External Meetings: Definitions Meeting with Working Group of Commercial Energy Firms

The Working Group of Commercial Energy Firms (WGCEF) expressed the following views on the proposed definition of “swap dealer”:  ~(1) The CFTC should finalize a narrow definition that would capture relatively few entities as swap dealers, and then gradually broaden the rule as more information about swap dealers’ activities becomes available.  If the CFTC were to start with a relatively broad rule it would be difficult to narrow its application in the future.~(2) Their primary use of swaps is to lay off the price risk that the firms assume through buying and selling in the physical markets.~(3) To identify swap dealing activity, it would be possible to begin with all swap activity and “peel away” all activity that is not dealing.  Their proposed definition would exclude hedging swaps, proprietary speculative swaps, swaps on an anonymous facility, physical options requiring delivery and episodic swaps for price discovery or to elicit bids.  The swap activity that is not any of these is swap dealing.  The term “customer-facing” also describes what is left after these activities are excluded. ~(4) Dealing activity can also be distinguished by a willingness to enter into swaps regardless of activity in the underlying commodity and regardless of views of fundamentals in the underlying market.  For a dealer, swap activity is disassociated from the underlying, while for non-dealers the two are closely linked (this distinction is valid for both financial and non-financial firms).  Another distinction is that a non-dealer (whether hedging or speculative) will use swaps only to assume or lay off risks that it “understands” (i.e., relates to its underlying business) while a dealer makes a business of assuming and laying off risk regardless of its views on the risk.~(5) Regarding the swap dealing or “customer-facing” activity as described above, WGCEF believes the de minimis exception should allow firms to engage in a reasonable amount of this activity.  Even beyond the de minimis threshold, there is a belief that the definition should permit firms that limit their swap activity to swaps relating to their underlying physical commodity business to engage in such dealing activity.  WGCEF suggested policy reasons for permitting this activity, the primary being that doing so would foster competition with the major swap dealing banks which have an advantage in terms of personnel, systems and other resources.~(6) The CFTC should provide more guidance regarding whether and when the following types of activity constitute swap dealing:  frequently executing swaps on electronic platforms, structuring swaps in combination with structuring financial transactions such as the construction and start up of a refinery or other facility, and engaging in dealer-type activity on a episodic or infrequent basis.~(7) Regarding the definition of “hedging or mitigating commercial risk” for purposes of the major swap participant (MSP) definition, the implication in footnote 128 of the proposing release, that swaps which hedge an underlying position held for speculative, investment or trading purposes would not qualify as hedging, raises concerns.  WGCEF asserted that it is difficult to distinguish speculation, investment or trading from other types of commercial activity, and that in fact speculation, investment and trading are fundamental to commercial activity.  Therefore, such swaps should qualify as swaps hedging commercial risk.