Swap Dealers and Major Swap Participants Regulation - Business Conduct - Comment Letters

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Dodd-Frank Timeline, Business Conduct Standards for Swap Dealers and Major Swap Participants
Final Rule Issue Effective Date Compliance Date (Extended)
February 17, 2012 April 17, 2012 May 1, 2013
Dodd-Frank Timeline, Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, SEC
Reopened Comment Period Deadline Final Rule Approved Effective Date
July 22, 2013 April 13, 2016 June 27, 2016

Comment Letters addressing business conduct standards for swap dealers and major swap participants.

CFTC Comment Letters

SIFMA and ISDA - February 17, 2011

Business Conduct Standards for Swap Dealers and Major Swap Participants
February 17, 2011

From the comment letter:

"Many of the standards included in the Proposed Rules are inherently subjective or uncertain, or are adopted either from industry best practices or SRO Rules. By design, best practices and [Self-Regulatory Organization](SRO) rules seek to improve practices and are able to do so, in part, by virtue of the fact that, in going beyond legal prescriptions, they do not subject covered persons to consequences such as private rights of action or rescission actions. In contrast, the Proposed Rules would expose SDs and MSPs to private rights of action and potential rescission based on conduct standards as to which reasonable minds could differ, particularly with the “benefit” of hindsight."

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Managed Funds Association - February 22, 2011

Business Conduct Standards for Swap Dealers and Major Swap Participants
February 22, 2011

"MFA generally agrees with the Commission’s approach to the business conduct standards. However, as a general comment, MFA respectfully suggests that the Commission, with respect to the Proposed Rule and all other rulemakings, consider separate regulatory regimes for SDs and MSPs. There are fundamental differences in the businesses, structures and other characteristics of SDs and MSPs, and fundamentally different reasons why the Dodd-Frank Act requires additional oversight of each. We believe that the Commission should focus MSP regulation on reducing default risk and focus SD regulation on market making and pricing and sales practices, in addition to default risk. Accordingly, MFA respectfully suggests that the Commission use this opportunity to implement regulations that are tailored to the specific, different market realities in which SDs and MSPs operate. In certain circumstances, identical rules will be appropriate for both types of entities, but that will not always be the case (e.g., counterparty duties and capital and margin requirements) and, in some circumstances, it might create unintended harm if the Commission applied one regulatory regime to such different types of market participants."

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CME Group - February 22, 2011

Business Conduct Standards for Swap Dealers and Major Swap Participants
February 22, 2011

"Dodd-Frank does not mandate that the Commission create a “best terms available” standard. The swap markets would be better served if the Commission refrained from creating execution standards that impose survey requirements based upon assumptions of what innovations might occur. In this case, waiting for actual market experience would allow the Commission to determine whether any rule in this area is needed and then to adopt a factually-based principled approach, rather than speculating on how the executed swap market might develop."

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Coalition of Physical Energy Companies - February 22, 2011

Business Conduct Standards for Swap Dealers and Major Swap Participants
February 22, 2011

While the Coalition of Physical Energy Companies understand that Dodd-Frank "requires that the Commission supervise Swap Dealers and Major Swap Participants, COPE is concerned that aspects of the notice of proposed rulemaking (NOPR) may increase Dealer costs (which will be passed on to end-users) and have a chilling effect on their Dealer counterparties' ability to engage in normal commerce as counterparties to physical energy end-users... Finally, to the degree the NOPR is based upon FCM or IB roles in futures markets, it is similarly misguided. Those entities are brokers, not counterparties. The proposed rules should oversee a counterparty relationship. COPE believes that the Commission should refocus these rules to the swaps market. The apparent wholesale adoption of a broker/dealer model will only increase costs to end-users and chill commerce"

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BlackRock - February 22, 2011

Business Conduct Standards for Swap Dealers and Major Swap Participants
February 22, 2011

BlackRock believes that "the Proposed Rule's standard for independence may create confusion with other established tests of independence. If adopted, this rule would increase unnecessarily the administrative burden of complying with CFTC regulation. We are also concerned that, as drafted, the Proposed Rule could preclude Plans from participating in swaps. This result should be avoided because Congress intended that the Dodd-Frank Act would not harm Plans and their participants and beneficiaries. If Plans are unable to enter into swaps to hedge their risks, their ability to generate targeted investment returns and to ensure that assets will be sufficient to pay benefits may be impaired. In addition, we believe that the proposed disclosure requirements are burdensome and disproportionate to any benefits that may be realized from their imposition. A final potential consequence of the Proposed Rule relates to the feasibility of the swap execution standards in proposed rule 155.7. The CFTC should adopt rules in this area once it has sufficient data about transactions on swap trading platforms. Otherwise, the Proposed Rule may not mesh with and reflect the reality of the new trading platforms."

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Federal Home Loan Banks - February 22, 2011

Business Conduct Standards for Swap Dealers and Major Swap Participants
February 22, 2011

The FHLBanks offer their suggestions to the Commission regarding the proposed rules. Specifically, the FHLBanks believe that the CFTC should, among other things:

  • sponsor and promote standardized disclosure to be distributed from the swap dealers and major swap participants to their counterparties,
  • clarify that end-user counterparties may request additional disclosure from their swap dealer or major swap participant counterparties with respect to certain, more complex swaps,
  • sponsor and promote standardized due diligence documentation to be completed by end-user counterparties and delivered to the swap dealers and major swap participants in compliance with the new due diligence requirements set forth in the proposed rule and
  • create standardized communication rules for swap dealers and major swap participants by reference to current market communication standards.
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Working Group of Commercial Energy Firms - February 22, 2011

Business Conduct Standards for Swap Dealers and Major Swap Participants
February 22, 2011

In their comment letter, the Working Group explains that:

  • The futures markets and the swaps markets are very different. Accordingly, the Commission should craft regulations that are appropriate for each market.
  • Entities with experienced, sophisticated investment and trading operations do not require the protections in the proposed rule, which was intended primarily to protect retail customers.
  • Major swap participants are not dealers; the Commission should not apply the same business conduct standards.
  • Transaction level requirements will increase costs to end-users.
  • The Commission should provide a more estimate of cost and benefits associated with the proposed rule.
  • All of the proposed rules should not apply if a swap dealer or major swap participant trades with another swap dealer or major swap participant.
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MetLife - February 22, 2011

Business Conduct Standards for Swap Dealers and Major Swap Participants
February 22, 2011

From the comment letter:

"MSPs regardless of their size are not dealers and cannot be presume to possess a level of market or product information equal to that of Swap Dealers. MSPs are also less likely than Swap Dealers to be members of designated facilities or designated clearing organizations. Further, MSPs are unlikely to have systems and personnel comparable to that of a Swap Dealer to allow them to model and value complex instruments. For these reasons, we urge the Commission to modify the Proposed Rules to treat MSPs like any other customer of a Swap Dealer. MSPs should under Rule 23.432 be able to elect where to clear trades; under Rule 23.431(a) get risk disclosure, the required scenario analysis for complex high risk bilateral swaps, information about incentives or compensation the dealer is getting, any new product analysis it does for risk management purposed; and under Rule 23.434 the protection of a suitability provision just as any other customer does."

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SEC Comment Letters

FIA, ISDA, SIFMA - August 26, 2011

Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants
August 26, 2011

From the comment letter:

"It is critical that swap and security-based swap (SBS) market participants, who by and large are sophisticated institutional investors, large corporate end users and financial intermediaries, retain the ability to establish, without ambiguity, the nature of their relationship. While it is clear that Congress did not intend for the SBS market to operate as a 'caveat emptor' marketplace, it is equally clear that Congress specifically intended to distinguish advisory relationships from the more common principal-to-principal relationships that characterize the swap and SBS markets. We believe that the Proposed Rules balance these objectives effectively, although... certain clarifications are necessary, including clarifications needed to enable parties to negotiate and execute SBS transactions in a timely fashion without subjecting end users to undue (and unwanted) market risk during changing market conditions."

The three organizations also call for further definition of the terms "advisor to a special entity," "associate persons" (independent representatives of a special entity), and "special entity."

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Managed Funds Association - August 29, 2011

Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants
August 29, 2011

In the comment letter, the Managed Funds Association suggests that the SEC:

  • "not subject Major SBS Participants to the same extensive supervisory and compliance structure to which it will subject SBS Dealers;
  • clarify that the Proposed Rules do not impose any new fiduciary or supervisory obligations or duties on market participants (i.e., duties beyond those to which participants in the futures and derivatives markets would otherwise be subject by agreement or by operation of common law);
  • not impose 'material information,' 'clearing rights' and 'daily mark' disclosure requirements on Major SBS Participants in arm’s-length transactions;
  • allow sophisticated counterparties to opt out of receiving additional disclosures provided by certain Proposed Rules that such counterparties do not seek or need; and
  • confirm that the definition of 'special entity' in the Proposed Rules does not include investment vehicles in which endowments, employee benefit plans or government entities invest."
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Better Markets - August 29, 2011

Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants
August 29, 2011

From the comment letter:

  • "The disclosure provisions in the Proposed Rules must be strengthened with respect to the parties entitled to disclosure, the timing and manner of disclosure, and the information disclosed;
  • The Proposed Rules must apply the best interest standard, not merely a suitability test, whenever an SBS Entity acts as an adviser to a prospective counterparty;
  • The Proposed Rules must be strengthened to better protect Special Entities;
  • The provisions in the Proposed Rules dealing with Chief Compliance Officers (CCOs) should be enhanced with additional measures designed to ensure the effectiveness and independence of the CCO."

Better Markets Inc. believes that the proposed rules miss the mark in two regulatory areas that are essential to standards of conduct for SBS transactions-- disclosure obligations and rules applicable to all counterparties, not just special entities.

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BlackRock - August 29, 2011

Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants
August 29, 2011

In the comment letter, BlackRock recognized the SEC's improvements upon the CFTC's business conduct standards rule.

The following comments are also put forward:

  • "The SBS dealer should be permitted to rely on simple representations regarding the qualifications of the independent representative;
  • The proposed rule establishes a new standard of independence that is unnecessary;
  • Suggestions with respect to the safe harbor from the definition of advisor [revised Section 15Fh-1(a)(1)(ii) to allow a special entity to rely on a qualified independent representative for advice or on a qualified professional asset manager (QPAM) or an in-house asset manager (INHAM) should those exemptions be in effect];
  • The requirement that an Advisor Act in the 'best interests' of a special entity should be eliminated from the proposed rule;
  • The SEC's exemptions for transactions executed on an exchange are too narrow;
  • The requirement to provide a daily mark should not make the SBS dealer a fiduciary; and
  • The SEC should clarify the definition of special entity."
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MarkitSERV - August 29, 2011

Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants
August 29, 2011

MarkitSERV recommends that the SEC improve the proposed rules by:

  • "requiring reconciliation to occur less frequently for smaller portfolios and to only require reconciliation for material disputes;
  • requiring counterparties to only reconcile 'key economic terms' as opposed to all material terms;
  • permitting counterparties to use qualified third parties registered as clearing agencies for the reconciliation process;
  • requiring security-based swap dealers and major security-based swap participants (collectively, 'SBS Entities') to institute policies and procedures reasonably designed to reconcile cleared SBS swaps;
  • ensuring that SBS Entities are not responsible for aspects of the reconciliation process which only their counterparties have control over; and
  • establishing timeframes for the resolution of disputes that reflect, among other factors, the complexity of the trade and dispute."
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SIFMA - August 29, 2011

Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants
August 29, 2011

SIFMA addresses in its letter concerns regarding the "best interests" standard, the exclusion of certain special entities, disclosure rules, ERISA fiduciary classifications, and pay-to-play rules, among other things.

Specifically:

  • "The Asset Management Group of SIFMA (AMG) believes that, absent clarification of the specific types of conduct giving rise to the “best interests” duty, this proposed standard may include a broad range of normal commercial activities, potentially leading SBS Dealers who do not intend to take on this heightened duty to restrict their communications with Special Entities to providing only the most generic information or to reduce their participation in security-based swaps transactions with Special Entities (including those that would help Special Entities to hedge their portfolios)."
  • "In order to rely upon the exclusion from advisor status with respect to a Special Entity to which it makes a recommendation, an SBS Dealer would be required to have 'a reasonable basis to believe' that the Special Entity has a qualified independent representative that, among other qualifications, '[h]as sufficient knowledge to evaluate the transaction and risks.' The AMG believes that it would be unnecessary, costly and ultimately counterproductive to require an SBS Dealer to undertake an independent due diligence investigation to determine whether a Special Entity’s representative has sufficient knowledge to evaluate the transaction before it may rely upon the exclusion. Such a requirement would effectively impose upon the SBS Dealer a duty to second guess the Special Entity's own assessment of its representative and provide the SBS Dealer with the ability to trump a Special Entity’s choice of asset manager."
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References

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