CFTC proposes long-awaited end user rule

By Reuters
Posted Dec. 9, 2010 at 9:55 a.m.

The U.S. futures regulator on Thursday unveiled a long-awaited rule outlining exemptions for firms using swaps to hedge risk, but at the last minute postponed issuing a separate rule with guidelines for swap trading platforms.

Without much explanation, Gary Gensler, chairman of the Commodity Futures Trading Commission, said he was delaying until next week the agency’s proposals to make swap execution facilities, or SEFs, transparent. The delay further underscores the tight deadline the agency is under, and different views by the agency’s five commissioners as to what Congress intended.

“We’re human,” Gensler said at a public meeting.

Gensler also said the regulator intends to propose on Dec. 16 another long-awaited plan to limit speculative positions held by commodity traders.

The CFTC and the Securities and Exchange Commission, another market regulator, are scrambling to comply with the Dodd-Frank bill that requires oversight of the $600 trillion over-the-counter derivatives market.

Under the CFTC proposal, end users, or those that use derivatives to manage commercial risk, would be exempt from rules if one party to the swap transaction is a non-financial entity.

Gensler was quick to point out that, if a company, fund or entity took a position to speculate, that transaction would not qualify for the end-user exception.

Major players who would be affected are closely watching how the rules are enacted, and the impact on their bottom line.

Corporations such as Exelon, Caterpillar, and Ford want to ensure they qualify for exemptions that would excuse them from requirements to clear most swap trades, which would force them to post billions of dollars in margin. Many firms now trade using credit lines with banks.

Other firms, including GFI Group and IntercontinentalExchange Inc, hope to qualify as so-called swap execution facilities specially designated to handle the mandatory trading of most swap contracts, a measure meant to decrease financial risk and increase transparency. Traditionally most swap trades were bilateral and private.

The new law also allows “end-users” such as manufacturers that use swaps to hedge “commercial risk” to be exempt from mandatory clearing requirements. Supporters contend this will keep costs lower by letting firms retain capital that otherwise would be used to post margin to cover cleared trades.

The CFTC said end-users could be exempt if at least one party to the swap transaction is not a financial entity, information is provided on how the firm meets its financial obligations associated with entering into non-cleared swaps, and the swap is being used to hedge or mitigate commercial risk.

Hedging or mitigating commercial risk would be determined by analyzing the facts and circumstances at the time the swap is entered into, and taking into account the person’s overall hedging and risk mitigation strategies. It would not include any swap position held for speculation, investing or trading.

An end-user would inform the CFTC it’s using the exemption, and provide information including the methods used to mitigate counterparty credit risk in the absence of clearing, the identity of the end user, whether an affiliate or financial entity is involved, and other information about the swap.

The CFTC said it was seeking public comment to help it determine if small banks should be granted a clearing exemption. That puzzled Republican commissioners Jill Sommers and Scott O’Malia.

“I am flummoxed as to why we are failing to fully address the issue of excluding small banks, farm credit institutions and credit unions from the definition of financial entity,” O’Malia said at the public meeting.

“All we are going to do today, after almost five months with this language, is punt it,” he said.

The Dodd-Frank bill prohibits most financial entities from receiving an exemption.


CFTC commissioners had been expected to decide on Thursday whether to propose rules to make swap execution facilities transparent.

Under tentative CFTC plans, the swap venues would be required to provide electronic trading systems or platforms that have a centralized limit order book open to all participants. They also could have a transparent quote system that meets certain requirements.

Without going into detail, Sommers expressed concern over the agency’s preliminary plan and said it was too narrow in scope.

Gensler said the agency would review its rule and said it ”might actually change by next week.”

Under the CFTC’s original plan, SEFs would offer three tiers of transactions: larger trades that meet a specific level of volume, smaller trades that are not block trades but don’t have major volume, and other transactions, such as block trades where a SEF could provide end users the chance to trade even though it’s not required.

One important aspect of the rules would require that all participants in the market be able to see all relevant trade information under a so-called “request for quote” system. In the past, one party could limit which potential counterparties it wanted to allow to see a request.

“Certainly, we know some markets right now that would have to adjust their current model,” an agency official said in a background briefing.

The rules would go into effect 90 days after they’re finalized, but provide a grace period for pending SEF applications.

CFTC said once certain conditions have been met, entities that meet the definition of a SEF could request the agency allow them to function as one while their application is reviewed.

Companies that traditionally have been big players in the over-the-counter swaps market are working to ensure they stay in the game as the business moves under the CFTC’s regulatory oversight. Barclays, Credit Suisse, Morgan Stanley and others have met with the agency to discuss the new trading platform.

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