Comment for Proposed Rule 75 FR 80174

Comment Text:

Definitions Team Meeting with the Coalition of Derivatives End-Users

Tuesday, December 21, 2010

Memo from
Fajfar, Mark

CFTC Staff :
Mark Fajfar
David Aron
Rosaria Troia
Somi Seong
Gregory Kuserk
Nela Richardson
Stephen Kane
David Johnson
Lee Ann Duffy
Irina Leonova

External Attendees :
Tom Quaadman (US Chamber of Commerce)
Christina Crooks (Financial Executives International)
Mark Barber (General Electric)
Renuka Gupta (General Electric)
Joe Siu (Chatham Financial)
Luke Zubrod (Chatham Financial)
Michael Bopp (Gibson Dunn)
Amanda Neely (Gibson Dunn)
Participated by phone:
Kirk Freeman (NAREIT)
Nathan Graham (Procter & Gamble)
Ed Perry (IBM)
Tammy Evans (IBM)
Jim Harshaw (General Motors)
Tom Deas (National Association of Corporate Treasurers and FMC Corporation)
Jim Allison (ConocoPhillips)
Keith Doliver (Microsoft)
Joshua Kans (SEC)
Richard Grant (SEC)
Peter Curley (SEC)

Additional Information :
The discussion covered the following topics.
i.) Further definition of swap dealer
a) Treatment of swaps between affiliated parties
The Coalition expressed the view that such swaps should not be included in determining if a person is a swap dealer and generally should not be subject to other requirements imposed under the Dodd-Frank Act.
The CFTC Staff pointed out that the preamble to the proposed rule says swaps between persons under common control may not be relevant to the determination if a person is a swap dealer (page 80183), but this is only for purposes of the swap dealer definition and the swaps would continue to be subject to all applicable requirements (footnote 52).
The Coalition expressed the view that in addition to swaps between wholly-owned affiliates, swaps between persons under common control should be disregarded in determining if a person is a swap dealer, and that for this purpose the concept of control should be interpreted broadly to include control exercised through joint ventures and relationships where one party is financially responsible for another.
b) De minimis exemption
The Coalition expressed the view that the thresholds for determining whether a person engages in a de minimis level of swap dealing are low.  The Coalition suggested an approach that would be conceptually similar to the proposed approach for determining whether a swap is a “block trade.”  That is, the de minimis threshold would be set as a certain percentage of the activity of a large swap dealer, measuring such activity in terms of the number of swaps, value of swaps and so forth.  The Coalition suggested as a starting point that a threshold in the range of one percent (1%) of a large swap dealer’s activity could be appropriate.
ii.) Further definition of eligible contract participant (ECP)
The Coalition expressed agreement with the proposal not to significantly change the definition of ECP.  The Coalition explained that certain real estate entities create multiple subsidiaries to hold certain property interests, and the rule should allow these subsidiary entities to qualify as ECPs.  The Coalition also repeated two comments from their earlier comment letter in response to the Advanced Notice of Proposed Rulemaking – there should be a “line of business” exception to the ECP definition, and the rule should allow a subsidiary entity to rely on its parent to meet the aspects of the ECP definition that test a party’s investment sophistication.
iii.) Further definition of major swap participant (MSP)
a) Treatment of swaps between affiliated parties
The Coalition expressed the view that such swaps should generally be disregarded in determining if a person is an MSP.  The CFTC Staff pointed out that the preamble to the proposed rule says a person should consider the economic reality of the swaps (page  80202).  The CFTC Staff also expressed interest in hearing the Coalition’s views on how swaps between affiliated could be treated in the determination of MSP status in a manner that would focus on the economic reality of such swaps.
b) Quantitative thresholds of MSP status
The Coalition expressed the view that the quantitative thresholds proposed to define substantial position and substantial counterparty exposure should be indexed so that the thresholds change relative to changes in the swap markets.  The Coalition noted that several different measures of the market (such as notional value, exposure and so forth) could be relevant in this regard. 
c) Treatment of cleared and margined swaps
The Coalition expressed the view that, in the calculation of substantial position and substantial counterparty exposure, the haircut (i.e., reduction in value) for determining the potential future exposure (PFE) of swaps that are cleared or subject to mark-to-market margining should not be applied in a manner that would create an inappropriate disincentive to the use of over-the-counter swaps.
The Coalition also questioned the discussion in footnote 113 of the preamble to the proposed rule, which explains the proposed treatment of uncollateralized “threshold” amounts and minimum transfer amounts in the calculation of PFE.  The Coalition is concerned that the inclusion of such amounts in PFE, regardless of actual exposure, may inappropriately cause a person to be treated as an MSP.  The CFTC Staff pointed out that the inclusion of such amounts applies only after the haircut for swaps that are subject to mark-to-market margining has been applied.
d) Hedging or mitigating commercial risk
The Coalition expressed the view that swaps used to hedge financial risks should be treated as swaps hedging commercial risk in the determination of MSP status.  In this regard, the CFTC Staff pointed to the discussion on pages 80195-97 of the preamble to the proposed rule which requests comment on various aspects of the definition of commercial risk.  The Coalition also said that the final rule should provide for an entity to use swaps to hedge risks faced by affiliates.  The CFTC Staff pointed to the requests for comment on page 80195 regarding hedging on a consolidated basis and regarding risks relating to offshore affiliates.
iv.) Transition period
The Coalition expressed the view that corporate treasury functions related to the determination of MSP status (such as the daily calculation of mark-to-market exposures) will take around one year to implement.  In the general, the Coalition was of the view that the regulations related to swap dealers and MSPs should be implemented over time following the effective date of the Dodd-Frank Act.