AFR Opposes Big Bank Calls for Loopholes in Derivatives Regulation

David A. Stawick, Secretary

U.S. Commodity Futures Trading Commission

Three Lafayette Centre 1155 21st Street, N.W.

Washington, D.C. 20581

Elizabeth M. Murphy, Secretary

U.S. Securities and Exchange Commission

100 F Street, N.E.

Washington, D.C. 20549

Re: Interpretation of the Definition of “Commercial Risk”

Dear Mr. Stawick and Ms. Murphy,

On behalf of Americans for Financial Reform, thank you for the opportunity to comment on the definitions contained in Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Americans for Financial Reform is an unprecedented coalition of over 250 national, state and local groups who have come together to reform the financial industry. Members of our coalition include consumer, civil rights, investor, retiree, community, labor, religious and business groups as well as Nobel Prize-winning economists.

Reckless swaps and derivatives trading played a critical role in the financial crisis, turning the fallout from the crash of the domestic housing market into a global economic catastrophe. Financial institutions and their lobbyists, having failed to stop Congress from passing strong derivatives regulation, are now trying to weaken the law through the regulatory process. The latest example of this can be found in industry suggested definitions for “commercial risk.”

The definition of “commercial risk” is relevant to both the determination of whether an entity is a “major swap participant” and whether a swap is exempt from the clearing requirement under the Dodd-Frank Act.

The Dodd-Frank Act defines a “major swap participant” to include any entity, other than a swaps dealer, that “maintains a substantial position in swaps for any of the major swap categories as determined by the Commission, excluding positions held for hedging or mitigating commercial risk.” The definition also includes entities that engage in significant swaps trading and are systemically dangerous or highly leveraged financial entities. Institutions categorized as major swap participants under the Dodd-Frank Act are subject to registration, record-keeping, business conduct and prudential requirements.

The clearing requirement “does not apply to a swap if 1of the counterparties to the swap (i) is not a financial entity; (ii) is using swaps to hedge or mitigate commercial risk; and (iii) notifies the Commission, in a manner set forth by the Commission, how it generally meets its financial obligations associated with entering into noncleared swaps.” As a result, the definition of “commercial risk” will have a direct bearing on whether a large portion of the over-the-counter derivatives market clears and trades as was intended by Congress when it passed the Dodd-Frank Act.

We are concerned by recent arguments made by financial industry groups that “commercial risks” should be defined to include financial risk where a commercial firm or a bank is hedging financial risk. For example, the International Swaps and Derivatives Association argued in a comment letter filed on September 20 that “commercial risk” should include anything “of, pertaining to, or characteristic of commerce… including financial risks.” Similarly, the American Bankers Association, in a September 20 comment letter, recommended that “‘commercial risk’ be interpreted broadly enough to include financial risk for depository institutions.”

The argument that transactions engaged in by commercial firms that are hedging financial risks should be exempt clearly contradicts the intention of Congress. If the Commission were to interpret the legislation as industry groups have suggested, the effect would be that all swaps traded by non-financial entities would be exempt from clearing and trading requirements. The term “commercial risk” would be rendered meaningless. If that was Congress’s intent, however, it would have simply exempted commercial entities from the clearing requirement altogether, an approach that Congress explicitly rejected. Notably, Congress rejected language in earlier versions of the legislation that would have exempted firms that were hedging “operating or balance sheet risk,” because of the concern that this would have made firms hedging financial risk eligible for the exemption.

The Commission should also reject the arguments in favor of adopting a broad definition of “commercial risk” to allow financial institutions using swaps to hedge financial risks to avoid regulation as major swap participants. The broad definition recommended by the American Bankers Association would not only provide the means whereby financial entities such as hedge funds and insurance companies could escape regulation as major swap participants but it would also result in a broader exemption from central clearing.

We urge the Commission to adopt a narrow definition of ‘commercial risk.’ Barron’s Dictionary of Finance and Investment Terms defines “commercial hedgers” as “companies that take positions in commodities markets in order to lock in prices at which they buy raw materials or sell their products.”[1] References to “commercial risk” in the Dodd-Frank Act are clearly intended to apply to commercial hedgers. Regulators should, therefore, interpret the term “commercial risk” to include only those risks that arise as a result of companies’ exposure to fluctuations in prices of raw materials they use to manufacture products or fluctuations in the prices of products they manufacture.

Industry tried and failed to get an expansive end-user exemption included in the legislation.  On behalf of Americans for Financial Reform, we urge you to reject the arguments made by financial industry groups in an attempt to maintain the opaque, unregulated over-the-counter derivatives market. The Commission must interpret “commercial risk” very narrowly to ensure that the legislation fulfills its promise to move the vast majority of derivatives out of the shadows and into the transparent, regulated market.

We appreciate the opportunity to comment on the definition of ‘commercial risk’ in Title VII of the Dodd-Frank Act. If you have any questions, please contact Heather Slavkin at or (202) 537-5318.

[1] Barron’s Dictionary of Finance and Investment Terms at 120 (6th ed. 2003).