Meeting Date:
Wednesday, February 2, 2011
CFTC Staff:
Mark Fajfar
David Aron
Rose Troia
Organization(s):
Stanford University Graduate School of Business
External Attendees:
Darrel Duffie (Stanford University Graduate School of Business)
Josh Kans (SEC)
Jeff Dinwoodie (SEC)
Additional Information:
Professor Duffie made the following points, primarily relating to the definition of major swap participant (MSP).
The definition of MSP should take account of the risk arising from large swap positions that would have to be liquidated quickly in a crisis. For example, these large positions could stress the liquidity of clearinghouses. There should be a threshold for swap positions, stated as an absolute dollar amount, above which the person holding the positions is an MSP, regardless of whether the positions are in-the-money, cleared, collateralized, etc. This threshold should be determined as a certain percentage of the relevant market for the type of swap; or, it could also be set according to the volume of the relevant type of swap at the clearinghouse(s) (e.g., 4 weeks of the volume of that type of swap).
The exception in clause (D) of the MSP definition for certain financing affiliates raises concerns. Even if these affiliates are using swaps to reduce risks, the affiliates may still have to liquidate large swap positions in a short time. Even if the swaps are related to physical assets or positions, the swaps may require payments or other resets on a schedule that is different from the physical positions; therefore the physical position may not help the affiliate in mitigating the risks of the swap position. Even if the swap’s hedge is economically effective, the terms of the hedge may not line up with the cash flow or liquidity available to the affiliate.
The statutory requirement to determine MSP status with respect to categories of swaps raises concerns. The categorization could allow users of swaps to divide positions among the categories. Although this may disperse risk among different types of swaps, there is a potential for abuse by miscategorizing swaps. The rule should include a catch-all that allows the CFTC or SEC to review large swap positions that appear to be structured to evade proper categorization. It would be helpful for market participants to suggest protocols for the categorization of swaps.
Regarding the calculation of the size of swap positions to determine MSP status:
(1) The exception for swap positions that hedge or mitigate commercial risk should be limited and should not include positions that hedge financial risks or speculative positions.
(2) Collateralization and netting of swap positions will not completely eliminate risk, so the calculation should not completely ignore positions that are collateralized or netted.
(3) The proposed 80% discount for cleared swap positions is overly optimistic regarding the benefits of clearing. A swap user that must quickly liquidate large cleared positions could still pose significant risk to the clearinghouse. Also, overly encouraging clearing may result in excessive concentration of swap positions at clearinghouses.
In determining if an asset manager is an MSP, the swap positions of all the investment funds under common management should be aggregated.
Foreign governments and other foreign jurisdictions (such as municipalities) should be treated as “financial entities” for purposes of the MSP definition and other requirements under the Dodd-Frank Act. Among other reasons, the market will perceive such entities as unlikely to fail and therefore they could become a source of systemic risk.
