. The 
Commissions' proposed ``one-size-fits-all'' rule fails to recognize the 
unique nature of these markets. Unlike major financial institutions, 
non-dealer commercial energy firms function primarily as principals by 
transacting futures and energy-related swaps on a daily basis to 
mitigate price risk associated with providing necessary electricity, 
heating oil, natural gas, propane, gasoline and other energy 
commodities at affordable prices.
    The Proposed Rule incorrectly assumes that swap markets, including 
energy commodity swap markets, do not operate without the involvement 
of swap dealers. It is well recognized that non-dealer commercial 
energy firms routinely enter into swap transactions with other non-
dealer commercial energy firms in over-the-counter (``OTC'') markets. 
Further, the Proposed Rule directly contradicts other proposed rules 
recently issued by the CFTC that clearly contemplate swap transactions 
occurring between two non-Swap Dealer counterparties.
    The proposed definition of Swap Dealer is over-broad and 
inconsistent with the statutory terms and Congressional intent. 
Congress intended to enhance substantially the regulation of those in 
the business of being Swap Dealers, not expand the definition to 
include almost any and all market participants in the swap markets. 
Congress expressly provided that the term Swap Dealer shall have a 
parallel meaning to the term ``dealer'' under the securities laws and 
as is otherwise set forth in the Act.
    Congress specifically listed four statutory criteria for Swap 
Dealers, provided for a General Exception, and created a de minimis 
test for those small or inconsequential Swap Dealers. The Commissions' 
authority to further define Swap Dealer is limited to providing 
certainty as to those listed criteria, not creating new criteria or 
interpreting the definition contrary to the express terms or intent of 
Congress. Thus, the definition of Swap Dealer must be construed 
narrowly, based on commonly understood terms of dealing activity, and 
must account for the existence of other market participants. Yet the 
Commissions' proposed ``core'' criteria of accommodating demand, being 
available to enter into swaps, entering into swaps with their own 
standard terms, or arranging swaps at the request of others provides 
for a broad definition of Swap Dealer that is not based on commonly 
understood terms of dealing activity.
    The Commissions' interpretation of ``market making'' is broad and 
inconsistent with the CFTC's own definition and interpretation of the 
term. Historically, ``market making'' is incident to dealing activity 
by those holding themselves out as and known in the market to be Swap 
Dealers. Swap Dealers are in the business of taking either side of a 
swap to effectuate the trade, regardless of price or commodity. They 
are not the producers or owners of commodities nor do they have 
obligations to buy or deliver commodities as their primary business, 
unlike non-dealer commercial firms. The Proposed Rule should be revised 
to expressly exclude activity legitimately incidental to the businesses 
of non-dealer commercial firms.
    Rather than providing clarity on the General Exception to swap 
dealing set forth by Congress, the Commissions proposed interpretation 
actually uses the General Exception to redefine the statutory Swap 
Dealer definition. The Proposed Rule ties the General Exception to 
language in the Swap Dealer definition, referring to swap dealing 
activity ``as an ordinary course of'' a ``regular business.'' However, 
the Commissions' interpret this provision to say that any market 
participant in the swap markets is doing so as part of its regular 
business and thus is a dealer and unable to avail itself of the General 
Exception. Clearly, Congress did not intend any user of swap markets to 
be deemed a Swap Dealer. A better interpretation of the General 
Exception is to exclude swaps entered into by producers, processors, or 
commercial users of physical energy or agricultural commodities used as 
prudent price and risk management tools as part of the business of such 
producers, processors or commercial users of such commodities.
    The proposed de minimis exemption swallows the rule. Rather than 
determining which ``mom and pop'' or inconsequential Swap Dealers are 
eligible for the statutorily provided exemption from the enhanced 
regulatory regime for significant Swap Dealers, the Proposed Rule uses 
this exemption to determine who is a Swap Dealer. The rule inexplicably 
provides that any entity who enters into more than twenty swaps, has 
more than fifteen counterparties, or holds more than $100 million in 
notional amount is a Swap Dealer regardless of its regular business. 
Such interpretation essentially makes every market participant in the 
swap markets a Swap Dealer and renders the express statutory definition 
superfluous. The Commissions should clarify that the de minimis 
exemption applies to those Swap Dealers that hold no more than one one-
thousand of one percent (.001%) of the total notional amount of the 
U.S. swap markets. Such definition would capture Swap Dealers with an 
inconsequential position and activity in the markets.
    Alternatively, the Commissions should reconsider its rejection of a 
``relative test'' for applying the de minimis exemption. Because the 
statutory definition of the de minimis exemption refers to 
``customers,'' it is entirely appropriate that the Commissions consider 
a relative test measuring the ratio of a firm's ``customer'' swaps 
notional amount to its total swaps notional amount. If an entity's 
ratio is less than 25%, it should be exempt from regulation as a Swap 
Dealer.
    The Proposed Rule should make clear that no affiliate transactions 
be considered dealing activity, including application of the de minimis 
criteria. Inter-affiliate transactions are used to manage and allocate 
risk within a company and do not present any risk to the markets or 
counterparties.
    Consistent with the Commissions' practices, the Proposed Rule 
should provide a safe harbor and process for market participants to 
determine in good faith and with due diligence whether they need to 
register as a Swap Dealer.
    Finally, the cost and benefit analysis provided by the Commissions 
in the Proposed Rule does not appear to be based on any empirical data 
and does not appear to be consistent with the expected costs of 
compliance anticipated by market participants. The Commissions should 
therefore issue a supplemental rule in this proceeding setting forth 
empirical data supporting its conclusions regarding the costs and 
benefits of the Proposed Rule.
III. Comments of the Working Group of Commercial Energy Firms
    The Working Group generally supports the efforts of Congress and 
the Commissions to reform the derivatives markets to prevent abuses 
that led to the current fiscal crisis. However, for reasons discussed 
herein, the Working Group urges the Commissions to carefully construe 
the definition of Swap Dealer and proposed interpretational guidance so 
that it achieves the overarching policy goals of the Act without 
imposing unwarranted burdens on domestic energy markets and undue costs 
on the energy sector of the U.S. economy.
    As drafted, the Commissions' proposed definition of Swap Dealer and 
associated interpretive guidance are fundamentally flawed. The proposed 
definition and guidance would implement a ``one-size-fits-all'' 
approach to commodities regulation, which fails to recognize the unique 
characteristics of the various OTC commodity markets in which swaps are 
traded, including energy markets. In this regard, the Commissions' 
overly broad definition and guidance will sweep in a wide array of 
market participants that do not hold themselves out as ``dealers'' or 
engage in what has traditionally been viewed as ``dealer'' activity.
    Such a result runs counter to the statutory language and Congress' 
intent to limit application of the Swap Dealer definition to those 
market participants engaged in what has historically been understood as 
``dealing'' activity. Although Congress intended to enhance 
substantially the regulation of such activity, Congress also envisioned 
a regulatory framework conducive to the continued participation of 
active non-dealer market participants. Without significant revision, 
however, the Commissions' proposed definition and guidance will thwart 
this effort and instead create unacceptable uncertainty, likely 
resulting in adverse impacts to energy markets and energy providers and 
their customers.
A. Application of the Definition of Swap Dealer Should Avoid Adversely 
        Impacting Domestic Energy Markets
    Final regulations and interpretive guidance further defining the 
term ``Swap Dealer'' should be appropriately construed to avoid adverse 
impacts to domestic energy markets. Indeed, in the Proposed Rule, the 
Commissions properly recognize that ``the swap markets are diverse and 
encompass a variety of situations in which parties enter into swaps 
with each other,'' such as in energy commodities markets, including 
swap transactions involving oil and natural gas, and electricity 
generation and transmission.\2\ The Commissions highlight the 
complexities and unique characteristics of such energy markets and 
correctly invite comment as to ``any different or additional factors 
that should be considered in applying the swap dealer definition to 
participants in these markets.'' \3\ In accordance with this request, 
and to assist the Commissions in finalizing an appropriate definition 
of Swap Dealer that will not unduly burden domestic energy markets, the 
Working Group provides these comments regarding the unique 
characteristics of energy markets and the participants operating within 
these markets.
---------------------------------------------------------------------------
    \2\ Proposed Rule at 80183.
    \3\ Id. at 80183-184.
---------------------------------------------------------------------------
    Energy markets possess unique characteristics in terms of the 
instruments transacted, the market participants themselves, and the 
underlying products transacted, such as certain commodities that are 
not stored and are not capable of being stored.\4\ Distinct from 
institutions in the banking and financial system, which play an 
intermediary role in financial markets, nondealer commercial energy 
firms typically do not play intermediary roles in financial markets, 
and their swap trading activity is generally related to their 
respective physical portfolios of energy commodities.\5\
---------------------------------------------------------------------------
    \4\ Such commodities are traded in markets typically regulated by 
other state and federal regulators and governed by well-understood 
market rules.
    \5\ Non-dealer commercial energy firms primarily transact swaps to 
support hedging and trading activity associated with their underlying, 
primary physical business operations and/or that of their affiliates. 
From a trading perspective, this business involves transactions 
executed in physical energy markets, as well as hedges (which are often 
undertaken on a portfolio basis) and proprietary price discovery 
transactions executed in swap markets for energy commodities.
---------------------------------------------------------------------------
    Unlike major financial institutions, non-dealer commercial energy 
firms function primarily as principals by transacting futures and 
energy-related swaps on a daily basis, among other things, to hedge 
(i.e., mitigate or off-set) the price risk associated with their core 
business of providing electricity, heating oil, natural gas, propane, 
gasoline and other energy commodities at competitive prices to satisfy 
current and future energy supply and demand. In this regard, the 
operation of assets and related trading activities of one non-dealer 
commercial energy firm are largely independent of other non-dealer 
commercial energy firms in the same product market. Should one party 
become unable to trade, its counterparties can easily enter the market 
to match the resulting open positions.
    Although significant external events can adversely impact multiple 
energy firms at the same time, the failure of one energy provider has 
never led to the systemic failure of the energy markets. Moreover, the 
failure of a non-dealer commercial energy firm has neither resulted in, 
nor raised concerns about, triggering a collapse of the U.S. banking 
and financial system. The absence of any large scale, long-term 
disruption of the operation of financial and physical energy markets 
following the Enron and Amaranth failures provides clear evidence that 
OTC derivatives in energy commodities do not create systemic risk to 
the financial system or within the energy industry of the type and 
nature that the Act is intended to prevent.\6\
---------------------------------------------------------------------------
    \6\ See Dodd-Frank Act Conference Report Summary, available at 
http://banking.senate.gov/public/
index.cfm?FuseAction=Issues.View&Issue_id=84d77b9f-c7ab-6fe2-4640-
9dd18189fb23. The summary explains that the goals of the Act, in part, 
are to ``identify and address systemic risks posed by large, complex 
companies, products, and activities before they threaten the stability 
of the economy.'' Id.
---------------------------------------------------------------------------
    Moreover, non-dealer commercial energy firms have a significant 
incentive to manage their exposure to all counterparties and, 
therefore, such firms are not materially at risk in the absence of 
government assistance. If the credit risk management practices and 
policies of non-dealer commercial energy firms are inadequate, the 
impacts of any resulting failure would fall on the shareholders of such 
entities, as was the case in the Enron and Amaranth failures. In the 
case of a failure of a non-dealer commercial energy firm, the burdens 
and obligations of the affected company will be borne by shareholders 
and investors, not by the federal government or, ultimately, taxpayers.
    In light of the above, applying the proposed definition of Swap 
Dealer and interpretive guidance to non-dealer commercial energy firms 
is inconsistent with Congressional intent and would result in the 
imposition of unnecessary and burdensome transactional, operating, and 
compliance costs.\7\ In order to cover such costs, non-dealer 
commercial energy firms will be forced to divert resources away from 
investment in innovation, infrastructure, growth and jobs. Further, 
this will adversely affect liquidity, competition, efficiency and price 
discovery in energy markets as market participants either withdraw or 
no longer participate to the same extent. This, in turn, will result in 
higher energy prices for commercial, industrial, and retail consumers.
---------------------------------------------------------------------------
    \7\ See Comments of the Working Group submitted to the CFTC on 
December 15, 2010 in response to the CFTC's request for comment 
concerning the cost-benefit analysis conducted pursuant to CEA Section 
15. See Regulations Establishing and Governing the Duties of Swap 
Dealers and Major Swap Participants, 75 Fed. Reg. 71397 (Nov. 23, 
2010). In those comments, the Working Group detailed the significant 
costs likely to be imposed on commercial energy firms should such firms 
be deemed Swaps Dealers.
---------------------------------------------------------------------------
B. The Application of the ``Core'' Swap Dealer Criteria to Energy 
        Markets Is Not Consistent With the Statutory Language
    It is the extensive experience of the Working Group members that 
non-dealer commercial energy firms and other ``traders'' routinely 
enter into swap transactions where both parties are holding a position 
to hedge or to benefit from a forward view of the market rather than 
holding themselves out as ``dealers.'' However, under the broadly 
worded and subjective ``core'' Swap Dealer criteria proposed by the 
Commissions, such non-dealer commercial energy firms could be viewed as 
``accommodating demand'' for these transactions--a key indicator of 
``dealing activity'' in the Proposed Rule.\8\ As described in Part 
III.C.2, below, this result is not consistent with the statutory 
definition of Swap Dealer or the Congressional intent underlying Title 
VII. Further, the mere fact that the terms and conditions are 
customized should not change the role of that counterparty from that of 
a commercial market participant to that of a Swap Dealer.
---------------------------------------------------------------------------
    \8\ Proposed Rule at 80176 (proposing that ``dealers tend to 
accommodate demand for swaps . . . from other parties.''). See also 
Part III.C.2.d., infra, discussing the proposed ``core'' Swap Dealer 
criteria.
---------------------------------------------------------------------------
1. Energy Swap Markets Routinely Operate Without the Involvement of 
        Swap Dealers
    The Working Group believes that the Commissions' assertion that 
significant parts of the swap markets do not operate without the 
involvement of Swap Dealers is both unsupported and flawed when applied 
to energy markets. Specifically, instead of providing any analysis of 
the issue, the Commissions offer only the following unsupported 
opinion:

        Some of the commenters appeared to suggest that significant 
        parts of the swap markets operate without the involvement of 
        swap dealers. We believe that this analysis is likely 
        incorrect, and that the parties that fulfill the function of 
        dealers should be identified and are likely to be swap 
        dealers.\9\
---------------------------------------------------------------------------
    \9\ Proposed Rule at 80177 n. 18.

    Further, when discussing transaction activity in swap markets, the 
---------------------------------------------------------------------------
Commissions contend that:

        in some markets, non-dealers tend to constitute a large portion 
        of swap dealers' counterparties. In contrast, non-dealers tend 
        to enter into swaps with swap dealers more often than with 
        other non-dealers.\10\
---------------------------------------------------------------------------
    \10\ Id. at 80177.

As detailed herein, the Working Group respectfully submits that these 
conclusions (i) are inaccurate with respect to energy markets, and (ii) 
are not supported by empirical data developed by, or provided at the 
request of, the Commissions.
    It is well recognized that non-dealer commercial energy firms 
routinely enter into swap transactions with non-dealer counterparties 
(e.g., other commercial firms) in OTC markets. Such transactions take 
place (i) in bilateral markets directly between the counterparties or 
where counterparties are matched by voice brokers, and (ii) on 
electronic trading facilities operating as exempt commercial markets, 
such as ICE. Indeed, a significant number of the transactions executed 
on ICE are between two end-user counterparties or between other non-
dealer market participants.
    In other proposed rules issued pursuant to the Act, the CFTC 
expressly contradicts its assertion here that significant parts of the 
swap markets do not operate without the involvement of Swap Dealers. 
For instance, in the recently released notice of proposed rulemaking 
addressing the end-user exception from mandatory clearing requirements, 
the CFTC recognizes that in certain markets more than one counterparty 
to a swap may be qualified to elect to use the end-user exception from 
clearing.\11\ Because only ``non-financial entities'' can elect to use 
this exception, the language proposed in the End-User NOPR supports the 
proposition that portions of swap markets, notably energy markets, 
operate without dealer involvement.\12\
---------------------------------------------------------------------------
    \11\ End-User Exception to Mandatory Clearing of Swap, 75 Fed. Reg. 
80747 (Dec. 23, 2010) (``End-User NOPR'').
    \12\ Id. (proposed CFTC Rule 39.6(a)). See also Real-Time Public 
Reporting of Swap Transaction Data, 75 Fed. Reg. 76141 (Dec. 7, 2010) 
(the proposed rule imposes reporting obligations on non-Swap Dealers 
for transactions executed off-facility ``if neither party is a swap 
dealer nor a major swap participant.''); Swap Data Recordkeeping and 
Reporting Requirements, 75 Fed. Reg. 76574 (Dec. 8, 2010) (same).
---------------------------------------------------------------------------
    With respect to energy markets, as detailed in the below examples, 
non-dealer commercial energy firms will agree to enter into the ``other 
side'' of a bilateral swap transaction proposed by another non-dealer 
counterparty where both parties are hedging or taking a forward view of 
the market. In this instance, neither party is engaged in swap dealing. 
They do not enter into such transactions (i) as a ``service'' to, or 
for the benefit of, their counterparty, (ii) to collect a fee, or (iii) 
as a ``service'' to, or for the benefit of the market generally, i.e., 
to enhance liquidity. Because they enter into such transactions to take 
a position for their own benefit, and not the benefit of their 
counterparty, this trading activity does not constitute swap dealing. 
Similarly, due to the unique characteristics of the underlying physical 
energy markets, non-dealer commercial energy firms often enter into 
swaps with customized terms and conditions. These terms are often 
highly negotiated and are intended to address the specific needs of the 
counterparties, i.e., hedging bespoke commercial risk or price 
discovery.
2. Specific Examples of Transactions Occurring in Energy Markets 
        Without Swap Dealer Involvement
    To assist the Commissions in better understanding the non-dealer to 
non-dealer transactions described above, the Working Group provides the 
following examples of transactions between non-dealer commercial energy 
firms that are ancillary or as an incident to their business as 
producers, processors, commercial users, or merchants of physical 
energy commodities.
Example 1: Hedge Between Two Non-Dealer Commercial Energy Firms
    The following example illustrates how two non-dealer commercial 
energy firms seeking to hedge commercial risk can ``respond to the 
interest of others'' without ``dealing.''

          Company A is a natural gas producer that sells into the 
        natural gas spot market.
          Company B is a retail seller of natural gas that sells 
        natural gas to its customers at fixed prices but purchases the 
        natural gas it sells in the spot market.
          Company A desires to hedge its spot sales exposure by 
        entering into a swap where it is the floating price payer and 
        receives a fixed payment. Company B desires to hedge its spot 
        purchase exposure by entering into a swap where it is the fixed 
        price payer and receives a floating payment.
          Company A and Company B have established bi-lateral trading 
        documents and agreed on credit terms. They are aware of each 
        others' business needs and regularly communicate regarding the 
        possibility of a mutually beneficial trade to hedge their 
        respective commercial risks.
          Company A and Company B enter into a swap where Company A is 
        the floating price payer and Company B is the fixed price 
        payer. The swap is priced such that Company B makes a margin 
        between the fixed price it receives from its retail customers 
        and the fixed price it pays to Company A. The floating price is 
        the spot natural gas price.
          Company A and Company B are not Swap Dealers. They are 
        entering into a swap to hedge their commercial risk. Company A 
        has fixed its output price. Company B has locked-in its margin 
        and hedged its purchase price. While the companies could 
        achieve the same result by using an intermediary such as a Swap 
        Dealer, their transaction is more economic as they have ``cut 
        out the middleman.''
Example 2: Structured Deals
    The following illustrates an example of how structured deals do not 
constitute ``dealing.''

          Company A enters into a deal to purchase all of the power 
        off-take from a power plant for a period of 10 years. Company A 
        also enters into a 10-year natural gas swap with the power 
        plant, allowing it to fix its margins. The combination of those 
        two transactions allows the owner of the plant to secure 
        financing. Company A is not engaged in ``dealing.''
C. The Definition of Swap Dealer: Scope and Application
1. The Definition of Swap Dealer and Interpretive Guidance Must Promote 
        Legal and Regulatory Certainty
    The definition of Swap Dealer is a critical element of the new 
framework for the regulation of swaps in OTC markets embodied in Title 
VII of the Act. Together with the proposed definition of Major Swap 
Participant (``MSP''), the definition of Swap Dealer is one of the 
``gateways'' through which the Commissions may exercise the new and 
expanded regulatory oversight authority granted to them under Title 
VII. The successful implementation of a new framework for the 
regulation of swaps is tied, in large part, directly to the 
Commissions' ability to further define and apply Swap Dealer in a 
fashion that (i) promotes regulatory and legal certainty, (ii) is 
faithful to the statutory provisions and intent of Congress, and (iii) 
is consistent with the overarching objectives and structure of Title 
VII.
    If adopted as proposed, the Working Group is concerned that the 
definition of Swap Dealer and related guidance could be interpreted in 
a manner that effectively (i) limits the concept of an end-user to that 
of a one-directional (i.e., buy-side only) hedger, and (ii) leaves 
commercial market participants with active swap trading operations at 
risk of being designated as a Swap Dealer, including commercial energy 
firms that primarily transact swaps to hedge underlying physical 
commodity portfolios, assets, or positions. Such an interpretation is 
not faithful to the statute or Congressional intent, would create legal 
and regulatory uncertainty, and would be highly disruptive to the 
efficient operation of swap markets.
    The regulations implementing the definition of Swap Dealer must 
include a clear methodology that will allow market participants to 
determine whether they, or the counterparties with whom they transact, 
fall within this definition. This clarity and guidance is vital to 
ensuring the legal certainty and stability necessary to facilitate an 
orderly transition to new regulation under Title VII and avoid 
disruptions to energy swap markets.
2. The Commissions Should Define and Interpret the Term Swap Dealer in 
        a Manner That Gives Effect to the Statutory Language and 
        Congressional Intent
a. Congress Intended the Definition of Swap Dealer to Capture Entities 
        Engaged in Traditional Dealing Activity
    The statutory language of new CEA Section 1a(49) establishes an 
unambiguous definition of Swap Dealer, including express exceptions and 
exemptions, to reflect Congress' intent to (i) capture only those 
entities engaged in sufficient ``dealing'' activities to necessitate 
regulation under the Act, and (ii) to avoid inadvertently sweeping in 
those entities that are responsibly managing commercial risk.\13\ At 
the outset of Title VII of the Act, Congress expressly made clear that 
the term Swap Dealer shall have the same meaning as used in the 
Securities Exchange Act of 1934 (``1934 Exchange Act'') and as amended 
by the Act.\14\ In this regard, Congress intended not to entirely 
redefine the well-known and understood meaning of what constitutes a 
``dealer,'' but rather Congress provided specific meaning and context 
to the definition by drawing from the 1934 Exchange Act and principles 
of the Dealer/Trader Distinction Rule.
---------------------------------------------------------------------------
    \13\ See Letter from Sen. Dodd, Chairman, Committee on Banking, 
Housing, and Urban Affairs and Sen. Lincoln, Chairman, Committee on 
Agriculture, Nutrition, and Forestry to Rep. Frank, Chairman, Committee 
on Financial Services, and Rep. Peterson, Chairman, Committee on 
Agriculture (June 30, 2010) (``Lincoln-Dodd Letter'') (explaining that 
``this is also why we narrowed the scope of the Swap Dealer and Major 
Swap Participant definitions. We should not inadvertently pull in 
entities that are appropriately managing their risk.''). See also 156 
Cong. Rec. H5248 (daily ed. June 30, 2010) (statements of Rep. Frank 
and Rep. Peterson recognizing Lincoln-Dodd Letter and entering into 
Congressional Record).
    \14\ See Section 711 of the Act (stating that the term ``Swap 
Dealer'' shall have the ``same meaning[] given the term[] in section 1a 
of the Commodity Exchange Act . . . .''). The ``same meaning'' is the 
meaning provided by Congress in setting forth the definition of Swap 
Dealer in new CEA Section 1a(49), which parallels the meaning of 
``dealer'' under existing securities laws and precedent.
---------------------------------------------------------------------------
    In setting forth the definition of a ``Swap Dealer,'' Congress 
expressly used the word ``means'' immediately following the term it 
intended to define, ``Swap Dealer.''\15\ Importantly, Congress did not 
use the word ``includes'' or ``consists of,'' nor did Congress list 
additional activities as illustrative, meaning Congress said what it 
meant.\16\ Any general authority Congress provided to the Commissions 
to further define Swap Dealer cannot exceed the bounds of the express 
definition or ignore the intent of Congress.\17\
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    \15\ See, e.g., Wilson v. U.S. Parole Commission, 193 F.3d 195, 198 
(3d Cir. 1999) (explaining that ``[a]s a rule, a definition which 
declares what a term means is binding.'') (citing National City Lines, 
Inc. v. LLC Corp., 687 F.2d 1122 (8th Cir. 1982); see also Colautti v. 
Franklin, 439 U.S. 379, 392-93 (1979) (explaining that ``[a] definition 
which declares what a term `means' . . . excludes any meaning that is 
not stated.'') (citing 2A C. Sands, Statutes and Statutory Construction 
 47.07 (4th ed., Supp. 1978).
    \16\ See, e.g., United States v. Gertz, 249 F.2d 662, 666 (9th Cir. 
1957) (explaining that ``the word `includes' is usually a term of 
enlargement, and not of limitation.''); Federal Election Commission v. 
Massachusetts Citizens for Life, Inc., 769 F.2d 13 (1st Cir. 1985); 
Argosy Ltd. v. Hennigan, 404 F.2d 14 (5th Cir. 1968).
    \17\ The Commissions cite to Sections 712(d) and 721(b) of the Act 
as providing authority to redefine the term Swap Dealer.
---------------------------------------------------------------------------
    Specifically, Congress set forth the statutory elements for 
determining whether a person is a Swap Dealer, explicitly providing 
that ``the term `swap dealer' means any person who'':

    (i) holds itself out 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

    (iv) engages in any activity causing the person to be commonly 
        known in the trade as a dealer or market maker in swaps, 
        provided however, in no event shall an insured depository 
        institution be considered to be a swap dealer to the extent it 
        offers to enter into a swap with a customer in connection with 
        originating a loan with that customer.\18\
---------------------------------------------------------------------------
    \18\ New CEA Section 1a(49)(A).

Accordingly, any person engaged in activities consistent with the 
express statutory criteria shall be deemed a Swap Dealer, and be 
subject to the applicable compliance obligations established in the 
Act. As detailed below, however, the Commissions went well beyond the 
express language of the statute, instead establishing additional 
``core'' and ``secondary'' Swap Dealer criteria that are wholly 
inconsistent with the express statutory definition of Swap Dealer.
    As part of the definition of Swap Dealer, Congress also included a 
General Exception to the definition, providing that the term Swap 
Dealer ``does not include a person that enters into swaps for such 
person's own account, either individually or in a fiduciary capacity, 
but not as a part of a regular business.'' \19\ The inclusion of the 
General Exception again reflects Congress' intent to capture entities 
engaged in traditional ``dealing'' activities, and thus the proper 
interpretation and application of the General Exception will avoid 
capturing entities not intended to be regulated as Swap Dealers, 
particularly those entities transacting in swap markets but not as a 
part of a regular business. To ensure the final rule and interpretive 
guidance properly reflect the statutory language and the intent of 
Congress, the Working Group provides, in Part III.D.1, below, specific 
comments and alternatives to the Commissions' definition and 
interpretation of the General Exception and the term ``regular 
business.''
---------------------------------------------------------------------------
    \19\ New CEA Section 1a(49)(C).
---------------------------------------------------------------------------
    Further, pursuant to the de minimis exemption established by 
Congress, entities that meet the swap dealing criteria set forth in new 
CEA Section 1a(49)(A) will nevertheless be exempt from the regulations 
of the Act applicable to Swap Dealers because their dealing activities 
would be so minimal as to not warrant regulation as a Swap Dealer.\20\ 
In contrast, the Commissions' interpretation of this exemption suggests 
that if an entity fails to satisfy the de minimis criteria proposed by 
the Commissions, such entity would be deemed a Swap Dealer. Thus, 
rather than further limiting the scope of entities subject to the Act's 
Swap Dealer regulations, as intended by Congress, such an 
interpretation establishes additional criteria by which to identify 
entities as Swap Dealers.
---------------------------------------------------------------------------
    \20\ Specifically, new CEA Section 1a(49)(D) provides that 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.'' Id.
---------------------------------------------------------------------------
b. The Statutory Definition of Swap Dealer is Based on the Definition 
        and Interpretation of ``Dealer'' Under the Securities Laws and 
        Rules
    All four elements contained in the definition of Swap Dealer set 
forth in new CEA Section 1a(49)(A) are based upon the definition of 
``dealer'' set forth in Section 3(a)(5) of the 1934 Exchange Act \21\ 
and upon key elements of the SEC's long-standing and well-known 
``Dealer/Trader Distinction Rule.'' \22\
---------------------------------------------------------------------------
    \21\ See 15 U.S.C.  78c(a)(5).
    \22\ See Definition of Terms in and Specific Exemptions for Banks, 
Savings Associations, and Savings Banks Under Sections 3(a)(4) and 
3(a)(5) of the Securities Exchange Act of 1934, 68 Fed. Reg. 8685, 
Final Rule, SEC Release No. 34-47364 (Mar. 2003) (``Dealer/Trader 
Distinction Rule''); Definition of Terms in Specific Exemptions for 
Banks, Savings Associations, and Savings Banks Under Sections 3(a)(4) 
and 3(a)(5) of the Securities Exchange Act of 1934, Proposed Rule, SEC 
Release No. 34-46745 (Dec. 2002).
---------------------------------------------------------------------------
    The first two prongs of the statutory definition of Swap Dealer--
holding oneself out as a dealer in swaps and making a market in swaps, 
respectively--were clearly relied upon by Congress in crafting the 
definition of Swap Dealer.\23\ Specifically, the Dealer/Trader 
Distinction Rule provides, in part, that a dealer is someone who is 
``holding itself out as a dealer or market maker or as being otherwise 
willing to buy or sell one or more securities on a continuous basis.'' 
\24\
---------------------------------------------------------------------------
    \23\ The SEC explained, in part, in the Dealer/Trader Distinction 
Rule that ``. . . the dealer definition has been interpreted to exclude 
`traders.' The dealer/trader distinction recognizes that dealers 
normally have a regular clientele, hold themselves out as buying or 
selling securities at a regular place of business, have a regular 
turnover of inventory (or participate in the sale or distribution of 
new issues, such as by acting as an underwriter), and generally provide 
liquidity services in transactions with investors (or, in the case of 
dealers who are market makers, for other professionals).'' See Dealer/
Trader Distinction Rule at 8688 (citations omitted).
    \24\ See Dealer/Trader Distinction Rule at 8689 n. 26 (citing OTC 
Derivatives Dealers, Release No. 34-40594, Section II.A.1., n.61, 63 
Fed. Reg. 59,362, 59,370 (Nov. 3, 1998)) (emphasis added).
---------------------------------------------------------------------------
    In relevant part, Section 3(a)(5) of the 1934 Exchange Act defines 
a ``dealer'' as ``any person that is engaged in the business of buying 
and selling securities for its own account through a broker or 
otherwise.'' This definition has clear overlap with the third prong of 
the definition of Swap Dealer, particularly the key element of engaging 
in, or entering into, activities for one's ``own account.''
    Additionally, the ``Exception'' from the definition of dealer 
provided in the 1934 Exchange Act provides that ``[t]he term `dealer' 
does not include a person that buys or sells securities for such 
person's own account, either individually or in a fiduciary capacity, 
but not as a part of a regular business.'' Importantly, this exception 
is virtually identical to the General Exception included in the 
definition of Swap Dealer in new CEA Section 1a(49)(C).
    The above comparison illustrates that Congress, in drafting the 
definition of Swap Dealer, adopted specific language and principles 
from the definition of ``dealer'' under the 1934 Exchange Act. Notably, 
Congress also chose not to adopt other SEC statutory language or 
principles based on SEC precedent. Accordingly, Congress intended that, 
in interpreting and implementing the term Swap Dealer, such 
interpretation should be modeled after the SEC's Dealer/Trader 
Distinction Rule, taking into account applicable differences between 
swaps and securities markets. Consequently, in further defining the 
term Swap Dealer, the Commissions were required to fully consider the 
SEC's interpretive guidance of the term ``dealer.'' \25\ However, as 
discussed below, the Commissions did not thoroughly consider existing 
precedent, choosing instead to adopt unsupported ``core'' and 
``secondary'' criteria, which resulted in a proposed definition and 
interpretation of Swap Dealer that fails to follow the statute or 
effectuate the intent of Congress.
---------------------------------------------------------------------------
    \25\ See note 14, supra.
---------------------------------------------------------------------------
    Furthermore, the Working Group believes that the Commissions' 
decision in the Proposed Rule to adopt Dealer/Trader Distinction--like 
guidance for security-based swaps, but not for swaps traded in 
commodity markets, is unreasonable in light of the statutory language 
and Congressional intent. The Commissions attempt to justify their 
distinction, in part, by explaining that:

        The definition of swap dealer should be informed by the 
        differences between swaps, on the one hand, and securities and 
        commodities, on the other. Transactions in cash market 
        securities and commodities generally involve purchases and 
        sales of tangible or intangible property. Swaps, in contrast, 
        are notional contracts requiring the performance of agreed 
        terms by each party.\26\
---------------------------------------------------------------------------
    \26\ Proposed Rule at 80176.

This is not, however, an informed basis to justify the SEC and CFTC 
adopting diametrically opposed positions for security-based swaps and 
swaps traded in commodity markets.\27\
---------------------------------------------------------------------------
    \27\ Notably, the SEC applies the Dealer/Trader Distinction Rule to 
options, which, like swaps, are a derivative for which there is no 
limitation on the quantity of the underlying asset and there is no 
requirement to hold inventory in order to be a dealer. Thus, the basis 
for the Commissions' distinction lacks a thorough understanding of the 
swaps and securities markets.
---------------------------------------------------------------------------
    To be sure, the definitions of ``Swap Dealer'' and ``Security-based 
Swap Dealer'' set forth in the Act are virtually identical and, as 
discussed above, modeled in large part on existing SEC precedent.\28\ 
Yet, with limited explanation, the Commissions reach opposite results. 
Thus, the distinction is contrary to the express statutory language and 
Congressional intent, which support definitions of Swap Dealer and 
Security-based Swap Dealer that are consistent with SEC precedent.
---------------------------------------------------------------------------
    \28\ Compare new CEA Section 1a(49) and new 1934 Exchange Act 
Section 3(a)(71).
---------------------------------------------------------------------------
c. The Definition of Swap Dealer Must Account for the Existence of 
        Other Market Participants
    The Commissions should establish guidance interpreting the 
definition of Swap Dealer that appropriately recognizes the existence 
of other market participants transacting in different types of swap 
markets. The regulatory framework adopted in Title VII is based upon 
the existence of, at a minimum, four classes of market participants: 
(i) Swap Dealers; (ii) MSPs; (iii) non-financial end-users (i.e., those 
eligible to use the clearing exception); and (iv) all other market 
participants that are not Swap Dealers, MSPs, or non-financial end-
users. Pursuant to the framework contemplated by Congress, the 
Commissions are required to further define Swap Dealer in a manner that 
gives meaning and effect to each distinct class of market participant.
    The proposed definition of Swap Dealer and the interpretational 
guidance in the Proposed Rule are based upon a very broad reading of 
the four disjunctive prongs of new CEA Section 1a(49)(A)(i)-(iv). 
Rather than proposing interpretational guidance for each of the four 
disjunctive prongs of the statutory definition of Swap Dealer, the 
subjective identifying characteristics promoted by the Commissions 
appear to apply to all prongs. This approach to identifying Swap 
Dealers, as well as the qualified guidance interpreting the General 
Exception to the definition of Swap Dealer, creates uncertainty 
regarding the universe of market participants that must register as a 
Swap Dealer.
    To minimize such uncertainty, to the greatest extent possible, 
concrete and objective fact-based guidance should be included in the 
final rule that clearly illustrates swap trading activity that falls 
either within (i) the definition of Swap Dealer or (ii) the General 
Exception. Because the Proposed Rule unequivocally places the 
obligation on market participants to self-select whether they must 
register as a Swap Dealer, this guidance is particularly important to 
mitigate potential non-compliance risk.
d. The Proposed ``Core'' Swap Dealer Criteria Do Not Distinguish 
        Between the Roles of Different Swap Market Participants
    Citing the unique characteristics of swap markets, the Commissions 
decline to adopt interpretive guidance distinguishing the activities of 
dealers from traders in swap markets.\29\ In lieu of adopting such 
guidance, the Commissions propose certain ``core'' criteria for 
identifying Swap Dealers (``Core S/D Criteria''), as well as other 
additional criteria (``Secondary S/D Criteria'').\30\ As noted above, 
in order to demonstrate consistency with the express statutory 
definition, the underlying Congressional intent, and the regulatory 
framework embodied in Title VII, the guidance interpreting the 
definition of Swap Dealer should distinguish the roles of different 
swap market participants in a meaningful manner. Moreover, such 
guidance should recognize that, in certain instances, dealers and 
traders engage in overlapping types of conduct; however, this fact 
alone should not result in a trader being subject to dealer 
regulation.\31\
---------------------------------------------------------------------------
    \29\ Proposed Rule at 80177-178.
    \30\ Id. at 80,176, 80,178. The Commissions' proposed Core S/D 
Criteria provide that:

         dealers tend to accommodate demand for swaps and 
security-based swaps from other
        parties;

         dealers are generally available to enter into swaps or 
security-based swaps to facilitate
        other parties' interest in entering into those instruments;

         dealers tend not to request that other parties propose 
terms of swaps or security-based
        swaps; rather, dealers tend to enter into those instruments on 
their own standard terms
        or terms they arrange in response to other parties' interest; 
and

         dealers tend to be able to arrange customized terms 
for swaps or security-based swaps
        upon request, or create new types of swaps or security-based 
swaps at the dealer's own
        initiative.
      
    \31\ It is instructive to look at the definitions of ``swap 
dealer'' and ``producer/merchant/processor/user'' set forth in the 
explanatory notes of the CFTC's Disaggregated Commitment of Traders 
Report:

      Producer/Merchant/Processor/User: An entity that predominantly 
engages in the produc-
  tion, processing, packing or handling of a physical commodity and 
uses the futures markets
  to manage or hedge risks associated with those activities.

      Swap Dealer: An entity that deals primarily in swaps for a 
commodity and uses the futures
  markets to manage or hedge the risk associated with those swaps 
transactions. The swap
  dealer's counterparties may be speculative traders, like hedge funds, 
or traditional commercial
  clients that are managing risk arising from their dealings in the 
physical commodity.

    See Disaggregated Commitments of Traders Report, Explanatory Notes, 
available at http://www.cftc.gov/MarketReports/CommitmentsofTraders/
DisaggregatedExplanatoryNotes/index.htm.
---------------------------------------------------------------------------
    The proposed Core and Secondary S/D Criteria do not accomplish 
these objectives. To be sure, Congress intended for the CFTC to 
regulate only those swap market participants who engage in dealing, a 
concept well-understood and recognized in securities markets. The 
proposed Core and Secondary S/D Criteria instead provide only vague 
concepts that will potentially sweep in numerous other market 
participants within the definition of Swap Dealer--a result clearly not 
contemplated by Congress given the distinct classes of market 
participants established by Title VII. Indeed, to avoid such an 
unintended result, Congress purposely based the definition of Swap 
Dealer on applicable SEC precedent in order to limit the term's 
application to only those market participants engaged in what has 
historically been understood as dealing activity.\32\
---------------------------------------------------------------------------
    \32\ See Part III.C.2.b., supra, discussing Congress' intent to 
base the definition of Swap Dealer on the 1934 Exchange Act definition 
of ``dealer'' and the Dealer/Trader Distinction Rule.
---------------------------------------------------------------------------
3. The Commissions Should Interpret ``Market Making'' Consistent With 
        Existing CFTC Interpretation
    The Working Group is concerned that the Commissions' interpretation 
of the ``market making'' language in new CEA Sections 1a(49)(A)(ii) and 
1a(49)(A)(iv) is overly broad and inconsistent with CFTC precedent. The 
Commissions should therefore reconsider their interpretation and issue 
interpretative guidance in the final rule clarifying the meaning and 
scope of this language. Such guidance should clearly recognize that the 
activity of ``market making'' is an incident of dealing activity in 
swap markets.
    Consistent with the CFTC's glossary definition of ``Market Maker,'' 
``dealing activity'' generally occurs when a party acts as an 
intermediary for others to access a market.\33\ A hallmark of dealing 
activity is that a party's business is to continually stand ready, 
willing, and able to take either side of a transaction and trade with 
its customers in accordance with a ``bid/ask'' spread on its own 
account. In fact, the CFTC's definition of ``Market Maker'' connotes 
this ``obligation'' to buy or sell.\34\ In general, a dealer seeks to 
remain neutral to price movements with respect to the swap at issue, as 
well as the underlying commodity. Dealers, in large part, profit from 
intermediation fees and ancillary services to their dealing activity 
(e.g., providing investment advice), not from realizing changes in the 
value of the swaps transacted or the underlying commodities.
---------------------------------------------------------------------------
    \33\ The CFTC's online glossary, titled ``A Guide to the Language 
of the Futures Industry,'' sets forth the Commission's own definition 
of the term ``Market Maker.'' As highlighted below, the CFTC views a 
market maker as an entity that has an obligation to buy or sell when 
there is an excess of sell or buy orders (as the case may be):

      [P]rofessional securities dealer or person with trading 
privileges on an exchange who has
  an obligation to buy when there is an excess of sell orders and to 
sell when there is an excess
  of buy orders. By maintaining an offering price sufficiently higher 
than their buying price,
  these firms are compensated for the risk involved in allowing their 
inventory of securities to
  act as a buffer against temporary order imbalances. In the futures 
industry, this term is some-
  times loosely used to refer to a floor trader or local who, in 
speculating for his own account,
  provides a market for commercial users of the market. Occasionally a 
futures exchange will
  compensate a person with exchange trading privileges to take on the 
obligations of a market-
  maker to enhance liquidity in a newly listed or lightly traded 
futures contract. (Emphasis
  added).

    See https://www.cftc.gov/ConsumerProtection/EducationCenter/
CFTCGlossary/index.htm.
    \34\ See note 33, supra. See also SEC online guidance interpreting 
a ``Market Maker'' as:

      a firm that stands ready to buy and sell a particular stock on a 
regular and continuous
  basis at a publicly quoted price. You'll most often hear about market 
makers in the context
  of the NASDAQ or other ``over the counter'' (OTC) markets. Market 
makers that stand ready
  to buy and sell stocks listed on an exchange, such as the New York 
Stock Exchange, are called
  ``third market makers.'' Many OTC stocks have more than one market-
maker. Market-makers
  generally must be ready to buy and sell at least 100 shares of a 
stock they make a market
  in. As a result, a large order from an investor may have to be filled 
by a number of market-
  makers at potentially different prices.

    See http://www.sec.gov/answers/mktmaker.htm.
---------------------------------------------------------------------------
    In contrast, a non-dealer commercial energy firm, on occasion, may 
take either side of any particular swap transaction, depending on its 
needs. This behavior is distinct from dealing activity as it is driven 
by the commercial energy firm's underlying commercial business 
operations, including specific customer-related obligations in physical 
markets. Given this direct nexus to the commercial energy firm's 
primary business operations in physical markets, such activity does not 
constitute ``market making'' and is not incident to dealing activity in 
swap markets.
    The Commissions should interpret ``market making'' in a manner that 
is generally consistent with the CFTC's own glossary definition of 
``Market Maker.'' This may be accomplished by the development of 
enumerated criteria that identifies different activities that 
constitute ``market making'' in swap markets, i.e., a person who has an 
obligation to buy when there is an excess of sell orders and to sell 
when there is an excess of buy orders.
    The Commissions should not, however, treat ``market making'' 
activity as the sole measure of whether an entity engaged in such 
activity is a Swap Dealer. An occasional two-way trade made by a market 
participant, when offered for customary commercial purposes, such as to 
briefly test a market for price discovery purposes or as an adjunct to 
an underlying physical business, does not constitute the type of 
``continuous, ready, willing and able'' trading activity that is a key 
indicium of a ``professional'' market maker.
4. The Working Group Offers a Proposed Alternative Definition of Swap 
        Dealer
    In light of the numerous statutory and policy concerns outlined 
above with respect to the Commissions' proposed definition of Swap 
Dealer and interpretive guidance, the Working Group offers the 
following alternative definition of Swap Dealer that will mitigate many 
of the identified concerns and bring the definition and its 
interpretation back within the limited scope originally intended by 
Congress:
  17 CFR 1.3(ppp) Swap Dealer.\35\
---------------------------------------------------------------------------
    \35\ Note, proposed new language is underlined. This alternative 
definition revises only new CEA Section 1a(49)(A). The Working Group 
offers revised language to the General Exception and the de minimis 
exemption in Sections III.D.1 and 2, herein. See also Attachment A, 
attached hereto.
---------------------------------------------------------------------------
          (1) In general. The term ``swap dealer'' means any person 
        who:

                  (i) Holds itself out as a dealer in swaps;
                  (ii) Makes a market in swaps;

                  ``Makes a market'' means regularly providing two-
                sided pricing:

                          (a) for a particular swap for execution for a 
                        person's own account; or
                          (b) pursuant to a contractual obligation.

                  (iii) Regularly enters into swaps with counterparties 
                as an ordinary course of business for its own account; 
                or
                  (iv) Engages in any activity causing it to be 
                commonly known in the trade as a dealer or market maker 
                in swaps.

        provided, however, that an entity shall not be considered to be 
        a swap dealer to the extent that it offers to enter into, or 
        enters into, a swap:

                                  (a) to hedge or mitigate commercial 
                                risk;
                                  (b) for the purpose of benefiting 
                                from future changes in the commodity 
                                reference price (i.e., the price to 
                                which the floating leg of a swap is 
                                indexed);
                                  (c) on a designated contract market 
                                or swap execution facility, unless 
                                suchentity is making a market in that 
                                swap; or
                                  (d) that is a physical option that 
                                includes the obligation to deliver or 
                                receive a commodity if the option is 
                                exercised.
                                  (d) to provide two-sided pricing in a 
                                market of limited or episodic liquidity 
                                for the purpose of:

                                          (I) discovering a price for 
                                        the swap or the underlying 
                                        commodity, or
                                          (II) eliciting bids and 
                                        offers for the swap from other 
                                        marketparticipants.

    Given that the Commissions' have interpreted the principle ``market 
making'' in a broad fashion, the first proposed change is to provide 
specificity to the second prong of the Swap Dealer definition by 
expressly defining the term ``makes a market'' as regularly providing 
two-sided pricing: (i) for a particular swap for execution for a 
person's own account, or (ii) pursuant to a contractual obligation. As 
previously described, making a market often means a party continually 
stands ready, willing, and able to take either side of a transaction 
and trade with its customers in accordance with a ``bid/ask'' spread on 
its own account.\36\ The proposed additional language will ensure the 
market making prong is applied narrowly so as to limit the scope of 
entities subject to regulation as Swap Dealers to those entities 
engaged in the sort of dealing activity intended to be regulated by 
Congress under the Act.
---------------------------------------------------------------------------
    \36\ See Part III.C.3, infra, discussing the need for a consistent 
interpretation of ``market making.'' See also note 34, infra, regarding 
SEC online guidance interpreting a ``market maker,'' in part, as: ``a 
firm that stands ready to buy and sell a particular stock on a regular 
and continuous basis at a publicly quoted price'' (emphasis added).
---------------------------------------------------------------------------
    The additional language offered by the Working Group--proposed 
subsections (a)-(d)--would expressly exclude from the definition those 
activities historically understood as not constituting dealing. Namely, 
the proposed language would exclude the following activities:

   Swaps for Hedging Commercial Risk: The Commissions should 
        expressly exclude from the Swap Dealer definition swaps offered 
        or entered into for purposes of hedging or mitigating 
        commercial risk. The Working Group recognizes that this 
        principle is generally accepted by the Commissions; however, 
        providing express language to this effect in the final rule 
        would provide greater certainty to market participants and 
        would effectuate Congressional intent.\37\
---------------------------------------------------------------------------
    \37\ The phrase ``hedge or mitigate commercial risk'' could 
ultimately be tied to proposed CFTC Rule 1.3(ttt), but only if the 
Commissions adopt the framework recommended by the Working Group with 
respect to proposed CFTC Rule 1.3(ttt) in comments submitted 
contemporaneously with this comment letter on the Commissions' proposed 
definitions of ``Major Swap Participant'' and ``End-User.''

   Swaps for Making a Profit: The Commissions should expressly 
        exclude from the definition of Swap Dealer swaps offered or 
        entered into for purposes of benefiting from a forward view of 
        the market, such as profits sought from future changes in the 
        price of the underlying commodity. Doing so will ensure that 
        the definition of Swap Dealer captures only those market 
---------------------------------------------------------------------------
        participants involved in ``dealing'' activities.

   Swaps Traded On-Facility: The Commissions should expressly 
        exclude from the definition of Swap Dealer swaps offered or 
        entered into on designated contract markets and swap execution 
        facilities, unless the entity entering into or offering the on-
        facility swap is making a market in that swap. Such an 
        exclusion will provide certainty that market participants who 
        are anonymously matched on a swap execution facility are not 
        accommodating demand. This scenario clearly should not be 
        considered as accommodating demand and yet because the 
        Commissions' Core S/D Criteria are broad, the Working Group 
        believes an express exclusion would better serve the market.

   Physical Options: The Commissions should expressly exclude 
        from the definition of Swap Dealer swaps offered or entered 
        into that are physical options that include an obligation to 
        deliver or receive a commodity if the option is exercised. Such 
        an exclusion is consistent with the definition of ``swap'' in 
        new CEA Section 1a(47), which, if interpreted properly, 
        excludes these physical options. Thus, without evidence to the 
        contrary, the Commissions have no authority to regulate 
        physical market participants as Swap Dealers simply for 
        transacting in physical commodity options.

   Providing Two-Sided Pricing in Markets of Limited or 
        Episodic Liquidity: The Commissions should exclude from the 
        definition of Swap Dealer swaps offered or entered to provide 
        two-sided pricing in a market of limited or episodic liquidity 
        either for the purpose of (i) discovering a price for the swap 
        or the underlying commodity, or (ii) eliciting bids and offers 
        for the swap from other market participants. Such activity is 
        distinct from dealing activity because the fundamental purpose 
        is price discovery. Nor is this ``market making'' given that 
        the market participant is not functioning specifically for the 
        purpose of being a liquidity provider, but rather the activity 
        is intended to be in furtherance of its commercial 
        business.\38\
---------------------------------------------------------------------------
    \38\ For example, a natural gas company holds natural gas inventory 
when the natural gas markets are thin at a value it believes to be 
$4.00/MMbtu. It posts a bid price of $3.80 and an offer of $4.20 for a 
portion of its inventory. If the bid price hits and the offer lifted, 
it now knows the $4.00/MMbtu estimation was low and it is in a better 
position to sell its full physical inventory at the higher price. If 
the company wanted to hold its inventory but try to execute its hedge 
position, it would engage in similar behavior to discover a true market 
price.
---------------------------------------------------------------------------
D. The Commissions Must Provide Greater Clarity and Guidance Regarding 
        the Proposed General Exception and the De Minimis Exemption
1. The General Exception
a. The Interpretive Guidance Explaining ``Regular Business'' Is 
        Circular and Creates Uncertainty
    The Working Group believes that the decision of the Commissions to 
tie prong three of the definition of Swap Dealer to the General 
Exception, i.e., to entities that regularly enter into swaps for their 
own account, is inconsistent with the clear Congressional intent of the 
General Exception and will result in significant legal and regulatory 
uncertainty for market participants. Specifically, the Proposed Rule 
states that:

        . . . clause [1a(49)](A)(iii) of the definition should be read 
        in combination with the express exception in subparagraph (C) 
        of the swap dealer definition, which excludes ``a person that 
        enters into swaps for such person's own account, either 
        individually or in a fiduciary capacity, but not as a part of a 
        regular business.'' Thus, the difference between the inclusion 
        in clause (A)(iii) and the exclusion in subparagraph (C) is 
        whether or not the person enters into swaps as a part of, or as 
        an ordinary course of, a ``regular business.'' \39\
---------------------------------------------------------------------------
    \39\ Proposed Rule at 80177.

---------------------------------------------------------------------------
The Commissions continue, explaining that:

        We believe that persons who enter into swaps as a part of a 
        ``regular business'' are those persons whose function is to 
        accommodate demand for swaps from other parties and enter into 
        swaps in response to interest expressed by other parties. 
        Conversely, persons who do not fulfill this function should not 
        be deemed to enter into swaps as a ``regular business'' and are 
        not likely to be swap dealers.\40\
---------------------------------------------------------------------------
    \40\ Id. (emphasis added).

    As evidenced by the above excerpts, rather than developing an 
independent basis by which to interpret ``regular business,'' the 
Commissions define the General Exception by simply citing to the 
definition of Swap Dealer, resulting in circular reasoning that does 
not assist market participants in determining whether their activities 
meet the exception. Said differently, the Commissions rely upon the 
Swap Dealer definition to define what ``regular business'' is not, 
which, given the broad interpretation of Swap Dealer proposed by the 
Commissions, will undoubtedly create significant legal and regulatory 
uncertainty. The Commissions should avoid this circular logic and 
instead develop clear guidance as to what constitutes ``regular 
business.''
    Additionally, the Commissions attempt to provide further guidance 
as to how the CFTC will determine whether an entity is a Swap Dealer, 
explaining that:

        In sum, to determine if a person is a swap dealer, we would 
        consider that person's activities in relation to other parties 
        with which it interacts in the swap markets. If a person is 
        available to accommodate demand for swaps from other parties, 
        tends to propose terms, or tends to engage in the other 
        activities discussed above, then the person is likely to be a 
        swap dealer. Persons that rarely engage in such activities are 
        less likely to be deemed swap dealers.\41\
---------------------------------------------------------------------------
    \41\ Id. (emphasis added).

    The Working Group believes that this interpretation, and the use of 
a number of qualifiers, such as the terms ``not likely,'' 
``available,'' ``tends to,'' ``likely,'' ``less likely,'' and 
``rarely,'' creates significant uncertainty regarding the scope and 
applicability of the General Exception. Congress provided an exception 
for those entities that engage in swap dealing activities that are 
incidental to their non-swap dealing businesses. Congress recognized 
that many businesses use swap markets to manage their financial and 
physical delivery obligations and commercial risk. This use is 
incidental to their primary businesses and their use of the swap 
markets in this manner does not make them Swap Dealers. Thus, the 
Commissions should clarify this language in order to (i) help more 
clearly define the universe of market participants that fall within the 
definition of Swap Dealer, and (ii) provide the legal and regulatory 
certainty required for market participants to rely in good faith on the 
General Exception.
b. In the Alternative, the Commissions Should Provide a Commodity-Based 
        Exception
    Given the shortcomings of the Commissions' proposed interpretation 
of ``as a part of a regular business,'' the Working Group recommends 
that the Commissions revise the proposed General Exception. In doing 
so, the Commissions should make it clear that swap transactions entered 
into for customary economic purposes relating to a market participant's 
primary underlying business as a producer, processor, commercial user, 
or merchant of a physical energy or agricultural commodity should not 
be considered part of an entity's ``regular business'' for purposes of 
the General Exception.
    To this end, the Working Group proposes the following revised 
definition of ``Exception'' for the Commissions' consideration:
  17 CFR 1.3(ppp)(2).\42\
---------------------------------------------------------------------------
    \42\ Note, proposed new language is underlined. See also Attachment 
A, attached hereto.
---------------------------------------------------------------------------
          Exception. The term ``swap dealer'' does not include a person 
        that enters into swaps for such person's own account, either 
        individually or in a fiduciary capacity, but not as a part of a 
        regular business.

                  (i) The following swap transactions shall not be 
                considered in determining a person's Regular Business:

                          (a) Swaps entered into by a producer, 
                        processor, or commercial user of, or a merchant 
                        handling a physical energy or agricultural 
                        commodity that are ancillary or as an incident 
                        to the person's business as a producer, 
                        processor, or commercial user of, or a merchant 
                        handling a physical energy or agricultural 
                        commodity.

                  (ii) ``Regular Business'' means a usual and 
                significant business activity of a person as measured 
                by, among other things, revenues, profits, volume, 
                value-at-risk, exposure and resources devoted to the 
                business.
2. De Minimis Exemption
a. Proposed Alternative Approach to the De Minimis Exemption
    The Commissions' interpretation of the de minimis exemption 
suggests that if an entity fails to satisfy the de minimis criteria 
proposed by the Commissions, such entity would be deemed a Swap Dealer. 
In this manner, the Commissions' proposed definition effectively 
establishes additional criteria by which to identify entities as Swap 
Dealers. Such an application of the exemption was not the intent of 
Congress. The Working Group believes Congress intended the de minimis 
exemption to apply to those Swap Dealers who engage in limited amounts 
of swap dealing or whose notional amount of exposure is small.
    Further, the Working Group recognizes the widely accepted reports 
that at least 92% of the total value of the notional amounts of the 
outstanding OTC swaps is held by the 25 largest bank holding 
companies.\43\ Such entities are Swap Dealers and should be covered by 
the Proposed Rule. The de minimis exemption should therefore be crafted 
to distinguish the remaining notional exposure in the entire U.S. swap 
market. The Commissions' proposed de minimis definition does not 
accomplish this objective.
---------------------------------------------------------------------------
    \43\ See Public Hearing to Review Implementation of Title VII of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act: Hearing 
Before the House Committee on Agriculture, 112th Cong. (Feb. 10, 2011) 
(testimony of CFTC Chairman Gary Gensler explaining that the size of 
the U.S. swaps market is approximately $300 trillion and that ``the 
largest 25 bank holding companies currently have $277 trillion notional 
amount of swaps.''). Based on Chairman Gensler's figures, the largest 
25 bank holding companies control approximately 92 percent of the U.S. 
swaps market. See also ``Goldman Sachs, Morgan Stanley Would Be Least 
Affected by Swaps Proposal,'' Bloomberg News (June 23, 2010), available 
at http://www.bloomberg.com/news/2010-06-23/goldmansachs-morgan-
stanley-would-be-least-affected-by-swaps-proposal.html (concluding that 
the five major U.S. commercial banks and their subsidiaries held 97 
percent of the notional amount of outstanding derivatives in the fourth 
quarter of 2009).
---------------------------------------------------------------------------
    In this context, the Working Group offers the following alternative 
approach to the de minimis exemption:
  17 CFR 1.3(ppp)(4).\44\
---------------------------------------------------------------------------
    \44\ Note, proposed new language is underlined. See also Attachment 
A, attached hereto.
---------------------------------------------------------------------------
          De minimis exception.

                  (i) A person shall not be deemed to be a swap dealer 
                for any major category of swaps as a result of swap 
                dealing in connection with transactions with or on 
                behalf of its customers if the notional amount of the 
                swap positions connected with those activities did not 
                exceed one one-thousandth of one percent (.001%) of the 
                total notional amount of swaps in the United States. 
                The total notional amount of swaps in the United States 
                shall be determined by the Commission on an annual 
                calendar basis.
                  (ii) For purposes of this section, the measure of the 
                percent of the total notional amount of swaps in the 
                United States during a calendar quarter shall equal the 
                arithmetic mean at the close of each business day, 
                beginning the first business day of each calendar 
                quarter and continuing through the last business day of 
                that quarter.
                  (iii) A person that is not registered as a swap 
                dealer, and which does not qualify for the exception in 
                Section 1.3(ppp)(2) above, but which exceeds the 
                criterion in this section as a result of its swaps 
                dealing will not be deemed to be a swap dealer until 
                the earlier of the date on which it submits a complete 
                application for registration as a swap dealer or two 
                months after the end of the calendar quarter in which 
                it first exceeds this criterion. Notwithstanding the 
                previous sentence, if a person that is not registered 
                as a swap dealer meets the criteria in this section to 
                be a swap dealer but does not exceed the threshold in 
                (ii) by more than twenty percent in that quarter that 
                person will not be subject to the timing requirements 
                unless and until at the end of the next fiscal quarter 
                that person exceeds the criterion.\45\
---------------------------------------------------------------------------
    \45\ Please note that in comments on the definition of ``Major Swap 
Participant'' submitted contemporaneously with this comment letter, the 
Working Group recommends different registration timing for MSPs than 
the timing presented here for Swap Dealers (i.e., two consecutive 
quarters vs. two months after the end of the calendar quarter). In this 
comment letter, the Working Group maintains the CFTC's proposed Swap 
Dealer registration timing requirements in order to demonstrate the 
framework analysis.
---------------------------------------------------------------------------
                  (iv) A person that is deemed to be a swap dealer in 
                this section shall continue to be deemed a swap dealer 
                until such time that its swap positions in (i) do not 
                exceed the criterion for four consecutive quarters.

    The Working Group suggests the alternative language as it provides 
an appropriate threshold to identify swap dealing which is above a de 
minimis level. The Working Group respectfully submits that one one-
thousandth of one percent of the total notional amount of swaps in the 
U.S. is by definition a de minimis amount. Further, the calculation, as 
set forth above, mirrors the Commissions' proposal for determination of 
a MSP.
b. Rejection of a Relative Test for Applying the De Minimis Exemption 
        Is Not Based on Reasoned Decision-Making
    The Working Group has concerns with the Commissions' rejection of 
proposals to apply the de minimis exemption using a test that measures 
the size of an entity's customer-facing, dealing activities relative to 
the size its overall swap trading operations.\46\ As support for this 
decision, the Commissions take the view that the use of a ``relative 
test'' for applying the de minimis exemption would favor larger, more 
active traders over smaller, less active traders. Specifically, the 
Proposed Rule states that:
---------------------------------------------------------------------------
    \46\ Proposed Rule at 80180.

        Aside from the fact that the statute does not explicitly call 
        for a relative test, such an approach would lead to the result 
        that larger and more active companies, which presumably would 
        be more able to influence the swap markets, would be more 
        likely to qualify for the exemption than smaller and less 
        active companies. Also, a relative test would require a means 
        of measuring the person's dealing activities, but also would 
        require a means of measuring the larger scope of activities to 
        which its swap dealing or security-based swap dealing 
        activities are to be compared, thus introducing unnecessary 
        complexity to the exemption's application.\47\
---------------------------------------------------------------------------
    \47\ Id. (emphasis added).

    Notwithstanding the Commissions' position that the adoption of a 
relative test would favor companies with larger, more active swap 
trading operations, the Working Group contends that the rejection of 
such a test actually could competitively disadvantage such companies. 
Moreover, the basis for qualifying for the de minimis exemption appears 
to be fundamentally different from the basis for determining whether an 
entity is a trader and thus the Working Group requests that the 
Commissions reconsider a relative test.
    The statement in the Proposed Rule that use of a ``relative test'' 
would harm smaller companies with less active trading operations is 
flawed. Regardless of an entity's size, if a dominant portion of its 
overall trading activities involve customer-facing transactions and the 
entity otherwise meets the definition of ``Swap Dealer,'' then that 
entity's functional role in swap markets should be viewed as that of a 
``dealer.'' If the Commissions do not wish to impose the onerous 
prudential, business conduct, record-keeping and reporting requirements 
applicable to Swap Dealers on smaller companies with less active 
trading operations, then the Commissions should establish an exemption 
from such regulatory requirements, rather than exempting them from Swap 
Dealer status.
    In this context, the Working Group recommends the Commissions 
consider replacing the proposed mechanism to define the de minimis 
threshold with an approach that examines the ratio of a firm's 
``customer'' swaps notional amount (on a delta-equivalent basis) to 
total swaps notional amount (delta-equivalent), and excludes from the 
Swap Dealer definition any entity for which this ratio is less than 
25%.\48\ For banks subject to the Volcker rule, the value for the 
proposed metric should never be less than 0.5. This is the value of the 
metric in a world in which (1) the bank's customer deals do not provide 
any diversification of risk, (2) the bank hedges all of the risk from 
the customer deals with non-customer deals, and (3) the bank does no 
other non-customer deals because they would be prohibited by the 
Volcker rule. To the extent customer deals hedge each other and the 
bank hedges only the residual with non-customer deals, the metric will 
approach one (1.0). As a result, the proposed critical value of 0.25 
provides ample room to assure that entities properly viewed as swap 
dealers cannot resort to the de minimis exception.
---------------------------------------------------------------------------
    \48\ A definitional distinction that is critical for this 
alternative metric is that between ``customer'' and ``counterparty.'' 
This distinction is created by the statutory language--new CEA Section 
1a(49)(A)(iii) of the Swap Dealer definition refers to 
``counterparties,'' while the de minimis provision in Section 1a(49)(D) 
refers to ``customers.'' However, the statute itself provides no 
definitional guidance for this distinction. The concept of ``customer'' 
seems to imply some manner of relationship that extends beyond the bare 
terms of the particular transaction, as distinct from the relationship 
of mere trading counterparties, where two entities have met in the 
market place and transacted, each for its own reasons. One element 
suggestive of a ``customer'' relationship might be a concept of 
``solicitation,'' in the sense that a counterparty would be an entity's 
customer if such entity solicits the counterparty to do a transaction 
on the grounds that it will be beneficial to the counterparty. This 
``solicitation'' concept must be distinguished from a ``Request for 
Proposal'' or ``Request for Quote'' process, in which an entity 
solicits transactions, but for the purpose of benefiting the entity 
itself, rather than for the benefit of the solicited counterparty or 
counterparties. In addition, a counterparty would seem to be an 
entity's customer if such entity provided advice on the transaction 
that was material to the counterparty's decision to transact, or with 
whom.
---------------------------------------------------------------------------
c. The Proposed Aggregate Gross Notional Amount Is Unsupported and 
        Unduly Restrictive
    Should the Commissions forego adopting the Working Group's proposed 
alternative de minimis definition or a relative test and instead 
maintain their proposed framework, the Working Group submits that the 
proposed hard cap on aggregate notional amount of $100 million is 
unsupported and unduly restrictive. Indeed, under the Commissions' 
proposal, a non-dealer commercial firm or end-user that has, for 
example, four customer-facing swaps with an aggregate notional amount 
of over $100 million would be required to register as a Swap Dealer. 
Such a result is at odds with Congressional intent to regulate as Swap 
Dealers only those entities commonly understood to engage in dealing 
activity.
    The Commissions attempt to justify this cap with an unsupported 
assumption that the average amount of a small swap transaction is $5 
million.\49\ The Commissions, however, fail to set forth in the 
Proposed Rule the underlying data to support this claim, and thus the 
Commissions' decision to set the cap at $100 million lacks a proper 
evidentiary foundation.
---------------------------------------------------------------------------
    \49\ Proposed Rule at 80180. The Proposed Rule provides that ``[w]e 
understand that in general the notional size of a small swap or 
security-based swap is $5 million or less . . . .'' Id.
---------------------------------------------------------------------------
    In a further attempt to justify the $100 million notional amount 
threshold, the Commissions explain that:

        given the customer protection issues raised by swaps and 
        security-based swaps--including the risks that counterparties 
        may not fully appreciate when entering into swaps or 
        securities-based swaps--we believe that this notional amount 
        reflects a reasonable limit for identifying those entities that 
        engage in a de minimis level of dealing activity.\50\
---------------------------------------------------------------------------
    \50\ Id.

This rationale, however, does not hold up to closer scrutiny. The Act 
expressly prohibits unsophisticated parties from entering into 
inappropriate derivatives transactions by limiting the types of 
counterparties that can participate in those markets.\51\ As such, only 
eligible contract participants (``ECP'') are eligible to participate in 
off-facility swap transactions. Given that ECPs are sophisticated 
parties that fully appreciate the attendant risks involved when 
engaging in swaps in physical markets, the Commissions' assertion that 
such parties require ``customer protection'' is contrary to the market 
participant framework contemplated by Congress and established by the 
Act.
---------------------------------------------------------------------------
    \51\ See new CEA Section 2(e).
---------------------------------------------------------------------------
    Due to the current economic recession in the U.S., energy prices 
remain depressed compared to periods of strong and sustained economic 
growth. Consequently, commercial energy firms that presently meet the 
requirements of the de minimis exemption may no longer meet this 
exemption if the aggregate notional amount of their existing deals 
exceed the $100 million threshold simply due to rising energy prices. 
As such, the Commissions should increase the hard cap for aggregate 
notional amount of customer-facing transactions beyond the proposed 
$100 million threshold, or otherwise provide some form of flexibility 
to market participants. At a minimum, the Commissions should include in 
the final rule any data related to its determination that the average 
value of a small swap transaction is $5 million.
d. The Commissions Should Revisit the Scope and Application of the 
        Twenty Transaction Threshold
    Based on guidance in the Proposed Rule interpreting proposed CFTC 
Rule 1.3(ppp)(3) as covering different ``types, classes, and categories 
of swaps,'' \52\ the Working Group believes that the twenty transaction 
threshold of the de minimis exemption is grossly insufficient and 
should be significantly higher. To be sure, market participants 
exceeding the twenty transaction threshold, including non-dealer 
commercial firms and end-users, will be deemed Swap Dealers simply for 
transacting in swap markets for their customary business purposes. 
Certainly Congress did not intend for such a far-reaching result. In 
the absence of any supporting data from the Commissions, the Working 
Group is unable to contemplate any justification for this number and 
requests the Commissions to identify their reasoning. To the extent the 
Commissions do not have a reasonable basis, the Working Group requests 
the Commissions to develop a more appropriate transaction threshold 
based on empirical swap market data.
---------------------------------------------------------------------------
    \52\ Proposed Rule at 80182.
---------------------------------------------------------------------------
    Should the Commissions fail to significantly increase the proposed 
threshold in the final rule, the Working Group seeks clarification 
regarding the scope and application of the proposed threshold embedded 
in the de minimis exemption. In the energy context, it is not clear 
whether the twenty transaction threshold would apply to all energy 
commodities combined (i.e., energy swaps or metals swaps), or on a 
commodity-by-commodity basis (i.e., power swaps, natural gas swaps, 
silver swaps, etc.). If the Commissions apply the threshold to all 
energy commodities combined, a commercial energy firm that engaged in 
the following customer-facing swaps would be required to register as a 
Swap Dealer: (i) three customer-facing crude swaps, (ii) three fuel 
swaps, (iii) three heating oil swaps, (iv) three gasoline swaps, (v) 
three natural gas swaps, (vi) three natural gas liquids swaps, and 
(vii) two power swaps. Such a result is clearly not intended by 
Congress, as numerous commercial energy firms will surpass the twenty 
transaction threshold simply by engaging in swaps for customary 
business activities, unrelated to any dealing activity whatsoever. At a 
minimum, therefore, the Commissions should apply the threshold on a 
commodity-by-commodity basis.
E. The Proposed Limited Designation Requirement Creates a Presumption 
        Contrary to the Statute
    The Commissions' proposed limited designation requirement creates a 
presumption that a person who is a Swap Dealer ``shall be deemed to be 
a swap dealer with respect to each swap it enters into regardless of 
the category of the swap or the person's activities in connection with 
the swap.'' \53\ Accordingly, the CFTC intends to view an entity deemed 
a Swap Dealer for one category of swaps to be deemed a Swap Dealer for 
all other activities, unless and until such entity seeks and obtains 
CFTC approval that its Swap Dealer designation should be limited to 
certain activities.
---------------------------------------------------------------------------
    \53\ Proposed CFTC Rule 1.3(ppp)(3).
---------------------------------------------------------------------------
    This presumption, however, is contrary to the express statutory 
language of the Act, which provides that:

        A person may be designated as a swap dealer for a single type 
        or single class or category of swap activities and considered 
        not to be a swap dealer for other types, classes, or categories 
        of swaps or activities.\54\
---------------------------------------------------------------------------
    \54\ New CEA Section 1a(49)(B).

The statute expressly presumes that an entity may be deemed a Swap 
Dealer for some activities without being considered a Swap Dealer for 
other activities, thus creating a presumption in favor of the market 
participant, meaning an entity deemed to be a Swap Dealer for a swap or 
category of swaps should be presumed to be a Swap Dealer only for that 
particular activity. The Commissions have effectively flipped the 
statute on its head, establishing a presumption in direct contrast to 
the express statutory language. As such, the Working Group respectfully 
requests the Commissions to abandon proposed CFTC Rule 1.3(ppp)(3) or, 
alternatively, to revise the rule to reflect the fact that entities 
designated as a Swap Dealer for one category of swaps shall not be 
deemed a Swap Dealer or any other financial entity (as defined under 
CEA 2(h)(7)(C)) for other swaps.
F. Additional Issues Requiring Clarification With Respect to the 
        Proposed Definition of Swap Dealer
1. Issues Related to Affiliate Transactions
    The Commissions invite comment with respect to how the Swap Dealer 
definition should be applied to swaps executed between members of an 
affiliated group. The Working Group generally supports the approach 
taken by the Commissions with respect to affiliate transactions, 
particularly the Commissions' recognition that transactions between 
affiliates are used for risk management purposes and that swaps between 
affiliates ``may not involve the interaction with unaffiliated persons 
that we believe is a hallmark of the elements of the definitions that 
refer to holding oneself out as a dealer or being commonly known as a 
dealer.'' \55\
---------------------------------------------------------------------------
    \55\ Proposed Rule at 80183.
---------------------------------------------------------------------------
    However, given that transactions between affiliates are used for 
the ``allocation of risk within a corporate group,'' the Working Group 
requests the Commissions to clarify that in no case shall any 
transactions between corporate affiliates be considered dealing 
activity for purposes of determining whether an entity is a Swap 
Dealer, including application of the de minimis criteria. As noted by 
the Commissions, inter-affiliate transactions do not carry any of the 
elements of dealing activity given that the transactions are used to 
manage and allocate risk within a holding company system or other 
organizational structure.
2. Safe Harbor for Good Faith Efforts To Comply With the Proposed Rule
    The Proposed Rule's requirement that market participants self-
select whether registration as a Swap Dealer is required raises 
significant compliance risks. Consequently, the Commissions should seek 
to facilitate compliance with the Proposed Rule and work with industry 
members as the definition of Swap Dealer becomes effective. Market 
participants that exercise due diligence and make good faith efforts to 
determine whether registration is required, but do not register, should 
not be subject to enforcement action. Thus, the CFTC should enhance 
relevant guidance, including the No Action Letter process, for 
providing comfort to market participants that enforcement would not be 
recommended under specific fact-based scenarios.
G. The Commission's Cost-Benefit Analysis Is Insufficient and 
        Inconsistent With Anticipated Compliance Costs
    Section 15(a) of the CEA requires the CFTC, before promulgating a 
rule, to ``consider the costs and benefits of the action of the 
Commission.'' \56\ As a general matter, the cost and benefit analysis 
specific to regulations regarding Swap Dealers does not appear to be 
based on any empirical data and does not appear to be consistent with 
the expected costs of compliance anticipated by market 
participants.\57\ In particular, the Swap Dealer cost-benefit analysis 
does not evaluate the costs to be imposed on the numerous additional 
market participants likely to be swept into the Swap Dealer category as 
a result of the overly broad definition of Swap Dealer proposed by the 
Commissions.
---------------------------------------------------------------------------
    \56\ 7 U.S.C.  19(a).
    \57\ Proposed Rule at 80204.
---------------------------------------------------------------------------
    If these market participants choose to exit the swap markets rather 
than absorb the costs of potential regulation as a Swap Dealer, such 
departures will adversely impact liquidity as remaining swap 
transactions become concentrated in a smaller number of market 
participants, notably financial institutions. Accordingly, the 
Commissions should perform a liquidity cost analysis that assesses the 
probability and impacts of such a result. Such an analysis also should 
consider the number of non-dealer market participants expected to be 
designated as Swap Dealers simply for exceeding the low thresholds set 
forth in the Commissions' proposed de minimis framework.
    The Working Group therefore requests that the Commissions (i) 
consider the costs and benefits associated with the Proposed Rule in 
the manner prescribed by CEA Section 15(a), (ii) issue a supplemental 
rule in this proceeding setting forth empirical data supporting its 
conclusions regarding the costs and benefits of the Proposed Rule, and 
(iii) notice the supplemental rule in the Federal Register for public 
comment.
IV. Conclusion
    The Working Group supports appropriate regulation that brings 
transparency and stability to the energy swap markets in the United 
States. The Working Group appreciates this opportunity to comment and 
respectfully requests that the Commission consider the comments set 
forth herein as it develops a final rule in this proceeding. If you 
have any questions, please contact the undersigned.
            Respectfully submitted,

Mark W. Menezes;
R. Michael Sweeney, Jr.;
David T. McIndoe;
Counsel for the Working Group of Commercial Energy Firms.
                              attachment a
Proposed Revised Definition of Swap Dealer
17 CFR 1.3(ppp) Swap Dealer.\1\
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    \1\ Please note that the underscored text reflects the Working 
Group's proposed revisions.
---------------------------------------------------------------------------
    (1) In general. The term ``swap dealer'' means any person who:

          (i) Holds itself out as a dealer in swaps;
          (ii) Makes a market in swaps;
          ``Makes a market'' means regularly providing two-sided 
        pricing:

                  (a) for a particular swap for execution for a 
                person's own account; or
                  (b) pursuant to a contractual obligation.

          (iii) Regularly enters into swaps with counterparties as an 
        ordinary course of business for its own account; or
          (iv) Engages in any activity causing it to be commonly known 
        in the trade as a dealer or market maker in swaps.

provided, however, that an entity shall not be considered to be a swap 
dealer to the extent that it offers to enter into, or enters into, a 
swap:

                  (a) to hedge or mitigate commercial risk; \2\
---------------------------------------------------------------------------
    \2\ The phrase ``hedge or mitigate commercial risk'' could 
ultimately be tied to proposed CFTC Rule 1.3(ttt), but only if the 
Commissions adopt the framework recommended by the Working Group with 
respect to proposed CFTC Rule 1.3(ttt) in comments submitted 
contemporaneously with this comment letter on the Commissions' proposed 
definitions of ``Major Swap Participant'' and ``End-User.''
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                  (b) for the purpose of benefiting from future changes 
                in the commodity reference price (i.e., the price to 
                which the floating leg of a swap is indexed);
                  (c) on a designated contract market or swap execution 
                facility, unless such entity is making a market in that 
                swap;
                  (d) that is a physical option that includes the 
                obligation to deliver or receive a commodity if the 
                option is exercised; or
                  (e) to provide two-sided pricing in a market of 
                limited or episodic liquidity for the purpose of:

                          (I) discovering a price for the swap or the 
                        underlying commodity, or
                          (II) eliciting bids and offers for the swap 
                        from other market participants.

    (2) Exception. The term ``swap dealer'' does not include a person 
that enters into swaps for such person's own account, either 
individually or in a fiduciary capacity, but not as a part of a regular 
business.

          (i) The following swap transactions shall not be considered 
        in determining a person's Regular Business:

                  Swaps entered into by a producer, processor, or 
                commercial user of, or a merchant handling a physical 
                energy or agricultural commodity that are ancillary or 
                as an incident to the person's business as a producer, 
                processor, or commercial user of, or a merchant 
                handling a physical energy or agricultural commodity.

          (ii) ``Regular Business'' means a usual and significant 
        business activity of a person as measured by, among other 
        things, revenues, profits, volume, value-at-risk, exposure and 
        resources devoted to the business.

    (3) Scope. [No proposed changes.]
    (4) De minimis exception.

          (i) A person shall not be deemed to be a swap dealer for any 
        major category of swaps as a result of swap dealing activity in 
        connection with transactions with or on behalf of its customers 
        if the notional amount of the swap positions connected with 
        those activities did not exceed one one-thousandth of one 
        percent (.001%) of the total notional amount of swaps in the 
        United States. The total notional amount of swaps in the United 
        States shall be determined by the Commission on an annual 
        calendar basis.
          (ii) For purposes of this section, the measure of the percent 
        of the total notional amount of swaps in the United States 
        during a calendar quarter shall equal the arithmetic mean at 
        the close of each business day, beginning the first business 
        day of each calendar quarter and continuing through the last 
        business day of that quarter.
          (iii) A person that is not registered as a swap dealer, and 
        which does not qualify for the exception in Section 1.3(ppp)(2) 
        above, but which exceeds the criterion in this section as a 
        result of its swap dealing activity will not be deemed to be a 
        swap dealer until the earlier of the date on which it submits a 
        complete application for registration as a swap dealer or two 
        months after the end of the calendar quarter in which it first 
        exceeds this criterion. Notwithstanding the previous sentence, 
        if a person that is not registered as a swap dealer meets the 
        criteria in this section to be a swap dealer but does not 
        exceed the threshold in (ii) by more than twenty percent in 
        that quarter that person will not be subject to the timing 
        requirements unless and until at the end of the next fiscal 
        quarter that person exceeds the criterion.\3\
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    \3\ In comments on the definition of ``Major Swap Participant'' 
submitted contemporaneously with this comment letter, the Working Group 
recommends different registration timing for MSPs than the timing 
presented here for Swap Dealers (i.e., two consecutive quarters vs. two 
months after the end of the calendar quarter). In this comment letter, 
the Working Group maintains the CFTC's proposed Swap Dealer 
registration timing requirements in order to demonstrate the framework 
analysis.
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          (iv) A person that is deemed to be a swap dealer in this 
        section shall continue to be deemed a swap dealer until such 
        time that its swap positions in (i) do not exceed the criterion 
        for four consecutive quarters.
                                 ______
                                 
March 22, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Rulemaking under Title VII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act.

    Dear Secretary Stawick:

    On behalf of the Working Group of Commercial Energy Firms (the 
``Working Group''), Hunton & Williams LLP respectfully submits this 
letter to the Commodity Futures Trading Commission (the ``Commission'') 
to offer certain observations regarding the approach by which the 
Commission might implement regulations under Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank 
Act'').\1\
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    \1\ This letter sets out general observations about the 
Commission's rulemaking process to date. The Working Group intends to 
submit a separate letter on the topic of sequencing the final rules and 
their implementation.
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    The Working Group is a diverse group of commercial firms in the 
energy industry whose primary business activity is the physical 
delivery of one or more energy commodities to others, including 
industrial, commercial and residential consumers. Members of the 
Working Group are energy producers, marketers and utilities. The 
Working Group considers and responds to requests for public comment 
regarding regulatory and legislative developments with respect to the 
trading of energy commodities, including derivatives and other 
contracts that reference energy commodities.
    Because the Commission has not finalized the regulatory definition 
of the terms such as ``swap dealer,'' ``major swap participant'' and 
``swap,'' members of the Working Group have commented on proposed 
rulemakings applicable to swap dealers and major swap participants and 
offer their thoughts contained herein on requirements imposed on ``swap 
dealers'' and ``major swap participants.'' While members of the Working 
Group have never considered themselves, or been viewed by others as 
swap dealers or major swap participants, they are concerned with the 
breadth and vagueness of the proposed rules and, thus, have commented 
on proposed rules imposing obligations on swap dealers and major swap 
participants.
I. Comments of the Working Group
    Title VII of the Dodd-Frank Act places a substantial burden on the 
Commission. The Commission is tasked with constructing a new regulatory 
regime for swap markets based on the contours set forth in the Dodd-
Frank Act. It is charged with completing this monumental task in less 
than a year with limited resources. The Commission must balance the 
timing requirements set forth by Congress with the need to construct 
rules that (1) accomplish the goals of the Dodd-Frank Act, (2) are 
enforceable by the Commission and (3) cause the least disruption in, 
and impose the lowest possible costs on swap markets.\2\ The Working 
Group respectfully submits this letter to assist the Commission in 
satisfying these three goals.
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    \2\ Satisfying these three goals would not only fulfill the 
Commission's obligation under Section 15(a) of the Commodity Exchange 
Act (``CEA'') to consider and evaluate the costs and benefits of a 
proposed rule, but it would also adhere to the intent of President 
Obama's Executive Order on Improving Regulation and Regulatory Review. 
Exec. Order No. 13563, 76 Fed. Reg. 3821 (January 18, 2011) (the 
``Executive Order''). The Working Group acknowledges, that as an 
independent agency, the Commission is not subject to the Executive 
Order. However, the Working Group encourages the Commission to adhere 
to President Obama's intent.
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A. Market Analysis
    As a threshold matter, when proposing a rule, the Commission should 
conduct a careful analysis of the markets and market participants to 
which the rule will apply. Without a comprehensive understanding of the 
relevant market and its participants, the Commission will be unable to 
ensure that such proposed rule will meet the three goals set forth 
above. Further, analysis of the relevant market and its participants is 
necessary to satisfy the Commission's cost benefit obligations under 
Section 15(a) of the CEA. Such analysis is warranted particularly for 
swap markets that traditionally have not been regulated pervasively by 
the Commission, such as the energy swap markets.
    The current approach taken by the Commission to the regulation of 
swap markets does not appear to have the benefit of such careful market 
analysis. For example, as Chairman Gensler has stated repeatedly, over 
$277 trillion in notional amount of domestic swaps are held by 25 bank 
holding companies.\3\ Said another way, those 25 bank holding companies 
are party to 91-99% of domestic swaps. Despite these compelling 
statistics, the proposed definition of ``swap dealer'' appears to be 
based on the premise that the universe of swap dealers extends far 
beyond this group of financial institutions.\4\ Drafting the definition 
of ``swap dealer'' in a manner that captures entities far beyond these 
25 bank holding companies will have serious implications for swap 
markets. As noted above, in crafting rules, the Commission must take 
into account the costs of regulation. In this instance, the Commission 
must weigh (a) the costs of extending the comprehensive regulation 
imposed on swap dealers to entities beyond the 25 bank holding 
companies against (b) the potential benefits of this additional 
regulation. If the Commission extends the definition of ``swap dealer'' 
beyond such bank holding companies, it will impose substantial 
additional costs on consumers and the overall swap markets, while 
providing little or no benefit to the economy. Further, extending the 
designation of swap dealers beyond these core bank holding companies 
will not further the underlying intent of the Dodd-Frank Act.
---------------------------------------------------------------------------
    \3\ See, Public Hearing to Review Implementation of Title VII of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act, 112th 
Cong. (Feb. 10, 2011) (statement of Hon. Gary Gensler, Chairman, CFTC). 
Chairman Gensler stated that, based on OCC estimates, the largest 25 
bank holding companies held $277 trillion in notional amount of swaps 
and that the domestic swap market was approximately seven times larger 
than the $40 trillion futures market. Based on those figures, the 25 
largest bank holding companies would hold 99% of the domestic swap 
market. See also, Chairman Gensler's Budget Transmission Letter (Feb. 
14, 2011). Chairman Gensler stated that, based on OCC estimates, the 
largest 25 bank holding companies held $277 trillion in notional amount 
of swaps and that some estimates placed the size of the U.S. swap 
market at ``as big as $300 trillion.'' Based on those figures, the 25 
largest bank holding companies would hold 91% of the domestic swap 
market.
    \4\ See, Gary Gensler, Chairman, CFTC, Remarks Before ISDA Regional 
Conference (Sept. 16, 2010). Chairman Gensler stated ``initial 
estimates are that there could be in excess of 200 entities that will 
seek to register as swap dealers.''
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B. The Commission Should Continue Its Principles-Based Approach
1. The Dodd-Frank Act Generally Allows the Commission To Adopt 
        Principles-Based Regulations
    The Commission has an established history of effective oversight 
through a principles-based approach to regulation. The Working Group 
believes that the Commission should remain squarely within this 
tradition. This tradition results in clear statements of the goals and 
requirements of regulation and is based upon the market participants' 
deep experience and knowledge of the swap markets to create efficient 
compliance solutions. It also reduces the burden on the Commission to 
craft and monitor compliance with granular criteria.
    While the Dodd-Frank Act is prescriptive in many of the 
requirements that it imposes,\5\ many of the rules proposed by the 
Commission have been prescriptive when the Dodd-Frank Act allows the 
Commission ample latitude to craft rules consistent with a principles-
based approach. For example, Section 731 of the Dodd-Frank Act requires 
the Commission to set basic duties of, and business conduct standards 
for, swap dealers and major swap participants, including disclosure of 
material risks associated with swaps and having processes in place to 
ensure compliance with position limits. However, the rules proposed by 
the Commission to implement such duties and business conduct standards 
go well beyond setting a general compliance, risk management, and 
disclosure framework for swap dealers and major swap participants. The 
Proposed Rule on Duties of Swap Dealers and Major Swap Participants 
would codify a set of detailed aspirational ``best practices,'' 
arguably appropriate only as guidance for financial entities, as legal 
requirements for all swap dealers and major swap participants. The 
Proposed Rule on Business Conduct Standards for Swap Dealer and Major 
Swap Participants with Counterparties would impose a suitability 
standard on swap dealers and major swap participants and also seeks to 
codify a set of detailed aspirational ``best practices'' intended as 
guidance for financial entities as legal requirements for all swap 
dealers and major swap participants.\6\
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    \5\ See, for example, the requirement in Section 731 of the Dodd-
Frank Act for swap dealers and major swap participants to provide daily 
marks to counterparties on uncleared swaps.
    \6\ See Notice of Proposed Rulemaking on Business Conduct Standards 
for Swap Dealer and Major Swap Participants with Counterparties 75 Fed 
Reg. 81519 (Dec. 28, 2010), notes 47, 50, 52. The ``best practices'' 
upon which the Commission relies on in certain circumstances are the 
work of the Counterparty Risk Management Policy Group, which was 
comprised almost entirely of representatives from the largest banks.
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    In these two rulemakings, among others, the Commission has taken an 
unnecessary prescriptive approach. This approach will not result in 
market participants taking the proper approach to compliance, i.e., 
developing an organic ``culture of compliance'' within the company to 
constantly improve compliance as markets evolve and react to 
conditions. A prescriptive approach limits the judgment of entities and 
their personnel to essentially binary decisions, and, thus, leads to 
robotic compliance practices that seek only to assure compliance with 
the letter of the Commission's regulations and not the intent. Under 
such prescriptive approach, market participants might know what they 
can and cannot do but will not fully understand the policy behind the 
rules.
2. Overly Prescriptive Rules Will Limit Participation in Swap Markets
    Adopting prescriptive rules for all market participants based on 
aspirational ``best practices'' for financial entities will limit 
competition in swap markets. Markets function best when there is a 
large and diverse group of participants. This is particularly true in 
the energy swap markets, where many large commercial energy firms are 
active traders. This activity brings liquidity to the markets, and it 
also helps disperse counterparty credit risk. As drafted, many of the 
proposed rules might not be workable for non-financial swap market 
participants and, even if they prove workable, they would likely impose 
substantial costs on such market participants.
    A prescriptive approach to rulemaking might lead to a perverse 
result of promoting the further concentration of market activity and 
risk in certain swap markets to institutions that are ``too big to 
fail.'' The consequence of being a swap dealer or a major swap 
participant for a non-financial entity, such as a commercial energy 
firm, is that it will be regulated as a financial entity. Accordingly, 
depending on the scope and compliance burden imposed under the final 
regulations, it is possible that non-financial entities will decrease 
or discontinue their participation in swap markets.
    Only entities that can structure their businesses to meet the 
prescriptive requirements included in many of the Commission's proposed 
rules will have the ability to be central players in markets. The 
burdens of regulatory compliance as a swap dealer or major swap 
participant effectively will become a substantial barrier to entry to 
those non-financial entities looking to become active, sophisticated 
traders in swap markets. Non-financial entities that are currently 
active market participants will have to reevaluate their activity in 
the swap markets. Some may continue as major market participants. 
Others may not. In such cases, the relative role of financial firms in 
the operation of the swaps market will increase and, as other entities 
leave the market, liquidity will likely decrease and volatility will 
increase.
    This concern is especially relevant in swap markets that currently 
rely on non-dealer market participants for a substantial amount of 
transaction volume. In energy swap markets, many parties trade directly 
without the involvement of a swap dealer or other intermediary. An 
overly broad definition of ``swap dealer'' or rules that force all 
energy swaps to be done through swap dealers or other intermediaries 
likely will harm an otherwise mature and efficient market. Swaps 
between commercial energy firms where neither party plays the role of a 
dealer bring cost savings to the market and energy consumers, valuable 
liquidity to the market and help disperse credit risk among a wide 
number of market participants that are generally outside the core of 
the U.S. financial system. Without certainty that they will not be 
regulated like financial entities, commercial energy firms will be 
reluctant to enter into swaps with each other. The end result will be a 
market dominated by financial firms that are ``too big to fail,'' a 
loss of liquidity, a possible increase in consumer energy prices and a 
loss of market expertise.
C. Elective Rule Makings
    As noted above, by requiring the Commission to issue numerous 
rulemakings in a short period of time, the Dodd-Frank Act tasks the 
Commission with a substantial undertaking. Given these mandatory 
obligations, the Working Group advises the Commission to postpone the 
consideration of any proposed rules not explicitly required by the 
Dodd-Frank Act (``Elective Rulemakings'') until all of the required 
rulemakings have been completed, and more importantly, until the 
effects of the required rulemakings on swap markets are known.\7\
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    \7\ Elective Rulemakings include, but are not limited to, proposed 
rules on portfolio compression, portfolio reconciliation, the 
suitability standard for non-swap dealer and non-major swap participant 
counterparties and the provision of scenario analysis.
---------------------------------------------------------------------------
    Delaying the consideration of the Elective Rulemakings would have 
multiple advantages. First, delaying these rulemakings will allow the 
Commission and market participants to dedicate their limited resources 
to only those undertakings required by Congress. Second, by waiting 
until the regulatory paradigm set forth by Title VII of the Dodd-Frank 
Act is in place, the Commission can determine if the Elective 
Rulemakings are in fact necessary. Third, if the Commission finds that 
the Elective Rulemakings are necessary, the delay will enable the 
Commission to focus on the Elective Rulemakings. Delay and subsequent 
consideration will ensure that the Elective Rulemakings further the 
intent of the Dodd-Frank Act, will work in swap markets, and will 
accomplish the desired result without imposing undue burdens on the 
Commission and swap market participants. In this light, the Working 
Group respectfully requests that the Commission postpone all Elective 
Rulemakings until the entire mandatory Dodd-Frank Act regulatory 
paradigm is in place.
D. Working Group Recommendations
    In light of the difficulties that the Commission faces in creating 
rules that (1) accomplish the goals of the Dodd-Frank Act, (2) are 
workable for the Commission and market participants and (3) accomplish 
these two goals while limiting the negative impacts on swap markets, 
the Working Group has the following three suggestions.
    First, the Working Group suggests that the Commission limit the 
scope of the definition of ``swap dealer'' in a manner that captures 
only those 25 bank holding companies that hold over 90% of the notional 
value of domestic swaps.\8\ Doing so will accomplish the intent of the 
Dodd-Frank Act in that it will capture the overwhelming majority of the 
U.S. swap market and will do so in a manner that limits the costs to 
market participants. Adopting such a definition will allow the 
Commission to focus its limited resources on a small number of market 
participants and will allow traders who are not thought of by the 
market as swap dealers to remain active market participants. Setting a 
definition of swap dealer that captures the remaining minimal 
percentage of the market will impose substantial marginal costs on the 
Commission and on the many market participants that will be captured. 
Therefore, to do so, the Commission should determine that there is a 
compelling benefit to the market that outweighs the additional costs.
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    \8\ The Working Group is not suggesting that the definition of 
``swap dealer'' be constructed to capture these 25 bank holding 
companies because they are large bank holding companies. The definition 
should focus on the role played in the market by potential ``swap 
dealers'' and should be calibrated to capture these 25 bank holding 
companies because they are party to a vast majority of domestic swaps. 
The Commission, of course, has the authority to expand the definition 
if it is necessary with regards to the post-Dodd-Frank Act market 
structure.
---------------------------------------------------------------------------
    Second, where possible, the Commission should retain its 
traditional principles-based approach to regulation. The Dodd-Frank Act 
is prescriptive in some specific areas, but it generally does not limit 
the Commission's ability to write rules that provide discretion to 
market participants to design and implement compliance measures. Such 
adaptability is necessary to allow a diverse community of active 
traders to remain in swap markets so that such markets remain liquid 
and well functioning. Permissive rules will allow market participants 
to put in place compliance and risk management infrastructure that is 
most efficient for their individual circumstances. Issuing permissive 
rules will also allow the Commission to easily adapt such rules to 
changing market conditions. Said differently, prescriptive rules will 
likely be too rigid to adapt to changing market conditions, and it is 
probable that the Commission will have to reissue such rules to account 
for such changes. Finally, if the Commission issues permissive rules, 
it will allow market participants to approach compliance from a 
holistic perspective. Market participants will be able to construct 
compliance and risk management programs that encourage self-governing 
and self-reporting and create a culture of compliance rather than the 
``check-the-box'' approach that is the logical outgrowth of 
prescriptive rules.
    If the Commission elects to retain its traditional principles-based 
approach, the Working Group respectfully submits that the Commission 
develop a formal policy statement with respect to compliance under the 
rules it proposes under the Dodd-Frank Act. The statement should 
identify the policy objectives for the overall regulatory effort, the 
proper design of regulations to support those policy objectives and the 
factors by which the Commission will determine if its proposed 
regulations adhere to Congress' intent. This statement would be the 
``blueprint'' for effective regulation of swap dealers and major swap 
participants. Adopting a policy statement will send a clear message to 
market participants of the Commission's policy goals and expectations, 
which will facilitate regulatory certainty as well as uniform and 
orderly enforcement of the existing and new rules and regulations 
adopted by the Commission.\9\
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    \9\ There is a good amount of academic writing supporting the 
Working Group's suggestion for an integrated, principles-based 
regulatory paradigm. See, John S. Moot: Compliance Programs, Penalty 
Mitigation and the FERC, 29 Energy Law Journal 547 (2008); Donald C. 
Langevoort, Monitoring: The Behavioral Economics of Corporate 
Compliance with Law, 2002 Colum. Bus. L. Rev. 71 (2002); Kimberly D. 
Krawiec, Corporate Decisionmaking: Organizational Misconduct: Beyond 
the Principal-Agent Model, 32 Fla. St. L. Rev. 571 (2005); and Jennifer 
Arlen and Reinier Kraakman, Controlling Corporate Misconduct: An 
Analysis of Corporate Liability Regimes, 72 N.Y.U.L. Rev. 687 (1997).
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    Third, the Working Group respectfully suggests that the Commission 
prioritize drafting sound and functional regulations over promulgating 
rules within a certain time period. Rulemaking should be a deliberate, 
methodical and iterative process. If the Commission, in its attempt to 
satisfy Congressionally mandated deadlines, issues rules that leave 
significant legal uncertainty, are unworkable or impose substantial 
unnecessary costs on swap markets, then it is likely that the 
Commission will have to revisit a number of rulemakings. If this is the 
case, not only would the Commission have to expend additional resources 
to do so, but swap markets will be confronted with an extended period 
of legal uncertainty.
    Thankfully, Congress provided the Commission with two tools with 
which it can take the time necessary to draft regulations that (1) 
accomplish the goals of the Dodd-Frank Act, (2) are enforceable by the 
Commission and (3) satisfy these latter two goals while causing the 
least disruption in and imposing the lowest possible costs on swap 
markets, without departing significantly from the timing requirements 
set forth in Title VII of the Dodd-Frank Act.
    Section 754 of the Dodd-Frank Act provides ``the provisions of this 
subtitle shall take effect on the later of 360 days after the date of 
the enactment of this subtitle or, to the extent a provision of this 
subtitle requires a rulemaking, not less than 60 days after the 
publication of the final rule or regulation implementing such 
provisions of this subtitle.'' Section 754 would allow the Commission 
to delay the effective date of any final rule promulgated under Title 
VII of the Dodd-Frank Act until the Commission determines the market is 
ready to comply. In addition, Section 723 of the Dodd-Frank Act grants 
the Commission the authority to allow market participants to remain 
subject to current Section 2(h) of the CEA for up to a year after the 
Dodd-Frank Act becomes effective.\10\ The Working Group respectfully 
submits that by using the authority granted to it under Sections 754 or 
723 of the Dodd-Frank Act, the Commission can take the time necessary 
to construct sound rules without violating Congress' required time 
frame.
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    \10\ If the Commission elects to use the 2(h) extension in Section 
723 to help phase in Title VII of the Dodd-Frank Act's compliance 
requirements, it is possible that the implementation dates for certain 
rules will be extended beyond the maximum one year 2(h) extension 
period. In such an event, the Working Group suggests that the 
Commission use its existing statutory authority to address any gaps in 
the regulatory treatment of swaps and swap market participants.
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II. Conclusion
    The Working Group supports tailored regulation that brings 
transparency and stability to the swap markets in the United States. We 
appreciate the balance the Commission must strike between effective 
regulation and not hindering the uncleared energy-based swap markets. 
The Working Group offers its advice and experience to assist the 
Commission in implementing the Act. Please let us know if you have any 
questions or would like additional information.
            Respectfully submitted,

David T. McIndoe;
R. Michael Sweeney, Jr.;
Mark W. Menezes;
Alexander S. Holtan;
Counsel for the Working Group of Commercial Energy Firms.
                                 ______
                                 
March 23, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Sequencing of Release of Final Rules under the Dodd-Frank Act

    Dear Secretary Stawick:

    On behalf of the Working Group of Commercial Energy Firms (the 
``Working Group''), Hunton & Williams LLP respectfully submits this 
letter regarding the order in which the Commodity Futures Trading 
Commission (the ``Commission'') might issue final rules under the Dodd-
Frank Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank 
Act''). The Working Group appreciates the opportunity to share its 
views with the Commission.
    The Working Group is a diverse group of commercial firms in the 
energy industry whose primary business activity is the physical 
delivery of one or more energy commodities to others, including 
industrial, commercial and residential consumers. Members of the 
Working Group are energy producers, marketers and utilities. The 
Working Group considers and responds to requests for public comment 
regarding regulatory and legislative developments with respect to the 
trading of energy commodities, including derivatives and other 
contracts that reference energy commodities.
    In developing the suggestions contained herein, the Working Group 
has focused on what it believes are the best interests of the swap 
markets, the Commission, other regulators, market participants, and the 
U.S. economy. The suggestions are based on the Working Group's 
experience in the energy markets, but can be applied to all swap 
markets. The ideas expressed herein are not intended to promote the 
interests of any one group. We firmly believe that the well-being of 
any market participant benefits the swap markets as a whole.
I. General Comments
    The Working Group fully supports the Commission's focus on the 
sequencing of its rules under Title VII of the Dodd-Frank Act and the 
solicitation of input from market participants. A considered approach 
to the release of the final rules will greatly assist the transition of 
many market participants to the new regulatory paradigm, particularly 
for participants in swap markets such as the energy swaps market that 
the Commission largely has not regulated previously. If the Commission 
releases final rules, sets effective dates and sets implementation 
dates in a logical manner, market participants will have a meaningful 
opportunity to review such rules, evaluate their compliance obligations 
under such rules, and design and implement measures to meet such 
obligations in a reasonably efficient manner.\1\
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    \1\ The use of different effective dates (the date on which a rule 
becomes effective) and implementation dates (the date on which market 
participants must comply with the relevant rule) will allow the 
Commission to gradually phase-in the regulatory requirements imposed by 
Title VII of the Dodd-Frank Act while providing the market with 
regulatory certainty as to regulatory obligations.
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    The Working Group urges the Commission to not sacrifice sound 
reasoning for expediency and to take the time necessary to implement 
Title VII of the Dodd-Frank Act properly.\2\ The Working Group 
recommends the Commission not release rules under title VII of the 
Dodd-Frank Act before such rules, taken in related subject matter 
groups, are fully developed. The market place is far better served if 
the Commission considers all of the final rules in a comprehensive and 
organized fashion. Doing so promotes consistency in terms and the 
overall design across the rules. Thus far, the rulemaking process has 
occurred piecemeal and not in a logical order, creating significant 
uncertainty in swap markets. A significant challenge in commenting on 
the rules proposed thus far is the impossibility for any market 
participant to understand how all of the rules fit together.\3\ It will 
be substantially burdensome and costly if market participants must 
design and implement regulatory compliance and risk management programs 
without knowing all of the requirements of the Commission's regulations 
issued under the Dodd-Frank Act. The burden and cost are amplified as 
market participants face compliance deadlines that are too close in 
time.
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    \2\ A similar request was made by Senator Stabenow, Chairman of the 
Senate Committee on Agriculture, Nutrition and Forestry. Senator 
Stabenow stated ``We must consider how new rules will fit together in a 
way that makes sense for the markets; whether that is phasing-in 
implementation or carefully sequencing the rules, . . . We must make 
sure the market infrastructure is in place, the technology is ready, 
and that market participants are able to meet the requirements of this 
law. The new accountability and transparency we have created is clearly 
in the public interest and the most important thing is to get it right, 
not do it quickly.'' Implementation of Title VII of the Wall Street 
Reform and Consumer Protection Act, Senate Committee on Agriculture, 
Nutrition and Forestry, 112th Cong. (Mar. 3, 2011) (statement of 
Senator Stabenow).
    \3\ The Working Group also is concerned that the proposed rules 
released to date mandate requirements that do not work well together. 
For example, in the proposed rule on Swap Trading Relationship 
Documentation Requirements for Swap Dealers and Major Swap Participants 
(76 Fed. Reg. 6715 (Feb. 8, 2011)), all documentation must be completed 
before or contemporaneous with trade execution, including the 
confirmation. (Proposed CFTC Rule  23.504). However, in the proposed 
rule on Confirmation, Portfolio Reconciliation and Portfolio 
Compression Requirements for Swap Dealers and Major Swap Participants 
(75 Fed. Reg. 81519 (Dec. 28, 2010)), confirmations are done after 
trade execution. (Proposed CFTC Rule  23.501).
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    A comprehensive review of the Commission's proposed rules shows 
that additional rulemakings are likely needed to further define key 
requirements and terms and how they will impact market participants.\4\ 
In certain cases it might be appropriate for the Commission to reissue 
substantially revised versions of a proposed rule as comments received 
might demonstrate the need for significant changes from the initial 
proposed rule. Also, under established principles of administrative 
law, final rules are susceptible to challenge if (a) they did not 
provide parties with sufficient notice that the proposed rule might 
apply to them, thereby providing that person with a meaningful 
opportunity to comment or otherwise participate in the rulemaking 
process, or (b) do not constitute a logical outgrowth of the proposed 
rule. The Working Group encourages the Commission to facilitate 
continued public comment as it develops regulations.
---------------------------------------------------------------------------
    \4\ For example, the term ``processed electronically'' as used in 
proposed CFTC Rule 23.501 (swap confirmation) and the term ``notional 
amount'' as used in the proposed definition of ``major swap 
participant'' in proposed CFTC Rule 1.3(qqq) also must be further 
defined.
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    At the close of the comment period of the last rule to be proposed 
under Title VII of the Dodd-Frank Act, the Commission should allow 
market participants a period of time to consider all of the rules 
proposed under Title VII of the Dodd-Frank Act in the aggregate.\5\ 
Following the review period, the Commission should provide a period in 
which market participants can comment on all of the rules. These 
comments would not only address the merits and impacts of the rules on 
a holistic basis, but also the ultimate cost of implementation and the 
time it will take to comply with all requirements. The comments will no 
doubt be substantiality more informed and complete as market 
participants will have the benefit of placing each rule within the 
overall context of the Commission's new regulatory regime.
---------------------------------------------------------------------------
    \5\ We note that the Commission has informally continued to accept 
comments even though stated deadlines have passed. The Working Group 
proposes an official ``open comment period.''
---------------------------------------------------------------------------
II. Market Participants Need Ample Time To Comply With Proposed Rules
    Market participants have not had sufficient time to prepare to 
comply with rules to be issued by the Commission under Title VII of the 
Dodd-Frank Act. Title VII is a fundamental redesign of the derivative 
markets, particularly for the energy swap market. Title VII by itself 
did not provide an adequate basis for market participants to foresee 
all the implications of the market redesign. Uncertainty continues as 
to certain key definitions, such as the definition of ``swap'' and the 
definition of ``swap dealer.'' Under the many proposed rules, entities 
face a myriad of potential requirements, many of which are interrelated 
and potentially redundant. While it might be reasonable to expect an 
entity to be in a position to quickly comply with one rule, it is not 
reasonable to expect an entity to be in immediate or almost immediate 
compliance with a substantial number of new rules at the same time or 
in rapid succession.
III. Two Important Observations About the Rules and the Marketplace
    When considering the order in which the Commission might issue 
rules and the dates by which such rules become effective, the 
Commission should consider two concepts.
    First, the Commission's regulations can be structured as building 
blocks, one set of rules providing the necessary foundation for 
subsequent rules. Said a bit differently, the Commission should issue 
final rules in a manner that allows an entity to allocate resources, 
hire personnel and design and test systems to meet the requirements of 
one rule that then prepares such entity to address the requirements of 
a subsequent rule. For example, entities should be able to first hire a 
chief compliance officer who should have a reasonable period of time in 
which to write, test and implement policies and procedures that, in 
turn, allow that entity to provide compliant disclosure to its 
counterparties. In addition, many of the requirements imposed by the 
Dodd-Frank Act depend on the existence of other new regulatory 
entities. For example, the reporting requirements largely depend on 
swap data repositories being fully operational.
    Second, not all entities that come within the definitions of ``swap 
dealer'' and ``major swap participants'' are the same or even similar. 
Some will have large swap portfolios and a substantial market share, 
presenting unique risks to the U.S. financial system. As these entities 
likely have been subject to prudential regulation by a financial 
regulator, their compliance and risk management infrastructure might be 
easily modified to meet the new requirements imposed by the Commission. 
Thus, compliance with the Commission's rules may be a minor incremental 
cost.\6\ In contrast, many entities that might come within the 
definitions of ``swap dealer'' and ``major swap participant,'' 
particularly those never subject to prudential regulation by a 
financial regulator, will likely have to make substantial or wholesale 
changes to their corporate structure and their compliance and risk 
management infrastructure. For these entities, the requirements of the 
Dodd-Frank Act and the Commission's rules represent a fundamental 
redesign of their operations and, in some cases, their business. In 
particular, many commercial energy firms still do not know if they are, 
and do not anticipate being, swap dealers. However, if they are deemed 
as such, this will be the first time many of them will be subject to 
prudential regulation and coming into compliance will be a costly, time 
consuming process.
---------------------------------------------------------------------------
    \6\ For example, if the Commission adopts capital and margin 
requirements modeled after those imposed on banks, a vast majority of 
such institutions are banks and will likely have systems in place to 
comply with such capital and margin requirements with minimal 
modifications.
---------------------------------------------------------------------------
    Recognizing that all entities potentially designated as swap 
dealers are not similar: the Commission should concentrate its 
attention and resources to overseeing compliance by market participants 
previously subject to prudential regulation by a financial regulator, 
and that are commonly known today as swap dealers. The Commission 
should allow other entities that come within the definitions of ``swap 
dealer'' and ``major swap participant'' a longer period to meet their 
compliance obligations.
    There is no standard test for determining which market participants 
are traditionally recognized as swap dealers. However, the Commission 
might focus on those bank holding companies that hold a vast majority 
of the market share in the swap markets. In his testimony before the 
House Committee on Agriculture, Chairman Gensler noted that 25 bank 
holding companies in the United States are a party to $277 trillion 
notional in swaps, which constitutes over 90% of domestic swaps.\7\ In 
addition, these bank holding companies are already subject to some 
degree of prudential regulation by a financial regulator. If the 
Commission concentrates on those 25 bank holding companies first, the 
Commission will capture a vast majority of U.S.-based swap activity as 
an initial matter and will likely be imposing regulation on those 
entities most prepared to comply in short order.
---------------------------------------------------------------------------
    \7\ Public Hearing to Review Implementation of Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, House 
Committee on Agriculture, 112th Cong. (Feb. 10, 2011) (statement of 
Hon. Gary Gensler, Chairman, CFTC).
---------------------------------------------------------------------------
    While the Dodd-Frank Act and the Commission's regulations place 
most compliance obligations on swap dealers and major swap 
participants, many requirements will fall on entities that are not swap 
dealers or major swap participants. The Working Group recommends the 
Commission, to the greatest extent possible, impose compliance 
obligations on these market participants last, and only if necessary. 
Said differently, a swap dealer should come into compliance ahead of 
the end-users with which it trades swaps.
    Even after the definitions of ``swap dealer'' and ``major swap 
participant'' are finalized, some entities still might not have a clear 
understanding if they are covered by the definitions and will need to 
seek guidance from the Commission as to their status or attributes of 
about their businesses. Such a consultation process should be developed 
in light of the vague and overly broad definitions that have been 
proposed.
IV. Recommended Implementation Process
    As alluded to above, each of the Commission's rules have at least 
three dates that the Commission should coordinate in the sequencing of 
the final rules it issues under the Dodd-Frank Act: (a) the date the 
rule is issued; (b) the date the rule is effective and (c) the 
implementation date(s) on which the compliance obligations must be 
satisfied. The distinction between these dates is important. The 
Commission should issue final rules with sufficient notice and, by 
careful structuring of effective dates and compliance deadlines, 
provide ample time for entities to come into compliance. As an 
alternative, the Commission could make the implementation date of one 
or more rules contingent on the implementation date of other rules that 
should logically come first in the series of rulemakings.
    The Working Group recommends that the Commission issue final rules 
and set their effective and related compliance dates as set forth in 
Exhibit A. Exhibit A is comprehensive, but not exhaustive, list of all 
of the rules the Commission has proposed under the Dodd-Frank Act. In 
constructing Exhibit A, the Working Group first determined the major 
goals of the Dodd-Frank Act, such as putting in place a mandatory 
clearing requirement and reporting regime. The Working Group then 
determined which rules must be in place to reach that goal and put such 
rules in groups for sequencing purposes. The Working Group next 
determined the order in which such rule groups should be implemented in 
order to allow the market to adapt and continue to function. Finally, 
the Working Group combined the implementation plans for each individual 
goal into a macro-implementation plan, or critical path for 
implementation, which is reflected in Exhibit A.
    The Working Group developed its recommendations based on the 
observation above that the rules work together in an iterative, 
building block manner. Accordingly, the Commission should first release 
the definitional rules, including the definition of swap, (with ample 
periods to facilitate entities engaging with the Commission to resolve 
uncertainties and otherwise reorganize or restructure their 
businesses). The definitional rules will allow parties to make critical 
determinations about their regulatory status and the derivatives 
transactions into which they enter. In addition, the Commission should 
issue final rules for the institutions, such as swap data repositories 
and derivatives clearing organizations, that will lay the ground work 
for the new regulatory regime as soon as practicable. Three months 
after issuing the final definitions, the Commission should issue the 
registration rules. This will allow the Commission to identify those 
entities that warrant immediate and longer term regulatory oversight. 
About the same time or shortly thereafter, the Commission should 
release rules for governance and internal business conduct standards. 
Swap dealers and major swap participants should have a period of time 
to organize and develop their systems and personnel to comply with 
regulations that do not entail counterparty interface. Only after swap 
dealers and major swap participants have their corporate structure, 
systems, policies and procedures in place should the Commission's rules 
governing transactions with counterparties become effective. Finally, 
rules that may place compliance obligations on entities that are not 
swap dealers or major swap participants should become effective.
    It is our expectation that, once all of the regulatory requirements 
are known, entities will immediately begin working to implement 
measures in an attempt to comply with all rules applicable to them. 
However, it would be unreasonable to expect entities to implement all 
of these measures at the same time. Time is needed to allow thoughtful 
design and preparation. In addition, a phased-in approach will allow 
entities to incur costs over time.\8\
---------------------------------------------------------------------------
    \8\ The Working Group of Commercial of Energy Firms, in its 
comments to the Commission's Proposed Rules on Real-Time Public 
Reporting of Swap Transaction Data, Swap Data Recordkeeping and 
Reporting Requirements, and Reporting, Recordkeeping, and Daily Trading 
Records Requirements for Swap Dealers and Major Swap Participants, all 
filed with the Commission on February 7, 2011, suggested a phase-in 
approach for the multiple reporting and record keeping requirements 
that might serve as a model for an overall phase-in approach.
---------------------------------------------------------------------------
    Finally, where a proposed rule requires substantial changes to 
existing information technology infrastructure or the creation of new 
information technology infrastructure, the Working Group requests that 
the Commission adopt a ``beta testing'' period coupled with a good 
faith safe harbor. During the beta testing period, market participants 
should be required to attempt to comply with the rule in question. 
However, if a market participant attempts to comply with such rule and 
fails because the relevant technology fails, the market participant 
should not face any sanction.
V. Chairman Gensler's Suggested Approach to Implementation
    In his speech before the Futures Industry Association, Chairman 
Gensler set forth a three group approach to the implementation of the 
final rules implementing Title VII of the Dodd-Frank Act.\9\ The 
Working Group sees value in the Chairman's suggested approach. However, 
there are three issues about which the Working Group disagrees with the 
Chairman's plan.
---------------------------------------------------------------------------
    \9\ CFTC Chairman Gary Gensler, Implementing the Dodd-Frank Act, 
Remarks before the Futures Industry Association's Annual International 
Futures Industry Conference, Boca Raton, Florida (Mar. 16, 2011).
---------------------------------------------------------------------------
    First, the definition of ``swap'' should be issued at the beginning 
of the implementation process along with all other definitions. For 
many market participants, the scope of the definition of ``swap'' will 
be a substantial factor in the determination of whether they are a swap 
dealer or major swap participant. For example, without knowing which 
derivatives will be included in the definition of ``swap,'' market 
participants will be unable to perform the tests necessary to determine 
whether they are a major swap participant. Waiting to the end of the 
implementation process to issue the final definition of ``swap'' will 
introduce significant uncertainty into the swap markets.
    Second, the rules that address the institutions that will serve as 
the foundation of the post Dodd-Frank Act market infrastructure should 
be introduced as soon as practicable. Without those rules in place, 
market participants might be required to put in place expensive, though 
temporary, changes to systems in order to comply with the Dodd-Frank 
Act requirements.\10\ The Chairman's proposed implementation plan would 
place many of these rules in the middle group. The Working Group 
suggests that these rules be addressed as a threshold matter.
---------------------------------------------------------------------------
    \10\ For example, if there are no SDRs in place, market 
participants could be required to put in place technology to report 
swaps directly to the Commission. Once SDRs come online, market 
participants will be required to put in place technology to report to 
SDRs.
---------------------------------------------------------------------------
    Third, the Chairman's proposal anticipates being able to issue all 
final rules within the next six months. The Working Group believes that 
Commission staff will need a substantial period of time to consider 
market participants comments on many rules and will need additional 
time to make necessary changes to such rules. The Chairman's suggested 
timing would severely limit Commission staff's ability to draft well 
reasoned and sound final rules.
VI. Statutory Support for Extended Compliance Periods
    Congress gave the Commission discretion in designing and 
implementing rules under the Dodd-Frank Act. In particular, Section 723 
of the Act provided that the Commission, upon petition by market 
participants, could continue the availability of the exclusion of 
Section 2(h) of the CEA with respect to certain commodity transactions 
for up to one year after the general effectiveness of Title VII of the 
Dodd-Frank Act. Several entities applied to the Commission for the 
continued application of Section 2(h). The Commission might provide 
such continuation of Section 2(h) to facilitate an orderly transition 
to a new regulatory regime under the Dodd-Frank Act.\11\ In addition, 
Section 754 of the Act allows the Commission to set effective dates for 
rules required under Title VII to be set at no earlier than sixty days 
after the publication of such rules. The authority granted to the 
Commission under Sections 723 and 754 of the Act should allow the 
Commission to provide the time necessary for market participants to 
come into compliance with the requirements of the new regulatory 
regime.
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    \11\ If the Commission elects to use the 2(h) extension in Section 
723 to help phase in Title VII of the Dodd-Frank Act's compliance 
requirements, it is possible that the implementation dates for certain 
rules will be extended beyond the maximum one year 2(h) extension 
period. In such an event, the Working Group suggests that the 
Commission use its existing statutory authority to address any gaps in 
the regulatory treatment of swaps and swap market participants.
---------------------------------------------------------------------------
VII. Conclusion
    The Working Group supports regulation that brings transparency and 
stability to the swap markets in the United States. The Working Group 
appreciates the balance the Commission must strike between effective 
regulation and not hindering the swap markets. Please let me know if 
you have any questions or would like additional information, including 
a working version of Exhibit A. In addition, members of the Working 
Group can be made available to meet with Commissioners or Commission 
staff to further discuss how the recommendations contained herein were 
reached.
            Respectfully submitted,

David T. McIndoe;
Mark W. Menezes;
R. Michael Sweeney, Jr.;
Alexander S. Holtan;
Counsel for the Working Group of Commercial Energy Firms.

                                                                        exhibit a
                                             Sequencing of Issuance of Final Rules Under the Dodd-Frank Act
--------------------------------------------------------------------------------------------------------------------------------------------------------This chart shows the order in which the Working Group suggests the Commission issue final rules.The suggested schedule for the issuance of final rules does not include a hard start date. The Working Group recommends that the Commission start
 releasing the final rules in the sequence set forth below when each group of rules is ready to be considered.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Month             0                1                2                3                4                5                6                7
--------------------------------------------------------------------------------------------------------------------------------------------------------
Definitions       Propose                           Comment Period                    Issue Final
                   Definition of                     Closes for All                    Rules
                   Swap and                          Definitions
                   Reopen Comment
                   Period on
                   Other
                   Definitions
Duties                                                                                                 Reopen Comment   Comment Period   Issue Final
                                                                                                        Period           Closes           Rules
Capital and       Propose Rules                     Comment Period                    Issue Final
 Margin                                              Closes                            Rules
Institutions                                        Issue Final
                                                     Rules Before
                                                     the End of
                                                     This Period
Mandatory                                           Issue Final
 Clearing                                            Rules Before
                                                     the End of
                                                     This Period
Position Limits                                     Reissue          Comment Period                    Issue Final
                                                     Proposed Rule    Closes                            Rules
Reporting                                           First TAC        Second TAC       Third TAC        Reopen Comment   Comment Period   Issue Final
                                                     Meeting *        Meeting *        Meeting *        Period           Closes           Rules
Market Practices                                                                      Issue Final
                                                                                       Rules
--------------------------------------------------------------------------------------------------------------------------------------------------------

 
--------------------------------------------------------------------------------------------------------------------------------------------------------
Definitions--Given that the definition of ``swap'' has yet to be proposed and the comment period is closed on all other definitions, the Working Group
 requests that the Commission reopen the comment period for the other definitions upon proposing a definition of ``swap,'' with such comment period for
 all such proposed rules closing in 60 days.Duties--After all the final definitions are issued, market participants will have a clearer picture as to which entities the definitions cover. Market
 participants, armed with knowledge of the scope of the definitions, should be given an opportunity to comment on the proposed rules that might impose
 duties on them. Therefore, the Commission should reopen the comment period on those rules that impose duties on swap dealers and major swap
 participants after the final definitions have been published.Capital and Margin--Capital and margin requirements should be made final (though not effective) on about the same day the definitions are finalized.Institutions--The Working Group urges the Commission to issue final rules for market institutions as soon as practicable. The existence of entities such
 as SDRs and SEFs is integral to the new regulatory framework for swap markets. These institutions must be in place before market participants can begin
 to comply with requirements such as mandatory clearing and reporting.Mandatory Clearing--As with market institutions, mandatory clearing rules should be finalized as soon as possible. The Commission should determine which
 swaps will be subject to the mandatory clearing requirements soon as possible. To make this process efficient, the Working Group recommends the
 Commission, as an initial matter, address only those swaps currently being cleared.Position Limits--The Working Group, as discussed in its forthcoming comments on the proposed rule on position limits, anticipates that certain parts of
 the proposed position limits rules will have to be amended to such a degree that the proposed rule will have to be reissued. Once reissued, market
 participants should have at least an additional 30 days during which to comment on that proposed rule.Reporting--Reporting will be a complex logistical undertaking. As a threshold matter, to even begin this process, an SDR must be registered for the
 relevant class of swaps. The Working Group recommends the Commission hold multiple Technology Advisory Committee meetings to walk through
 implementation issues with regard to the proposed reporting rules. After those meetings, market participants should be given the chance to file
 additional comments on such proposed rules.Market Practices--Market practice rules should be issued by July 21, 2011, as required by Section 753 of the Act.
--------------------------------------------------------------------------------------------------------------------------------------------------------
* Assuming there is an SDR.


                                          Sequencing of Implementation Dates for Rules Under the Dodd-Frank Act Box Opening = Final Rule Released (or operation begun).Box Closing = Implementation DateThe Implementation Date represents the time at which market participants must be in compliance with the relevant rule. For example, on the
 Implementation Date for the proposed rules on Registration and Core Principles for SDRs, any potential SDRs would have to be operational. The suggested
 implementation process does not include a hard start date. The Working Group recommends that the Commission start the suggested process when the final
 rules are ready to be issued in the sequenced manner suggested by the Working Group.

            [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                                    Sequencing of Implementation Dates for Rules Under the Dodd-Frank Act--Continued 1 In its comments to the Commission's proposed rule on the registration of swap dealers and major swap participants, the Working Group recommended that
 the Commission allow market participants a one year period in which they could determine if they would have to register as a swap dealer or major swap
 participant. Following the registration period, the Working Group suggests a phased in approach to the certification of compliance for rules applicable
 to swap dealers and major swap participants.2 The Working Group recommends that the Commission require market participants first hire a CCO, then allow the CCO to put in place internal business
 conduct standards and then put in place business conduct standards for interaction with counterparties.3 The Working Group recommends that the Commission delay issuing any rules regarding portfolio compression and reconciliation until after the compliance
 deadline for all rules required under Title VII of the Dodd-Frank Act have been issued. If the Commission chooses to issue such rules, the Working
 Group estimates that the compliance deadline for such rules would be up to 12 months after what is currently depicted given the likely intensive IT
 modifications that will be required to comply.4 Capital Requirements may be one of the most costly regulatory requirements under Title VII. Market participants should be afforded the opportunity to
 review these rules prior to making elections as to whether to continue trading that results in such entity being designated a swap dealer or major swap
 participant. Such entities should also be afforded ample time to take corporate actions necessary to meet the capital requirements.5 The implementation of margin requirements will require documentation standards to be in place.6 The Working Group suggests that DCOs be operational within ten months of the effective date of the Dodd-Frank Act. Such a time frame will allow the
 Commission to complete action to effect the mandatory clearing requirement as soon as practicable.7 The Working Group realizes that this proposed rule might require existing DCOs to alter their current ownership structure, so the implementation time
 period is set at 26 months. However, rules that are not affected by the ownership structure of the DCO should be implemented earlier.8 The Working Group realizes that the Commission has not issued a proposed rule on this topic. To allow market participants to understand the
 implications of central clearing of swaps, segregation requirements for DCOs must be in place prior to the mandatory clearing requirement.9 SDRs would have to be operational on this date to allow market participants to begin to comply with reporting requirements in a timely fashion.10 This short implementation period assumes that (a) the Commission only initially reviews swaps that are currently cleared to determine if they should
 be subject to the mandatory clearing requirement and (b) the DCOs clearing these swaps will quickly be able to comply with the requirements imposed on
 DCOs by the Dodd-Frank Act. Those swaps should be deemed submitted to the Commission on the effective date of Dodd-Frank and the Commission should
 review them within the statutorily required 90 day period. The proposed timeline would allow the Commission to start the implementation process as late
 as June of 2012 and still meet the G20 goal of clearing all standardized derivatives by the end of 2012.11 The Working Group is still reviewing the Commission's Proposed Rule on Position Limits and will provide comment on the implementation timing in
 comments on that proposed rule.12 All traditional swap dealer reporting parties previously subject to prudential regulation by a financial regulator (``Traditional Swap Dealers'').13 All other reporting parties.14 All swaps executed on facility or cleared through a DCO.15 All standardized swap executed off-facility and not centrally cleared entered into by Traditional Swap Dealers.16 All other standardized swap executed off-facility and not centrally cleared and all non-standardized swaps executed off-facility and not centrally
 cleared entered into by Traditional Swap Dealers.17 All other non-standardized swaps executed off-facility and not centrally cleared.

                                                 Rule Categories
----------------------------------------------------------------------------------------------------------------
                           Capital and                 Mandatory   Position                 Market
 Definitions     Duties       Margin    Institutions   Clearing     Limits     Reporting   Practices     Other
----------------------------------------------------------------------------------------------------------------
Definition    NOPR on      Capital      NOPR on Core  NOPR on     Position    IFR on      ANOPR on    JNOPR on
 of Swap       Swap         Requiremen   Principles    Process     Limits      Reporting   Disruptiv   Reporting
               Trading      ts           and Other     for                     of Pre-     e Trading   by
               Relationsh                Requirement   Review of               Enactment   Practices   Investmen
               ip                        s for SEFs    Swaps for               Swaps                   t
               Documentat                              Mandatory                                       Advisors
               ion for                                 Clearing                                        to
               SDs and                                                                                 Private
               MSPs                                                                                    Funds and
                                                                                                       Certain
                                                                                                       Commodity
                                                                                                       Pool
                                                                                                       Operators
                                                                                                       and
                                                                                                       Commodity
                                                                                                       Trading
                                                                                                       Advisors
                                                                                                       on Form
                                                                                                       PF
NOPR on       JNOPR on     Margin       NOPR on       NOPR on                 IFR on      NOPR on     NOPR on
 Further       Orderly      Requiremen   Governance    Requireme               Reporting   Prohibiti   Commodity
 Definitions   Liquidatio   t            and           nts for                 of Post-    on of       Pool
 of SD, MSP    n                         Additional    Processin               Enactment   Market      Operators
 and ECPs      Terminatio                COI           g,                      Swaps       Manipulat   and
               n                         Requirement   Clearing,                           ion         Commodity
               Provisions                s for DCOs,   and                                             Trading
               in Swap                   DCMs, and     Transfer                                        Advisors:
               Trading                   SEFs          of                                              Amendment
               Relationsh                              Customer                                        s to
               ip                                      Positions                                       Complianc
               Documentat                                                                              e
               ion for                                                                                 Obligatio
               SDs and                                                                                 ns
               MSPs
NOPR on End-  NOPR on                   NOPR on Core                          NOPR on                 NOPR on
 User          Designatio                Principles                            Real-Time               Conformin
 Exception     n and                     and Risk                              Public                  g
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----------------------------------------------------------------------------------------------------------------

                                 ______
                                 
March 28, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Position Limits for Derivatives, RIN 3038-AD15 and 3038-AD16

    Dear Secretary Stawick:
I. Introduction
    On behalf of the Working Group of Commercial Energy Firms (the 
``Working Group''), Hunton & Williams LLP hereby submits these comments 
in response to the request for public comment set forth in the 
Commodity Futures Trading Commission's (the ``CFTC'' or ``Commission'') 
Notice of Proposed Rulemaking, Position Limits for Derivatives (the 
``Proposed Rule''), published in the Federal Register on January 26, 
2011,\1\ which establishes position limits for certain physical 
commodity derivatives pursuant to newly amended Section 4a(a) of the 
Commodity Exchange Act (``CEA''), as established by Section 737 the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-
Frank'' or the ``Act'').\2\
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    \1\ Position Limits for Derivatives, Notice of Proposed Rulemaking, 
76 Fed. Reg. 4752 (Jan. 26, 2011).
    \2\ Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. 
L. 111-203, 124 Stat. 1376 (2010).
---------------------------------------------------------------------------
    The Working Group is a diverse group of commercial firms in the 
energy industry whose primary business activity is the physical 
delivery of one or more energy commodities to others, including 
industrial, commercial, and residential consumers. Members of the 
Working Group are energy producers, marketers, and utilities. The 
Working Group considers and responds to requests for public comment 
regarding regulatory and legislative developments with respect to the 
trading of energy commodities, including derivatives and other 
contracts that reference energy commodities.
II. Executive Summary
    The Working Group strongly supports the goals of the Act to enhance 
transparency and reduce systemic risk in the swap markets. The Working 
Group appreciates the opportunity to provide the comments set forth 
herein and requests the Commission's consideration of such comments in 
order to adopt, if at all, position limits that are effective and 
workable for market participants.
    As an initial matter, and as discussed in Part III.A, below, the 
Working Group submits that, prior to establishing and imposing 
speculative position limits in any specific market, the CEA requires 
the Commission to analyze the relevant markets and find that such 
position limits are indeed necessary. If implemented without sufficient 
study, speculative position limits will disrupt today's highly 
efficient energy commodity markets by (i) reducing liquidity, (ii) 
impairing price discovery, and (iii) preventing market participants 
from effectively and efficiently hedging their commercial risk 
exposure.
    Additionally, as set forth in Part III.A, below, the Commission's 
proposal for Phase II single-month and all-months-combined (``AMC'') 
position limits are entirely unnecessary, and accordingly, should be 
rejected. The Working Group submits that such limits could have 
significant adverse impacts on derivatives markets. As such, the 
Working Group strongly urges the Commission to use the discretion 
afforded to it pursuant to new CEA Section 4a(a) and decline the 
adoption of single-month and AMC position limits in any final rule 
issued in this proceeding at this time.
    As discussed in Part III.B, below, the Working Group believes that 
there are several flaws in the proposed definition of a bona fide 
hedging transaction that could disrupt the efficient operation of 
energy commodity markets. In failing to provide a vehicle for market 
participants to apply for, and receive, an exemption from speculative 
position limits for ``non-enumerated hedges,'' the Commission, contrary 
to the intent of Congress, has eliminated several important classes of 
transactions from the definition of a bona fide hedging transaction 
that are routinely undertaken in energy markets to hedge or mitigate 
commercial risk. The Working Group provides in Parts III.B.1, below, 
several examples of such excluded transactions. As illustrated by these 
examples, this proposed definition simply does not reflect the hedging 
practices generally used in commodity markets, especially energy 
markets. Specifically, as discussed in Part III.D, below, to qualify 
for a bona fide hedging exemption, the proposed definition appears to 
require market participants to match on a one-to-one basis a swap 
transaction to a specific physical transaction. Participants in energy 
commodity markets, however, frequently enter into swaps and futures to 
hedge underlying physical assets on a portfolio or aggregate basis. The 
Working Group submits that any final rule adopted by the Commission in 
this proceeding must preserve the ability of commercial energy firms to 
effectively and efficiently hedge their commercial risk exposure.
    The Working Group further requests in Part III.C, below, that the 
Commission provide certainty to market participants as to how the 
process will work for applying for exemptions from speculative position 
limits should the Commission adopt one in any final rule. As written, 
the Proposed Rule provides an insufficient application process for 
exemptions and instead requires market participants to file daily 
reports on their cash market commodity activities upon exceeding any 
position limit. The Working Group submits that this creates not only an 
unnecessary compliance burden on market participants but also a 
significant burden on the Commission who will have to review and 
evaluate daily such position reports. Should the Commission adopt an 
application process in any final rule, the Working Group strongly 
suggests that it provide market participants an opportunity to comment 
on such process.
    As discussed more thoroughly in Part III.F, below, the Working 
Group believes the Phase I spot-month position limits must (i) be 
reconsidered in many respects and (ii) more appropriately accommodate 
the hedging needs of market participants. As recommended in Part 
III.F.1, below, the process for determining deliverable supply must be 
fully transparent and provide market participants the opportunity to 
comment on the DCM estimates of deliverable supply and any Commission 
proposal for spot-month position limits. Further, as set forth in Part 
III.F.2, below, with respect to the proposed spot-month position limits 
for cash-settled contracts, the Working Group submits that (i) the 
Commission's proposal to set the limit for cash-settled contracts equal 
to the level for physically-settled contracts is not grounded in a 
sound regulatory foundation, (ii) the proposal unduly restricts the 
position of cash-settled referenced contracts that may be held by 
market participants, and (iii) the proposed conditional exemption for 
cash-settled contracts inappropriately requires market participants to 
hold no physically settling futures contracts in order to qualify for 
such exemption. In Part III.F.3, below, the Working Group recommends 
that the Commission initially identify the universe of referenced 
paired contracts based only on those contracts that are cleared, and 
after such initial identification, identify which swaps constitute a 
referenced paired contract during its process for determining whether a 
swap must be mandatorily cleared pursuant to the Act.
    Regarding the proposed visibility levels and related reporting 
requirements, the Working Group submits in Part III.G, below, that such 
are unnecessary in light of the transparency created by the Act and the 
Commission's existing special call authority. The Working Group 
believes that such requirements will result in a substantial and 
disproportionate burden on bona fide hedgers without providing any 
benefit to the markets.
    Moreover, as discussed in Part III.I, below, the Working Group 
generally supports the proposed aggregation rules and disaggregation 
exemption as applied to ``owned'' non-financial entities. Yet it 
respectfully requests that the Commission (i) provide guidance on the 
required showing a market participant must make in demonstrating 
independent control, (ii) permit market participants discretion in 
using internal or external personnel to make any assessments relating 
to the independence of its owned non-financial entities, and (iii) 
confirm that the positions of owned non-financial subsidiaries or 
affiliates demonstrating independent control will not be aggregated 
with a parent financial entity.
    Finally, and not of least importance, as discussed in Part III.J, 
below, the Working Group strongly recommends that the Commission 
conduct a thorough cost-benefit analysis of this Proposed Rule, which 
should include the costs presented in the Paper Reduction Act section 
of the Proposed Rule.
III. Comments of the Working Group of Commercial Energy Firms
A. The Commission Has Not Established the Foundation for the Imposition 
        of Federal Speculative Position Limits for Exempt and All 
        Agricultural Commodities
    As a threshold matter, the Working Group respectfully submits that 
Congress did not mandate the establishment of speculative position 
limits for exempt and all agricultural commodities or authorize the 
Commission to so impose them without an analysis and finding of the 
need for, or appropriateness of, speculative position limits in any 
specific market.\3\ This issue has been addressed in comment letters 
filed in response to the Commission's January 26, 2010 Notice of 
Proposed Rulemaking, Federal Speculative Limits for Referenced Energy 
Contracts and Associated Regulations,\4\ and in pre-rulemaking comments 
filed in connection with the potential implementation of speculative 
position limits under Dodd-Frank.\5\ Moreover, the Working Group is 
informed that other interested parties will address this issue in their 
comments submitted in this rulemaking proceeding. The Working Group 
supports the principle that the CEA requires additional analysis before 
the Commission can finalize a speculative position limit rule for 
exempt and all agricultural commodities.
---------------------------------------------------------------------------
    \3\ See CEA Sections 4a(a)(2)-(5) (requiring that the Commission 
establish position limits ``as appropriate'').
    \4\ See Federal Speculative Limits for Referenced Energy Contracts 
and Associated Regulations, Notice of Proposed Rulemaking, 75 Fed. Reg. 
4144 (Jan. 26, 2010); The Futures Industry Association, Inc., Comment 
Letter (Mar. 8, 2010); International Swaps and Derivatives Association, 
Inc. (``ISDA''), Comment Letter (April 16, 2010); Working Group of 
Commercial Energy Firms, Comment Letter (April 26, 2010).
    \5\ See CME Group, Pre-Rulemaking Position Limit Comments (Oct. 25, 
2010); The Futures Industry Association, Inc., Pre-Rulemaking Position 
Limit Comments and Recommendations (``FIA Pre-Rulemaking Comments'') 
(Oct. 1, 2010).
---------------------------------------------------------------------------
    In Section III.F, below, the Working Group presents its concerns 
regarding the proposed spot-month limits for referenced contracts 
should the Commission move forward and implement such limits using the 
phased approach outlined in the Proposed Rule. In addition to its 
concerns regarding the proposed Phase I spot-month limits, the Working 
Group submits that imposing position limits for non-spot months and AMC 
could result in significant, unintended adverse impacts on derivatives 
markets, particularly markets for energy commodities.
    The Proposed Rule fails to provide any verified, empirical data, or 
cost-benefit analysis justifying the imposition of Phase II non-spot-
month and AMC limits that can be reviewed and commented upon by 
interested parties--even on a prophylactic basis. Notwithstanding this 
lack of analysis, non-spot month and AMC position limits are 
unnecessary if the Commission develops appropriate spot-month limits. 
As such, the Working Group strongly recommends the Commission use the 
discretion afforded under new CEA Section 4a(a) and forego the 
implementation of Phase II non-spot month and AMC position limits in 
any final rule issued in this proceeding.
    The comments that follow are submitted by the Working Group to 
address concerns with respect to specific provisions in the Proposed 
Rule so that a final rule, if one is ultimately adopted, will contain 
the clearest and most workable provisions.
B. The Proposed Definition of a Bona Fide Hedging Transaction Is 
        Seriously Flawed
    The Working Group submits that there are several, very specific and 
somewhat technical, flaws in the proposed definition of a bona fide 
hedging transaction that threaten its utility for commercial energy 
firms. As such, the Working Group provides the following comments 
addressing its concerns with specific provisions of the Proposed Rule 
and respectfully requests that the Commission address each of them 
prior to the adoption of any final rule. Doing so will ensure that any 
final rule adopted by the Commission in this proceeding will be clearer 
and more workable (i.e., commercially practicable).
1. There is No Basis for the Elimination of ``Non-Enumerated'' Hedges
    Without much explanation, the Commission excluded from proposed 
CFTC Rule 151.5 provisions that would define ``non-enumerated hedges'' 
or provide a vehicle for a commercial energy firm to apply for, and 
receive, an exemption from speculative position limits for ``non-
enumerated hedges.'' \6\ In contrast, the Proposed Rule provides that 
the only transactions or positions that would be recognized as bona 
fide hedges would be those described under proposed CFTC Rule 
151.5(a)(2) as ``enumerated hedges.'' Specifically, the proposed rule 
states, in relevant part:
---------------------------------------------------------------------------
    \6\ The analogs in existing Commission regulations are Sections 
1.3(z)(3) and 1.47. Under the Proposed Rule, Section 1.3(z) would not 
apply to speculative position limits for exempt and agricultural 
commodities and Section 1.47 would be deleted altogether.

        ``[N]o transactions or positions shall be classified as bona 
        fide hedging for purposes of  151.4 unless . . . the 
        provisions of paragraph (a)(2) of this section have been 
        satisfied.'' \7\
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    \7\ Proposed CFTC Rule 151.5(a)(1).

    In taking this position (hereinafter referred to as the 
``Enumerated Hedges Only'' provision), the Commission has eviscerated 
the general definition of bona fide hedging transactions or positions 
as set forth in proposed CFTC Rule 151.5(a)(1), which came directly 
from CEA Section 4a(c)(2), as amended by Dodd-Frank. Significantly, the 
Commission has effectively eliminated from the bona fide hedging 
definition numerous classes of transactions that Congress intended to 
include.\8\ The Working Group identifies and describes several of these 
transactions in subparts III.B.1.i-III.B.4, below.
---------------------------------------------------------------------------
    \8\ In addition, the Commission's proposal simultaneously 
establishes and eliminates the availability of the so-called ``pass-
through'' exemption identified in proposed CFTC Rule 151.5(a)(1)(iv)(A) 
and CEA Section 4a(c)(2)(B). To be certain, proposed CFTC Rule 
151.5(a)(1)(iv)(A) is nearly identical to the discretionary pass-
through provision in new CEA Section 4a(c)(2)(B). As such, the 
Commission clearly sought to establish a pass-through exemption. And 
yet the Commission's proposed CFTC Rule 151.5(a)(2) would eliminate the 
use of any such exemption. The Working Group believes that the 
Commission likely did not intend such a result.
---------------------------------------------------------------------------
    The Working Group respectfully submits that it is neither in the 
public interest nor is it in the Commission's interest as a market 
regulator to structure a rule that eliminates its flexibility to allow 
hedge exemptions based on ``non-enumerated hedging transactions.'' 
Markets are dynamic. Many of the proposed rules being implemented by 
the Commission pursuant to Dodd-Frank, particularly this Proposed Rule, 
may have the result of diminishing liquidity in certain markets. Thus, 
the Working Group submits that the Commission should preserve its 
ability to allow exemptions based upon non-enumerated transactions.\9\
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    \9\ This does not mean that the Commission is compelled to grant 
exemptions--it will retain its discretion on a case-by-case basis based 
on the market's ability to support it, among other things. What it does 
mean, however, is that if the Commission believes an exemption may be 
warranted to add liquidity to a particular market at a particular time 
it would not be forced to promulgate an amendment to Part 151.5 in 
order to do so.
---------------------------------------------------------------------------
    Accordingly, in order to ensure consistency with the statutory 
language of new CEA Section 4a(c) and avoid harmful impacts to markets 
for Referenced Contracts, the Working Group suggests that the 
Commission (i) strike the last clause in proposed CFTC Rule 
151.5(a)(1)(iv)(B)--``and the provisions of paragraph (a)(2) of this 
section have been satisfied;'' and (ii) revise the lead-in language of 
proposed CFTC Rule 151.5(a)(2) to add following the word ``includes'' 
the phrase ``, but is not limited to,''. Specifically, the Working 
Group proposes the following revisions:
  Sec. 151.5  Exemptions for referenced contracts.
          (a) Bona fide hedging transactions or positions.

                  (1) Any trader that complies with the requirements of 
                this section may exceed the position limits set forth 
                in Sec. 151.4 to the extent that a transaction or 
                position in a referenced contract:
          * * * * *
                          (iv) Reduces risks attendant to a position 
                        resulting from a swap that--
          * * * * *
                                  (B) Meets the requirements of 
                                paragraphs (a)(1)(i) through 
                                (a)(1)(iii) of this section. 
                                Notwithstanding the foregoing, no 
                                transactions or positions shall be 
                                classified as bona fide hedging for 
                                purposes of Sec. 151.4 unless such 
                                transactions or positions are 
                                established and liquidated in an 
                                orderly manner in accordance with sound 
                                commercial practices and the provisions 
                                of paragraph (a)(2) of this section 
                                have been satisfied.

                  (2) Enumerated hedging transactions. The definition 
                of bona fide hedging transactions and positions in 
                paragraph (a)(1) of this section includes, but is not 
                limited to, the following specific transactions and 
                posi-
                tions: . . .

    Subparts III.B.1.i-III.B.4, below, address the identified flaws 
with the Commission's current proposal for the definition of a bona 
fide hedge, and support the Working Group's recommendation to revise 
the proposed language of the bona fide hedging transaction definition.
i. Hedges Relating to Assets That a Person Anticipates Owning or 
        Merchandising Would Not Constitute Bona Fide Hedges Under the 
        Proposed Rule
    Proposed CFTC Rule 151.5(a)(1) includes as a bona fide hedge the 
anticipated ownership, production, manufacture, processing, or 
merchandising of an exempt or agricultural commodity.\10\ Yet proposed 
CFTC Rule 151.5(a)(2), which sets forth ``Enumerated Hedging 
Transactions,'' does not contain a parallel provision. Indeed, only 
``unsold anticipated production'' \11\ and ``unfilled anticipated 
requirements,'' including requirements for ``processing, manufacturing, 
and feeding'' \12\ qualify as enumerated hedges. Thus, as a result of 
the Enumerated Hedges Only provision, certain transactions entered into 
to hedge anticipated ownership or merchandising of an exempt or 
agricultural commodity would not qualify as bona fide hedging 
transactions under the Proposed Rule.\13\ The Working Group provides 
two such examples.
---------------------------------------------------------------------------
    \10\ See analogous new CEA Section 4a(c)(2).
    \11\ Proposed CFTC Rule 151.5(a)(2)(i)(B).
    \12\ Proposed CFTC Rule 151.5(a)(2)(ii)(C).
    \13\ To the extent that language in the enumerated hedging section 
of the proposal parallels language in the enumerated hedging section of 
current Rule 1.3(z), the Working Group submits that the impact is 
different as a result of the elimination of the availability of an 
exemption for non-enumerated hedges.
---------------------------------------------------------------------------
Example 1.
    At 8:00 a.m. commercial energy firm X becomes aware of the 
availability of a spot cargo of heating oil moving from Europe to the 
United States. Firm X believes that it can acquire the cargo over the 
next few hours or days, manage the discharge of the product at the end 
of the voyage, and re-sell the heating oil to a distributor in the 
northeast at the end of the month. While Firm X begins negotiations to 
purchase and re-sell the cargo, it is not concerned about upward price 
risk during the period of its purchase negotiations but is seriously 
concerned about downward price risk between now and the time it 
establishes its sale price. It sells New York Mercantile Exchange 
(``NYMEX'') heating oil futures contracts for its expected delivery 
month. Under the Commission's proposal, this transaction would not 
qualify as a bona fide hedge.
Example 2.
    Utility X periodically issues requests for proposals (``RFP'') 
looking to obtain fixed price electricity supply for groups of its 
customers. For example, it may be looking for a fixed price for 
electricity for a term of three (3) years for its commercial customer 
class. In its RFP, Utility X requires that Bidders provide firm 
electricity at a fixed price and at designated locations on its 
electrical system. As it is for Full Requirement, Bidders must ensure 
that enough electric supply is delivered to Utility X so that it can 
meet the load requirements of its commercial customers. Actual 
deliveries of electricity are equal to actual usage of electricity by 
Utility X's commercial customers and results in physical delivery of 
electricity. Finally, the RFP requires that the fixed price offer be 
provided on or before the close of business, March 31, and be left 
open; that is, the price quoted must remain firm while Utility X 
evaluates and then selects the winning bidder on April 3.\14\
---------------------------------------------------------------------------
    \14\ Often times, commercial energy firms competing to serve load 
under similar RFP arrangements have been required to leave in place 
fixed price quotes longer than the four (4) day window set forth in the 
example above.
---------------------------------------------------------------------------
    Power Marketer Y is preparing to respond to Utility X's RFP. It 
believes it can arrange for a physical supply of electricity supply on 
competitive terms. However, Power Marketer Y is concerned that prices 
in the electricity market will increase while it is holding open its 
fixed price for Utility X and then completing the transaction for the 
physical supply. Power Marketer Y enters into an electricity swap to 
protect against increases in prices while it leaves open the bid during 
the three day evaluation period and thereafter completes negotiations 
for the physical electricity purchase if Utility X accepts its price 
quote. Under the Commission's proposal, the electricity swap 
transaction would not qualify as a bona fide hedge. If Power Marketer Y 
faces position limit restrictions in this situation, it would have to 
raise its fixed price quote to Utility X to account for the risk of the 
price moving and this could result in higher costs to Utility X's 
customers.
    The Working Group notes that the variance in the treatment of 
marketing or merchandising activities and the treatment of producers or 
processors in the Proposed Rule is remarkably similar to the 
differential treatment of cash market ``trading'' positions provided in 
footnotes 23 and 128 of the proposed rules implementing the End-user 
Exception and further defining the term Major Swap Participant, 
respectively, and upon which the Working Group commented in the 
relevant proceedings.\15\ The Working Group's concern was that in those 
proposed rules, the Commission appeared to take the position that a 
marketer or merchandiser that acquired a commodity for resale (i.e., a 
cash market ``trading'' position) would not be entitled to treat a 
hedge of that position as ``mitigating or reducing commercial risk'' in 
order to avail itself of the end-user exception or certain calculations 
in connection with the definition of Major Swap Participant.
---------------------------------------------------------------------------
    \15\ End-User Exception to Mandatory Clearing of Swaps, Notice of 
Proposed Rulemaking, 75 Fed. Reg. 80747 (Dec. 23, 2010) (``Proposed 
End-User Exception Rule''); Working Group of Commercial Energy Firms, 
Comment Letter (Feb. 22, 2011); Further Definition of ``Swap Dealer,'' 
``Security-Based Swap Dealer,'' ``Major Swap Participant,'' ``Major 
Security-Based Swap Participant'' and ``Eligible Contract 
Participant,'' 75 Fed. Reg. 80174 (Dec. 21, 2010); Working Group of 
Commercial Energy Firms, Comment Letter (Feb. 22, 2011).
---------------------------------------------------------------------------
    As in the instant proceeding, such differential treatment in those 
proposed rules wouldeffectively eliminate ``merchant,'' \16\ 
``merchandiser,'' \17\ or ``middlemen'' \18\ from the litany of 
commercial parties historically recognized as part of the chain from 
the production to the consumption of commodities. These parties own 
physical commodities and bear significant price risk as a result. The 
Working Group respectfully submits that this result is contrary to the 
CEA and that the use of derivatives by these firms to hedge that risk 
should qualify as bona fide hedges and as ``hedging and mitigating 
commercial risk'' under the Commission's rules.
---------------------------------------------------------------------------
    \16\ See 17 CFR  32.4(a) (2010) (``a producer, processor, or 
commercial user of, or a merchant handling, the commodity'' may be an 
offeree of an option under the trade option exemption) (emphasis 
added).
    \17\ Exemption for Certain Contracts Involving Energy Products, 58 
Fed. Reg. 21286 (Apr. 20, 1993) (granting exemptive relief in response 
to an application filed by a group of entities which represented that 
each was a producer, processor and/or merchandiser of crude oil, 
natural gas and/or crude oil and natural gas products, or was otherwise 
engaged in a commercial business in these commodities).
    \18\ See Section 4a(c) of the CEA (``producers, purchasers, 
sellers, middlemen, and users of a commodity or product derived 
therefrom'' should be eligible for hedge exemptions) (emphasis added).
---------------------------------------------------------------------------
ii. Hedges of Services Would Not Constitute Bona Fide Hedges Under the 
        Proposed Rule
    Proposed CFTC Rule 151.5(a)(1) would include as a bona fide hedging 
transaction ``services that a person provides or purchases, or 
anticipates providing or purchasing.'' \19\ However, proposed CFTC Rule 
151.5(a)(2), which sets forth Enumerated Hedging Transactions, does not 
contain a parallel provision. Thus, under the Enumerated Hedges Only 
provision, hedges of the potential change in value of services would 
not constitute as bona fide hedging under the Commission's proposal. 
The Working Group provides the following two examples to illustrate 
such hedges.\20\
---------------------------------------------------------------------------
    \19\ See analogous new CEA Section 4a(c)(2).
    \20\ Without impacting their illustrative value, these examples 
have been simplified, and certain factors, such as the time value of 
money, have been eliminated.
---------------------------------------------------------------------------
Example 1.
    Commercial energy firm Z is a wholesale marketer of natural gas. It 
has an opportunity to acquire one year of firm transportation on 
Natural Gas Pipeline (``NGPL'') from the Texok receipt point to the 
Henry Hub delivery point for an all-in cost of $.30/mmbtu. The 
``value'' of that service at that time is $.33/mmbtu, measured as the 
difference between the price at which one can sell the natural gas at 
the delivery point minus the price at which one can purchase the gas at 
the receipt point. At that time, commercial energy firm Z can enter 
into a swap locking in the calendar 2012 strip at Texok at a price of 
$4.00/mmbtu and sell a calendar strip of NYMEX Henry Hub natural gas 
futures contracts locking in a sale price at a weighted average of 
$4.33/mmbtu. Entering into those two separate transactions without 
having actually purchased or sold natural gas to transport has allowed 
commercial energy firm Z to hedge the value of the firm transportation 
service that it holds or can acquire.\21\ However, under the 
Commission's proposal, the transaction would not qualify as a bona fide 
hedge transaction.
---------------------------------------------------------------------------
    \21\ Note that this ``value'' exists whether commercial energy firm 
Z ever owns or intends to own the physical commodity. In some 
circumstances, the firm might choose to release the capacity to a 
third-party and realize the value of the transportation service from 
the capacity release transaction.
---------------------------------------------------------------------------
Example 2.
    Natural Gas Producer X has new production coming on line over the 
next few years in the Gulf of Mexico. The production is located near 
Point A on Pipeline Y's interstate natural gas pipeline system. 
Producer X has the desire to sell gas to customers in Region B as the 
price for natural gas in Region B is significantly higher than at Point 
A, where natural gas would currently be delivered into Pipeline Y's 
system. Producer X contacts Pipeline Y and negotiates a Precedent 
Agreement with the pipeline under which Pipeline Y will build new 
transportation capacity from Point A to Region B. Under the Precedent 
Agreement, Producer A is obligated to pay demand charges to the 
pipeline for a term of 5 years from the date the pipeline goes into 
commercial operation, if Pipeline Y is able to complete a successful 
open season and obtains the necessary permits to construct and operate 
the new section or expansion of its pipeline system from Point A to 
Region B. The open season is designed to attract commitments from other 
potential shippers to help support the cost of building and operating 
the pipeline expansion. The schedule calls for a completion of 
construction and commercial operation of the pipeline expansion on 
March 31, 2013.
    Producer X is concerned that the natural gas price differential 
between Point A and Region B could collapse and is fairly confident the 
expansion project will be completed. In order to manage the risk 
associated with the 5-year financial commitment to Pipeline Y, i.e., 
pipeline demand charges, Producer X enters into swaps at Point B for a 
term of April 1, 2013 to March 31, 2018, to lock-in the price spread 
between Point A and Region B. Under the Commission's Proposed Rule, the 
swap transactions would not qualify as bona fide hedges. In this case, 
the expansion of the pipeline system that would afford customers in 
Region B more access to lower priced gas might not occur without the 
ability to count the swaps associated with this transaction as a bona 
fide hedge.
Example 3.
    Commercial energy firm A is an electric utility that owns coal-
fired generation facilities. Firm A enters into contracts with major 
railroads to transport coal from producing regions to its various 
generating facilities. One or more of these contracts are subject to a 
fuel surcharge, whereby rates paid by firm A to transport coal are 
indexed to the price of diesel fuel. As prices for the diesel fuel 
rise, the rate paid by firm A to transport coal also rises. To mitigate 
this risk, firm A could enter into a long position in futures contracts 
or swaps for the diesel fuel, whereby gains realized on these 
instruments should prices rise would off-set any increase in the rate 
paid by firm A to transport coal. Under the Proposed Rule, however, 
these transactions would not qualify as bona fide hedge transactions 
since they would be entered into as a hedge of services--in this case, 
coal transportation services.
2. Spreads and Arbitrage Positions Would Not Qualify as Bona Fide 
        Hedges Under the Proposed Rule
    Section 4a(a) of the CEA both before and after the passage of Dodd-
Frank authorizes the Commission to ``exempt[] transactions normally 
known to the trade as `spreads' or `straddles' or `arbitrage' or from 
fixing limits applying to such transactions or positions different from 
limits fixed for other transactions or positions.'' Under the regimes 
for speculative position limits currently administered by both NYMEX 
and the IntercontinentalExchange (``ICE''), exemptions from speculative 
position limits are available for arbitrage, intra-commodity spread, 
inter-commodity spread, and eligible option/option or option/futures 
spread positions.\22\ Under the Proposed Rule, these classes of 
transactions would not qualify for an exemption.
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    \22\ See NYMEX Rule 559.C and ICE OTC Regulatory Rulebook for 
Significant Price Discovery Contracts, Rule 1.17 (``ICE OTC Rule 
1.17'').
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    Arbitrage and spread positions create a limited risk of causing 
sudden or unreasonable fluctuations or unwarranted changes in the price 
of a commodity. In fact, they are universally recognized as 
transactions that limit unwarranted changes in price by tying the price 
of one instrument to another, creating a market efficiency that reduces 
the risk of aberrational pricing. The Working Group submits that there 
has never been an issue of sudden or unreasonable fluctuations or 
unwarranted changes in price attributable to arbitrage or spread 
positions that would justify the elimination of exemptions for such 
transactions at this time.
    The Working Group respectfully suggests that the fact that these 
positions currently exist in the market and may be the basis for an 
exemption from limits on both NYMEX and ICE requires that the 
Commission consider the potential negative impact on liquidity if such 
positions were no longer to be permitted such treatment. Therefore, as 
provided for under CEA Section 4a(a), the Commission should permit 
exemptions from position limits for transactions such as spreads or 
arbitrage.
3. Cross-Commodity Hedges Would Not Be Permitted To Be Carried Into the 
        Spot Month
    Proposed CFTC Rule 151.5(a)(2)(v) would permit cross-commodity 
hedges ``provided that the positions shall not be maintained during the 
five last trading days of any referenced contract.'' This would result 
in transactions, such as the one set forth in the following example, 
being excluded from treatment as a bona fide hedging transaction.
Example.
    Commercial energy firm J supplies jet fuel to airlines at a variety 
of airports in the United States, including Houston Intercontinental 
Airport. It has a fixed-price contract to purchase jet fuel from a 
refinery on the gulf coast during early June. Because there is no 
liquid jet fuel futures contract, commercial energy firm J uses the 
June NYMEX physically-delivered WTI crude oil futures contract to hedge 
its price risk. Under the Proposed Rule, commercial energy firm J would 
be required to liquidate its hedge during the last five trading days of 
the June contract and either remain unhedged or replace its June hedge 
with a contract that represents a completely different delivery period 
and, therefore, a different supply/demand and pricing profile.
4. The Working Group Questions the Phraseology Used in the Proposed 
        Rule that Would Treat as Bona Fide Hedges ``Purchases of 
        Referenced Contracts'' on the One Hand, and ``Sales of Any 
        Commodity Underlying Referenced Contracts'' on the Other
    The purpose and effect of the distinction presented in proposed 
CFTC Rule 151.5(a)(2) are unclear to the Working Group. Specifically, 
the lead-in language to proposed subpart 151.5(a)(2)(ii) states that 
``purchases of referenced contracts'' may qualify as bona fide hedges 
provided certain conditions are met. In contrast, the lead-in language 
to proposed subpart 151.5(a)(2)(i) states that ``sales of any commodity 
underlying referenced contracts'' may qualify as bona fide hedges 
provided the right conditions are met. Nowhere in the Proposed Rule 
does the Commission explain the purpose behind this distinction. Under 
the analogous provisions of Section 1.3(z) of the Commission's current 
regulations,\23\ purchases and sales are treated equally--that is, 
purchases or sales of futures contracts (and not the underlying 
commodity) may qualify as bona fide hedging transactions. Thus, it 
appears that the phrase ``any commodity underlying'' ought not to be 
included in proposed CFTC Rule 151.5(a)(2). The Working Group 
respectfully requests that in any final rule issued in this proceeding 
the Commission either (i) harmonize the two provisions in the Proposed 
Rule, or (ii) clarify the intent and purpose behind the distinction 
should the Commission adopt such language.
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    \23\ 17 CFR  1.3(z).
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C. The Process for Applying for, and Receiving, Exemptions From 
        Speculative Position Limits Is Also Flawed
1. The Proposed Rule Unnecessarily Abandons the Current Energy Market 
        Process of Applying in Advance for Exemptions From Speculative 
        Position Limits
    Current practice on both NYMEX and ICE permits a commercial energy 
firm to apply, in advance, for an exemption from speculative position 
limits. With the exception of exemptions for ``anticipated unsold 
production'' and ``anticipated unfilled requirements,'' \24\ the 
Proposed Rule abandons that construct. The Working Group respectfully 
submits that such an approach is flawed for the reasons set forth 
below.
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    \24\ See proposed CFTC Rule 151.5(c) (with respect to hedging 
anticipated unsold production or anticipated unfilled requirements, a 
trader must submit to the Commission a 404A filing at least ten days in 
advance of the date that such transactions or positions would exceed 
the applicable position limits). See also proposed CFTC Rule 
151.5(c)(1)(ii), (iv), and (v) (each subsection contains the phrase 
``which may not exceed one year''). This restriction, however, should 
only be applied to referenced agricultural commodities. The Working 
Group is also concerned that this proposed rule could be read to 
effectively restrict the ability of participants in exempt commodity 
markets to hedge exposure to price volatility for transactions that are 
more than one year in duration. The Commission should clarify and, as 
necessary, rectify, the language of proposed CFTC Rule 151.5(c)(1)(ii), 
(iv), and (v) to avoid such a result.
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i. The Proposed Rule Creates Uncertainty for Market Participants
    Under current practice, a market participant would apply for an 
exemption from speculative position limits that would allow it to hold 
positions subject to the exemption up to a stated quantity. Such 
practice provides commercial energy firms with certainty and precise 
knowledge as to what the exchange (i.e., NYMEX) or exempt commercial 
market (``ECM'') with significant price discovery contracts (i.e., 
ICE), as applicable, will permit. Unlike current practice, the Proposed 
Rule leaves the upper limit of an exemption undefined.\25\ Unless the 
Commission is proposing that there is no upper limit for bona fide 
hedge transactions, which is highly doubtful, then the proposed process 
leaves a market participant without any knowledge as to when its 
positions will be deemed by the Commission to be ``too much.''
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    \25\ The Commission would be fully justified under the CEA to make 
such a determination to leave the upper limit of an exemption 
undefined. See CEA Sections 4a(a)(2)(A) and 4a(a)(5)(A). If that was 
the Commission's intention behind this proposed exemption process, the 
Working Group would fully support it.
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    By way of example, assume the speculative position limit for an 
energy commodity is 1,000 contracts, and a commercial energy firm with 
significant inventory could justify an exemption to allow it to hold 
6,000 contracts. In NYMEX's view, however, the market could support an 
exemption only to a level of 3,000 contracts. Under current practice, 
the commercial energy firm would know, in advance, that the potential 
acquisition of additional cash market risk would not result in 
additional room to hedge on NYMEX and could make a considered decision 
to make, or not make, the acquisition, knowing it might have to hold it 
unhedged.
    In contrast, the Proposed Rule does not provide a market 
participant the opportunity to know in advance what the Commission 
would determine to be the upper limit that the market could support. 
Pursuant to the Proposed Rule, a market participant must make the 
required filings with the Commission upon reaching the position limit 
of 1,000 contracts. In accordance with its internal policies and 
business practice, a market participant would continue to increase its 
position and make the corresponding required filings without ever 
knowing when and at what level the Commission would say ``enough.''
    The Working Group believes that, at some point, the Commission 
would say ``enough'' on the same basis that NYMEX currently limits 
exemption levels even when they would be fully justified based upon a 
participant's cash market exposure. Yet the Proposed Rule makes no 
provision for when or how the Commission would establish an upper 
bound, and fails to state whether a market participant would be 
required to liquidate or offset positions established in good faith 
before an upper bound was communicated. Commercial energy firms cannot 
afford to operate under this process, or lack thereof, as it creates a 
high level of uncertainty.
ii. The Commission Should Provide Clear Guidance on the Application 
        Process for Hedge Exemptions Should It Adopt One in Any Final 
        Rule Issued in the Proceeding
    Should the Commission adopt an application process for bona fide 
hedge exemptions in any final rule issued in this proceeding, the 
Working Group suggests that the Commission provide clear guidance on 
such process and permit market participants an opportunity to 
comment.\26\ Any application process adopted by the Commission should 
require market participants to apply for exemptions only once. 
Currently, market participants seek exemptions from the exchanges. Yet, 
under any final rule adopted by the Commission, market participants 
should not be required to apply for exemptions from both the CFTC and 
the exchanges. Such a requirement would impose significant burdens on 
market participants.\27\
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    \26\ The Working Group notes that in a prior rulemaking to 
establish federal speculative position limits, the Commission sought to 
establish an application process for bona fide hedge exemptions. See 
Federal Speculative Position Limits for Referenced Energy Contracts and 
Associated Regulations, Notice of Proposed Rulemaking, 75 Fed. Reg. 
4144 (Jan. 26, 2010).
    \27\ In addition to providing market participants with the ability 
to provide comments on the application process in the context of the 
instant rulemaking, the Working Group suggests that the Commission also 
host a technical conference or other forum to permit market 
participants to interface with the Commission and make recommendations. 
Upon issuance of a proposed application process, the Commission should 
then provide an appropriate opportunity for comment.
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iii. Daily Reporting of Cash Market and Other Positions Is Burdensome 
        and Unnecessary
    Under current practice on both NYMEX and ICE, a party with a hedge 
exemption is not required to make regular filings with the exchange or 
ECM. Nevertheless, a market participant remains subject to inquiry by 
NYMEX or ICE \28\ and the requirement to justify the use of the 
exemption. Additionally, the market participant remains subject to the 
special call authority of the CFTC \29\ and an enforcement action if 
such market participant used an exemption to hold speculative positions 
in excess of the position limit.
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    \28\ See NYMEX Rule 559; ICE OTC Rule 1.16.
    \29\ See 17 CFR  18.05; 21 (2010).
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    Under the Proposed Rule, a party will be required to submit daily 
reports itemizing the following information with respect to such 
position: (1) the cash market commodity hedged, the units in which it 
is measured, and the corresponding referenced contract that is used for 
hedging the cash market commodity; (2) the number of referenced 
contracts used for hedging; (3) the entire quantity of stocks owned of 
the cash market commodity that is being hedged by a position in a 
referenced contract; (4) the entire quantity of open fixed price 
purchase commitments in the hedged commodity outside of the spot month 
of the corresponding referenced contract; (5) the entire quantity of 
open fixed price purchase commitments in the hedged commodity in the 
spot month of the corresponding referenced contract; (6) the entire 
quantity of open fixed price sale commitments in the hedged commodity 
outside of the spot month of the corresponding referenced contract; and 
(7) the entire quantity of open fixed price sale commitments in the 
hedged commodity in the spot month of the corresponding referenced 
contract.\30\ Building the system to perform such reporting will be a 
significant and unnecessary expense, and the management and execution 
of the system to satisfy the daily reporting obligation an unnecessary 
burden.
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    \30\ See proposed CFTC Rule 151.5(b).
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iv. Daily Review of Positions Is a Burden that the Commission Does Not 
        Need To Impose Upon Itself
    In order to manage the speculative limit regime that the Commission 
is proposing to establish, CFTC staff will be required to review and 
evaluate daily the positions of all market participants that exceed the 
speculative position limits. First, as described in Part III.C.1.i, 
above, CFTC staff will need to do so to determine when to say 
``enough'' to a bona fide hedger with legitimate hedging needs that may 
be greater than the market for a particular instrument can bear. 
Second, staff will also need to do so to verify the veracity of a 
market participant's claim of eligibility for a hedge exemption, 
something that is currently only done on a periodic basis. The Working 
Group respectfully submits that the monitoring and verification 
obligations placed on CFTC staff will require the expenditure of 
considerable Commission resources and are unnecessary, especially at a 
time of significant budgetary constraint.
D. The Proposed Framework for Bona Fide Hedge Exemptions Should Reflect 
        the Hedging Practices of Commodity Markets
    In addition to the Working Group's specific concerns regarding the 
technical flaws with the proposed definition of the bona fide hedging 
exemption and the process of applying for an exemption, the Working 
Group respectfully requests the Commission to recognize that, although 
market participants in physical energy commodity markets use swaps and 
futures to hedge underlying physical positions, they frequently do not 
execute such transactions specifically for the purpose of hedging a 
specified underlying physical position (i.e., on a one-for-one basis). 
Prudent risk management practices generally involve hedging underlying 
physical assets and related positions on a portfolio or aggregate 
basis.\31\ A commercial firm will normally hedge these exposures 
utilizing physical transactions, futures, and swaps, the exact 
combinations of which will be determined by various characteristics 
that may be unique to such firm.
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    \31\ The Working Group notes that, in the CFTC's proposed rule on 
the end-user exception from mandatory clearing, the Commission 
recognizes that whether a position is used to hedge or mitigate 
commercial risk should be determined by the facts and circumstances at 
the time the swap is entered into, and should take into account the 
person's overall hedging and risk mitigation strategies. See Proposed 
End-User Exception Rule, at 80753. In relevant part, the Proposed End-
User Exception Rule states:

      As a general matter, the Commission preliminarily believes that 
whether a position is used
  to hedge or mitigate commercial risk should be determined by the 
facts and circumstances
  at the time the swap is entered into, and should take into account 
the person's overall hedging
  and risk mitigation strategies. The Commission expects that a 
person's overall hedging and
  risk management strategies will help inform whether or not a 
particular position is properly
  considered to hedge or mitigate commercial risk for purposes of the 
clearing exception.

    The Working Group respectfully submits that the Commission should 
take this same approach herein and recognize that the determination of 
what is a bona fide hedge transaction is informed by a market 
participant's overall hedging and risk management strategy.
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    Further, in order to effectively and efficiently mitigate 
commercial risk associated with underlying physical assets and related 
positions, commercial energy firms will also dynamically hedge their 
aggregate exposures on a regular and on-going basis to optimize the 
value of underlying physical assets or portfolios. A key aspect of 
dynamic hedging is the ability to modify the hedging structure related 
to the physical asset or positions when the relevant pricing 
relationships applicable to that asset change. Dynamic hedging may 
involve leaving an asset or position unhedged when necessary to 
mitigate the risk of lost opportunity costs, which may require hedges 
to be established, unwound, and re-established on an iterative basis 
over time.
    In this context, the concept of bona fide hedging should include 
all hedging activity that maximizes the value of the asset. The 
adoption of a prescriptive one-to-one matching requirement of each swap 
to a specific physical transaction or an asset position is inconsistent 
with the hedging practices of many participants in commodity markets, 
particularly energy markets, and is thus unnecessary and overly 
burdensome.\32\ As such, the Working Group requests that the Commission 
modify its hedge exemptions and their related reporting requirements to 
reflect more appropriately the actual hedging practices of participants 
in energy markets in any final rule it adopts in this proceeding.
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    \32\ For example, a commercial energy firm may enter into several 
swap transactions to hedge a single physical position. This approach is 
used to spread out risk among different counterparties and to obtain 
the best overall pricing possible for the hedge. Given the dynamic and 
volatile nature of energy markets, it is very difficult for a 
commercial energy firm or any other market participant to assert on an 
intra-day, real-time basis or at a later point in time whether a 
particular swap or futures transaction is functioning as a hedge. Under 
this example, it would be difficult, if even possible, for a swap 
dealer to step into the shoes of its commercial counterparty on a 
transaction-by-transaction-basis for purposes of applying the pass-
through provisions of CEA Section 4a(c)(2)(B).
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E. The Pass-Through Provision Is Not Required, and Therefore, the 
        Commission Should Adopt an Alternative Approach: Permit Risk 
        Management Exemptions From Position Limits
    As amended by Title VII of the Act, new CEA Section 4a(c)(2)(B) 
permits the pass-through of a bona fide hedge exemption from 
speculative position limits to swap dealers taking the other side of a 
hedge transaction from an end-user. In relevant part, new CEA Section 
4a(c)(2)(B) states:

          (2) For the purposes of implementation of subsection (a)(2) 
        for contracts of sale for future delivery or options on the 
        contracts or commodities, the Commission shall define what 
        constitutes a bona fide hedging transaction or position as a 
        transaction or position that--
          * * * * *
                  (B) reduces risks attendant to a position resulting 
                from a swap that--

                          (i) was executed opposite a counterparty for 
                        which the transaction would qualify as a bona 
                        fide hedging transaction pursuant to 
                        subparagraph (A); or
                          (ii) meets the requirements of subparagraph 
                        (A).

    This discretionary provision effectively allows a swap dealer to 
``step into the shoes'' of a commercial firm or end-user counterparty 
for purposes of being exempted from applicable speculative position 
limits.
1. The Pass-Through Is No Longer Required; the Concerns Over Risk 
        Management Exemptions Have Been Ameliorated
    The Working Group submits that the transparency created in exempt 
commodity markets by Title VII of the Act, together with the 
Commission's exemptive authority under new CEA Section 4a(a)(7), render 
this pass-through provision unnecessary.
    The Working Group supports pre-rulemaking comments submitted by 
other interested parties \33\ recommending that the Commission continue 
its practice of granting arbitrage and risk management exemptions from 
position limits for positions that serve the same or similar function 
as a bona fide hedge position, but do not fall squarely within the 
definition of a bona fide hedge.\34\ Risk management exemptions from 
position limits are essential to the risk management practices of 
commercial energy firms; however, such exemptions had come under 
scrutiny because they allowed a swap dealer to get a hedge exemption to 
hedge the risk of swaps opposite speculative traders whose swap 
positions were unknown to the Commission and were subject to neither 
position limit nor accountability rules. Under Dodd-Frank, those 
concerns are no longer present. That is, virtually all swap 
transactions will be reported to swap data repositories (``SDRs''), 
prices will be reported to the public, and the parties will be subject 
to large trader reporting rules. Accordingly, the Commission may grant 
risk management exemptions on the basis of a party's need, ability to 
manage the positions, and the ability of the market to support the 
positions, all without concern that it has enabled a ``dark market'' 
with attendant risks of ``excessive speculation.''
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    \33\ See FIA Pre-Rulemaking Comments at 8; Morgan Stanley, Position 
Limits Pre-Rule Proposal Comments and Recommendations, at 10 (Oct. 25, 
2010).
    \34\ Section 4a(a) of the CEA states: ``[N]othing in this section 
shall be construed to prohibit the Commission from . . . exempting 
transactions normally known to the trade as `spreads' or `straddles' or 
`arbitrage.' ''
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    Section 4a(a)(7) provides the Commission with broad authority to 
exempt any persons or transactions from speculative position limits 
that it sets under Section 4a. The Working Group respectfully submits 
that the Commission exercise its exemptive authority to grant 
exemptions in appropriate circumstances rather than establish a pass-
through exemption, the need for which has been significantly diminished 
given the transparency created in exempt commodity markets by the Act.
2. If Adopted, the Pass-Through Provision Raises Significant Compliance 
        Concerns
    To the extent the Commission declines the Working Group's 
recommendation to eliminate the pass-through provision in favor of risk 
management exemptions, the Working Group submits that the 
implementation of such provision in energy markets would create several 
practical concerns. Importantly, for the reasons described below, the 
resulting burdens and cost impacts of a pass-through provision will be 
disproportionately borne by those commercial firms, including energy 
firms, that presently manage risk through hedging practices.\35\
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    \35\ The Working Group submits that the Proposed Rule will impose 
costs for monitoring compliance associated with the Commission's 
proposed pass-through provision. See infra Part III.J, discussing the 
Commission's costs and benefit analysis.
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i. The Proposed Rule Contemplates One-for-One Hedging
    For example, the Working Group is concerned that market 
participants will be required to engage in a transaction-by-transaction 
analysis for purposes of determining whether a particular trade is in 
fact a bona fide hedge. As discussed in Part III.D, above, such an 
approach is inconsistent with the routine hedging practices employed by 
many participants in commodity markets, particularly energy markets. 
Specifically, these market participants determine their aggregate 
underlying exposures in physical markets and match hedges to those 
physical positions rather than hedging on a one-to-one basis.
    With this in mind, the pass-through of bona fide hedge exemptions 
as contemplated in the Proposed Rule is unworkable as it would require 
hedgers claiming the use of a bona fide hedge exemption to match a swap 
that hedges or mitigates commercial risk with a specified underlying 
physical commodity transaction. To the extent the Commission uses its 
discretion to retain the pass-through of bona fide hedge exemptions, 
the Working Group suggests that the Commission maintain the approach 
currently used by DCMs and ECMs with significant price discovery 
contracts--which is to focus on market participants' overall physical 
exposures and match hedges to the physical position.\36\
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    \36\ See, e.g., ICE OTC Rule 1.16.
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ii. Written Trade-by-Trade Representations and Acknowledgements Are Not 
        Practical in Dynamic, Fluctuating Markets
    Proposed CFTC Rule 151.5(g) requires that a party relying on the 
bona fide hedging exemption provide a written representation verifying 
that the particular swap qualifies as a bona fide hedging transaction 
under proposed Rule 151.5(a)(1)(iv).\37\ Given the discretionary nature 
of new CEA Section 4a(c)(2)(B), the Working Group believes that such 
written representation should be optional, not mandatory (understanding 
that absent a representation, there would be no pass-through). It is 
impracticable to require a trader to make a determination at the time 
of the trade on the nature of the transaction, particularly, whether 
the swap is a hedge or speculative in nature.\38\ Moreover, as stated 
above, it would be impracticable, if not impossible, for the vast 
majority of market participants to link hedges with specified 
underlying physical positions for purposes of complying with the pass-
through requirements in proposed CFTC Rule 151.5(g).
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    \37\ Proposed CFTC Rule 151.5(g)(1) states: ``The party not hedging 
a cash market commodity risk, or both parties to the swap if both 
parties are hedging a cash market commodity
risk . . . .'' The Working Group submits that if both counterparties 
are hedging, there is no need to pass through their respective hedge 
exemptions and thus fails to understand the provision as written.
    \38\ The Commission also recognizes the difficulty in discerning 
between speculation and hedging. See End-User Exception Rule, at 80753.
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iii. The Requirement that Parties Verify the Ongoing Nature of a Hedge 
        Is Not Workable
    The Working Group is also concerned with proposed CFTC Rule 
151.5(j)(2), which permits a party to exceed a position limit only ``to 
the extent and in such amounts that the qualifying swap directly 
offsets, and continues to offset, the cash market commodity risk of a 
bona fide hedger counterparty.'' This provision is problematic as it 
implies that a hedger must monitor and track the status of a each 
transaction it represented to its counterparty as a bona fide hedge and 
continually inform and represent to the counterparty that such swap 
continues to be a bona fide hedge. Such requirement would result in 
significant and costly burdens on hedgers.
F. Problems With the Proposed Spot-Month Limits
1. The Determination of Deliverable Supply Should Be Fully Transparent 
        and Subject to Public Notice and Comment
    Pursuant to proposed CFTC Rule 151.4(c), DCMs that list referenced 
physical delivery contracts would be required to submit estimates of 
deliverable supply for those physical commodities to the Commission on 
an annual basis. The Proposed Rule notes that the Commission will rely 
on a DCM's estimate of deliverable supply unless it ``determines to 
rely on its own estimate.'' Given the overwhelming importance of the 
determination of deliverable supply for a Referenced Contract in 
establishing workable spot-month position limits under the framework 
set forth in the Proposed Rule, this process should be fully 
transparent,\39\ and the Commission should provide public notice and 
permit comment by interested parties. In furtherance of this process, 
the Working Group suggests the following approach:
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    \39\ The Working Group supports proposed CFTC Rule 151.4(c)(3) 
requiring estimates submitted by a DCM to be accompanied by a 
description of the methodology used by the DCM and any supporting data.

   November 30--DCM Estimate Submissions. DCMs submit to the 
        Commission deliverable supply estimates for each physical 
        delivery referenced contract that is subject to a spot-month 
        limit and listed or executed pursuant to the rules of such 
        DCMs. This submission is immediately noticed by the Commission 
---------------------------------------------------------------------------
        for public comment.

   Mid-December--Comment Deadline on DCM Estimates. Interested 
        parties would have 15 days to submit comments to the Commission 
        providing their views on the DCM's deliverable supply 
        estimates.

   Mid-January--CFTC Issues Proposed Position Limits. 
        Approximately 30 days following the submission of comments on 
        the DCM deliverable supply estimates, the Commission would 
        publish (or post on its website) proposed position limits for 
        each referenced contract.

   February 1--Comment Deadline on Proposed Position Limits. 
        Interested parties would have 15 days to submit comments on the 
        Commission's proposed position limits for each referenced 
        contract.

   March 1--CFTC Issues Final Position Limits. The CFTC would 
        release (or post on its website) final position limits for each 
        referenced contract.

   April 1--New Position Limits Become Effective. Affected 
        market participants would receive approximately 30 days to come 
        into compliance with the new position limits. The new position 
        limits would remain in effect until March 31st of the following 
        year.

    Finally, the Working Group strongly recommends that the Commission 
grandfather any position put on in good faith prior to the effective 
date of any final position limit set by Commission rule, regulation, or 
order.
2. The Proposed Spot-Month Position Limits for Cash-Settled Contracts 
        Should be Reconsidered
i. The Working Group Respectfully Submits that the Limit for Cash-
        Settled Contracts Does Not Need to Equal the Limit for 
        Physically-Settled Contracts
    In the first transitional phase, proposed CFTC Rule 151.4 would 
apply spot-month position limits separately for physically-delivered 
contracts and all cash-settled contracts, including cash-settled 
futures and swaps. The Commission has proposed to set the limit for 
cash-settled contracts at the same level as the level for physically-
settled contracts, a level which is established as 25% of deliverable 
supply. While the Working Group notes that the establishment of 
identical spot-month limits for cash- and physically-settled contracts 
has been the practice in recent years, it respectfully submits that the 
practice is not grounded in a sound regulatory foundation. Cash-settled 
contracts have substantially different potential impacts on pricing. 
Although deliverable supply is an important component for establishing 
position limits, if any, for physically-delivered contracts, its 
importance is greatly diminished with respect to cash-settled 
contracts. The Working Group respectfully submits that the Commission 
reconsider this approach and establish a much higher, more appropriate 
spot-month limit, if any, on cash-settled contracts.
ii. As Applied to Cash-Settled Referenced Contracts, the Proposed Rule 
        Significantly Reduces a Trader's Permitted Position
    The Working Group submits that such approach inappropriately cuts 
in half position limits on cash-settled referenced contracts. For 
example, a NYMEX Henry Hub Natural Gas (NG) physically-settled futures 
contract has a spot-month limit of 1,000. As a result, NYMEX (NN) cash-
settled futures and an ICE HH LD1 swap each have a spot-month limit of 
1,000. By separating the spot-month limits into ``physically-
delivered'' and cash-settled,'' and setting each spot-month limit at 
1,000, a market participant is effectively forced to add its NN 
position to its HH LD1 position, and whereas it previously could have 
held 1,000 in each (2,000 in total), it can now only hold 1000 cash-
settled contracts in total. Such a result will likely constrict 
liquidity in the NYMEX NN and ICE HH LD1 markets. This is contrary to 
two of the express policy goals of CEA Section 4a(a): (i) ensuring 
sufficient market liquidity, and (ii) ensuring that the price discovery 
function of the underlying market is not disrupted.
    Post Dodd-Frank position limits also will include swaps that 
previously were traded over-the-counter (``OTC'') and not subject to 
limits. As a result, the imposition of limits on cash-settled positions 
will be even more constraining, as positions previously excluded from a 
market participant's position will now be required to be included, 
while the levels will be reduced in some circumstances. Thus, the 
Working Group respectfully requests that the Commission reconsider its 
spot-month position limits and modify them accordingly.
iii. Conditional Exemption for Cash-Settled Contracts Should Permit 
        Market Participants To Hold Physically-Settled Futures 
        Contracts
    In order to promote liquidity and efficient price discovery, 
proposed CFTC Rule 151.4(a)(2) provides for a conditional spot-month 
limit. A trader would be permitted to acquire positions that are five 
times the spot-month limit if such positions are exclusively in cash-
settled contracts, and the trader holds physical commodity positions 
that are less than or equal to 25 percent of the estimated deliverable 
supply of a physical commodity.\40\ However, to qualify for the 
conditional exemption, market participants may not hold any physically-
settled futures contracts.
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    \40\ Specifically, the conditional exemption for cash-settled 
contracts would apply if (i) such positions are exclusively in cash-
settled contracts, and (ii) a trader holds physical commodity positions 
that are less than or equal to 25 percent of the estimated deliverable 
supply. With regard to the second condition, a trader may not hold or 
control (a) positions in cash-settled contracts in the spot month that 
exceed the level of any single month position limit, (b) any positions 
in the physical delivery referenced contract based on the same 
commodity that is in such contract's spot month, and (c) cash or 
forward positions in the referenced contract's spot month in an amount 
that is greater than one-quarter of the deliverable supply in the 
referenced contract's underlying commodity. See proposed CFTC Rule 
151.4(a)(2).
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    The Working Group believes the condition requiring market 
participants to hold no physically settling futures contract is 
contrary to the statutory goals of CEA Section 4a to promote 
transparency, protect price discovery, and ensure the efficiency of 
markets. To the extent a hedger wants to avail itself of the 
conditional spot-month limit, it would be required to move out of 
physically settled futures, which would reduce liquidity and price 
discovery in the physically settled futures markets. The Working Group 
is concerned that the diminution in liquidity could negatively impact 
price convergence in the core physical delivery contract.
    Accordingly, to accommodate more appropriately the hedging needs of 
market participants, the Working Group suggests an approach wherein 
cash-settled position limits are set as a multiple of physically-
settled position limits, and so long as a market participant is not in 
violation of any position limit, their physical positions should not be 
limited in any manner.
3. The Commission Should Identify All Referenced Paired Contracts 
        Subject to Spot-Month Position Limits
    Without clear guidance from the Commission, the broad and vague 
language defining referenced paired contracts could lead to subjective 
and inconsistent interpretations by market participants seeking to 
identify the universe of referenced paired contracts. As such, the 
Working Group requests that the Commission identify the universe of 
futures contracts, option contracts, swaps, or swaptions that 
constitute referenced paired contracts and provide market participants 
the opportunity to comment on any Commission determination. Because the 
Commission cannot identify uncleared contracts until they are executed, 
it should limit referenced paired contracts to only those that are 
cleared.\41\
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    \41\ The Commission should not be concerned about excluding 
uncleared contracts because as soon as they become large or material 
for limit purposes, the Commission can make them subject to mandatory 
clearing.
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    Further, after the Commission's initial identification, the Working 
Group suggests that, in its process for determining whether a swap must 
be cleared pursuant to the Act, the Commission should also determine 
whether such swap constitutes a referenced paired contract. New CEA 
Section 4a(a)(7) provides the Commission with broad authority to exempt 
swaps from speculative position limits it establishes pursuant to 
Section 4a. If a swap is not required to be cleared pursuant to the 
mandatory clearing requirements of the Act, it should not be included 
for purposes of determining position limits.
G. The Proposed Position Visibility Levels Will Impose a 
        Disproportionate Burden on Hedgers
    Notwithstanding the absence of any mandate from the Act, the 
Commission proposes to establish position visibility levels for 
referenced contracts other than agricultural contracts,\42\ and 
establishes reporting requirements for all traders exceeding those 
levels in all months or in any single month, including the spot 
month.\43\ Traders with positions above visibility levels in these 
referenced contracts would be required to submit statements containing 
additional information about their cash market and derivatives 
activity, including data relating to substantially the same commodity 
(i.e., commodities that are different grades or formulations of the 
same basic commodity).\44\
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    \42\ The core referenced futures contracts in the energy sector 
that are subject to position visibility levels are: NYMEX Light Sweet 
Crude Oil (22,500 contract level); NYMEX NY Harbor Gasoline Blendstock 
(7,800 contract level); NYMEX Henry Hub Natural Gas (21,000 contract 
level); and NYMEX NY Harbor No. 2 Heating Oil (9,900 contract level).
    \43\ See proposed CFTC Rule 151.6. The Working Group notes that the 
visibility limits are below, and in some cases, significantly below, 
the all months combined and any month position limits.
    \44\ These statements must include: (i) the date the trader's 
position initially reached or exceeded the visibility level; (ii) gross 
long and gross short positions on an all-months-combined basis; (iii) 
the contract month and the trader's gross long and gross short 
positions in the relevant single month (if visibility levels are 
reached or exceeded in any single month); and (iv) if applicable, 
certification no positions subject to the additional reporting 
requirements set forth in the Proposed Rule are held.
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    These visibility and consequent reporting requirements are 
unnecessary given the transparency provisions that currently exist 
under the CEA and those being implemented under Title VII of the Act. 
For example, transparency is provided under: (i) the Large Trader 
Reporting System for futures markets; and (ii) reporting requirements 
adopted under Title VII applicable to large swap traders and registered 
entities, including derivative clearing organizations (``DCO''); and 
(iii) reporting requirements of uncleared OTC transactions to SDRs or 
the Commission itself. Further, to the extent that the Commission seeks 
specific information regarding the hedge exposures of a large market 
participant (or group of large market participants), it can exercise 
its special call authority set forth in Rule 18.05 of the Commission's 
Regulations.\45\
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    \45\ 17 CFR  18.05.
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    Further, the Proposed Rule fails to address and analyze adequately 
the compliance costs of meeting such visibility requirements and 
articulate any material benefits accruing to swap or futures 
markets.\46\ The Working Group submits that, in contrast to 
speculators, compliance with the proposed visibility levels will result 
in a substantial and disproportionate burden on bona fide hedgers, as 
hedgers will be required to produce voluminous data.
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    \46\ See infra Part III.J, discussing the Commission's costs and 
benefit analysis.
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    Therefore, in light of the transparency created by Title VII of the 
Act and the Commission's ability to request data from market 
participants pursuant to its existing special call authority, the 
Working Group submits that the imposition of position visibility levels 
and periodic reporting requirements for hedge exposures is unwarranted. 
Such requirements will unnecessarily impose a substantial compliance 
burden for all markets participants and would not provide any benefit 
that justifies the costs.
H. Transactions Between Affiliates Should Not Be Counted for Position 
        Limit Compliance Purposes
    Inter-affiliate transactions that merely shift risk between one 
corporate affiliate and another (i.e., a book transfer) should not be 
counted for purposes of complying with position limits. Indeed, inter-
affiliate swaps do not in any way enhance systemic risk, nor do they 
affect liquidity in swap markets. Specifically, inter-affiliate 
transactions do not add to concentration in the market and therefore 
cannot lead to an attempt by a market participant to corner the market 
through excessive speculation. Consequently, the Working Group submits 
that there is no benefit in including affiliate transactions in any 
position limit.
I. Aggregation of Positions
    The Working Group generally supports the proposed aggregation rules 
and disaggregation exemption as applied to ``owned'' non-financial 
entities. However, the Working Group respectfully requests 
clarification on the scope and application of the indicia of 
independent control. Specifically, the Commission should (i) clarify 
the type of showing a market participant must make to demonstrate 
independent control; (ii) provide reasonable flexibility for market 
participants to address specified indicia through alternative, yet 
functionally equivalent, measures; and (iii) confirm that the positions 
of a non-financial subsidiary or affiliate that meet the applicable 
independent management and trading requirements will not be aggregated 
with a parent financial entity.
    The Working Group submits that employees such as attorneys, 
accountants, and risk management personnel may be shared between two 
affiliate companies without violating the independence requirements 
under proposed CFTC Rule 151.7, so long as they do not actively and 
personally perform day-to-day trading activities and engage in day-to-
day trading decisions. The Working Group further submits that risk 
management systems may also be shared between affiliated companies 
without violating the independence requirements under proposed CFTC 
Rule 151.7, so long as appropriate security mechanisms are in place to 
prevent each company from gaining access to information or data about 
its affiliated companies' positions, trades, or trading strategies.
    Although the Working Group generally supports the proposed 
aggregation rules and disaggregation exception, it fails to understand 
certain aspects of proposed CFTC Rule 151.7(g). Specifically, subpart 
(g)(1)(ii) requires that, in any application for a hedging exemption, a 
market participant must provide an ``independent assessment report'' as 
described in proposed CFTC Rules ``151.9(c)(1)(iii) and 151.9(f)(3).'' 
The Working Group notes that these cross-references do not exist and 
believes this discrepancy is the result of a typographical error that 
should be corrected. Notwithstanding these errors, the Working Group 
requests that the Commission provide market participants flexibility in 
meeting the requirements of proposed CFTC Rule 151.7(g). Specifically, 
the Working Group respectfully requests that the Commission permit 
market participants discretion in using internal or external personnel 
to make assessments relating to the independence of its owned non-
financial entities.
    Finally, the Working Group recommends that the Commission treat the 
application for exemption from aggregation requirements for non-
financial entities required by proposed CFTC Rule 151.7(g) as a self-
certification requirement that is effective immediately upon filing. In 
addition, the Commission should provide a safe harbor for market 
participants that submit such applications in good faith to promptly 
correct inadvertent errors or make adjustments in an orderly manner to 
comply with newly implemented regulatory requirements under Title VII 
of the Act.\47\
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    \47\ Such safe harbor protection is required to permit certain 
market participants to communicate internally to determine how they 
must comply with the proposed aggregation requirements and ensure that 
they do not violate the Commission's proposed rules or the rules and 
regulations of other federal regulators with jurisdiction over their 
operations.
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J. Meaningful Comment on the Anticipated Costs and Benefits of the 
        Proposed Rule Is Not Possible at This Time
    The Working Group respectfully submits that it cannot meaningfully 
respond to the costs unless a comprehensive and complete view of all 
Dodd-Frank rulemakings are known. In particular, the Commission has not 
yet issued a proposed or final rule further defining the term ``swap,'' 
as set forth in new CEA Section 1a(47)(A). As such, the Working Group 
and other market participants are unable to ascertain the universe of 
transactions that may be subject to Commission oversight as ``swaps'' 
and, thus, subject to the requirements of the Proposed Rule. This 
guidance is critical to the efforts of affected market participants to 
identify and understand the scope and impact of the Proposed Rule and 
effectively comply with it.
    The reporting requirements proposed by the Commission as discussed 
above are commercially impractical and if implemented would create 
substantial and perhaps irreparable costs to the market and market 
participants. Further, it is difficult, if not impractical, to 
meaningfully analyze the costs to traders applying for, and reporting 
pursuant to, the bona fide hedge exemption because it is unclear how 
the reporting obligations would fit at this time with the many other 
reporting requirements proposed by the Commission for market 
participants. Therefore, the Working Group respectfully reserves the 
right to comment at a later date on the costs from the Proposed Rule, 
when those costs can be better understood and quantified. However, the 
Working Group offers analysis on several issues regarding the 
Commission's discussion of costs in the Proposed Rule.
    The Proposed Rule's analysis of requirements under the Paperwork 
Reduction Act address three main areas of costs that commercial firms 
can anticipate: (i) bona fide hedge related reporting requirements, 
(ii) record-keeping requirements for traders applying for bona fide 
hedge exemptions, and (iii) costs arising from the visibility level 
reporting obligations. The Proposed Rule states that the costs related 
to the reporting of bona fide hedges are anticipated to be $37.6 
million in the aggregate. This equates to $188,000 per market 
participant. The record-keeping requirements for traders applying for 
bona fide hedge exemptions are anticipated to be an additional $10.4 
million in the aggregate for annualized start up and capital costs and 
annual operating costs, which equates to $65,000 per market 
participant.\48\ In addition, the Proposed Rule estimates that the 
costs to implement the position visibility levels is approximately 
$29.7 million in the aggregate, which equates to $212,000 per market 
participant. The costs associated with those market participants that 
exceed the visibility levels and need to seek a bona fide hedge 
exemption are estimated to be approximately $465,000 per market 
participant.
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    \48\ The Commission does not provide a breakdown between annualized 
capital and start up costs and annual total operating and maintenance 
costs in the discussion of costs in the Paperwork Reduction Act 
analysis. Therefore it is not possible to ascertain the operating and 
maintenance costs noted in the Proposed Rule, and discussed herein, 
which the impacted market participants can expect to bear on an annual 
basis.
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    The costs set forth in the Paperwork Reduction Act analysis are not 
considered in the cost-benefit analysis set forth in the Proposed Rule. 
The costs outlined in the Paperwork Reduction Act section, along with 
the additional costs imposed by the Proposed Rule on bona fide hedgers, 
should be subject to a thorough cost-benefit analysis of any final rule 
issued in this proceeding. For example, should the Commission exercise 
its discretion and adopt the pass-through provision, additional costs 
not considered by the Proposed Rule are the costs associated with 
monitoring compliance with the pass-through provision set forth in 
proposed CFTC Rule 151.5(a)(1)(iv) that will be imposed on entities 
relying on the bona fide hedge exemption.
    The Proposed Rule does not offer any empirical evidence as to the 
criteria for selecting, or process for identifying, the universe of 
market participants likely to be impacted by this rulemaking. For 
example, the Commission anticipates that on an annual basis, 140 market 
participants would be subject to the visibility level reporting 
obligations, and 200 would be subject to the reporting requirements 
applicable to bona fide hedging transactions. Given that visibility 
limits are to be set at a substantially lower level than the proposed 
position limits, the Working Group respectfully submits that it would 
be reasonable to assume that the number of entities impacted by the 
visibility limits would be greater than those which would need to seek 
a bona fide hedge exemption. However, the Proposed Rule espouses an 
opposite view.
    Further, the cost estimates for wage and salary have been estimated 
from the Securities Industry and Financial Markets Association 
(``SIFMA'') information. Internal data collected and analyzed by 
members of the Working Group suggest that the average cost per hour is 
approximately $120, much higher than SIFMA's $78.61, as relied upon by 
the Commission.\49\ In addition, many commercial firms, including 
members of the Working Group, are not staffed with the expertise to 
build the systems that will be required to comply with the various 
reporting provisions of the Proposed Rule. The Working Group 
anticipates that its members will be utilizing the expertise of 
consultants to create and implement the information technology systems 
required by the Proposed Rule. Firms will be seeking these services at 
a time when consultants are in high demand and even before the 
implementation of Dodd-Frank requirements are at capacity. Thus, the 
cost estimates offered in the Proposed Rule regarding anticipated wage 
and salary impacts may be significantly below the costs of consultants.
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    \49\ For a complete discussion regarding the Working Group's cost 
estimates of the CFTC's proposed rules, see the Comments of the Working 
Group submitted in response to the CFTC's proposed rule regarding the 
duties of swap dealers and MSPs, filed on January 24, 2011. Regulations 
Establishing and Governing the Duties of Swap Dealers and Major Swap 
Participants, 75 Fed. Reg. 71,397 (Nov. 23, 2010).
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IV. Open Comment Period
    Given the complexity and interconnectedness of all of the 
rulemakings under Title VII of the Act, and given that the Act and the 
rules promulgated thereunder entirely restructure OTC derivatives 
markets, the Working Group respectfully requests that the Commission 
hold open the comment period on all rules promulgated under Title VII 
of the Act until such time as each and every rule required to be 
promulgated has been proposed. Market participants will be able to 
consider the entire new market structure and the interconnection 
between all proposed rules when drafting comments on proposed rules. 
The resulting comprehensive comments will allow the Commission to 
better understand how its proposed rules will impact swap markets.
V. Conclusion
    The Working Group supports appropriate regulation that brings 
transparency and stability to the energy swap markets in the United 
States. The Working Group appreciates this opportunity to comment and 
respectfully requests that the Commission consider the comments set 
forth herein as it develops a final rule in this proceeding.
    The Working Group expressly reserves the right to supplement these 
comments as deemed necessary and appropriate.
    If you have any questions, please contact the undersigned.
            Respectfully submitted,

R. Michael Sweeney, Jr.;
Mark W. Menezes;
David T. McIndoe;
Counsel for the Working Group of Commercial Energy Firms.
                                 ______
                                 
                          Submitted Questions
Response from Hon. Gary Gensler, Chairman, Commodity Futures Trading 
        Commission
Questions Submitted by Hon. Collin C. Peterson, a Representative in 
        Congress from Minnesota
    Question 1. Your testimony suggests that regulations may be applied 
to some asset classes before others. Which asset classes do you think 
would see regulation first, and what qualities about these asset 
classes make them ripe for regulation as opposed to others?
    Answer. The Commission proposed a rule to establish a process for 
the review and designation of swaps for mandatory clearing. One of the 
primary goals of the Dodd-Frank Act was to lower risk by requiring 
standardized swaps to be centrally cleared. The process set out in the 
proposed rule is consistent with the Congressional requirement that 
derivatives clearing organizations (DCOs) be eligible to clear the 
swaps and that before a swap becomes subject to mandatory clearing, the 
public gets to provide input on the contract or class of contracts. The 
proposed rule would provide a process to implement the Dodd-Frank Act 
requirement that a DCO that plans to accept a swap (or group, category, 
type, or class of swaps) for clearing to submit the swap to the 
Commission for review. The proposed rule also includes a process to 
implement the Dodd-Frank requirement for Commission-initiated review of 
swaps, including by class. The Commission sought public comment on all 
aspects of the review process. In addition, DCO submissions and 
Commission-initiated reviews would be subject to public comment under 
the proposed rule's processes.

    Question 2. There have been a number of concerns raised about the 
Commission's proposed definition of swap execution facility (SEF) and 
its requirement that participants must request price quotes from 
multiple participants. In contrasts the SEC and European regulators 
appear to be willing to allow one-to-one price quotations, similar to 
what occurs in over-the-counter markets today.

    (a) Explain the reasoning behind the Commission proposal. How will 
        the multiple bid requirement benefit market participants?

    (b) Given that the legislative language for SEFs and security-based 
        SEFs are virtually identical, is it possible for both the 
        CFTC's and the SEC's very different proposals to be in 
        compliance with the law? If so, what is a rationale for living 
        with the differences?

    (c) Assuming the Commission and the EU continue down their separate 
        paths on this issue, what is to prevent business from moving 
        overseas to what may be viewed as a more favorable trading 
        venue?

    Answer. The CFTC's proposed SEF rule will provide all market 
participants with the ability to execute or trade with other market 
participants. It will afford market participants with the ability to 
make firm bids or offers to all other market participants. It also will 
allow them to make indications of interest--or what is often referred 
to as ``indicative quotes''--to other participants. Furthermore, it 
will allow participants to request quotes from other market 
participants. These methods will provide hedgers, investors and Main 
Street businesses both the flexibility to execute and trade by a number 
of methods, but also the benefits of transparency and more market 
competition. The proposed rule's approach is designed to implement 
Congress' mandates for transparency and competition where multiple 
market participants can communicate with one another and gain the 
benefit of a competitive and transparent price discovery process.
    The proposal also allows participants to issue requests for quotes, 
whereby they would reach out to a minimum number of other market 
participants for quotes. It also allows that, for block transactions, 
swap transactions involving non-financial end-users, swaps that are not 
``made available for trading'' and bilateral transactions, market 
participants can get the benefits of the swap execution facilities' 
greater transparency or, if they wish, would still be allowed to 
execute by voice or other means of trading.
    In the futures world, the law and historical precedent is that all 
transactions are conducted on exchanges, yet in the swaps world many 
contracts are transacted bilaterally. While the CFTC will continue to 
coordinate with the Securities and Exchange Commission (SEC) to 
harmonize approaches, the CFTC also will consider matters associated 
with regulatory arbitrage between futures and swaps. The Commission has 
received public comments on its SEF rule and will move forward to 
consider a final rule only after staff has had the opportunity to 
summarize them for consideration and after Commissioners are able to 
discuss them and provide feedback to staff.
    As the Commission works to implement the derivatives reforms in the 
Dodd-Frank Act--with regard to execution requirements as well as all 
other areas--we are actively coordinating with international regulators 
to promote robust and consistent standards and avoid conflicting 
requirements in swaps oversight. The Commission participates in 
numerous international working groups regarding swaps, including the 
International Organization of Securities Commissions Task Force on OTC 
Derivatives, which the CFTC co-chairs with the SEC. The CFTC, SEC, 
European Commission and European Securities Market Authority are 
coordinating through a technical working group.

    Question 3. Most estimates place the world's 25 largest banks as a 
party to more than 90% of the world's swaps. When you testified here 
last, you suggested that 200 entities would likely register as swap 
dealers and that most of them would be affiliates of the large banks, 
who are being required to spin off parts of their swap business under 
other provisions of Dodd-Frank. Assuming the CFTC's proposed definition 
of swap dealer remains, of these 200 entities, how many do you believe 
will not be affiliates of these 25 large banks and who generally would 
make up these non-affiliated swap dealers?
    Answer. In the first week of December 2010, the CFTC and the SEC 
jointly issued a proposed rulemaking to further define the term ``swap 
dealer.'' To date, there are more than 200 comments responding to the 
proposal. Many of the commenters addressed why the definition of swap 
dealer should or should not encompass particular types of companies. 
The particular characteristics and activities that would require a 
company to register as a swap dealer will be addressed in the final 
rule, after taking the comments into account.

    Question 4. In his testimony for the next panel, Mr. McMahon with 
Edison Electric Institute appears to not want regulators to impose 
capital or margin requirements on swaps entered into strictly between 
swap dealers and major swap participants because of potential costs. 
Given that you think the risks involved with swaps between end-users 
and financial players do not merit margin requirements, what are your 
thoughts about Mr. McMahon's idea to do the same for dealer to dealer 
swaps?
    Answer. In passing the Dodd-Frank Act, Congress recognized the 
different levels of risk posed by transactions between financial 
entities and those that involve non-financial entities, as reflected in 
the non-financial end-user exception to clearing. The CFTC also has 
recognized this, for example, in its proposed rule regarding margin 
requirements for swap dealers and major swap participants. For any 
transaction involving a non-financial end-user engaged in hedging or 
mitigating commercial risk, neither party is required to post margin.
    In the joint rulemaking to further define the term ``swap dealer,'' 
the SEC and the CFTC proposed factors for the de minimis exemption 
based on the aggregate effective notional amount of an entity's trades, 
its level of trading activity with special entities, the number of 
counterparties it transacts with and the number of swaps it trades.
    Before the Commission proceeds to final rules, Commission staff 
will read and summarize all submitted public comments, and 
Commissioners will have the opportunity to review comments and provide 
feedback.

    Question 4a. In his testimony for the next panel, Mr. McMahon with 
Edison Electric Institute worries that his members' ``accommodating'' 
the demand of third parties for swaps are being viewed by the CFTC as 
dealing activity and such activity could get his members listed as swap 
dealers.

    (a) Have you heard about this ``accommodating'' swap activity that 
        his members have engaged in and what do you see are the 
        similarities and differences between it and a dealer's swap 
        activity?

    (b) Although it would not qualify now under the proposed rules, 
        isn't such ``accommodating'' swap activity a likely reason why 
        Congress included a de minimis exception to the definition of 
        swap dealer?

    (c) Assuming this activity does classify one of his members as a 
        swap dealer:

      (i) Would the full scope of regulation under the proposed rules 
            apply to all his swap activity or just this 
            ``accommodating'' activity?

      (ii) If his counterparties to these ``accommodating'' swaps were 
            end-users, wouldn't such swaps still be eligible for the 
            clearing exception and an exception from margin, as you 
            envision it?

    Answer. The CFTC and SEC jointly issued a proposed rule to further 
define the terms ``swap dealer,'' ``securities-based swap dealer,'' 
``major swap participant'' and ``major securities-based swap 
participant.'' The Commissions specifically sought public comment 
regarding the appropriate clarifications to the detailed definition 
included in the statute. While the de minimis exemption may apply in 
particular relevant circumstances, the Commissions sought specific 
comment with regard to additional factors to be considered where the de 
minimis exemption level may be exceeded. The Commission has received 
substantial public comment in response. Staff will analyze, summarize 
and consider public comments before the Commission proceeds further.
Question Submitted by Hon. Randy Hultgren, a Representative in Congress 
        from Illinois
    Question. As you know, the Committee has expressed concerns that 
the Commission is not conducting adequate cost-benefit analysis, and as 
a result does not know the impact the wave of proposed regulations will 
have on the economy and our markets. For example, you've received 
public comments that calculations of the costs of proposed rules by 
stakeholders have far surpassed those calculated by the Commission--by 
as much as 20 times, 63 times and even 4,000 times.

   As you hit the ``natural pause'' in rulemaking and review 
        the ``whole mosaic of rules and how they interrelate,'' do you 
        intend to review the costs and benefits of the rules when 
        applied comprehensively?

   If no--Don't you think that's the critical component to 
        understanding whether the rules will have a negative impact on 
        the economy and jobs?

   If yes--Do you intend to improve the cost-benefit analysis 
        that you're conducting so that your estimates are not 4,000 
        times below those calculated by stakeholders?

    Answer. The CFTC has endeavored to include well-developed 
considerations of costs and benefits in each of its proposed 
rulemakings. Relevant considerations are presented not only in the 
cost-benefit analysis section of the CFTC's rulemaking releases, but 
additionally are discussed throughout the release in compliance with 
the Administrative Procedure Act, which requires the CFTC to set forth 
the legal, factual and policy bases for its rulemakings.
    In addition, Commissioners and staff have met extensively with 
market participants and other interested members of the public to hear, 
consider and address their concerns in each rulemaking. CFTC staff 
hosted a number of public roundtables so that rules could be proposed 
in line with industry practices and address compliance costs consistent 
with the CFTC's obligations to promote market integrity, reduce risk 
and increase transparency as directed in Title VII of the Dodd-Frank 
Act. Information from each of these meetings--including full 
transcripts of the roundtables--is available on the CFTC's website and 
has been factored into each applicable rulemaking.
    With each proposed rule, the Commission has sought public comment 
regarding costs and benefits.
    With the substantial completion of the proposal phase of rule-
writing, the public in recent weeks has had the opportunity to review 
the whole mosaic of proposed rules. To facilitate this review, the CFTC 
reopened or extended comment periods for most of our proposed rules for 
an additional 30 days--allowing the public to submit any comments they 
may have after seeing the entire mosaic at once, including comments 
about potential compliance costs as well as phasing of implementation 
dates to help the agency as we go forward with finalizing rules. In 
addition, in May CFTC and SEC staff held a 2 day roundtable to hear 
from the public on implementation dates for final rules. The Commission 
also offered a 60 day public comment file to hear specifically on this 
issue. This comment period allowed for presentation of information 
regarding the costs and benefits of the rules on a comprehensive basis. 
Final rules will be developed only after staff can analyze, summarize 
and consider comments; after the Commissioners are able to discuss the 
comments and provide feedback to staff; and after we consult with 
fellow regulators on the rules.
Question Submitted by Hon. Christopher P. Gibson, a Representative in 
        Congress from New York
    Question. At a time when our economy is struggling to recover, I 
remain particularly concerned with our international competiveness. 
Technology and expertise have allowed the futures industry to spread 
throughout the globe. I understand the CFTC has been working closely 
with the European Commission, the European Central Bank, new European 
Securities and Markets Authority and other regulators overseas. I 
appreciate those efforts, and I hope the close consultations will 
continue. In a speech you delivered last month, you discussed the 
importance of ``harmonizing oversight'' of the swaps market. My 
question gets back to process and the speed at which the CFTC is 
moving, as well as the lack of clarity and definitions. Given the pace 
of the proposed rules, do you believe the CFTC is in danger of moving 
ahead of the EU and others? How is it possible to ``harmonize 
oversight'' if our rule making preempts theirs?
    Answer. Regulators across the globe continue to work together 
towards achieving common goals including the G20 agreement of September 
2009 that: all standardized OTC derivative contracts should be traded 
on exchanges or electronic trading platforms, where appropriate, and 
cleared through central counterparties by the end of2012 at the latest. 
OTC derivative contracts should be reported to trade repositories. And 
non-centrally cleared contracts should be subject to higher capital 
requirements.
    Japan is now working to implement its reforms. In September of last 
year, the European Commission (E.C.) released its swaps proposal. The 
European Council and the European Parliament are now considering the 
proposal. Asian nations, as well as Canada, also are working on their 
reform packages.
    As we work to implement the derivatives reforms in the Dodd-Frank 
Act, we are actively coordinating with international regulators to 
promote robust and consistent standards and avoid conflicting 
requirements in swaps oversight. The Commission participates in 
numerous international working groups regarding swaps, including the 
International Organization of Securities Commissions Task Force on OTC 
Derivatives, which the CFTC co-chairs with the Securities and Exchange 
Commission (SEC). The CFTC, SEC, European Commission and European 
Securities Market Authority are intensifying discussions through a 
technical working group.
    As we do with domestic regulators, we are sharing many of our 
memos, term sheets and draft work product with international 
regulators. We have been consulting directly and sharing documentation 
with the European Commission, the European Central Bank, the UK 
Financial Services Authority, the new European Securities and Markets 
Authority, the Japanese Financial Services authority and regulators in 
Canada, France, Germany and Switzerland.
    The Dodd-Frank Act recognizes that the swaps market is global and 
interconnected. It gives the CFTC the flexibility to recognize foreign 
regulatory frameworks that are comprehensive and comparable to U.S. 
oversight of the swaps markets in certain areas. In addition, we have a 
long history of recognition regarding foreign participants that are 
comparably regulated by a home country regulator. The CFTC enters into 
arrangements with our international counterparts for access to 
information and cooperative oversight. We have signed Memoranda of 
Understanding with regulators in Europe, North America and Asia.
Questions Submitted by Hon. William L. Owens, a Representative in 
        Congress from New York
    Question 1. Will the Commission fully exempt end-users, including 
utilities, to hedge their commercial risks without having to clear 
those swaps and without the parties having to post margin?
    Answer. In passing the Dodd-Frank Act, Congress recognized the 
different levels of risk posed by transactions between financial 
entities and those that involve non-financial entities, as reflected in 
the non-financial end-user exception to clearing. The CFTC has 
recognized this in its proposed rule regarding margin requirements for 
swap dealers and major swap participants. For any transaction involving 
a non-financial end-user engaged in hedging or mitigating commercial 
risk, neither party is required to post margin.
    Before the Commission proceeds to final rules, Commission staff 
will read and summarize all submitted public comments, and 
Commissioners will have the opportunity to review comments and provide 
feedback.

    Question 2. The business conduct rules established for governmental 
entities could potentially affect the access to and cost of swaps for 
public power utilities. What is the Commission doing in its rulemaking 
to ensure that governmental entities, like public power systems, 
continue to have access to swaps without the imposition of new 
burdensome and costly requirements?
    Answer. The Commission's proposed business conduct standards rules 
track the statutory directive under the provisions of the Dodd-Frank 
Act that create a higher standard of care for swap dealers dealing with 
Special Entities, which include governmental entities. The proposed 
rules were designed to enable swap dealers to comply with their new 
duties in an efficient and effective manner. The Commission is 
reviewing the comments it has received on the proposed rules to ensure 
that the final rules achieve the statutory purpose without imposing 
undue costs on market participants. The proposed rulemaking release 
specifically asked that the public provide comment regarding associated 
costs and benefits.

    Question 3. As you note in your testimony, the CFTC has yet to 
issue any guidance on what constitutes a ``swap'', and has yet to issue 
final rules on who's a ``swap dealer'', or a ``major swap 
participant.'' How has this process impacted the SEC-CFTC Working 
Group's ability to participate in the rulemaking process, and, perhaps 
more importantly, how has it impacted the ability of members of the 
Working Group to evaluate how the CFTC's proposed regulatory regime 
will impact business operations?
    Answer. The joint CFTC-SEC proposed rule to further define the 
terms ``swap,'' ``security-based swap,'' ``mixed swap'' and ``security-
based swap agreement'' was published in the Federal Register on May 23, 
2011.

    Question 4. As you know, the CFTC is mandated under Dodd-Frank to 
have final rules issued by mid-July 2011. Can you provide a timeline on 
an appropriate strategy or timeline by which the CFTC should make 
effective its final rules in a manner that will provide entities, such 
as those in the SEC-CFTC's Working Group, adequate time for compliance? 
If applicable, please describe any potential implementation phase-ins, 
delaying of effective dates, or order by which certain final rules 
should be issued or become effective.
    Answer. In enacting title VII of the Dodd-Frank Act, Congress gave 
the CFTC latitude with respect to the effective dates of particular 
requirements. In May, the Commission re-opened many of its comment 
periods that had closed and extended some existing comment periods so 
that the public could comment in the context of the entire mosaic of 
proposed rules. This opportunity was available with respect to all 
relevant proposed rules, giving the public and market participants the 
opportunity to comment on compliance costs and to make recommendations 
regarding the schedule of implementation. That extended comment period 
closed on June 3, 2011. In addition, on May 2 and 3, CFTC and SEC staff 
held roundtable sessions to obtain public input on implementation dates 
of the various rulemakings. Prior to the roundtable, on April 29, CFTC 
staff released a document that set forth concepts that the Commission 
may consider with regard to the effective dates of final rules for 
swaps under the Dodd-Frank Act. We also offered a 60 day public comment 
file to hear specifically on this issue. The roundtable and resulting 
public comment letters will help inform the Commission as to what 
requirements can be met sooner and which ones will take a bit more 
time.

    Question 5. If subject to the regulatory requirements associated 
with being a swap dealer or major swap participant, you've testified 
that energy firms would face significant compliance costs. Could you 
briefly describe for this Committee how regulation as a swap dealer or 
major swap participant would impact additional compliance costs on 
energy companies?
    Answer. The Dodd-Frank Act requires that swap dealers comply with 
rules establishing capital requirements, margin requirements, and 
business conduct standards. For non-bank swap dealers, the CFTC is 
responsible for issuing regulations establishing those requirements. 
The Commission has endeavored to include well-developed considerations 
of costs and benefits in each of its proposed rulemakings. Relevant 
considerations are presented not only in the cost-benefit analysis 
section of the CFTC's rulemaking releases, but additionally are 
discussed throughout the release in compliance with the Administrative 
Procedure Act, which requires the CFTC to set forth the legal, factual 
and policy bases for its rulemakings.
    In addition, Commissioners and staff have met extensively with 
market participants and other interested members of the public to hear, 
consider and address their concerns in each rulemaking. CFTC staff 
hosted a number of public roundtables so that rules could be proposed 
in line with industry practices and address compliance costs consistent 
with CFTC obligations to promote market integrity, reduce risk and 
increase transparency as directed in Title VII of the Dodd-Frank Act. 
Information from each of these meetings--including full transcripts of 
the roundtables--is available on the CFTC's website and has been 
factored into each applicable rulemaking.
    With each proposed rule, the Commission has sought public comment 
regarding costs and benefits.

    Question 6. You mentioned in your testimony that the CFTC is 
reviewing the de minimis exception for swap dealers. What do you 
believe would be an appropriate de minimis exception?
    Answer. In the joint rulemaking to further define the term ``swap 
dealer,'' the SEC and the CFTC proposed factors for the de minimis 
exemption based on the aggregate effective notional amount of an 
entity's trades, its level of trading activity with special entities, 
the number of counterparties it transacts with and the number of swaps 
it trades. Specifically, to qualify for the de minimis exemption under 
the proposed rule, the entity's total notional swap activity must not 
exceed $100 million in a 12 month period, the notional amount of 
transactions with special entities must not exceed $25 million, it must 
not enter into swaps with more than 15 counterparties, and must not 
enter into more than 20 swaps as a dealer in a 12 month period. The 
Commissions specifically requested that the public provide comments 
regarding the proposal with respect to the de minimis exemption.

    Question 7. Congress directed the CFTC to ``consider whether to 
exempt small banks, savings institutions, farm credit system 
institutions, and credit unions.'' Will the Commission clarify in its 
final rules that farm credit system institutions, credit unions and 
small banks with under $10 billion in assets will qualify for the end-
user clearing exemption?
    Answer. The Dodd-Frank Act specifically provides for an exception 
from the clearing requirement for non-financial end-users hedging or 
mitigating commercial risk. It also requires the CFTC to consider 
whether to exempt farm credit system institutions, depository 
institutions and credit unions with total assets of $10 billion or less 
from the clearing mandate. The CFTC issued a proposed rulemaking with 
respect to the end-user exception from the clearing requirement that 
also requested comment regarding such small financial institutions. The 
Commission has received substantial public comment in response. Staff 
will analyze, summarize and consider public comments before the 
Commission proceeds further.
Response from James M. Field, Senior Vice President and Chief Financial 
        Officer, Deere & Company
Question Submitted by Hon. Randy Hultgren, a Representative in Congress 
        from Illinois
    Question. I'm concerned about the impact of Title VII on pension 
plans. Can you tell me if Deere's pension plan engages in swaps? What 
would be the impact for Deere retirees if the plan were no longer able 
to engage in swaps or if they became prohibitively expensive?
    Answer. The John Deere Pension Trust maintains trading positions in 
derivative contracts to implement asset allocation, investment 
strategies, and for risk management. Interest rate swaps are used for 
asset/liability surplus risk management. Currency spots and forwards 
are used to mitigate foreign exchange risk for investments held in 
currencies other than the U.S. dollar. Commodity total return swaps are 
used as a liquid alternative for implementing commodity exposures. If 
the pension trust was no longer able to engage in swaps, or swaps 
became prohibitively expensive due to Title VII or other regulations, 
the plans would incur higher transactions costs and experience higher 
volatility and surplus risk. This is clearly not in the best interest 
of plan beneficiaries nor the corporate plan sponsor, and ultimately 
could impact the level of benefits provided to plan participants, 
including the possibility of freezing, closing or termination of the 
plans.
Response from Ann E. Trakimas, Chief Operating Officer, CoBank, 
        Greenwood Village, CO; on behalf of Farm Credit Council
Question Submitted by Hon. Christopher P. Gibson, a Representative in 
        Congress from New York
    Question. I remain extremely concerned about potential effects on 
my family farms and coops in my district. Falling under the definition 
of a swap dealer could significantly harm the ability of my farmers, 
who already face financial challenges, to hedge risk. On a related 
note, I am troubled over the testimony on Farm Credit Institutions. In 
your written testimony you address the potential for the CFTC to take a 
narrow approach to the $10 billion asset limit. What might an overly 
narrow interpretation of the asset limit mean for the Farm Credit 
System? Additionally, what could collateral and mandatory clearing mean 
to farm credit in my district?
    Answer. Attached is a copy of the comment letter we submitted June 
3 to the CFTC regarding the costs associated with both mandatory 
clearing and swap dealer regulation. Also attached is an earlier 
comment letter (Feb 22, 2011) we submitted to the CFTC regarding the 
``swap dealer'' definition and ``end-user'' exception.
    As you will note it is difficult to precisely estimate the costs of 
collateral and mandatory clearing, both in general as well as with 
respect to your Congressional District. We do note that the as a 
cooperative system, the costs of compliance become part of the 
operating rate that borrowers are ultimately responsible to bear. All 
farmers, ranchers and their cooperatives in your district would share 
proportionately in those costs.
    We hope this additional information is responsive to your inquiry. 
If we can provide further assistance, please let us know.
                              attachment 1
June 3, 2011

By Electronic Submission

Mr. David A. Stawick,
Secretary,
Commission Commodity Futures Trading Commission,
Washington, D.C.

Re: Entity Definitions (RIN 3038-AD06, RIN 3235-AK65) End-User Clearing 
Exception (RIN 3038-AD10)

    Dear Mr. Stawick:

    The Farm Credit Council, on behalf of its members, submits further 
comments on rules issued by the Commodity Futures Trading Commission 
(the ``Commission'') to implement the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (``Dodd-Frank'').\1\ As you know, on February 
22, 2011, we submitted comments on the notices of proposed rulemaking 
concerning both the further definition of ``swap dealer'' and the end-
user clearing exception.\2\ We appreciate the opportunity to supplement 
these comments in light of the comprehensive regulatory framework that 
the Commission has now proposed.\3\
---------------------------------------------------------------------------
    \1\ Pub. L. No. 111-203, 124 Stat. 1376 (2010).
    \2\ See End-User Exception to Mandatory Clearing of Swaps, 75 Fed. 
Reg. 80747 (proposed Dec. 23, 2010) (to be codified at 17 CFR pt. 39); 
Further Definition of ``Swap Dealer,'' ``Security-Based Swap Dealer,'' 
``Major Swap Participant,'' ``Major Security-Based Swap Participant'' 
and ``Eligible Contract Participant,'' 75 Fed. Reg. 80174 (proposed 
Dec. 21, 2010) (to be codified at 17 CFR pts. 1 & 240).
    \3\ See Reopening and Extension of Comment Periods for Rulemakings 
Implementing the Dodd-Frank Wall Street Reform and Consumer Protection 
Act, 76 Fed. Reg. 25274 (May 4, 2011).
---------------------------------------------------------------------------
    The Farm Credit Council is the national trade association for the 
Farm Credit System, a government instrumentality created ``to 
accomplish the objective of improving the income and well-being of 
American farmers and ranchers by furnishing sound, adequate, and 
constructive credit and closely related services to them, their 
cooperatives, and to selected farm-related businesses necessary for 
efficient farm operations.'' \4\ Today, the Farm Credit System 
comprises five banks and 87 associations, which together provide 40% of 
agricultural lending in the United States. To provide tailored 
financing products for farmers and farm-related businesses, Farm Credit 
System institutions rely on the safe use of derivatives to manage 
interest rate, liquidity, and balance sheet risk, primarily in the form 
of interest rate swaps. These non-speculative swaps are backed by 
collateral. Specifically, as of March 31, 2011, the Farm Credit 
System's total derivatives exposure, net of collateral ($204 million), 
represented approximately 11 to 12 basis points of the System's total 
loan volume ($177.5 billion). Respectfully, we would advocate that such 
a limited FCS exposure does not rise to current concerns related to 
systemic risk and/or interconnectivity.
---------------------------------------------------------------------------
    \4\ 12 U.S.C.  2001(a).
---------------------------------------------------------------------------
    As we have previously explained, Congress intended Farm Credit 
System institutions to qualify for the end-user exception to mandatory 
clearing. In this regard, we urged the Commission to clarify that it 
will consider (1) the average assets of that bank's affiliated lending 
organizations, and (2) risk-based factors to determine whether a 
financial institution's derivatives activity should be subject to 
mandatory clearing. Further, we have explained that no Farm Credit 
System institution should be regulated as a swap dealer. In this 
regard, we have urged the Commission to clarify that, like the 
commercial banks with which they compete, Farm Credit System 
institutions will be exempt from swap dealer regulation for swaps 
entered into in connection with originating customer loans.
    Mandatory clearing or swap dealer regulation would raise the costs 
of risk management for Farm Credit System institutions and their 
borrowers. These new costs would reduce liquidity, discourage effective 
risk management, and frustrate the Farm Credit System's congressionally 
endorsed mission of providing financing to rural America. Having had 
more time to evaluate the consequences of these proposed regulations, 
the Farm Credit Council can now provide a clearer estimate of the costs 
that would result from mandatory clearing or swap dealer regulation. 
Although proposed requirements for margin on uncleared swaps will 
impose still additional costs on Farm Credit System institutions, the 
Farm Credit Council will address those proposed rules in separate 
comment letters.
I. Costs of Mandatory Clearing
    We estimate that, conservatively, mandatory clearing would impose 
new costs on Farm Credit System institutions ranging from $6 million to 
$27.2 million, per year. This estimate depends on the direction and 
volatility of interest rates, which in some scenarios, may require Farm 
Credit System institutions to post additional margin and thereby incur 
costs exceeding even the high end of our estimate. For example, our 
estimate would have to be raised if exchanges were to increase initial 
margin requirements in response to changes in interest rates.
    Our estimate represents the incremental costs that would result 
from moving the Farm Credit System's current bilateral interest rate 
swaps to major clearinghouses. First, we estimate that clearing would 
impose millions of dollars annually in transaction and operational 
costs. Specifically, Farm Credit System institutions would have to pay 
new fees to clearinghouses, futures commission merchants, and swap 
execution facilities. Additionally, Farm Credit System institutions 
would have to incur the cost of developing new systems to process 
cleared trades.
    More significantly, Farm Credit System institutions would incur 
financing costs associated with posting initial and variation margin at 
clearinghouses. These financing costs are more difficult to predict 
because they depend on both the value of the Farm Credit System's swap 
positions, which may trigger variation margin requirements, and the 
level of interest rates, which will govern the cost of meeting margin 
calls. In fact, the negative carry associated with financing margin 
calls could easily exceed the assumptions we used to arrive at our 
estimates, pushing the annual cost of mandatory clearing above $27 
million.
    Finally, in addition to the up to $27 million in new annual costs 
discussed above, mandatory clearing will require Farm Credit System 
institutions to post funds as margin that they could otherwise lend to 
farmers and farm-related businesses. The largest two Farm Credit System 
banks estimate that they will likely have to post $250 million and $50 
million in initial margin annually. In an adverse scenario, Farm Credit 
System institutions will have to post even larger amounts in variation 
margin. To be sure, the Farm Credit System currently posts--and 
collects--collateral from its bilateral swap counterparties, and Farm 
Credit System institutions carefully manage counterparty credit risk. 
To the extent that more margin is required at a clearinghouse, however, 
those funds will no longer be available for loans to farmers, ranchers, 
and farm-related businesses.
    Accordingly, we continue to believe that, especially given the 
costs it would impose, mandatory clearing is not warranted for the Farm 
Credit System, which poses little risk to the United States financial 
system.
II. Costs of Swap Dealer Regulation
    The costs of swap dealer regulation are more difficult to quantify. 
Currently, one Farm Credit System bank, CoBank, provides swaps to its 
customers, most commonly in the form of interest rate swaps tied to the 
financial terms of the loans it issues. If CoBank did not qualify for 
the exception granted to insured depository institutions providing 
swaps in conjunction with loans to a customer or the de minimis 
exception to the swap dealer definition, compliance risks and new 
regulation would force CoBank to cease activity causing it to be a swap 
dealer. This would impose costs on both CoBank and its member 
associations.\5\
---------------------------------------------------------------------------
    \5\ Consistent with the Farm Credit Act's ``objective . . . to 
encourage farmer- and rancher-borrowers['] participation in the 
management, control, and ownership of a permanent system of credit for 
agriculture,'' 12 U.S.C.  2001(b), Farm Credit System banks are 
cooperatives primarily owned by their affiliated associations, and Farm 
Credit System associations are cooperatives owned by their borrowers.
---------------------------------------------------------------------------
    As we explained in our February 22 letter, CoBank manages the risk 
of customer default by requiring certain customers to enter into swaps 
that hedge fluctuations in interest rates. This way, if interest rates 
rise--thereby raising the cost of loan payments--the customer will be 
hedged. CoBank usually has between $2 to $3 billion in these risk-
reducing customer transactions. Eliminating the ability to help 
customers hedge changes in interest rates would increase credit risk to 
CoBank on this portion of its loans.
    If CoBank ceased its customer derivatives activity, CoBank's 
affiliated associations would also face additional costs. These 
associations use swaps provided by CoBank to position their equity over 
a medium-term timeframe to earn a consistent return on equity. A 
consistent return on equity is important because, unlike commercial 
banks, cooperative Farm Credit System associations return their profits 
to their borrower-members in the form of patronage distributions. The 
consistent return therefore allows the associations to pay a consistent 
level of patronage distributions to the farmers and ranchers that 
borrow from them. We estimate that losing the ability to invest their 
equity over a longer time horizon would cost CoBank's affiliated 
associations an estimated $5 to $15 million in funds that are currently 
returned to borrower-members in patronage distributions.
    Accordingly, we continue to believe that no Farm Credit System 
institution warrants regulation as a swap dealer. To the contrary, the 
risk-reducing products that CoBank offers actually make the bank safer 
and provide benefits to the Farm Credit System's member-borrowers.
III. Conclusion
    For the reasons set forth above, the Farm Credit Council continues 
to urge the Commission to clarify both that Farm Credit System 
institutions will: (1) be eligible for the end-user clearing exemption, 
such as looking through each Farm Credit Bank to the average size of 
its affiliated associations, and (2) that Farm Credit System 
institutions will not be regulated as swap dealers to the extent they 
enter into swaps in connection with originating customer loans. 
Mandatory clearing or swap dealer regulation would raise costs--and 
increase risk--to the Farm Credit System and the farmers and ranchers 
that rely on it as a source of financing. Because Farm Credit System 
institutions are already safe and sound, and because they responsibly 
manage their derivatives exposure, we do not believe they pose systemic 
risk warranting these costly new regulations.
    The Farm Credit Council appreciates the opportunity to comment. If 
you have any questions or we can provide other information, please do 
not hesitate to contact us. As always, we would welcome the opportunity 
to work with the Commission in developing the final rule.
            Sincerely,

            [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
            
Robbie Boone,
Vice President, Government Affairs,
Farm Credit Council.

CC:

Honorable Gary Gensler, Chairman;
Honorable Michael Dunn, Commissioner;
Honorable Jill E. Sommers, Commissioner;
Honorable Bart Chilton, Commissioner;
Honorable Scott D. O'Malia, Commissioner.
                              attachment 2
February 22, 2011

By Electronic Submission

Mr. David A. Stawick,
Secretary,
Commission Commodity Futures Trading Commission,
Washington, D.C.

Re: End-User Exception to Mandatory Clearing of Swaps (RIN 3038-AD10)

    Dear Mr. Stawick:

    The Farm Credit Council, on behalf of its members, submits these 
comments on the Notice of Proposed Rulemaking (``NOPR'') issued by the 
Commodity Futures Trading Commission (``Commission'') concerning the 
end-user exception to mandatory clearing under Section 723 of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (``Dodd-
Frank'').\1\
---------------------------------------------------------------------------
    \1\ End-User Exception to Mandatory Clearing of Swaps, 75 Fed. Reg. 
80747 (proposed Dec. 23, 2010) (to be codified at 17 CFR pt. 39). 
Section 723 of Dodd-Frank, Pub. L. No. 111-203, 124 Stat. 1376, 1675-82 
(2010), amends Section 2 of the Commodity Exchange Act (``CEA''), 7 
U.S.C.  2.
---------------------------------------------------------------------------
    The Farm Credit Council is the national trade association for the 
Farm Credit System, a government instrumentality created ``to 
accomplish the objective of improving the income and well-being of 
American farmers and ranchers by furnishing sound, adequate, and 
constructive credit and closely related services to them, their 
cooperatives, and to selected farm-related businesses necessary for 
efficient farm operations.'' \2\ Fulfilling this mission, the Farm 
Credit System's five banks and 87 associations currently account for 
40% of agricultural lending in the United States. To provide tailored 
financing products for farmers and farm-related businesses, Farm Credit 
System institutions rely on the safe use of derivatives to manage 
interest rate, liquidity, and balance sheet risk, primarily in the form 
of interest rate swaps. Because we believe Congress intended the end-
user exception to preserve our ability to provide dependable financing 
to farmers, farm-related businesses, and rural America, the Farm Credit 
Councilappreciates the opportunity to comment.
---------------------------------------------------------------------------
    \2\ 12 U.S.C.  2001(a).
---------------------------------------------------------------------------
I. Summary of Comments
    The Farm Credit Council supports Dodd-Frank's goal of making the 
derivatives market safer, and appreciates that mandatory clearing of 
swaps entered into by risky Wall Street institutions will provide 
important protections for the market. But clearing would also make the 
derivatives that the Farm Credit System safely and effectively uses to 
manage risk more expensive. These new costs would reduce liquidity, 
discourage effective risk management, frustrate the Farm Credit 
System's congressionally endorsed mission, and diminish rural America's 
access to credit. Congress did not intend, and the Commission should 
not endorse, such a result. Accordingly, the Commission should permit 
all Farm Credit System institutions to use the end-user clearing 
exception.
    Specifically, our comments address the following issues:

   Dodd-Frank does not limit eligibility for the end-user 
        exception to institutions with total assets of $10 billion or 
        less, and any such limit would be particularly inappropriate 
        for the Farm Credit System.

   In order to preserve competition for agricultural lending, 
        the Commission must ``look through'' Farm Credit System banks 
        to the smaller associations that own them and that benefit from 
        the banks' derivatives activity. Otherwise, Farm Credit System 
        associations would have to bear the cost of mandatory clearing, 
        while competing commercial banks would not.

   Because the Farm Credit Administration effectively regulates 
        Farm Credit System institutions; because Farm Credit System 
        institutions only enter into safe, non-speculative swaps backed 
        by collateral; and because the Farm Credit System is not 
        interconnected with other financial entities, the Farm Credit 
        System's derivatives activity does not warrant mandatory 
        clearing.

   Alternatively, the Commission should adopt a risk-based 
        approach to mandatory clearing, similar to the proposed 
        definition of major swap participant, that would exempt small 
        financial institutions whose current uncollateralized exposure 
        and potential future exposure fall below certain thresholds.
II. Dodd-Frank Does Not Impose an Asset Limit on Which Farm Credit 
        System Institutions May Qualify for the End-User Clearing 
        Exception
    Dodd-Frank requires the Commission to ``consider whether to exempt 
. . . farm credit system institutions, . . . including . . . farm 
credit system institutions with total assets of $10,000,000,000 or 
less.'' \3\ The Farm Credit Council urges the Commission to clarify 
that this language does not set an asset limit on which institutions 
the Commission may exempt from mandatory clearing.
---------------------------------------------------------------------------
    \3\ Pub. L. No. 111-203,  723, 124 Stat. at 1680 (CEA  
2(h)(7)(C)(ii)).
---------------------------------------------------------------------------
    In fact, Congress gave the Commission broad authority to permit 
Farm Credit System institutions, including those with total assets of 
more than $10 billion, to use the end-user exception. The following 
colloquy between Representatives Holden and Peterson of the House 
Agriculture Committee makes this clear:

          Mr. Holden. . . . Mr. Speaker, I now would like to enter into 
        a colloquy with the chairman of the Agriculture Committee.
          Mr. Chairman, the conference report includes compromise 
        language that requires the Commodity Futures Trading Commission 
        to consider exempting small banks, Farm Credit System 
        institutions and credit unions from provisions requiring that 
        all swaps be cleared. We understand that community banks, Farm 
        Credit institutions and credit unions did not cause the 
        financial crisis that precipitated this legislation. While the 
        legislation places a special emphasis on institutions with less 
        than $10 billion in assets, my reading of the language is that 
        they should not in any way be viewed by the Commodity Futures 
        Trading Commission as a limit on the size of the institution 
        that should be considered for an exemption.
          Mr. Chairman, would you concur with this assessment?
          Mr. Peterson. Yes, I fully agree. The language says that 
        institutions to be considered for the exemption shall include 
        those with $10 billion or less in assets. It is not a firm 
        standard. Some firms with larger assets could qualify, while 
        some with smaller assets may not. The regulators will have 
        maximum flexibility when looking at the risk portfolio of these 
        institutions for consideration of an exemption.\4\
---------------------------------------------------------------------------
    \4\ 156 Cong. Rec. H5246 (daily ed. June 30, 2009) (emphasis 
added).

Senator Lincoln made a similar statement in the Senate. She observed 
that ``small financial entities, such as banks, credit unions and farm 
credit institutions below $10 billion in assets--and possibly larger 
entities--will be permitted to utilize the end-user clearing exemption 
with approval from the regulators.'' \5\
---------------------------------------------------------------------------
    \5\ 156 Cong. Rec. S5921 (daily ed. July 15, 2010) (emphasis 
added).
---------------------------------------------------------------------------
    In giving the Commission the authority to exempt institutions with 
assets exceeding $10 billion, Congress sought to avoid imposing new, 
clearing-related costs on the Farm Credit System. As Senators Dodd and 
Lincoln explained, ``These entities did not get us into this crisis and 
should not be punished for Wall Street's excesses. They help to finance 
jobs and provide lending for communities all across this nation. That 
is why Congress provided regulators the authority to exempt these 
institutions.'' \6\
---------------------------------------------------------------------------
    \6\ See Letter from Sens. Dodd and Lincoln to Reps. Frank and 
Peterson, in 156 Cong. Rec. S6192 (daily ed. July 22, 2010).
---------------------------------------------------------------------------
    Further, as Representative Holden described in detail, mandatory 
clearing would have no benefit as applied to Farm Credit System 
institutions because they already effectively manage risk:

        Farm Credit System institutions are regulated and examined by a 
        fully empowered independent regulatory agency, the Farm Credit 
        Administration, which has the authority to shut down and 
        liquidate a system institution that is not financially viable. 
        In addition, the Farm Credit System is the only GSE that has a 
        self-funded insurance program in place that was established to 
        not only protect investors in farm credit debt securities 
        against loss of their principal and interest, but also to 
        protect taxpayers.

        These are just a few of the reasons why the Agriculture 
        Committee insisted that the institutions of the Farm Credit 
        System not be subject to a number of the provisions of this 
        legislation. They were not the cause of the problem, did not 
        utilize TARP funds, and did not engage in abusive subprime 
        lending. We have believed that this legislation should not do 
        anything to disrupt this record of success.\7\
---------------------------------------------------------------------------
    \7\ 156 Cong. Rec. H5246 (daily ed. June 30, 2009) (statement of 
Rep. Holden).

    Although Farm Credit System associations have, on average, total 
assets that are well under $10 billion, all of the five Farm Credit 
System banks have total assets exceeding $10 billion. If, despite the 
Commission's broad authority to exempt all Farm Credit System 
institutions, the end-user exception were confined to institutions with 
total assets of $10 billion or less, no Farm Credit System bank would 
qualify, and the bulk of the System's derivatives activity would be 
subject to a costly new clearing requirement. As the legislative 
history demonstrates, the Commission can and should avoid this result. 
Accordingly, the Farm Credit Council urges the Commission to permit all 
Farm Credit System institutions--regardless of their total assets--to 
use the end-user clearing exception.
III. If the Commission Adopts an Asset Test, It Should Look Through 
        Farm Credit System Banks to the Small Associations Whose Risk 
        They Hedge With Derivatives
    If the Commission adopts an asset-based test for which financial 
institutions qualify for the end-user exception, it should clarify that 
it will look through Farm Credit System banks and consider the average 
assets of their affiliated associations. As explained below, any other 
approach would give commercial banks an unfair competitive advantage in 
the market for agricultural lending.
    Consistent with Congress's ``objective . . . to encourage farmer- 
and rancher-borrowers['] participation in the management, control, and 
ownership of a permanent system of credit,'' \8\ the Farm Credit System 
has a unique structure. Farm Credit System banks are cooperatives 
primarily owned by their affiliated associations.\9\ The Farm Credit 
Act authorizes the banks ``to make loans and commitments to eligible 
cooperative associations.'' \10\ Farm Credit System associations are, 
in turn, authorized to make loans to bona fide farmers and ranchers, 
rural residents, and persons furnishing farm-related services.\11\ Put 
simply, Farm Credit banks lend to Farm Credit associations, which lend 
to farmers, and farmers own the Farm Credit associations, which own the 
Farm Credit banks.
---------------------------------------------------------------------------
    \8\ 12 U.S.C.  2001(b).
    \9\ See id.  2124(c) (providing that ``[v]oting stock may be 
issued or transferred and held only by . . . cooperative associations 
eligible to borrow from the banks'').
    \10\ Id.  2128(a).
    \11\ See id.  2075.
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    Accordingly, Farm Credit System banks are larger than their 
affiliated associations. For example, AgriBank, FCB, is the largest 
district bank, and its assets exceed $10 billion. But the 17 
associations that own 99% of AgriBank have average assets of $3.6 
billion, well below the $10 billion threshold suggested in Dodd-Frank.
    Unique among agricultural lenders, the Farm Credit System's legal 
structure places the funding function for each district with the 
district bank. Centralized funding, in turn, enables the associations 
to benefit from lower administrative and operational costs. Swaps are 
executed by the district bank to gain hedge accounting, to minimize 
administrative costs, and to minimize counterparty credit risk and 
margin requirements via district-wide netting of offsetting exposures. 
This is more cost effective and strengthens the liquidity of the 
System. As a result, Farm Credit System associations have a lower risk 
profile than the small commercial banks with which they compete.
    If the Commission adopted a $10 billion asset limit, this structure 
would place Farm Credit System associations at a competitive 
disadvantage with respect to commercial banks. Absent a ``look 
through'' provision for Farm Credit System institutions, small 
commercial banks would be eligible for the end-user exception on a 
standalone basis, while Farm Credit System associations would have to 
bear the costs of mandatory clearing. Clearing costs would, in turn, be 
passed on to farmers and ranchers in the form of higher effective 
interest rates on loans. Community banks eligible for the end-user 
clearing exception would therefore be able to gain market share by 
offering lower interest rates. Even banks that do not qualify for the 
end-user exception would benefit from spreading the costs of clearing 
across their entire business, including segments outside agriculture.
    Although the majority of Farm Credit System associations have 
assets of less than $10 billion, the few associations with greater 
assets do not present risk requiring mandatory clearing. Even the 
failure of a large association would have no material impact on the 
Farm Credit System's ability to meet its debt obligations because the 
five Farm Credit System banks are jointly and severally liable for the 
System's notes and bonds. Thus, no association is so large that it 
would impact System debt holders if it were placed in receivership. By 
contrast, if a standalone commercial bank fails, its bondholders will 
likely face losses.
    As noted, Congress gave the Commission ``maximum flexibility'' to 
adopt an equitable solution for which small financial institutions will 
qualify for the end-user exception.\12\ The Farm Credit Council 
believes that the fair way to compare the hedging activities that 
benefit Farm Credit System associations with the hedging activities of 
their competing commercial banks is to consider the average assets of 
Farm Credit System associations in a particular district. If the 
Commission does not adopt such a ``look through'' approach, small Farm 
Credit System associations would be forced to raise interest rates for 
farmers and ranchers, and they would be placed at a competitive 
disadvantage in the market for agricultural lending.
---------------------------------------------------------------------------
    \12\ 156 Cong. Rec. H5246 (daily ed. June 30, 2009) (statement of 
Rep. Peterson).
---------------------------------------------------------------------------
IV. Farm Credit System Institutions Should Qualify for the End-User 
        Clearing Exception
    The Commission requested comment on, among other issues, whether an 
exception for Farm Credit System institutions would be appropriate.\13\ 
As we describe more fully below, an exception is appropriate because 
the non-speculative, collateralized derivatives activity of 
comprehensively regulated Farm Credit System institutions does not pose 
risk to the United States financial system warranting mandatory 
clearing. Further, imposing a costly new clearing requirement on Farm 
Credit System institutions would frustrate Congress's equally important 
mission of providing a dependable source of financing for rural 
America.
---------------------------------------------------------------------------
    \13\ NOPR, 75 Fed. Reg. at 80753.

    A. Farm Credit System Institutions Do Not Cause Systemic Risk 
---------------------------------------------------------------------------
        Warranting Mandatory Clearing

      1. Comprehensive Regulation by the Farm Credit Administration 
            Adequately Mitigates the Risk of Farm Credit System 
            Institutions

    The Farm Credit Council agrees that the Commission should ``take 
into account the supervisory regimes to which Small Financial 
Institutions are currently subject, and whether those regulatory 
regimes adequately mitigate any risks associated with an exception[.]'' 
\14\ Farm Credit System institutions are regulated by the Farm Credit 
Administration, an independent federal agency that adequately mitigates 
any risks associated with permitting Farm Credit System institutions 
not to clear derivatives.
---------------------------------------------------------------------------
    \14\ Id.
---------------------------------------------------------------------------
    First, the Farm Credit Act authorizes the Farm Credit 
Administration to exercise broad powers ``for the purpose of ensuring 
the safety and soundness of System institutions.'' \15\ Those powers 
include:
---------------------------------------------------------------------------
    \15\ 12 U.S.C.  2252(a)(10).

   Bringing cease and desist proceedings against any 
        institution or institution-affiliated party that has engaged, 
        is engaging, or is about to engage in an unsafe or unsound 
        practice; \16\
---------------------------------------------------------------------------
    \16\ See id.  2261.

   Suspending or removing directors or officers of Farm Credit 
        System institutions who engage in unsafe or unsound practices; 
        \17\ and
---------------------------------------------------------------------------
    \17\ See id.  2264-2265.

   Assessing civil monetary penalties against institutions or 
        individuals thatviolate provisions of the Farm Credit Act or 
        Farm Credit Administrationregulations.\18\
---------------------------------------------------------------------------
    \18\ See id.  2268.

Further, if the Farm Credit Administration determines that a System 
institution is in an ``unsafe or unsound condition to transact 
business,'' the Farm Credit Administration may place that institution 
in conservatorship or receivership.\19\
---------------------------------------------------------------------------
    \19\ See id.  2183.
---------------------------------------------------------------------------
    Second, the Farm Credit Administration effectively oversees the 
capital adequacy of System institutions. By regulation, the Farm Credit 
Administration ensures that institutions meet minimum capital 
requirements and establish written capital adequacy plans reviewed by 
that agency.\20\ Specifically, each Farm Credit System institution must 
maintain permanent capital of at least 7% of its risk-adjusted asset 
base.\21\ The Farm Credit Administration also rates the safety and 
soundness of each System institution using the uniform Financial 
Institutions Rating System, or CAMELS.\22\ At the end of 2009, 82% of 
Farm Credit System banks and direct lending associations earned a score 
of one or two, out of five, on the CAMELS scale, with a score of one 
indicating that the institution is ``sound in every respect.'' \23\ 
Indeed, more than 90% of System assets are currently housed in 
institutions rated one or two.
---------------------------------------------------------------------------
    \20\ See 12 CFR  615.5200-615.5215.
    \21\ See id.  615.5205.
    \22\ The name CAMELS derives from the rating's focus on six 
factors: capital, assets, management, earnings, liquidity, and 
sensitivity to market risk.
    \23\ Farm Credit Administration, 2009 Annual Report on the Farm 
Credit System 42, available at http://www.fca.gov/Download/
AnnualReports/2009AnnualReport.pdf.
---------------------------------------------------------------------------
    Third, the Farm Credit Administration adequately oversees 
derivatives activity. By regulation, Farm Credit System institutions 
must adopt policies that mitigate risk, including credit risk, by 
limiting their exposure to single or related counterparties, 
geographical areas, industries, or obligations with similar 
characteristics.\24\ The Farm Credit Administration has further 
directed each Farm Credit System institution ``to establish a policy 
with appropriate limits to ensure that counterparty risks are 
consistent with the institution's risk-bearing capacity.'' \25\ In 
reviewing institutions' policies on exposure to counterparty credit 
risk, the Farm Credit Administration considers:
---------------------------------------------------------------------------
    \24\ See 12 CFR  615.5133.
    \25\ Memorandum from Roland E. Smith, Director, to Chairman, Board 
of Directors, Chief Executive Officer, All Farm Credit Institutions 
Regarding Counterparty Risk (Oct. 21, 2003), available at http://
www.fca.gov/apps/infomemo.nsf (click on ``Counterparty Risk'').

   Criteria for appropriate due diligence including processes 
---------------------------------------------------------------------------
        for measuring and managing counterparty risk;

   Criteria for selecting and maintaining relationships with 
        counterparties, which may include credit ratings;

   Controls that limit the exposure of capital to single 
        counterparties expressed as a percent of the institution's 
        capital base;

   Periodic reporting and monitoring of counterparty exposures 
        to the board;

   Periodic reporting to the board on each counterparty's 
        financial condition, including an assessment of its ability to 
        perform on agreements and contracts executed with the 
        institution; and

   Actions to mitigate an institution's exposure in the event 
        the financial condition of a counterparty deteriorates and 
        doubts arise about its ability to perform in accordance with 
        the relevant agreements or contracts.\26\
---------------------------------------------------------------------------
    \26\ Id.

    Together, these comprehensive regulatory requirements effectuate 
the Farm Credit Administration's mission of ensuring a safe, dependable 
source of credit for agriculture and rural America. The Commission 
should not add a costly, unnecessary clearing requirement when the Farm 
Credit Administration's regulation and oversight already effectively 
---------------------------------------------------------------------------
mitigate risk to the financial system.

      2. Farm Credit System Institutions Primarily Use Fixed-for-
            Floating Interest Rate Swaps and Effectively Manage 
            Counterparty Credit Risk

    The Farm Credit Council further agrees that the Commission should 
``consider treating different types of swaps differently when 
considering whether any exception should be available.'' \27\ Because 
the Farm Credit System uses safe, non-speculative interest rate swaps 
and already effectively addresses counterparty credit risk, clearing 
should not be required.
---------------------------------------------------------------------------
    \27\ NOPR, 75 Fed Reg. at 80753.
---------------------------------------------------------------------------
    Farm Credit System institutions primarily use plain vanilla, fixed-
for-floating interest rate swaps, and materially all of our derivatives 
qualify for hedge accounting treatment. Farm Credit System institutions 
do not use swaps to speculate, and do not use the credit default swaps 
that caused the financial crisis. As the Commission determined in 
setting a higher substantial position threshold in the rate swaps 
category for purposes of identifying major swap participants, interest 
rate swaps are less risky than more complex or speculative 
instruments.\28\
---------------------------------------------------------------------------
    \28\ See Further Definition of ``Swap Dealer,'' ``Security-Based 
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap 
Participant'' and ``Eligible Contract Participant,'' 75 Fed. Reg. 
80174, 80187-94 (proposed Dec. 21, 2010) (to be codified at 17 CFR pts. 
1 & 240).
---------------------------------------------------------------------------
    Further, Farm Credit System institutions already effectively manage 
counterparty credit risk. To minimize the risk of credit losses from 
derivatives, Farm Credit System institutions deal with counterparties 
that have an investment grade or better long-term credit rating from a 
nationally recognized statistical rating organization, and further 
monitor the credit standing of and levels of exposure to individual 
counterparties. System institutions enter into master netting 
agreements that govern all derivative transactions with a counterparty. 
Substantially all derivative contracts are supported by credit support 
agreements requiring the bilateral posting of collateral in the event 
certain dollar thresholds of exposure are reached. These thresholds are 
small relative to the bank's capital. Accordingly, as of September 30, 
2010, the net exposure of Farm Credit System institutions to swap 
dealers was only $252 million.\29\
---------------------------------------------------------------------------
    \29\ See Federal Farm Credit Banks Funding Corporation, Third 
Quarter 2010--Quarterly Information Statement of the Farm Credit System 
26 (Nov. 10, 2010) (hereinafter ``Third Quarter 2010 Information 
Statement''), available at http://www.farmcredit-ffcb.com/farmcredit/
financials/quarterly.jsp.

    B. The Farm Credit System Is Not Interconnected with Other 
---------------------------------------------------------------------------
        Financial Institutions

    The Farm Credit Council recognizes that the determination of 
whether Farm Credit System institutions should be exempted from 
mandatory clearing depends not only on their safety and soundness, but 
also on the extent to which they are interconnected with other 
financial entities. As Chairman Gensler has recognized, ``[t]he risk of 
a crisis spreading throughout the financial system is greater the more 
interconnected financial companies are to each other.'' \30\ Farm 
Credit System institutions are not so interconnected with other 
financial entities to raise this concern.
---------------------------------------------------------------------------
    \30\ Testimony of Chairman Gary Gensler before the House Committee 
on Agriculture (Feb. 10, 2011), available at http://www.cftc.gov/
PressRoom/SpeechesTestimony/opagensler-68.html.
---------------------------------------------------------------------------
    First, based on their unique funding structure, Farm Credit System 
institutions neither borrow from nor lend to commercial banks. As a 
result, Farm Credit System institutions' primary credit relationships 
with other financial entities include (1) derivatives counterparty 
relationships and (2) federal funds investments. As described above, 
Farm Credit System institutions carefully manage derivatives 
counterparty relationships with bilateral collateral agreements, so 
that the System's exposure to counterparties is at low levels relative 
to capital. Federal funds investments, which are primarily overnight, 
can be unwound on any day with no transaction costs should credit 
concerns arise.
    Second, because Farm Credit System institutions do not take 
deposits, Farm Credit System banks and associations cannot experience a 
``run on the bank.'' To the extent the concern about interconnectedness 
involves the consequences of declining depositor confidence, it does 
not apply to the Farm Credit System because the System does not rely on 
depositors for funding.
    Finally, the Systemwide Debt Securities used to fund the Farm 
Credit System are insured by the Farm Credit System Insurance 
Corporation, a government-controlled, independent entity, that 
administers an insurance fund. As of September 30, 2010, the assets in 
the insurance fund totaled $3.193 billion, or roughly 2% of the Farm 
Credit System's aggregate insured obligations.\31\ If a bank cannot pay 
principal or interest on an insured debt obligation, the Insurance 
Corporation must pay investors from the fund. In the event that the 
entire insurance fund is exhausted, investors have further recourse to 
the five Farm Credit System banks, which are jointly and severally 
liable for Systemwide Debt Securities. Accordingly, even though most 
investors in Systemwide Debt Securities are professional money 
managers, not banks, these layers of investor protection make sure that 
the Farm Credit System will not cause a run on the funding of other 
entities.
---------------------------------------------------------------------------
    \31\ See Third Quarter 2010 Information Statement 32 (Nov. 10, 
2010).

    C. Imposing a Costly, New Clearing Requirement Would Frustrate the 
        Farm Credit System's Mission of Providing Financing to Rural 
---------------------------------------------------------------------------
        America

    Although mandatory clearing would not make the Farm Credit System's 
derivatives activity safer, it would substantially raise the costs of 
derivatives for our members. For example, our members would incur 
significant negative carry costs on investments or cash posted to meet 
new initial margin requirements. Furthermore, if the clearing 
alternatives do not offer end-users interest on initial and variation 
margin, the Farm Credit System's costs could easily increase by tens of 
millions of dollars.
    Market volatility, the direction of interest rates, and the 
maturity term of outstanding swaps also affect the amount of margin 
required. If market volatility returned to the levels observed after 
the Lehman Brothers bankruptcy in September 2008, the initial margin 
requirement for the Farm Credit System's derivatives could be expected 
to at least triple, and the projected negative carry expense on this 
component would easily exceed $2 million annually.
    At September 30, 2010, the majority of the System's derivative 
positions had positive market value, so on an aggregate basis, the 
System was not required to provide a material amount of collateral or 
variation margin to our derivative counterparties. If, however, 
interest rates increase, the derivative exposure would swing in favor 
of our counterparties, and System institutions would then be required 
to provide variation margin, in addition to required initial margin. In 
this scenario, negative carry on variation margin is expected to be a 
significant cost. To minimize negative carry, it is especially 
important that clearing rules provide a mechanism for end-users of 
over-the-counter swaps to earn interest on the variation margin 
provided to our counterparties. On top of these costs would be new 
account fees paid to clearing members, which we estimate could easily 
reach $1.5 to $2.5 million each year.
    These millions of dollars in new costs would make derivatives less 
attractive for risk management. To the extent new costs discourage Farm 
Credit System institutions from safely entering into derivatives to 
hedge or mitigate risk, mandatory clearing would actually make the Farm 
Credit System less safe. These new costs also represent millions of 
dollars that the Farm Credit System could otherwise lend to farmers and 
farm-related businesses, and new costs the Farm Credit System will have 
to offset with higher interest rates to farm-related businesses. In 
this way, mandatory clearing would frustrate the Farm Credit System's 
mission of providing safe, dependable financing to rural America.
    In deciding which institutions should be eligible for the end-user 
exception, the Commission should consider that the Farm Credit System's 
mission is also federal policy. Congress created the System ``to 
accomplish the objective of improving the income and well-being of 
American farmers and ranchers by furnishing sound, adequate, and 
constructive credit and closely related services to them.'' \32\ Dodd-
Frank does not alter this congressional goal. To the contrary, Congress 
``insisted that the institutions of the Farm Credit System not be 
subject to a number of the provisions of [Dodd-Frank].'' \33\
---------------------------------------------------------------------------
    \32\ 12 U.S.C.  2001(a).
    \33\ 156 Cong. Rec. H5246 (daily ed. June 30, 2009) (statement of 
Rep. Holden).
---------------------------------------------------------------------------
V. Alternatively, the Commission Should Adopt a Risk-Based Approach for 
        Determining Which Small Financial Institutions Will Be Exempt 
        From Mandatory Clearing
    The Commission requested comment on whether ``measures other than 
total assets of $10 billion, such as financial risk or capital, . . . 
could be used for determining whether an entity qualifies for an 
exception.'' \34\ The Farm Credit Council believes that systemic risk 
created by derivatives is not a function of an institution's asset 
size; it is a function of the type and amount of derivative activity 
after netting offsetting positions and collateral. Put simply, small 
financial institutions entering into many risky trades pose greater 
risk to the financial system than larger institutions that carefully 
manage their derivatives portfolio. Accordingly, the Commission should 
focus on risk instead of asset size.
---------------------------------------------------------------------------
    \34\ NOPR, 75 Fed. Reg. at 80754.
---------------------------------------------------------------------------
    The Commission has already proposed such a risk-based framework for 
determining when an entity has a ``substantial position'' in a major 
swaps category warranting regulation as a major swap participant.\35\ 
The Farm Credit Council proposes that a similar test measuring 
uncollateralized current exposure or current exposure plus potential 
future exposure would be appropriate in determining which small 
financial institutions pose enough risk to warrant mandatory clearing. 
Specifically, we believe that current uncollateralized exposure of $2 
billion in the rate swaps category and $1 billion in other categories--
or current uncollateralized exposure and potential future exposure of 
$3 billion for rate swaps or $1 billion for other swaps--would be 
appropriate. These proposed thresholds, which are lower than the 
thresholds the Commission has proposed for identifying major swap 
participants, would both address risk among financial entities and more 
accurately capture financial institutions whose swap exposure poses 
risk to the financial system.
---------------------------------------------------------------------------
    \35\ See Further Definition, supra note 28, at 80188-94.
---------------------------------------------------------------------------
    Alternatively, the Commission could adopt a test based on an 
institution's exposure to swaps as a percentage of capital. The Farm 
Credit Council suggests that appropriate risk limits would be current 
uncollateralized exposure to swaps of 10% of capital, or current 
uncollateralized plus potential future exposure to swaps of 20% of 
capital. We believe these limits would appropriately identify which 
small financial institutions pose systemic risk warranting mandatory 
clearing. We believe that mandatory clearing would not be justified for 
institutions with less exposure to swaps as a percentage of capital. A 
test of current uncollateralized swap exposure as low as 5% of capital 
would, however, allow most of the Farm Credit System's risk management 
activities to survive without a costly new clearing requirement.
VI. Conclusion
    For the reasons described above, the Farm Credit Council urges the 
Commission to exercise its ample authority to permit all Farm Credit 
System institutions--including those with total assets exceeding $10 
billion--to use the end-user clearing exception. Because Farm Credit 
System banks use derivatives on a district-wide basis to manage risk 
for much smaller associations, the Commission should look through the 
banks to the average asset size of their affiliated associations. 
Otherwise, mandatory clearing would put small Farm Credit System 
associations at a competitive disadvantage with respect to competing 
commercial banks. This approach is appropriate because safe, sound Farm 
Credit System institutions do not need an additional, redundant layer 
of regulation. And new clearing regulation would impose costs that 
would both discourage Farm Credit System institutions from mitigating 
risk and diminish the availability of credit for farmers and rural 
America.
    The Farm Credit Council appreciates the opportunity to comment. If 
you have any questions or we can provide other information, please do 
not hesitate to contact us. As always, we would welcome the opportunity 
to work with the Commission in developing the final rule.
            Sincerely,

            [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
            
Robbie Boone,
Vice President, Government Affairs,
Farm Credit Council.

CC:

Honorable Gary Gensler, Chairman;
Honorable Michael Dunn, Commissioner;
Honorable Jill E. Sommers, Commissioner;
Honorable Bart Chilton, Commissioner;
Honorable Scott D. O'Malia, Commissioner.

                                  
