April 18, 2012
Good morning. This meeting will come to order. This is a public meeting of the Commodity Futures Trading Commission (CFTC) to consider final rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). I’d like to welcome members of the public, market participants and members of the media, as well as those listening to the meeting on the phone or watching the webcast.
Today is the 26th open meeting on Dodd-Frank rules. We will consider two final rules:
• Entity definitions, which is a joint rule with the Securities and Exchange Commission (SEC); and
• Commodity Options
I would like to thank Commissioners Sommers, Chilton, O’Malia and Wetjen for their significant contributions to the rule-writing process and the CFTC’s hardworking and dedicated staff.
I also want to thank the SEC’s five commissioners, Chairman Mary Schapiro and Commissioners Walter, Aguilar, Paredes and Gallagher. The two Commissions worked hand-in-hand on the entity definitions rule. It has been a true collaborative effort.
Today’s rules provide market participants greater clarity regarding key terms in the Dodd-Frank Act and the regulatory reach of the law. We received significant public comment on both of the proposals, and the final rules we will vote on today greatly benefitted from this important public input.
Regulating banks and other firms that deal in derivatives is central to financial reform. Leading up to the financial crisis, it was assumed by many that swap dealers were largely regulated. The 2008 crisis revealed the inadequacy of this approach: while banks and securities firms were regulated for their lending and securities activities, there was no comprehensive regulation of their swap dealing activity. Furthermore, their affiliates trading swaps often had ineffective or no oversight.
Exhibit 1, AIG was a regulated insurance company, but its swaps affiliate brought down the company and helped to nearly topple the U.S. economy.
The CFTC is well on the way to implementing reforms Congress mandated in Dodd-Frank to regulate dealers and help prevent another AIG. The Commission has finished rules requiring swap dealers to deal fairly with customers, provide balanced communications and disclose conflicts of interest before entering into a swap. In addition, this agency has finalized rules to require swap dealers to establish policies to manage risk, as well as put in place firewalls between a dealer’s trading, and clearing and research operations.
The rule we will vote on today further defining entities builds on this significant progress and is pivotal to lowering risk that swap dealers may pose to the rest of the economy.
The rule fulfills Congress’ direction to further define the terms “swap dealer,” “major swap participant” and “eligible contract participant” and appropriately addresses the many comments we received. It will provide essential direction to market participants on whether they will be required to register.
The final rule gives market participants guidance on the Dodd-Frank Act definition of swap dealer:
• First, it does so by allowing market participants to draw on useful precedents developed by the SEC to help distinguish between dealing and trading.
• Second, it does so by providing further clarity on the Dodd-Frank act term “makes a market in swaps” by focusing on entities that routinely seek to profit by accommodating other market participants’ demand for swaps.
• Third, it does so by clarifying another key term “regular business,” focusing on whether a person has an identifiable swap dealing business.
• Fourth, it does so by fulfilling Congress's mandate that swaps entered into by an insured depository institution in connection with originating a loan are not to be considered dealing activity.
• Fifth, it does so by providing direction on the distinction between hedging and dealing and within this provides a specific rule for swaps that hedge price risk associated with a physical commodity.
• Sixth, it does so by clarifying that swaps between an agricultural cooperative or cooperative financial institution and its members does not constitute dealing.
• Seventh, it does so by setting a de minimis threshold for swap dealing, as directed by Congress. The threshold is $3 billion total, across all asset classes, subject to a phase in level of $8 billion. As we proposed, the final rule would define as a swap dealer any entity with more than $25 million of dealing activity with pension funds and municipals – so-called “special entities.”
True to congressional intent, end-users other than those genuinely making markets in swaps won’t be required to register as swap dealers. The swap dealer definition benefited from the many comments from end-users who use swaps to hedge their risk.
As the swap dealing market is dominated by large entities, though, I believe that the final swap dealer definition will encompass the vast majority of swap dealing activity, as Congress had intended. For those who question the level of the de minimis, we considered the threshold in the context of an overall $300 trillion notional swaps market. Further, the statute defines swap dealing by referencing “making a market in swaps” and conducting a “regular business” in swaps. The $3 billion threshold in the rule represents $12 million a trading day, with the phase-in of $8 billion representing $32 million notional per trading day. Putting this in perspective, the interest rate swap market, transacts, on average, over $500 billion notional per day. As further reference, this year the futures markets for crude oil traded, on average, $65 billion of notional per day.
During this phase-in period the Commissions will collect and analyze data to evaluate the appropriate de minimis.
Another question that has been raised is whether the swap dealer definition should appropriately be activities-based or relate to how an entity is classified. The final rule is consistent with Congressional intent that we take an activities-based approach.
Though many of these large swap dealers are financial entities, Congress anticipated that some non-banks would be registered as swap dealers. Congress provided in Dodd-Frank that capital and margin for bank swap dealers be set by the bank regulators, but for non-bank swap dealers, by the CFTC. Instructive in this regard is the list of primary dealers on the International Swaps and Derivatives Association’s (ISDA) website, which includes a number of non-bank dealers. The Association describes as meeting that designation an entity “that deals in derivatives as part of its business.” Congress closed the so-called “Enron loophole,” which let traders evade oversight by using electronic trading platforms. But it’s important to recall that Enron was also a swap dealer. Congress did not intend to create a new type of loophole in its place.
The rule we will consider today also further defines the term “major swap participant.” Relying on Congress’ three-prong test, this category is clearly limited to only those entities with swaps positions that pose a risk large enough to threaten the U.S. financial system.
The further definition of the term “eligible contract participant” provides guidance regarding who is eligible to transact swaps off of an exchange. Based upon the many comments received, we incorporated further guidance to ensure that small businesses and real estate developers can continue to have access to swaps to hedge commercial risks. The final rule also clarifies how the ECP definition applies to certain foreign exchange transactions conducted by commodity pools.
Swap dealer and major swap participant registration will begin when the CFTC and SEC finalize the further definition of “swap.” As the Commissions work to complete this rule, the CFTC soon will issue for public comment a proposed extension of the temporary exemptive order regarding the effective date of certain provisions of Dodd-Frank’s Title VII requirements. I also anticipate the Commission will explicitly seek public input on the cross-border application of Title VII, and we may look for an appropriate approach to phased-in compliance for certain requirements for cross-border swap dealers.
Today we also will consider final rules on Commodity Options. The Dodd-Frank Act includes commodity options within the statutory definition of “swap.” Today’s rule confirms that the same rules apply to commodity options as are applicable to other swaps, just as the law directs. In addition, the Commission will consider and seek comment on an interim final rule to provide a trade option exemption for certain commodity options that are physically delivered.
We received a lot of feedback from commercial market participants that commodity options used by commercial entities to deliver or receive physical commodities in connection with their business don’t need the same level of oversight as swaps. However, trade options will still be subject to position limits, appropriate reporting and recordkeeping requirements, and anti-fraud and anti-manipulation rules. The Commission is seeking additional comments on the trade option exemption, but the interim final rule makes the relief immediate.
After today we will have completed the first of two key CFTC and SEC joint definition in Dodd-Frank. Now it is critical that we move to the joint rule further defining the terms “swap” and “security-based” swap, which is necessary to implement position limits.
With the completion of today’s two rules, the CFTC will have finalized 31 Dodd-Frank financial reforms. Though with today’s final rules we’re more than halfway done, much work needs to be completed to fulfill the promise of the Dodd-Frank financial reforms and protect the public.
As the G-20 returns to Washington this week for spring meetings, I’m reminded of the commitments made at the 2009 Pittsburgh summit. G-20 leaders agreed that by the end of this year all standardized over-the-counter derivatives contracts should be reported to trade depositories, cleared and traded on platforms as appropriate. The goal was for these reforms to be in place by the end of this year, and the CFTC is on track to meet this goal.
Last Updated: April 18, 2012