April 18, 2012
I would like to start my remarks today by personally thanking the teams that are about to present to the Commission two final rules and two interim final rules, which implement various provisions of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).1 I appreciate the tireless hours, days, and months that Commission staff has dedicated to writing today’s rules, which when combined are over 700 pages in length. Commission staff has had to review hundreds of comment letters, meet with dozens of interested persons, tackle tough legal issues, and, in the case of the final and interim final entities definition rules, coordinate with staff of the Securities and Exchange Commission (“SEC”) and regularly consult with staff of the Federal Reserve Board. Preparing these rules in advance of today’s open meeting was no small feat.
The final rules that are before the Commission today will establish the cornerstones of the Commission’s rules under Title VII. For that reason, it is paramount that the Commission issues these final rules in the right way—not only in terms of the right policy, but also in terms of sound legal analysis.
Final Entities Definition Rule and Interim Final Rule2
One set of final and interim final rules further define the principal participants in the swaps market: “swap dealers,” “major swap participants,” and “eligible contract participants.”3 Given the weaknesses and concentrations of risk exposed by the 2008 financial crisis, it is appropriate that the Commission is adopting a final entities rule today. Unfortunately, however, I am unable to support this rule not because it fails to make positive policy choices, but because it undertakes several unnecessary and astonishing contortions to achieve those results. These contortions may lead to potentially adverse inconsistencies and instabilities in the years that follow.
I have a number of concerns with each definition in the final entities rule. The concerns I raise today, however, are focused on the legal analysis describing the “swap dealer” definition. Simply put, the Commission’s rationale in the final rule defining the term “swap dealer” has ignored basic canons of statutory construction4 by not simply excluding commercial end-users, as entities, from the “swap dealer” definition.
Today, the Commission has erected the final entities rule on the infirm scaffold of the proposal.5 At the proposal stage and now, I have supported providing absolute certainty to commercial end-users that their swaps activities–whether to mitigate financial or physical risks– will not deem them to be swap dealers. I am not the sole voice calling for a commercial end-user exclusion. Indeed, various members of Congress have asked that we exclude commercial end-users.6 It is beyond me why the Commission has chosen a winding path to reach such a straightforward policy result.
In addition, the final entities rule is silent on the manner in which the hedging definition in the interim final rule interacts with the End-User Exception rulemaking, which similarly contains a hedging or mitigating commercial risk definition similar to that found in the definition of “major swap participant.” Any entity that falls within the definition of swap dealer will be unable to rely on the end-user exception to clearing. Therefore, if the Commission overreaches in defining “swap dealer,” it may narrow the end-user exception in a way that is incongruent with congressional intent.
More specifically, I would like to have seen a consistent hedging definition in the interim final rule that would have allowed commercial firms trading both financial swaps (such as currency and interest rates swaps) and physical commodity swaps to not have either counted as “swap dealing activities.” The better approach would have been for the Commission to permit non-financial entities to use the same hedging definition as provided to major swap participants. The SEC has wisely adopted this approach.
I think it is important to note that a great deal of the Commission’s analysis was drafted in the days leading up to today’s meeting. Although I have strong concerns regarding the Commission’s interpretative gymnastics, I think industry can breathe a little easier today knowing that the Commission finally has seen the light by raising the de minimis threshold, which masks many of the challenges commercial end-users would have faced if the threshold remain at a much lower level.
The Commission has made many positive policy changes in today’s rules. To enable these changes, however, the Commission engages in a series of statutory contortions. As a result, Commission staff will likely spend several years issuing guidance cleaning up the abstruse reasoning found in the final swap dealer definition.
Mr. Chairman, I have prepared a dissent that I will include in the record that will more thoroughly explain my views.
Final Commodity Options Rule and Interim Final Rule
The other set of final and interim final rules before the Commission today repeal and replace the Commission’s current regulations concerning commodity options and incorporate a trade option exemption for physically-settled commodity options. Unlike the first set of rules, I support the final commodity options rule and interim final rule.7 In particular, I support these rules because the Commission: (1) has accurately interpreted the relevant provisions of the Commodity Exchange Act, as amended by Title VII;8 (2) is issuing a rule that will improve transparency into the commodity options market; and (3) has taken the time to carefully analyze the costs and benefits of the final rule and the interim final rule.
I applaud the work of Don Heitman, Ryne Miller, and their team by including a thoughtfully-crafted exemption that will allow commercial users and eligible contract participants to trade options on physically-settled commodities subject to certain conditions. Those conditions attempt to strike the appropriate balance in providing the Commission with maximal transparency into, and oversight over, the trade options market while avoiding unnecessarily burdensome regulation for the sake of regulation.
Of significant note in this rulemaking is its cost-benefit analysis, which sets forth a good template for our upcoming rulemakings to follow. Specifically, it identifies viable alternatives,9 includes a robust discussion of the section 15(a) factors, and contains an appropriate baseline. Although, the cost-benefit analysis in the interim final rule does not quantify the costs imposed by the trade option definition and the conditions to the exemption, the team provided an explanation of why those costs are not presently quantifiable and a series of detailed questions seeking public input and data regarding costs and benefits resulting from this rulemaking.10
In conclusion, I again thank the teams for their hard work in putting these two rules together. The Commission has made many positive policy changes in today’s rules. To enable these changes in the final swap dealer definition, however, the Commission engages in a series of statutory contortions. As a result, Commission staff will likely spend several years issuing guidance.
1 See Pub. L. 111-203, 124 Stat. 1376 (2010). The short title of Title VII of the Dodd-Frank Act is the “Wall Street Transparency and Accountability Act of 2010.”
2 For a complete perspective on my arguments, please see my dissent to the final entities rule, available at: http://www.cftc.gov/PressRoom/SpeechesTestimony/CommissionerScottDOMalia/index.htm.
3 These terms will be codified at 17 CFR pt. 1. As noted above, the final entities rule and interim final rule are joint between the Commission and the SEC. My statement, however, refers only to Commission’s portion of the final entities rule and interim final rule.
4 The canons of statutory construction are “important rules and conventions” that courts apply to determine the meaning of statutory provisions. See, e.g., Congressional Research Service, Report for Congress, Statutory Interpretation: General Principles and Recent Trends, updated Aug. 31, 2008.
5 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 (Dec. 21, 2010) (the “Proposal”).
6 See Letter from Chairman Christopher Dodd, Committee on Banking, Housing, and Urban Affairs, United States Senate, and Chairman Blanche Lincoln, Committee on Agriculture, Nutrition, and Forestry, United States Senate, to Chairman Barney Frank, Financial Services Committee, United States House of Representatives, and Chairman Colin Peterson, Committee on Agriculture, United States House of Representatives (June 30, 2010) . See also Letter from Chairman Debbie Stabenow, Committee on Agriculture, Nutrition, and Forestry, United States Senate, and Chairman Frank D. Lucas, Committee on Agriculture, United States House of Representatives, to Chairman Gary Gensler, United States Commodity Futures Trading Commission (Mar. 29, 2012).
7 I note that the trade option exemption may provide some comfort to market participants reviewing the final entities rule. Whereas the Commission has made a positive policy choice in considering these two sets of rules together, I still believe that the Commission has engaged in statutory contortions that were unnecessary and that may have potentially adverse consequences.
8 See 7 U.S.C.1 et seq.
9 See ___ FR ___, (unpublished final rule) (2012) (“The range of alternative conditions available to the Commission with respect to who may transact trade options is wide – that is, the Commission could have decided that anyone or no one could be an offeror or offeree.”) and (“The Commission also had a range of alternatives with respect to regulatory requirements applicable to trade option transactions.”).
10 See id. (“Commenters are encouraged to submit any data or other information that they may have quantifying or qualifying the costs and benefits of the interim final rule trade option exemption with their comment letters. In addition, the Commission seeks comment on whether the offeror requirement imposes any additional costs, particularly when compared with the general Dodd-Frank swaps regime, which does not otherwise provide for the trade option classification, and whether limiting the trade option exemption to physically delivered contracts (and requiring all other commodity options to transact under the general swaps rules) imposes any significant or unreasonable cost on market participants.”)
Last Updated: April 18, 2012