Comprehensive regulation of dealers and major participants in swaps market was a major component of regulatory reform efforts in Congress. Under the Dodd-Frank financial overhaul law, dealers and major participants in the market must register with the federal government and meet margin and other requirements set by the Commodity Futures Trading Commission and the Securities and Exchange Commission. The two agencies are jointly developing rules that will establish which entities must comply (for a related story, see here).

Offered up the week of Nov. 29, the proposed definitions of which entities are subject to registration, as well as the accompanying regulation, are quite specific. Usually, such specificity indicates that the regulators have made up their minds, and the final rule they approve is likely to be almost identical. In this case, however, the details appear to be merely a starting point for public and industry comment on the plan, which could change significantly before rules are set.

It's certain that every entity that engages in hedging -- from end users of derivatives trying to lessen their business risk to all-out speculators -- will lobby hard for changes. The biggest fight is likely to be over who qualifies for exemption as end user. The Dodd-Frank law makes clear that nondealers who are simply trying to hedge risks faced in their everyday operations, such as rising commodities prices or currency volatility, are not the target of the regulation. They are widely seen, unlike speculators, as contributing little to the financial crisis. However, the law did not give a blanket exemption for all commercial businesses that engage in swaps trading -- a loophole that could easily be exploited by speculators.

Despite that possibility, Republican SEC Commissioner Troy Paredes voiced concerns that fall in the center of GOP opposition. "My primary concern is that the proposal may be unduly precautionary, subjecting some firms to heightened regulatory requirements when it may not be warranted given the extent and nature of their participation in the security-based swap market," he said Dec. 3 in response to the SEC's solicitation of comments.

Specifically, he warned that the de minimis exemption thresholds both for security-based swap dealers and major security-based swap participants may be too low. "Do the proposed thresholds appropriately delineate the point at which a firm poses such a risk that subjecting the firm to more costly regulation is justified?" he asked.

Under the SEC's proposal, a business would be exempt from registering as a swaps dealer if its total security-based swaps dealings over the prior 12 months did not exceed $100 million or its dealing with governmental or other "special entities" didn't exceed $25 million. It also must not have acted as a dealer with more than 15 counterparties or engaged in more than 20 security-based swaps as a dealer over the previous year.

Swaps users must register as a "major swaps participant" if they maintain a "substantial position" in any security-based swap categories, excluding positions held for hedging or mitigating commercial risk exposures faced by employee benefit plans. Also, any party with outstanding security-based swaps positions substantial enough that they could have serious adverse effects on the financial stability of the U.S. banking system or financial markets would be considered a major participant. Finally, any highly leveraged nonbank financial entity that maintains a substantial position in any of the major security-based swap categories would also fall under the requirement.

Paredes rattled off a long list of questions that industry participants will have strong opinions on, including whether the lower de minimis threshold for dealers that transact with government and other special entities is warranted. He also questioned under what circumstances a market participant would pose a sufficient threat to the financial system and whether the distinctions among "speculation," "trading" and "hedging" are sufficiently clear.

Similar questions are being asked about the similar provisions governing the CFTC's jurisdiction, which covers nearly every other nonsecurities swap. But however much end users may wish otherwise, there will be some level of oversight on their activities if they are big players in swaps.

Democratic Commissioner Luis Aguilar concedes that those are fair questions. But he warns that regulators' goal should be to balance the need for closer oversight of the swaps market with danger to restricting companies' ability to mitigate their operational risk. "The statute does not simply say all swaps used to hedge a risk are excluded," he says. Consequently, "it seems unlikely that all risks a business faces and could hedge would qualify" for an exemption.

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Bill McConnell is Washington bureau chief for The Deal magazine.