Statement of Commissioner Dan M. Berkovitz Regarding the De Minimis Exception to the Swap Dealer Definition; Final Rule

November 5, 2018

I support amending the swap dealer de minimis exception to set the threshold at $8 billion.  This limited amendment relies on extensive data analysis to achieve a balance between the policy objectives of the de minimis exception and the registration of swap dealers.

At the outset, I would like to acknowledge the leadership of Chairman Giancarlo and the efforts of my fellow Commissioners to achieve consensus on this rulemaking.  I look forward to working together to continue to find areas of agreement where it makes sense for our markets and the American people.

Data-Driven Rulemaking

Title VII of the Dodd-Frank Act directed the Commodity Futures Trading Commission (“Commission”) and the U.S. Securities and Exchange Commission (“SEC”) to jointly further define, among other things, the term “swap dealer.”[1]  At the same time, Congress enacted Section 1a(49)(D) of the Commodity Exchange Act (“CEA”), which directed the Commission to exempt from designation as a swap dealer entities that engage in a de minimis quantity of swap dealing.

In 2012, the Commission—jointly with the SEC—adopted the further definition of the term swap dealer.  In this rulemaking, the de minimis swap dealing threshold was set at $3 billion.  However, recognizing that a lack of swap trading data made it difficult to set an appropriate threshold, the Commission implemented a long phase-in period during which the threshold was set at $8 billion.[2]  The regulation directed Commission staff to study the data on swap dealing activity that would be collected through swap data repositories (“SDRs”) and publish a report for public comment, enabling the Commission at a later time to make a data-based judgment regarding the de minimis quantity threshold.[3]

To this end, the staff built a comprehensive database to aggregate data from all four SDRs.  Over several years, the staff developed and refined new techniques to sort and evaluate the data, published two reports on the de minimis exception, and continued to revise its analysis in response to public comments.  This process was not without considerable challenges, but the staff worked diligently to produce meaningful, data-driven information to guide the Commission’s decision-making regarding the appropriate de minimis threshold.

This effort provided a highly significant data point:  approximately 98 percent of all swap transactions involved at least one registered swap dealer.  We now know that at the $8 billion threshold, nearly all swap transactions benefit from swap dealer regulation.

The staff’s analysis also showed that reducing the threshold to $3 billion would have a minimal impact on the amount of swaps activity that would be subject to swap dealer regulation.  Indeed, based on the analysis, reducing the threshold to $3 billion would only add swap dealer coverage to less than one-tenth of one percent of reported swaps.  By the same token, the analysis demonstrated that increasing the threshold quantity above $8 billion would have almost no impact on the amount of swaps subject to dealer regulation until that threshold reaches a significantly higher level.  At those levels, the effect on specific categories of swaps—notably non-financial commodity swaps (“NFC”)—becomes much more significant.

When considering amending a rule, the Commission should consider both the benefits and costs from those rule changes.  Here, data analysis has shown that the benefits of changing the current $8 billion threshold are relatively small because nearly all swap activity is already covered by dealer regulation.

On the other hand, decreasing the threshold from its current level would impose tangible costs on market participants.  If the threshold were lowered to $3 billion, unregistered dealers that are currently under the $8 billion level, but that could exceed the $3 billion threshold, would have to re-evaluate whether swap dealing in excess of $3 billion would continue to make business sense.  The de minimis rulemaking proposal[4] noted that this issue is particularly important in the NFC swap market.  The staff’s data analysis showed that many of the smaller swap dealers for physical commodities are physical commodity producers, distributors, consumers, or merchandizers.  Swap dealing is an ancillary business for them.  Where the costs of registering as a swap dealer exceed anticipated benefits, it is likely that many of these entities would withdraw from providing swap dealing services to their customers.  That would leave many end users looking to hedge their risks with either no dealers available, or very few dealers to provide competitive pricing.

The Commission should seek to preserve and foster competition for swap dealer services.  One of the fundamental purposes of the CEA is to “promote . . . fair competition among boards of trade, other markets and market participants.”[5]  American businesses throughout the country that need to use swaps to hedge their risks should not be forced to rely solely on large Wall Street banks.  Retaining the de minimis threshold at $8 billion will help preserve competition and choice for American businesses for these swap dealing services.

It is important to note that this rulemaking represents one of the first times in which the Commission has relied on SDR data to set policy, and the staff that undertook this principled and thorough analysis should be commended for their efforts.  Given the technological advancements in data collection and analysis, effective use of data to inform policy making is critical for the Commission to meet its policy objectives of fostering open, transparent, competitive, and financially sound markets.

In sum, the data demonstrates that the current de minimis threshold level is largely accomplishing its intended purposes.  Where the current regulations are working, regulatory stability also is an important objective.  Accordingly, after considering the results of the swap data analysis, relevant policy implications, and limited benefits and potential costs of altering the de minimis threshold quantity, I believe that maintaining the threshold at $8 billion is appropriate and sound public policy.

Physical Commodity Swaps

The proposal noted that Commission staff encountered challenges in measuring the aggregate gross notional amount of NFC swaps.  Instead, the staff used counterparty and transaction counts to approximate swap dealing activity for NFC swaps.  The staff’s analysis indicated that fewer NFC swap transactions—86 percent—involved at least one registered swap dealer, as opposed to 99 percent for other swap categories.   

The market participants who use physical commodity swaps to hedge their risks typically include farmers, ranchers, farm product processors, energy producers and consumers, manufacturers, and other end users.  These consumer-facing businesses need a properly functioning physical commodity derivatives marketplace to maintain consistent prices for their customers.  Ultimately, the American people benefit from stable prices on the products that these businesses produce and distribute.

I am therefore calling on the Commission to continue to focus on improving our data collection and analysis for NFC swaps.  More robust data collection will help us improve regulation in this space, including considering ways to balance the benefits of de minimis swap dealing in physical commodities with the need for customer protections and the other benefits of swap dealer registration.

Joint Rulemaking Required for Swap Dealer Definition

I am voting today solely in favor of setting the de minimis exception threshold quantity at $8 billion because it is within the Commission’s authority to do so.  Looking forward, however, I will not support other amendments to the swap dealer definition without a joint rulemaking with the SEC, as required by the Dodd-Frank Act.

In addition to setting the threshold level, the proposal sought to alter the swap dealer definition by excluding from counting toward that de minimis threshold:  (1) swaps entered into by an insured depository institution (“IDI”) in connection with originating loans; (2) swaps hedging financial or physical positions; and (3) swaps resulting from multilateral portfolio compression exercises.  The proposal also asked questions about excluding from the threshold calculation swaps that are cleared and/or exchange traded and non-deliverable forwards.

Although the Commission is not adopting these provisions today, my view is that any such changes would effectively amount to an amendment of the swap dealer definition, not the de minimis exception.  Doing so unilaterally and not as a joint rulemaking with the SEC would be contrary to the statutory language and inconsistent with Congressional intent.

When Congress enacted Title VII of the Dodd-Frank Act, its intent was clear:  “[T]he [Commission] and the [SEC], in consultation with the Board of Governors, shall further define the term[] . . . ‘swap dealer,’” among other terms.[6]  Congress clarified that the Commission must use the joint rulemaking process to make any other rules regarding these definitions that it and the SEC determine are necessary for the protection of investors.[7]  To underscore this point, Congress noted that rules prescribed jointly by the Commission and the SEC under Title VII must be “comparable to the maximum extent possible,” and that any interpretation of, or guidance regarding, a provision of the Dodd-Frank Act would be effective only if issued jointly by the Commission and the SEC.[8]  Pursuant to this statutory directive, the agencies adopted a joint rulemaking to define “swap dealer” and “security-based swap dealer.”

Congress created one exception to the joint rulemaking requirement.  CEA subsection 1a(49)(D) authorizes “the Commission” to exempt from designation as a swap dealer “an entity that engages in a de minimis quantity of swap dealing” and “to establish factors with respect to the making of this determination to exempt.”[9]  The Commission included this de minimis exception in paragraph 4 of the swap dealer definition, notably separate from other provisions in the definition addressing the IDI exclusion (paragraph 5) and the physical hedging exclusion (paragraph 6).

By its terms, the de minimis exception relates solely to exempting a numerical quantity of swap dealing activity.  Under the statutory structure, the Commission and the SEC must jointly determine which activities are dealing activities and therefore must be counted toward the threshold; the Commission itself may set a numerical quantity of such dealing as a threshold for registration.  Put simply, deciding “which” activity gets counted must be done jointly; deciding “how much” of that activity triggers the registration requirement may be done singly.

The proposal framed these additional proposed changes to the swap dealer definition as “factors” in the de minimis threshold determination.  In doing so, the proposal sought to use the Commission’s unilateral authority to “establish factors” as provided in the second sentence in CEA subsection 1a(49)(D).  However, that interpretation is a misreading of the statutory provision.  The second sentence in CEA subsection 1a(49)(D) authorizes the Commission to promulgate regulations to “establish factors with respect to the making of this determination to exempt.”[10]  The words “this determination” clearly refer to the quantity determination in the first sentence of the subsection:  “[t]he Commission shall exempt from designation as a swap dealer an entity that engages in a de minimis quantity of swap dealing in connection with transactions with or on behalf of its customers.”[11]  In other words, the “factors” referred to in the second sentence relate to the numerical quantity determination in the first sentence; this sentence does not create a distinct directive authorizing the Commission to independently determine what constitutes swap dealing.[12]

This point is clear when we examine what would happen if each of the five categories of swap dealing activity identified in the proposal as “factors” (i.e., IDI, physical hedging, multilateral portfolio compression exercises, cleared and/or exchange traded, and non-deliverable forwards) were removed from the definition of swap dealing through this interpretation of the de minimis exception.  Combined, these five categories of swaps likely total more than half of the notional amount traded.  There would appear to be no limit to what dealing activity could be excluded from dealer regulation through the de minimis exception by framing whole categories of swaps to be excluded as “factors.”  The Commission could effectively determine unilaterally what constitutes swap dealing.  The de minimis exception would swallow the swap dealer definition.  This result cannot be reconciled with the Dodd-Frank Act’s joint rulemaking requirement.

For these reasons, while I am amenable to considering further refinements to the swap dealer definition and what gets counted as dealing, I am of the view that this cannot be accomplished without joint rulemaking with the SEC.