More than 6 months after the CFTC voted 3-2 to implement position limits in commodities, the CFTC is meeting today to
define the word swap discuss the word swap, which is the final step required prior to the actual implementation of the limits, which will go into effect 60 days after swap is defined.
- Certain swaps will be excluded from rule if entered into to hedge a physical position
- Interim final rule includes a list of questions and requests for public comment. Comments will be due 60 days
- CFTC & FTC will still need to further define ‘swap’ at a later date
So if it takes the CFTC 6 months to get around to discussing the word swap, how long will it take them to get around to actually defining the word and begin enforcing position limits 60 days later?
Full transcript now available below:Watch live after the jump:
We will continue updating the transcript, so keep refreshing your browser for the most current info.
Chairman Shapiro and our colleagues at the SEC and I thank the public and the market participants who have been coming into us months and months and months, telling us their views about. This thank you very much, Mr. Chairman.
>> CHAIRMAN GARY GENSLER: Thank you. It was a lovely weekend, but I think it was good.
With that, I think I will turn it over to the — we have spoken so much about entities. That was just the warmup act, really for commodity options. Don, I mean, again, your service to this commission and the American public is remarkable but since this is an interim final, you might actually serve us a little longer. I just wonder if that’s all right when we get those comments, Don Heitman and Dave Aron, Ryne Miller, and Rick Shilts from Division of Market Oversight and Steve Kane, office of Chief Economists, on cost benefit considerations. Don?
>> DON HEITMAN: I feel like the under card before the heavy weigh championship match. I would like to thank the other members of the ag swaps and options team particularly Steven Kane our economist and David Aron who is our OGC guy who is also doing double duty for the equities team and Ryne Miller who does most of the real heavy lifting for the team.
This is the sixth time we have come before the commission. The previous five documents, one advanced notice of proposed rulemaking, two proposed rules and two final rules were all approved unanimously and we’re hoping to maintain our perfect record. I have done my part by wearing the same lucky tie at all five previous meetings and the rest is up to Ryne Miller, who will be briefing the commission.
>> RYNE MILLER: As Don mentioned, we had a strong team working on this rule, and I also want to thank each of them for their contributions. I will just mention Crystal Lack and done and mark Higgins who distributed to our cost benefit considerations.
Today we present for your consideration a final rule and an interim final rule for commodity options. As you know, the Dodd-Frank Act swap definition includes an option of any kind for one or more commodity. Consistent with that provision in February of 2011, the commission proposed rules that would replace the commission’s preDodd-Frank options rules with a rule generally permitting commodity options to trade pursuant to the same rules applicable to every other swap. The rulemaking proposal also requested comment on the appropriate treatment of trade options, which were generally commodity options used by commercial entities to deliver or receive physical commodities in connection with their business.
We received multiple comments on the proposal and after reviewing the comments received, the team presents for the commission’s consideration this final rule and interim final rule. Our final rule largely adopts the February 2011 proposal which would align the commission’s general commodity options rules with the Dodd-Frank Act. It does so by authorizing commodity options to transact subject to the same rules applicable to every other swap. The final rule also streamlines and simplifies the options rules by deleting several obsolete, including the dealer option provisions and no longer relied upon agricultural trade provisions.
Moving to the interim final rule, the interim final rule responded to comments and implemented a trade option exception that exempts trade options from most but not all of the rules otherwise applicable to swaps. There are three requirements in the interim final rule for a transaction to be considered a trade option. One, the offerer or seller of the trade option must be either an eligible contract participant or a commercial. Two, the offeree or the buyer of a trade option must be a commercial entity, just as was required under the pre-Dodd-Frank trade option and three, the trade option if exercised must result in the sale of an exempt or agricultural, that is a nonfinancial commodity for immediate or deferred shipment or delivery so that the trade option, if exercised must result in a spot or a forward transaction.
The trade option exemption as mentioned, would be subject to a few conditions, including appropriate record keeping and reporting, requirements, or in the alternative for unreported trade options an annual notice filing requirement for anyone who is a counterparty to an unreported trade option.
Two, the interim final rule retains the commission’s position limits and large trader reporting swaps rules. Three, the interim final rule retains certain swap risk management and reporting and record keeping duties for swap dealers and major swap participants that are engaging in trade options, and finally, for all trade options, as of any commodity option generally, the interim final rule retains the commission’s antifraud, antimanipulation and enforcement authorities.
The interim final rule includes a list of questions and requests for public comment. Comments will be due 60 days. The effective date for the final rule and the interim final rule will be 60 days aft publication in the federal register however, the compliance date will not be until 60 days after the term swap has been further defined by the FTC and the CFTC. We will be happy to answer any questions that you may have on this rule.
>> CHAIRMAN GARY GENSLER: I think I would like to consider a motion on the staff recommendation on the final rule and interim final rule from commodity options.
>> COMMISSIONER JILL SOMMERS: So moved.
>> CHAIRMAN GARY GENSLER: As I said earlier, I support this final rule and interim final rule, and I’m going to let you off the hook. I don’t have any questions, Ryne.
>> RYNE MILLER: Thank you.
>> CHAIRMAN GARY GENSLER: Commissioner Sommers?
>> COMMISSIONER JILL SOMMERS: Thank you, Mr. Chairman. Just as a quick comment, as I said in my opening remarks, I think we could have provided more clarity with regard to this rule, if we would have paired it with the product definitions instead of with the entity definitions, but just wanted to get your comments with regard to that. We have heard from a lot of different market participants who use transactions that have not historically been considered options, but nonetheless, have some element of optionality.
Those market participants have asked us for clarification, whether or not those transactions will be deemed options, and so if you could just give us comments about what kind of clarity we hope to give those market participants.
>> RYNE MILLER: Sure and as Commissioner Wetjen noted in his opening remarks. This rule is for commodity options not excluded from the swap definition. If you go to footnote 6 of our rule, I will just read the last sentence of it, which is the guidance we are sending out, it says if a commodity option or a transaction with optionality is excluded from the scope of the swap definition, as to be further defined by the two agencies, this final rule and the interim final rule do not apply to that transaction. And so that’s the guidance we are sending out.
I might ask Dave Aron if he has any further comments because we did combine on this rule.
>> DAVE ARON: I’m also on the product rules, commissioners, and Julian and I have been working over the last few weeks to do just what you were saying, give more guidance on transactions with optionality in the past. There were a number of exemptions that people could rely on so they didn’t really have to think about it. Now because options and swaps were important so we talked about a number of transactions in the product rule. We thought it was more appropriate to do it there because that’s a definitional rule. Here we are not defining it. So there should be quite a bit of guidance in there and, of course, we will be available afterwards if it’s not clear in a particular transaction.
>> COMMISSIONER JILL SOMMERS: Thank you.
>> I would also like to point out that throughout this whole process, our team has coordinated with the products definition team we have had joint meetings. We had joint meetings with outside people. We shared comments across the team. So we are closely in sync on this.
>> COMMISSIONER JILL SOMMERS: That’s encouraging. And just, I guess, for the record, I’m very supportive in the product rule of being as clear as we can be about the definitions of these products that contain optionality. Thank you.
>> CHAIRMAN GARY GENSLER: Commissioner Sommers, I would say, because I have been in a lot of meetings, it’s often the electricity companies, but it’s not always with electricity companies, about volumetric options and I think we’ll get it right in the product rule, but if — if you and your staff — and I say this to all of your commissioners, have thoughts now, if you could get them into Julian Hammer and LeAnn Duffy and Dave Aron, because it’s two commissions, if we can get this in now, into this draft working arrangement with the SEC, we’ll probably save us from — I mean, it was a lovely weekend, by the way, but, I mean, if — I think it would be helpful. Because I think the volumetric option, I hope, there’s a meeting of the minds around this commission around, but sometimes the devil is in the detail and the earlier we get to it, the better.
I do want to say for market participants that if there’s a real intent to deliver something, that’s historically been a forward is not a future and Congress is very clear that a forward would not be a swap. And I think that’s what we put out in the proposal and the challenge just here is when it has some optionality, you know, what is effectively a forward for electricity or for other. Sometimes it’s natural gas and sometimes it’s other products as well. Sorry that I went off script, but — Bart, you are next. Commissioner O’Malia?
>> COMMISSIONER SCOTT D. O’MALIA: Thank you. I just want to thank the team for your cooperation and helping get some alternative reporting requirements that lower the burden on kind of commercial end users that aren’t — provides an alternative to Part 45 and I just appreciate your help on that. Thanks.
>> CHAIRMAN GARY GENSLER: Commissioner Wetjen.
>> COMMISSIONER MARK WETJEN: I just have one question. It’s mostly for the benefit of the public, but this rule requires some transaction reporting that has not been required in the past with respect to trade options and so I just would ask the staff if you could go over some of the reasons or rationale why we are requiring the reporting here on this rule.
>> RYNE MILLER: Sure there’s two tiers of reporting in the trade option exenterrion. The first, the rationale is we went for the minimally burdensome approach that we could, which was if an entity is already reporting their swaps to the extend they will engage in trade options they will also have to report their trade options. SDR connectivity which is where swaps are reported is sometimes the cost cited as the major barrier or the high cost. If that’s already involved with an entity and its other transactions, they can report their trade options as well.
If a trade option involves two entities, neither of which are reporting swaps otherwise, as Commissioner O’Malia mentioned, we are only going — the interim final rule only required an annual notice filing, and so that — what that does is it provides the commission with kind of a database or a who to call list in the event that market circumstances warrant looking into a particular commodity class or a commodity category and what kind of trade options activity is occurring.
As it stands with the pre-Dodd-Frank trading option, there’s no visibility whatsoever, and so we wanted to take this opportunity to address that.
>> COMMISSIONER SCOTT D. O’MALIA: I will just add that under this — well, I would like to give Commissioner O’Malia a lot of credit to provide for the tiered reporting redeem, and Mr. O’Malia is able to find consensus among the commissioners and I think it’s a great improvement to the rule.
>> CHAIRMAN GARY GENSLER: Yes, I think it was a great improvement. I think what we were challenged with here is that Congress included commodity options expressly included commodity options, so keeping with Commissioner Wetjen’s in following the Congress’ intent and the statutes and doing what all five of us thought was appropriate for physically — physically settled options on physical commodities. Did I get the physicals right?
>> RYNE MILLER: That’s right.
>> CHAIRMAN GARY GENSLER: All right. Mr. Staywick.
>> COMMISSIONER MARK WETJEN: Aye.
>> COMMISSIONER SCOTT D. O’MALIA: Aye.
>> COMMISSIONER BART CHILTON: Aye.
>> COMMISSIONER JILL SOMMERS: Aye.
>> The ayes are five, the nays are zero.
>> CHAIRMAN GARY GENSLER: Thank you, Mr. Staywick, the ayes having it unanimously, we’ll be sending the staff recommendation to the federal register. I guess I’m supposed to also now do a use consent to allow staff to make technical changes, absent objection. We’ll do that. So ordered.
Thank you, all. Don, you are not off the hook when the IFR comes, all right? And stick around for products and help us on that too.
So now we will have the team come up on the much talked about further definition of entities be joint rule. Dan Berkovitz, our general counsel, I don’t yet see him here, but Jeff Burns, Mark Fajfar and Dave Aron. I don’t know if they have their — their buttons on, but Dave Aron is Mr. ECP. Mr. Fajfar is Mr. Swap dealer and Jeff Burns is major swap participants. Do you have your button, Mr. ECP. He does.
All of the Office of General Counsel. As well as Steve Kane from the Office of Chief Economist and I know that there’s just probably dozens of other people in the agency who have worked on this, and collaboratively with their counterparts at the SEC.
To whom do I have the pleasure to turn it over to? Jeff?
>> JEFFREY BURNS: I’m first. Good morning, Mr. Chairman and commissioners. Before I begin, I would like to thank my colead Mark Fajfar, as well as David Aron, cam Nunnery and the other fellow team members, as well as our counterparts at the SEC for their efforts in finalizing the joint entities definitions rulemaking that we are about to present.
Today staff is recommending that the commission approve final rule further defining the terms swap dealer, major swap participant and eligible contract participant as well as an interim final rule excluding certain swaps from the swap dealer determination if entered into for hedging physical position.
As the commission is aware, an entity that meets the definition of a swap dealer and major swap participant will be required to register with the commission and be subject to various substantive regulatory requirements that are the subject of separate rulemakings.
In connection with the term “eligible contract participant.” The Dodd-Frank Act makes it unlawful for persons that are not eligible contract participants to enter into a swap other than on or subject to the rules of a designated contract market.
As a result, a person cannot engage in swap transactions with persons that are not ECPs on swap execution facilities or on a bilateral off exchange basis. The ECP definition also provides guidance regarding who is subject to the retail 4X regime. The staff in connection with the final rule also consulted and coordinated with staff from the fed, the OCC, the FDIC and the Department of the Treasury. We have incorporated the input received by all parties to the extent possible within our statutory framework.
During the comment period of the rulemaking, the commission received over 968 comment letters, and staff participated in over 114 meetings with interested parties. In addition, the commission jointly with the SEC held a public round table in June 2011. Commenters provided the staff with invaluable input. As a result of the comments and additional staff review, we have recommended a number of changes to the proposal that are detailed in the final rules and will be discussed in turn.
The effective date for the entity definitions will be 60 days after publication of federal register, however, mandatory compliance with the registration and other substantive requirements is contingent on the effective date of the definition of the term swap. Generally, compliance with the ECP, retail floor ex regime, will be June 20th, 2012.
>> MARK FAJFAR: The Dodd-Frank Act defines swap dealer. Holding one’s self out as a dealer in swaps regularly entering into swaps Hans ordinary course of business or being commonly known in the trade as a dealer or market maker in swaps. The final rule follows the statutory definition.
To determine whether a person is covered by the definition of swap dealer one would start with the statutory definition and apply the rules and the interpretive guidance in the release. We expect that this would proceed as follows.
>> CHAIRMAN GARY GENSLER: Could you just move the mic a little closer.
>> MARK FAJFAR: I have a bit of a cold today. First the person would review the rules that implement the four statutory tests and the swap activities that not part of a regular business. The person would apply the interpretive guidance in the release which provides for consideration of all the relevant facts and circumstances. As part of this consideration, the person could apply the SEC’s dealer trader distinction. This review would determine if the person is engaged in swap dealing activity. The rule allows the person to exclude certain swaps from this determination. The person may exclude swaps entered into by an insured depository with a person originating a loan with that customer, swaps between majority owned affiliates swaps between agricultural cooperative or financial cooperative and its members, swaps with floor traders that was mentioned this morning. And swaps entered into to hedge price risks related to physical commodities.
It is important to note that while the list of swaps that are specifically excluded is limited and narrowly drawn, this does not necessarily mean that every other swap is indicative of swap dealing. Rather, those other swaps are part of an overall multi factor determination of whether the person is engaged in the activities that the statute defines as swap dealing. If this review shows that the person is engaged in swap dealing, the next step is to determine if the person is engaged in more than a de minimis quantity of swap dealings. The final rule provided that the threshold for this is to enter into swaps resulting from dealing activity with a notional amount of $3 billion or more over a 12-month period, subject to the phase-in amount of $8 billion.
The phase-in amount presents an orderly implementation of the swap dealer. Termination of the phase-in period relates to a study that the commission staff will repair, examining among other things the de minimis threshold. The study will be due two and a half years after data starts to be reported. So that the study can consider this data. Nine months after the study, the commission may end the phase-in period, or propose new rules to change the de minimis threshold, either up or down. If the commission does not take action to end the phase-in period, it will terminate automatically five years after data starts to be reported to swap data repositories.
In reviewing the hundreds of comments we received on the proposed swap dealer definition and considering the alternatives they suggested, we focused especially on how the final rule would affect persons on the margin of the definition. That is, while a very large majority of swap users will not be covered by the definition and a few swap users will be clearly within it, the rule will have its greatest effect on the firms at the boundary between those two groups. We thought carefully about the potential for increased costs if the final rules are overbroad and the potential that if the final rules are too narrow, the benefits of the Title 7 will be dampened. We also considered whether specific provisions of the rule and the ways that swap users would respond to them would have distortive effects. With all of this in mind, we expect that the final rules will help swap users to apply the statutory definition of swap dealer efficiently and uniformly.
For example, the final release provides further interpretive guidance on concepts from the proposing release. This guidance says that market making is appropriately described as routinely standing ready to enter into swaps at the request or demand of a counterparty on whether a person’s swap activity constitutes a regular business, the guidance focuses on activities that are usual and normal and the person’s course of business and identifiable as a swap dealing business.
An example of that is to enter into swaps to satisfy the business or risk management needs of the counterparty. Also, the release explains that even though the CFTC is not formally adopting the SEC dealer trading precedents, those precedents can be applied as appropriate as we noted.
Many commenters addressed whether swaps used for hedging could be indicative of dealing. Although the statutory definition does not have any provisions specifically about hedging, we agreed that in certain circumstances a person entering into swaps for the purpose of hedging price risks related to physical positions is not swap dealing. The rule text specifies when this is the case. The release then explains that other swaps used for hedging may or may not be indicative of swap dealing depends upon the facts and circumstances. As said, this is an interim final rule and we are looking forward to comment.
The rule provides specificity on when a swap is considered to be in connection with the origination of a loan. We balanced the need for flexibility and matching such swaps to the particular circumstances of the borrower and the lender against the limited scope of the statutory exclusion. The final rule provides that the swap must be entered into within 90 days before or 180 days after the loan agreement or any draw of principle under the loan. Also, the swap must relate to the financial terms of the loan or it must be a condition of the loan agreement that the borrower enter into the swap to hedge its commodity price risk.
Last, the rule provides that if a person is required to register as a swap dealer, it may apply to limited designation as a swap dealer to specified categories of swaps or specified activities based on the considerations that are relevant in the person’s particular situation.
Thank you and I welcome your questions.
>> CHAIRMAN GARY GENSLER: I will entertain a motion to adopt the staff recommendation on entity definitions.
>> COMMISSIONER JILL SOMMERS: So moved.
>> CHAIRMAN GARY GENSLER: I guess my first question is one I was trying to figure out back here. I will ask. Where in the document, because I worked so closely with Jackie mason, the international side and with my fellow commissioners, particularly Commissioner Sommers on the international reach of this to central banks and sovereign banks. What page and what section did we tuck that into?
>> In one of the MSP sections.
>> CHAIRMAN GARY GENSLER: Can you just turn me to a page? I’m now being whispered it’s in the 360s.
>> There’s also a discussion in the ECP discussion about one aspect of cross border.
>> CHAIRMAN GARY GENSLER: Okay. So I just want to confirm, I thank you because I now see it and I remember working on the language. Just to confirm the approach and if Dan Berkovitz, you want to talk about international commenting, maybe you can give a shoutout to thank Jackie Mesa. But if I would have remembered, I would have put it in my opening statement. This is mostly for market participants and those central bankers around the globe listening. Dan?
>> DAN BERKOVITZ: Right. The release provides that the CFTC does not believe that foreign governments, foreign central banks and international financial institutions should be required to register as swap dealers or major swap participants. This is based on our reading of congressional intent, that Congress in enacting this did not intend to apply the act in a way that would be inconsistent with principles of international commenting. So we did not require international registration for those categories.
>> CHAIRMAN GARY GENSLER: I’m not entirely sure how we would have told a central bank to have capital and margin and so forth, in any event. But could you walk through a little bit more, just — because I think this is absolutely the right thing, that — that the concepts of international commenting.
>> DAN BERKOVITZ: Being right, the Section 2i of the commodity exchange act, which was added by Section 722 (D) of the Dodd-Frank Act provides that the provisions of the commodity exchange act, the swaps provisions of the CEA shall not apply to activities outside the United States, unless such activities have a direct and significant connection with activities in or effect on commerce of the United States. In interpreting the scope of Section 2 (I), the CFTC is guided by the Supreme Court and case law and principles of statutory construction, which generally provide that agencies and courts are to interpret statutes with extra territorial application as the commodity exchange act is through Section 2 (I) in a manner consistent with principles of international commodity, and it takes into being the concerns of foreign regulators, foreign jurisdictions, and construing the statute in a way that does not unduly interfere or present conflicts with foreign jurisdictions.
Clearly foreign governments, one government trying to regulate the activities of other foreign governments or such is the sort asserting jurisdiction over activities that other foreign governments have a clear jurisdictional interest in present these types of issues and that’s why we considered the effect of applying Dodd-Frank and requiring dealer registration, or major swap participation to members of foreign government.
Along with registration comes — as you mentioned, Mr. Chairman, capital requirements, CFTC having certain enforcement authorities and so taking into account that this would be applied to foreign governments actually a matter of international commenting we believed a better interpretation of the statute is that Congress did not intend to apply those activities.
>> CHAIRMAN GARY GENSLER: You want to read footnote 1184. International financial institutions, but it basically ties into the list that comes straight out of statute and straight out of BASL.
I have another question, another area, hedging and this will be my last question. As I said in my opening statement, I think we addressed the between hedging and trading, market making and not market making and along the route, and I think end users unless they are genuinely market making are not going to be caught up into this swap dealer definition, but some people have raised a question, well, why are we putting into rule text the specific set of words around the physical markets that — that — and does that in some way limit other hedging? So I just — Mark, if you can. Because I believe if a company — I will state it a differently.
If a company enters into a loan, borrows money, and then in connection with that, also enters into a swap, is that swap dealing?
>> MARK FAJFAR: No, that wouldn’t be swap dealing, because as we say in the release, the swap dealing requires to you engage in the activities that are set out in the statute. Swap dealing is basically being a point of connection to the market.
>> CHAIRMAN GARY GENSLER: Right. Right. So hedging — by hedging your loans, hedging your currency risk, edging other risks are also not dealing?
>> MARK FAJFAR: That’s correct, because you are not accommodating other’s demands for swaps.
>> CHAIRMAN GARY GENSLER: But we happen to take the added step that Congress didn’t ask to do, an added step to give even further clarity when it related to hedging physical commodities in this rule text, in this interim final rule, is that correct?
>> MARK FAJFAR: That’s correct.
>> CHAIRMAN GARY GENSLER: Okay. Thanks. Commissioner Sommers?
>> COMMISSIONER JILL SOMMERS: I’m going to stick with that same theme, and ask with regard to the hedging definition in this swap dealer provisions and ask why it’s different from the hedging definition in MSP.
>> Right. We addressed that topic on page 71 to 72. There’s two primary reasons. First, the common sense reason that this is — this exclusion that we are putting into rule text as compared to the multifactor analysis that applies also is it’s in the nature of a safe harbor and so we have to be careful when we draw that distinction and apply rules that we have experience applying, and I think Commissioner Wetjen made a very good point about the difficulty of distinguishing the two.
The second reason is more technical, but it’s very important. It’s that the swap dealer definition and the major swap participant definition where we use the hedging test, a different hedging test, serve two different purposes, and they are structurein the statute to be effectively applied at two different times.
The major swap participant definition applies to anybody who is not a swap dealer. So it presumes that swap dealers are identified first, they are sorted out and they are picked out and they are identified as swap dealers and then the major swap participant test comes in for a different purpose and says, okay, now all of these people who are not swap dealers, which one of those are posing this very high level of risk?
And so since you are only trying to identify in that second step the subsequent step who is a very high level of risk, you want a rule that excludes a high level of risks, a lot of hedging swaps done pose a high level of risk. If you want to take that second rule and put it into the first step and say, well, I’m going to do that first, basically. I’m going to exclude all the hedging swaps, all the hedging swaps mitigating commercial risk, that wouldn’t be correct, as our view for the interim final rule, it wouldn’t be correct, first you identify swap dealers by their activity and you say which activities are swap dealing?
>> COMMISSIONER JILL SOMMERS: Can you give examples of transactions that you think qualify under the MSP definition that wouldn’t qualify for hedging under the swap dealer definition of hedging?
>> MARK FAJFAR: Yeah. I think trying to think about it on the spot, the — the definition of the exclusion and the major swap participate definition would include where I’m borrowing money and I’m hedging my risk. It’s a pure and simple interest rate swap that. Would be excluded under the major swap participant test but if you were to limit yourself and put — and look at just the rule text on the swap dealer definition, you would see there that’s talking about physical commodity price risk. One the reasons is under the multifactor test, you know, as we just discussed, that the swap hedging and interest rate risk is not dealing activities. So you don’t need the additional bright line rule to assure yourself of that.
>> COMMISSIONER JILL SOMMERS: So, you know, what kind of comments are you looking for in the interim final rule that would persuade you that we didn’t get this right with the definition for swap dealer?
>> MARK FAJFAR: We talk in the release about two certain questions and two in particular, are first, whether the two definitions should be consistent? Is it consistent or do we say because these are two different situations that consistency requires treating different situations differently or is it the case that they should be consistent? And the other to address Commissioner Wetjen’s point, again, put very well, how do you identify hedging swaps as opposed from dealing swaps. The hedging swaps are not dealing swaps. They were not so unanimous on how you identify a hedging swap versus a dealer swap.
>> COMMISSIONER JILL SOMMERS: I now have a couple of questions about the ECP and I will switch to the man with the ECP button on. It’s nice to see that you keep your humor.
>> One thing, David was going to present a short presentation on ECP, but we can do question and answer, if you like.
>> COMMISSIONER JILL SOMMERS: You want me to wait.
>> It’s up to the commissioner.
>> CHAIRMAN GARY GENSLER: Why don’t you let Commissioner Sommers just ask her question. Or did you want — do you want to do one?
>> It’s nothing special. It was funny before, but I just cut the funny part. Now it’s just dry.
>> CHAIRMAN GARY GENSLER: By unanimous consensus, does everyone want him to do it with the funny part. You are on.
>> Without objection.
>> DAVE ARON: Did you want me to do the presentation? Okay. I don’t have the funny part anymore but there might be one remnants. I guess I can wing that one. Basically, if you spend too much — you know, 2C2, which a lot of this ECP rules are based on, it’s hell. So, you know, if you have any sway with Congress, the next time they reauthorize, maybe they could start from scratch with 2C2. It’s very complicated which is why the ECP section is very dense and I liken it to “the shining” it’s kind of like a maze. The big topiary out in front of the hotel. If you spend too much time thinking about the 2C2, you might end up like jack Nicholson did at the end of “The Shining.”
The ECP regs, Dodd-Frank added 2E which provides that a non-ECP can enter into a swap, except on and subject to the rules of a designated contract market. Dodd-Frank expanded the ECP definition that for purposes of foreign exchange transactions listed in 2C2B and C, which we call retail floor ex transactions. Depending on the outcome of the analysis and if you fall within one of the relief parts of the regs, it might not be within the retail floor ex regime but for simplicity we used that term.
So a commodity pool is not an ECP if any pool participant is not an ECP in its own right and this is known as the look through provision. I will now quickly describe the final ECP regulations. The first four, there are eight parts. It’s in 1.3m1 through 8 and some say you are an ECP and some say you are not and they give some further detail. The first four state that SDs, MSPs and the securities analogs are ECPs just based solely on their status as such and then there’s the retail floor ex commodity pool look through, prong 5 of the regulation states that a pool that’s a party to a retail floor ex transaction which we call a transaction level pool, and that has one or more non-ECP participants is not itself an ECP for purposes of the CFTC’s retail floor ex regime, under either prong 4 of the statutory definition which is the pool prong or prong 5, which is the generallennity prong, with certain exceptions discuss in “the shining” section of the preamble, non-ECP pools and their counterparties are subject to the CFTC. 2, limits it by looking through only the transaction level pool unless that any — any level of the pool structure has been structured to evade the retail floor ex regime and we give some guidance on when that’s not the case in the preamble.
The impact of the look knew, is delivering the date consistent with the compliance date for CPOs affected by the recent recall of 4.13A .4 and CPOing outside the US to be deemed ECPs.
And there’s also an alternative to the retail floor ex look through, notwithstanding the look through language in the statute and the regulation, that tracks the statute for the most part, commodity pool that enters into a retail floor ex transaction is an ECP regardless of whether each participant in the pool an ECP if it satisfies three conditions. It’s not inform odd to eveil the floor ex regime and total assets exceeding $10 million and formed and operated by a registered CPO, or exempt pursuant to certain regulations. Because it may be formed by those exempt by registration, for the 14A3 excepts prong eight will not be a requirement for pools formed before the end of this year. Related to prong eight of the further definition — oh, I think I mentioned this the offshore, the commissions with consider a pool, to non-US persons’ defined in current CFTC regulation 4.7 with one modification and whose CPO is offshore, to be an ECP for purposes of the look through.
The — the 1.3M6 provides that a pool not satisfying — this is a pool specific prong the CEA’s ECP definition because its total assets are $5 million or less or it’s not formed and operated by a person subject to CEA regulation cannot be an ECP pursuitant to the generallennity prong of the CFTC’s definition, the CEA’s ECP definition.
Unlike 1.3M5, M6 does not have a look through but it does apply to swaps and as I said before, the impact is that is mitigated by delaying the effective date to the end of the year and we’ve got the line of business ECP prong and I’m winding up here. Is this too long? It’s a lot longer than the other guys? Should I keep going or — keep going?
>> CHAIRMAN GARY GENSLER: Well, it’s ECP. It’s going to be long.
>> DAVE ARON: Well, I’m long winded by nature. There’s two more.
>> CHAIRMAN GARY GENSLER: Just do it.
>> DAVE ARON: There’s the line of business and — and the incorrect cross reference. Yeah. All right. So seventh prong preserves our line of business concept from our 1989 swap policy statement, subject to certain conditions, yeah, I think I will.
An enter diski not qualify as an ECP on its own, and can now qualify as an ECP with respect to a swap used to hedge or mitigate its commercial risks. The fall of its owners are ECP based on any prong of the ECP definition.
And any of its owners — all right. A net worth of more than $1 million. And Mark advises I can stop here and turn to questions.
>> COMMISSIONER JILL SOMMERS: Do you want me to — unfortunately, I still have questions after all of that.
So my questions begin with the bank common funds and collective investment vehicles, the issue that the OCC brought up in their comment letter. Would these be considered ECPs under this rule?
>> DAVE ARON: Well, I think the answer is it depends. We had a call with them and the SEC during the process and it wasn’t clear but there did seem to be a couple of ways to interpret it that way.
As you know, there’s a footnote in the preamble that says the commission may in the future consider a number of the comments received and we list a few, and I don’t think this is one listed but you can consider that if the commission considers that in another round of guidance.
>> COMMISSIONER JILL SOMMERS: Should be considered on par with mutual funds, these?
>> DAVE ARON: It depends. We did start talking about it at the staff level and we didn’t get enough information about the regulatory scheme that applies and we are not certain that it is as protickive as the mutual fund regulatory regime so there may be a reason that Congress didn’t add those funds specifically to the ECP list. So we think it needs further consideration and we would be happy to direct us to.
>> COMMISSIONER JILL SOMMERS: Will there be a follow-up ECP proposal?
>> DAVE ARON: I sure hope so because I drafted about 40 extra pages and I would love to keep doing, it but it –
>> COMMISSIONER JILL SOMMERS: We would not want that to be for nothing, right?
>> DAVE ARON: Right.
>> COMMISSIONER JILL SOMMERS: Are there other issues that that follow-up proposal will include?
>> DAVE ARON: Yeah.
>> COMMISSIONER JILL SOMMERS: That you haven’t talked about here?
>> DAVE ARON: Yeah, I can list the things in the footnote in the preamble. The meaning of amounts invested under the discretionary basis and the individual prong of the ECP definition because it used to be total assets so we got comments asking what the new language should mean. We got a comment asking whether bond proceeds also would count towards that same language in the governmental ECP context. There are various permutations of how credits support is given by entities to — by the owners of entities to the entity guarantees and joint and several liability and a number of banks asked about that, and can these permutations result in ECP if the entity itself is not an ECP depending on credit support providers and the proprietary, are the runs we list.
>> COMMISSIONER JILL SOMMERS: Thank youing, Dave. I don’t have any other questions.
>> CHAIRMAN GARY GENSLER: Thank you Mr. ECP. Commissioner Chilton.
>> COMMISSIONER BART CHILTON: Thanks, Mr. Chairman.
The de minimis provision here, we struck a good balance, but, you know, my initial thought and I appreciate the chairman and your remarks talking about the notionallize of markets and what it really meant, but, you know, my first thought is how do you even say de minimis and then the figure $8 billion without laughing? I mean, it seems like just a huge number when you consider we started at 100 million, you know, really? But like everything, it’s a comprise and we got there and I’m okay with it, but the reason that I’m okay with it is, one, we really don’t have enough information. It’s sort of the problem with what we are doing in the OTC world to begin with. We don’t know what’s out there and so we have to find it out. So I think we have done the best we can, given what we have.
But I’m okay with it because of what happens if there’s not another action. I just want to make sure that I’m clear about that. There is a study in 30 months, as I recall, and then there may or may not be a rulemaking or an order or some other action that the commissions may in their discretion decide to take. But if nothing is done, when you get to five years, we could all get a car right now and pay off a car in five years but when we get to five years, the de minimis goes back down to $3 billion, it’s sort of a hard stop. So absent anything else by the commissions, it goes down to three years; is that correct — goes down do $3 billion, is that correct?
>> JEFFREY BURNS: That’s correct:
>> COMMISSIONER BART CHILTON: I think that’s keeps us all honest, the people who think it may be higher, and they may be right, as we are learning more and more about these numbers or people who think it should be lower, we will have this study and if we can, we do the right thing, we can come up with a more appropriate or fine tuned recalibrated level, but I think we have erred way on the high side with the eight and I’m glad we go to the three.
I do have one question and maybe this is for the chairman, if you like, but — so we have this — we are going to do this study and we are going to look at, like, who is under $3 billion and we are going to look at who is under $8 billion but they are not required to provide information here to us, so how are we going to look at that and figure out what this appropriate level is?
>> CHAIRMAN GARY GENSLER: Well, I think we will benefit, I think that’s an excellent question, Commissioner Chilton. I think we will benefit because swap data reporting will have begun actually 60 days after we finish the product rule. So sometime this year, later this summer, in fact, I would anticipate that you would start to have data reporting in the markets.
That study that we do in 30 months would benefit in what we expressly said it would be based on the first two years of market information that’s in those swap data repositories. We would, of course, already also have folks registered that are over $8 billion and if we have got ten wrong, and — gotten it wrong and, for instance, there was no one registered in a certain category, that would be illustrative, if there was no one in the cotton or corn or wheat markets that’s registered, that would tell us something, in that regard as well.
On the other hand, if we had folks that had been knocking on our door and said we are over $8 billion and we are not out because of dealer trader and we are not out because of hedging and we are not out because of market making, and we sort of all look at it together and said, that doesn’t feel like a dealer. You know, we would have it — so I think we’ll hear on both sides one from the swap data repository, two from people that if you just look at it and you say, this — this kind of looks under inclusive, or — or, in fact, over those 30 months if somebody, you know, we collectively said it feels over inclusive.
>> COMMISSIONER BART CHILTON: Okay. Good. Thank you.
I have to put on my glasses for this one. I don’t know the coppy that the others have, it has important footnotes that I want to refer to. It happens to be about 4 point type. I want to talk in my opening comments I discussed how there were folks that we defined that were in and folks that we defined that were out, and I want to talk specifically about these prop traders that HFTs and first of all, actually, I will refer to the law. You know, we expressed how Jeff, you were talking about — I think it was you, Jeff, you talked about the four criteria of being a swap dealer. And, you know, one of them is if you engage in any activity, it’s the fourth one, engage in any activity the person that they are — that they would be commonly known as a trader — commonly known in the trade as a dealer or market maker in swaps.
So that’s the law. So if somebody, even a prop trader is involved in a market maker program, that they are going to be a swaps dealer. We don’t have the discretion to say whether or not they are –
>> CHAIRMAN GARY GENSLER: That’s how I — that’s certainly how I read the law and I think the staff has read the law, that the fourth, as you say, prong, says if you are commonly known as the train — in the trade as a market maker in swaps, and you might be out for a de minimis, but –
>> COMMISSIONER BART CHILTON: Yeah.
>> CHAIRMAN GARY GENSLER: So in the future — there’s not necessarily electronic trading of swaps right now. But if someone is the equivalent of a floor trader, we provided for that. Those floor traders could sign up as floor traders and the equivalent and Commissioner Sommers was the — I mean, many people raised this but I attribute Commissioner Sommers saying this. We don’t want to capture a locals of pits in the rings that register $8 billion. Then we get to this question. I think the statute is the statute and we have to be consistent with Congress.
I believe because we also addressed an issue if you are a swap dealer who is solely doing cleared swaps, and you are doing those cleared swaps guaranteed by a futures commission merchant, that our capital rules should take that when we finalize the capital rules that we should take that into consideration. I think that’s the important footnote that –
>> COMMISSIONER BART CHILTON: Yeah, that’s the footnote one. It’s insightful.
>> CHAIRMAN GARY GENSLER: I’m just doing lead up.
>> COMMISSIONER BART CHILTON: Thank you. Great job. That was my question. Let me tease it out a little bit more.
So if they are using only their money, and it’s cleared, and it’s guaranteed by an FCM, then — and I know you are not prejudging the rule or what will be ultimately in our capital rule, but it’s your view that there shouldn’t be a capital requirement whatsoever?
>> CHAIRMAN GARY GENSLER: The question that’s raised, actually, is not whether there’s a capital requirement. The question was there had to be a minimum. There have been comments –
>> COMMISSIONER BART CHILTON: My question is whether there has to be a capital requirement.
>> CHAIRMAN GARY GENSLER: I think the question that the commenters made is whether there has to be a minimum capital requirement, particularly how they organize themselves might be in multiple entities and if I recall, that’s what the footnote spoke to.
>> COMMISSIONER BART CHILTON: What I was asking about was your personal opinion about proprietary traders. You obviously have a — a little more than a fifth of the input of what a final rule looks like and so I’m curious as to your personal –
>> CHAIRMAN GARY GENSLER: Sometimes only a tenth.
>> COMMISSIONER BART CHILTON: That’s true. I’m curious as to your personal view about a proprietary trader who has cleared — only doing cleared and doing it through an FCM that is guaranteeing it. Is there any reason that they –
>> CHAIRMAN GARY GENSLER: I think the risk of the system still is that somebody has some capital standing behind their trades, and so the capital rule has a minimum that we proposed of $20 million. And it also says as our rules have in the past, that you have 8% of your margin. It is a relationship. Like if you have a lot of margin at the clearing house you in essence have an 8% cushion. 8% of the margin you have — the clearinghouse, you have an 8% cushion back at home and so it’s all scale to how much you have at the clearinghouse.
And what I understand the commenters have come in on, why do they have to have a minimum? Because most of these folks don’t have open positions at the end of the day. Most of these folks actually don’t have risk at the end of the day.
It would be a pretty small amount of capital, this 8%, but they said why are you forcing us to have 20 million when we don’t really have many open positions? That’s the nature of these high frequency traders.
>> COMMISSIONER BART CHILTON: Right. Right. So we’ll get to it when we get to the capital rule and I will be keenly interested in it.
>> CHAIRMAN GARY GENSLER: Right.
>> COMMISSIONER BART CHILTON: Now, the last thing I had, was, so, of these folks that the — the prop traders, they — unless they are mandated to fit in because we don’t have discretion in the law, or they choose to be a market maker and then we — and then they are a swap dealer, if they choose to be a market maker, and then we can deal within the capital rule what additional requirements are. But if they are not a market maker, they are not either in the law or in the rule, our intent is to put out another rule that would allow them to register as a floor trader?
>> CHAIRMAN GARY GENSLER: It’s actually in here. There’s a whole floor trader right in here.
>> COMMISSIONER BART CHILTON: And with regard to that, what would be required in addition to — and the other things that we are doing, for example, would they be required to deal — and I could ask staff. Would they be required to deal with external business conduct standards?
>> The rule provides for the –
>> CHAIRMAN GARY GENSLER: Pull the mic again.
>> MARK FAJFAR: The people who register as floor traders there are certain external conduct standards that they would have to comply with.
>> COMMISSIONER BART CHILTON: Is it the items we passed in the external business conduct rules?
>> CHAIRMAN GARY GENSLER: There’s no external business conduct in there. It’s just risk management.
>> MARK FAJFAR: Right. I stand corrected.
>> COMMISSIONER BART CHILTON: What about internal business conduct standards?
>> CHAIRMAN GARY GENSLER: Do you want to go through the list? Frank is here as well. Yes, you are waving. You don’t want to come up to the table?
>> MARK FAJFAR: There’s specific references to Section 23 of specific rules in Section 23 that would apply.
>> CHAIRMAN GARY GENSLER: I will help out. It’s basically what we finalized two to six weeks ago, that within those rules, there are some risk management and record keeping that they would have to be registered with the CFTC as a floor trader, a local or a floor trader as the term goes, and then be willing to comply with some risk management and record keeping. Not chief compliance officer or fire walls or anything, and not external business conduct, not — not any of the whole regimes.
>> COMMISSIONER BART CHILTON: And the last thing. I appreciate the patience of the staff or anybody else.
>> CHAIRMAN GARY GENSLER: No, this is an open meeting. We are deliberating.
>> COMMISSIONER BART CHILTON: So with regard to record keeping, you know, one of the things that has been heretofore ungettable for us, with the HFCs are things like their — their change books. Mr. Berkovitz, did you want to comment?
>> DAN BERKOVITZ: I didn’t want to interrupt. I wanted to clarify in terms of internal business conduct standards. One of the conditions that the chairman is referring to in terms of these floor traders is that they do not directly or through an affiliated person negotiate the terms swap agreements other than price or quantity, or to participate in a request for quote process subject to the rules of a designated contract market. They are not negotiating. They are not — they are — they are only doing price and quantity. They are not negotiating other terms of the swap.
>> COMMISSIONER BART CHILTON: Thank you. So my question was whether or not — the section which requires — that calls for records would extend to their change logs, the change logs are what the HF Ts do when they change their algorithm so you can track what they are doing. Commissioner O’Malia has heard a lot about this. You have the algorithms in place, but then they morph as they trade, as they go on. And unless we know what they are doing, and I don’t know how we would actually analyze all of this yet without the technology, but the ability for us to get the books and records is a key reason why I thought these guys, these traders, market participants do need to be registered. We need to have access if there’s a problem. It puts them on the radar screen.
Could we get the change log? Would that include their records?
>> CHAIRMAN GARY GENSLER: Frank, you are being brought up to the table. I have it by unanimous consent if you want, but this would be a question on the rule that was passed for swap dealers as well.
>> The risk management rule includes a section that requires them to have policies and procedures for testing, review of any programmatic trading programs. So there would be some written policies and procedures surrounding change logs that, kind of thing. The daily trading records rule would also require, you know, the recording of execution times all of those things would apply as well.
>> CHAIRMAN GARY GENSLER: But that’s daily trading records to be clear, that’s — that may not have addressed Commissioner Chilton’s question. Do we require swap dealers to keep — I’m not familiar with this term.
>> COMMISSIONER BART CHILTON: Change log.
>> CHAIRMAN GARY GENSLER: I’m just not familiar with the term.
>> COMMISSIONER BART CHILTON: As their trading algorithm.
>> The risk management rule does have a requirement that they have written policies and procedures surrounding the use of trading systems, the testing of trading system, the review of those trading systems. I would think that would cover things like change logs.
>> COMMISSIONER BART CHILTON: Thank you. That’s what I was getting at. You answered it perfectly. I appreciate you coming up. I don’t have anything else on that list. Is there something you needed to add?
>> CHAIRMAN GARY GENSLER: No. No.
>> COMMISSIONER BART CHILTON: Okay. There’s no other additional rule we will need to do to make these guys –
>> CHAIRMAN GARY GENSLER: There may be — there may be whatever it’s called technical or conforming things that the SEC and we are doing on this document, but –
>> COMMISSIONER BART CHILTON: Okay. So get these guys registered, these traders and market participants, I want to make sure that there’s not additional rulemaking that we have to do.
>> CHAIRMAN GARY GENSLER: Eric Uganis is reminding me. We have proposed amendments. We have to finalize conforming amendments because they are very critical.
>> COMMISSIONER BART CHILTON: Is that rulemaking? Is it something that goes out for public comment?
>> CHAIRMAN GARY GENSLER: It’s already up for public comment. We last June proposed conforming amendments to the term floor trader and floor broker to include for the first time the word “swap.” Because, of course, prior to Dodd-Frank, that was not the case. So working amongst all of us, you know, we just have to finalize those conforming — the definition of floor trader has to be finalized to include, you know, swaps, for people to benefit from this.
>> COMMISSIONER BART CHILTON: Thank you for your patience.
Is this something and know we have another 20 or so rules to go but is this something that as far as you know and you may not know, that is on a faster track than other things or is it months away or –
>> CHAIRMAN GARY GENSLER: The conforming rules, give the credit to the staff, we are in really good shape. I haven’t served them up to the ninth floor, partly because of the capacity issues of the ninth floor and I think some commissioners have had a view. I think I generally agree with it. They are sort of a little bit better as everything else comes together, you know, and now we will be done 31 and maybe we will peel some off. But they could be done quite soon but I sort of held them off just to see, just like here. We have a new approach to the floor trader. We want to make sure these conforming amendments incorporate the — you know, that they benefit from. So I was sort of thinking maybe if we got closer to the — you know, not to the full end, a little closer that it would be a good time for everyone to weigh in on the conforming finals.
>> COMMISSIONER BART CHILTON: Okay.
>> CHAIRMAN GARY GENSLER: Do I have that right?
>> COMMISSIONER BART CHILTON: My only thing is we — essentially we figured these guys, these prop traders will not be in here like we proposed and I think that’s a good thing. I think we struck a reasonable balance but I want them registered. I mean, I want to have they will on our radar screen. I don’t want this to mean — I mean, my personal preference is this not something that goes on for another six or seven months. So to the extent that we –
>> CHAIRMAN GARY GENSLER: So what you are — with your encouragement, we will try to get maybe some of the conforming stuff up during the springtime.
>> COMMISSIONER BART CHILTON: Okay. Thank you. And thank you again for your patience.
>> CHAIRMAN GARY GENSLER: Commissioner Sommers, no we did. We are with Commissioner O’Malia now.
>> COMMISSIONER SCOTT D. O’MALIA: Commissioner Sommers raised a good point, several good points about the hedging definition and some of the uncertainty. And there’s a — I’m sure I have the wrong draft, but there’s a line in — in the definition that says, a per se exclusion of this type, referring to hedge definition, is not appropriate because it is possible that in some circumstances a person that might enter into swaps are connected to — that are connected to physical commodity business but also serve a market function characteristics of the function served by swap dealers, which obviously raises questions, you know, some of the questioning that went back and forth said there was a more definitive hedging is not dealing. This seems to say that in some cases hedging isn’t — isn’t necessarily excluded. And could you explain that a little bit and how we are going to understand that and provide the certainty that everybody has claimed in this rule?
>> MARK FAJFAR: I think a good place to start is one of the comments made at the round table. Swaps by their nature is a hedge. Every swap hedges things and every hedge hedges something else. So a person could be entering into a swap that serves — that has a consequence of hedging their exposure that they have somewhere else, but that doesn’t tell you whether or not they are holding themselves out as a swap dealer.
>> COMMISSIONER SCOTT D. O’MALIA: Where would — let me just say that that — that is part of my rub on this rule, and frustration. It isn’t very clear. It is going to be facts and circumstances and there’s going to be a lot of instances where people are confused. What will be the process if people are confused? How will they appeal to the commission for certainty? Do we have a process, of standards, an exemptive process that we are considering that you guys are going to set up a hotline?
>> MARK FAJFAR: We’ve had a process for a number of the rules that we provide –
>> DAN BERKOVITZ: We have a process for a number of rules that we provide in the Office of General Counsel or a number of other provisions depending on the rule, we are available to answer questions about the rule and this rule — this particular rule, we have been discussing, we haven’t put it into place yet, more established interdivisional process, where the Office of General Counsel, division of swap, inimmediateary oversight, what we want to do is both be available to answer questions and provide guidance and at the same time make sure it’s consistent and communicated and we’re considering exactly how to do that.
>> COMMISSIONER SCOTT D. O’MALIA: Good. Well, that’s very helpful. Thank you.
What category would Fannie and Freddie fall into in this dealer MSP definition?
>> MARK FAJFAR: The dealer or the MSP? Are you asking whether they would be a dealer or MSP?
>> COMMISSIONER SCOTT D. O’MALIA: Yeah.
>> MARK FAJFAR: Well, from what I know about Fannie May and Freddie, they don’t hold themselves out as swap dealer. I think we have the question we talk about whether they have a staff or resources dedicated to customer on boarding, collateral management and so forth. As far as I know, I don’t think they have that, but that would be the question they would have. And then they would ask whether they are routinely standing red to enter into swaps at the request or demand of a counterparty. Are they doing that with a profit with an intention of profiting liquidity to the market? That’s one of the keystones of dealer/trader disfunction. If they say, well, we are not fronting a market making operation then they won be a dealer and then as I said, the subsequent determination to run their swaps and see if they proposed a level, a high degree of risk that’s under the MSP test.
>> And we always thought the analysis for those entities would be MSP and whether they met the thresholds or not under the MSP definition.
>> COMMISSIONER SCOTT D. O’MALIA: So we don’t know? You don’t have a — we put in the rule 125 dealers, six MSPs.
>> MARK FAJFAR: I think your question is whether we know now who is a swap dealer and who is an MSP. There is a lot of different factors to consider in answers to that. First of all, the basis of this rule is that we set out rules and guidance to the public and they apply those rules and guidance, and they decide if they need to come in and register or not.
Second of all, we didn’t — I think just to cut to the chase, there are many other factors but we didn’t write the rule to achieve a certain result. I think an interesting comparison and analogy would be to think about a city board saying, well, if we drop the speed limit, if we drop the speed limit on this street from 25 to 20, how many tickets would we write?
And we didn’t think that was the question. We thought the question was, what’s a prudent rule that can be applied efficiently and uniformly, appropriately considering all of these factors?
Now, we have to estimate and there are estimates in the document. We have to, for various purposes, you know, how many people do we think it’s reasonable to think would be captured by the different definitions and those, but those numbers appear in the back. Those are systems for purposes of trying to talk about the effect of the rule, and there’s — some of those estimates in the back were for budgetary purposes we refer to.
>> COMMISSIONER SCOTT D. O’MALIA: Fair enough, but when we kind of do the forensics on the financial meltdown, they are the smoldering heap that people always point to, and I’m just wondering where they fall in this rule.
I have no further questions.
>> CHAIRMAN GARY GENSLER: Can I just ask, who is the they? The smoldering heap?
>> COMMISSIONER SCOTT D. O’MALIA: Fannie and Freddie.
>> CHAIRMAN GARY GENSLER: Oh. Yeah, I don’t know — I don’t know. What little bit I know, it’s a question of whether they come over the major swap participant category, rather than a dealer category.
>> COMMISSIONER MARK WETJEN: Thanks, Mr. Chairman. Thanks again to the staff for your work on this. I have enjoyed our multiple conversations over the last few months trying to sort all of this out.
Just real briefly, I wanted to try and clarify a point that I think has already been made by the staff in response to other questions but there’s a lot of different factors that could go into the determination but any one of which by itself wouldn’t be dispositive, isn’t that generally correct?
>> MARK FAJFAR: That’s correct, it’s a multifactor test.
>> COMMISSIONER MARK WETJEN: So, for example, if you fall on some trade association’s list of members, that could be indicative but not necessarily dispositive, correct?
>> MARK FAJFAR: Correct. Clearly that’s true.
>> COMMISSIONER MARK WETJEN: And the same holds true with accommodating demand, correct? I mean, just because the swap — just because an entity does swap to accommodate demands, not necessarily the case that it’s a dealing kind of swap that would render the entity a dealer?
>> MARK FAJFAR: Exactly. You have to consider the other factor.
>> COMMISSIONER MARK WETJEN: I have another question related to compliance, which I would like to loop the chairman in on as well, but do we say anything in this rule with respect to when a dealer would have to register as a dealer if they believe they are one?
>> MARK FAJFAR: Well, we talked about the effective date being effectively the registration compliance date being 60 days after the swap definition is completed.
>> COMMISSIONER MARK WETJEN: Yes so obviously our swap rule will come later, but 60 days after that would be the trigger for an entity registers, correct?
>> MARK FAJFAR: That’s correct.
>> COMMISSIONER MARK WETJEN: And Mr. Chairman, and you alluded to this in your opening statement, but we have a number of entities who are not necessarily located in the US, who have questions about whether they could be required to register as dealers. I think you indicated in your statement, there’s additional work by the commission to address that question. I just wondered if you could share with us the latest thinking on how the commission might take that up.
>> CHAIRMAN GARY GENSLER: I do think it’s a very critical point. We have worked in partnership here and with the SEC and this remarkable effort, but also with international regulators, and in Europe — let me at least publicly congratulate him, because I have done it privately, but just last month, they finished their key legislation on clearing and risk management and data reporting called Amir for derivatives they still have some post trade and pretrade transparency and on some sales practices and on position management, what we call position limits, those four areas are still to be done and review. But they have made tremendous strides. It’s not identical to where we are, but it’s — it’s largely consistent in the clearing regime with end users and so forth.
But I anticipate that the commission will expressly seek public input on cross border application of Title 7. We have still been working on that, and the documentation has benefited from a lot of input from the Securities and Exchange Commission, treasury and the Federal Reserve and it’s still — they still haven’t given me a draft. Dan keeps saying I can’t read it yet. I kind of substantively know what they are working on and Carly Kim who is the head of that team.
I also believe it would be appropriate to through an order to think about a phased in compliance for certain requirements of this cross border swap circumstance. You know, frankly speaking, if you are a swap dealer, you are located in New York, and you are dealing with US persons, I think it’s pretty clear what the cross border, unless they are worried about cross border from New York to Kansas –
>> COMMISSIONER MARK WETJEN: Those entities likely know.
>> CHAIRMAN GARY GENSLER: Yes, that’s a different type of cross border issue. But as it relates to certain requirements, you negotiation the real cross border stuff, and I think we can do that. Dan, we can do that if we wanted to through some order, is that, as I understand it?
>> DAN BERKOVITZ: That’s correct. We could do an exemptive order. We could address that in an exemptive order.
>> CHAIRMAN GARY GENSLER: So I just envision that we have a lot of things on our plate in the next month or two, get this product rule done, get a cross border release out for public comment, consider an exemptive — what we’ll call the Dunn set, that’s what we call it for Mike Dunn, consider a couple of rules that are in the hopper, there are two that are pens down with the commissioners, the designated contract market and the end user.
There are now some pens down versions of non-Dodd-Frank, the ownership and the control reporting rule that I know many commissioners care deeply about, but it’s a really good way to get more transparency for us, but then also working through these questions of the — you know, the appropriate approach for phased in compliance. We’ve had some good dialogues with adeer Turner who runs the financial services authority, the FSA and I have had good dialogue and I had good dialogue with Michele Barnier and with industry representatives. So that’s –
>> COMMISSIONER MARK WETJEN: I think that’s reassuring. I’m sure a lot of folks listening will be reassured by that too. We will in other words provide legally binding certainty to these firms so that they know — well, I guess in the first instance, they will know that they don’t necessarily have to register right away, even within 60 days of the swap rule.
>> CHAIRMAN GARY GENSLER: Or if they register there,’s a phased-in compliance. I long felt that we want to get these rules done right, not against a clock and that we want to provide market participants appropriate, balanced phased in periods. We are doing a big phase in today on this — this de minimis. It’s just another form of it.
>> COMMISSIONER MARK WETJEN: Thank you.
I just have one other subject I wanted to cover with a few questions and that is this section of our release that deals with limited designations. As I mentioned in a statement, there are a lot of these firms that do a lot of different swaps, some of which might fall within the bona fide hedging definition in this rule, some of which might not, some of which clearly firms have acknowledged are dealing swaps, but I think our rule takes into account the fact that if they are dealing swaps among a larger pod of other swaps, the commission’s interest, regulatory interest is mostly in the dealing-type swaps which is why we have laid out this limited designation regime.
But I wonder if you could give me a few examples of what might be appropriate limited designations.
>> MARK FAJFAR: Yes, I come one area where this comes up is especially in the agricultural area where there could be a wide difference in how different types of swaps on different agricultural products can be traded.
Some can be very liquid and others less liquid. So it’s possible that somebody could be a swap dealer with respect to a very liquid commodity but not others. The other — another scam; the point that we just talked about, where an institution has a variety of institutions that they are using swaps some for hedging and others where they are having a profit motive of providing liquidity to the market and so forth. And so those two activities could be split and the latter activity would be registered.
>> COMMISSIONER MARK WETJEN: So with a firm that has part of its business, that is — that is registered under a swap dealer under a limited designation, how do the swap dealer requirements, the whole panoply, how does that apply to the firm as a whole or would it apply to the limited designee?
>> MARK FAJFAR: Well, the rule on the definitional rule provides that only the portion that is designated as a swap dealer, whether it’s a unit or whatever the designation is, the swap dealer requirements would apply to that unit.
>> COMMISSIONER MARK WETJEN: And that also applies — or that also would hold true with respect to our capital requirements, correct?
>> MARK FAJFAR: To the extent I’m familiar with the capital rule. I have been concentrating on this one, that’s generally the way the capital rule would work.
>> COMMISSIONER MARK WETJEN: That’s all I have.
>> CHAIRMAN GARY GENSLER: Thank you, Commissioner Wetjen. I just wanted to come back to one thing that just Commissioner Chilton and I were going back and deliberating early on. There is amongst three sets of conforming rules that we proposed. They are in pretty good shape. I mean, I think — I didn’t do it for this meeting but I think two of the sets — I think all three sets comment summaries and staff recommendations have been to the commissioners, but not the — there’s no pens down but there’s like two of them are kind inform my office. I just haven’t felt like to flood the system with conforming rules. I will go back and ask staff what could we do as an early package, including what is the definition of floor trader and 1.3x because maybe there are other things that given where we come to and with today, maybe 30 some rules finished, there’s some conforming rules we really should just — because it lowers market uncertainty and it lowers uncertainty for a lot of participants rather than holding them all. So I think that was a good suggestion.
>> COMMISSIONER BART CHILTON: Thanks, Mr. Chairman.
>> CHAIRMAN GARY GENSLER: If there’s no other –
>> DAN BERKOVITZ: If I could add a clarification to Commissioner Wetjen’s limited designation and a capital requirement, which would, I believe apply to the whole firm, one of the things that I think if somebody comes in and this is explained in the preamble and applies for a limited designation, the way it’s structured we have flexibility or in terms of — we are looking for the applicants to demonstrate how they would apply or comply with, for example, the capital requirement in the limited designation context. So if they want to say certain of their activities we’re only swap dealing of these activities, they would still be required to show and to demonstrate how they can satisfy the capital requirement because that would generally be applied across the firm. So we look to them for how to comply with a requirement like that.
>> COMMISSIONER MARK WETJEN: But the point you are also making, Dan, it’s not necessarily the case that — well, I would like to make an even stronger statement than that. It’s not the case that all the swaps that any company it does, if it happens to have part of its business as a limited designate. It’s not automatically the case that it would determine what the capital requirements would be of the limited designee.
>> DAN BERKOVITZ: Correct.
>> COMMISSIONER MARK WETJEN: That’s my understanding.
>> DAN BERKOVITZ: Yeah, I’m not sure I can get — I — I’m not sure of answer to that right now. I mean, I –
>> COMMISSIONER MARK WETJEN: We’ll have to continue discussing it. And the capital rule, perhaps.
>> CHAIRMAN GARY GENSLER: Yeah. Before you call the roll, Mr. staywick. I thought I would thank the Security and Exchange Commission, which I have been informed has voted on this joint rule and they voted unanimously some moments ago. So I do sincerely thank the five commissioners, all of whom have weighed in on this, four of whom I have personally been talking to about it, probably all five of us have been talking to probably all five of them and their staffs and their excellent work. But Mr. Staywick, I guess you call the roll and we will find out here.
>> COMMISSIONER MARK WETJEN: Aye.
>> COMMISSIONER SCOTT D. O’MALIA: No.
>> COMMISSIONER BART CHILTON: Aye.
>> COMMISSIONER JILL SOMMERS: Aye.
>> CHAIRMAN GARY GENSLER: Aye.
>> This question, the ayes are four, the Fays are one.
>> CHAIRMAN GARY GENSLER: The majority having it or the ayes having it, the staff recommendation is accepted and apparently since the Securities and Exchange Commission did so also today, it will be sent to the Federal Register in the appropriate way. At this point, I ask unanimous consent to allow the staff of the CFTC and SEC to make technical corrections to the document voted on today prior to sending it to the federal register. Without objection, so ordered.
Let me just see if there’s anything else.
>> COMMISSIONER MARK WETJEN: Mr. Chairman, this is usually where you lay out the schedule.
>> CHAIRMAN GARY GENSLER: Oh, all right. Here we go. This is also usually when I make Mr. Danski nervous. But I think that as we all just did know, there were two — there’s actually four matters that are — yeah. So there’s two. Reporting of historical swaps in part 46, which is greatly benefited from all five commissioners’ efforts and is ready, and we might end up just doing that by notational vote because it’s a matter that I think everybody has weighed in on and the document is in good shape. That the other thing is this approach to an interpretive guidance on indemnification, which is also, I think everybody has now weighed in for swap data repositories, I think, we will probably just put that into notational. That will seek public comment and we’ll benefit from public comment.
The two rules that have been in pens down version for final consideration, designated contract market and end user exception, I’m hoping to get everybody’s feedback into staff, whatever changes, consensus, let’s try to move on those.
And, you know, thoughtful but prompt way. In terms the next up — and there’s a pens down version for the ownership and the control which I’m certainly willing to do in public meeting or notational, whichever way, folks, because that’s an important rule. We could do it either way. Is there another pens down?
There may be something non-Dodd-Frank. Oh, there is. There’s the consideration of the petition on aggregation and position limits that went pens down in the last day or two. So if you can all give feedback on that, that would be excellent. That’s a proposal, but it’s some reaction to an important petition on aggregation and position limits. That’s what I think is in your offices.
What I think is next up, very importantly is this product definition rule. We made excellent progress with the SEC. It’s not quite ready to give to the ten commissioners’ offices but any feedback, particularly on the volumetric options or the border line between forwards and swaps would be, you know, Julian Hammers and LeAnne Duffy’s phone numbers.
Then it’s these orders that we are talking about, cross border, exemptive and some approach to phased possible implementation of compliance states. I think the other two things that are pretty near and I see Sarah Josephum here and Frank — oh, Frank left because he doesn’t want — the other two that are pretty close to coming to the ninth floor is the phased implementation of the clearing mandate, as well as documentation netting and portfolio compression. So the rest of internal business conduct, and phased implementation are pretty close to getting to the ninth floor.
And then a proposed — Dan, you will have to help me what’s it’s called 4C relief on regional transmission organizations, RTOs?
>> DAN BERKOVITZ: That’s correct.
>> CHAIRMAN GARY GENSLER: That Bob Wasserman and Laura Estrada and others are pretty close to getting to the ninth floor. I’m sorry, I don’t have a list doing this. Dan, is there something that I’m — no. Always making Dan nervous.
>> Anything on MF global reforms, policy reforms?
>> CHAIRMAN GARY GENSLER: You are just talking about broad customer protection? Is Gary Burnett here? I don’t see him. If somebody can just have Gary follow up with –
>> COMMISSIONER BART CHILTON: Well, I thought we were going to do a round table or a hearing on those customer protection things.
>> CHAIRMAN GARY GENSLER: Again, wherever — I mean, Gary would have to give us an update, he can give us all an update.
>> COMMISSIONER BART CHILTON: To follow up on Commissioner O’Malia, are we going to have a meeting on a certain date that you are contemplating or –
>> CHAIRMAN GARY GENSLER: No, I don’t have a date to announce.
>> COMMISSIONER BART CHILTON: So not May 10th? Not sure about it?
>> CHAIRMAN GARY GENSLER: I –
>> COMMISSIONER BART CHILTON: Okay. We will wait to hear.
>> CHAIRMAN GARY GENSLER: Anything else? Then I will consider a motion to adjourn the meeting.
>> COMMISSIONER JILL SOMMERS: So moved.
>> CHAIRMAN GARY GENSLER: All in favor. Aye. Thank you all very, very much.